Lloyd's of London has recently announced its first profits for several years. Sarah Goddard looks at the market's latest results.

After years of waiting, Lloyd's has finally come through with some good news for its backers. Headline results are that the Lloyd's market overall is heading for a £1.5bn profit for the 2002 year of account, though this figure remains a projection and will not be crystallised until 2005, under Lloyd's three-year accounting regime. At the same time, pro forma annual accounting estimates point towards a £834m profit for 2002. These numbers compare somewhat favourably to the final result for the 2000 year of account, which turned in a £2.4bn loss, and the 2001 estimates which are indicating a loss in the region of £1.7bn. On a pro forma annual basis, 2001 is estimated as a £3.1bn loss.

Market resilience
Speaking at the announcement of the 2002 results, Lloyd's Chief Executive Nick Prettejohn commented: "These results demonstrate a very strong performance. It was the market's resilience and disciplined approach, at a time when the industry as a whole has faced many difficulties, that generated 2002's healthy result." It was, of course, the hardening that took place in late 2001 and early 2002 which has had such a profound impact on the fortunes of the market, and proved once again that Lloyd's is expert at outperforming at the top of the cycle. As Mr Prettejohn said when unveiling the most recent results, "These figures compare very favourably when measured against the market's peer group. Lloyd's combined ratio for 2002 was 98.6%. This compares with an average of 105.1% for European reinsurers, 121.3% for US reinsurers and 108.3% for US property and casualty insurers."

The 2002 figures are in line with expectations, according to David Wharrier of Fitch Ratings in London. But for Lloyd's, as with other international re/insurance providers, a major issue is reserves. "Our concerns have been inaccurate forecasting and reserve deterioration," he said. With directors and officers (D&O) cover an increasing problem, and an increasing uncertainty over the level of reinsurance recoverables which will be collectible in the future, Lloyd's as a market is proving just as vulnerable as the large international re/insurance companies to the underlying business uncertainties prevalent in the current trading climate.

Nevertheless, Lloyd's, unsurprisingly, is remaining bullish about its current financials. With the 2002 combined ratio for the market coming in at a very respectable 98.6% (2001: 140.3%), and only XL Capital turning in a better performance, Lloyd's is looking strong, at least for the near future. Breaking down Lloyd's 2002 results on the annual account, the market reported net earned premiums of £10.7bn for 2002, compared to £9.9bn the previous year. Net incurred claims fell in 2002 to £6.7bn, a 36% drop from £10.3bn in 2001 (the year of the World Trade Center loss, to which Lloyd's had a proportionately large exposure compared to the rest of the industry). With syndicate investment returns slightly up in 2002 to £644m (£638m in 2001), and net operating expenses also up to £3.8bn from £3.3bn the previous year, overall the annual account in 2002 posted a profit of £834m compared to a £3.1bn loss in 2001.

Net resource rise
Lloyd's is also proud of the 85% increase in net resources in 2002. This breaks down into a 21% year on year increase in cash and investments, up to £24.5bn. Reinsurers' share of technical provisions dropped 15% to £13.7bn, while other assets were boosted 10% to £11.1bn. Offsetting the total assets are £41.8bn in total liabilities, resulting in net resources of £7.5bn (£4.1bn in 2001). Of course, as with the rest of the industry, there are uncertainties over the proportion of reinsurance recoverables which will ultimately be collectible.

'Collectability' is already proving an issue with the Central Fund insurance contract, written by SR International Business Insurance Co Ltd (part of Swiss Re), Employers Reinsurance Corp, St Paul International Insurance Co Ltd, International Insurance Co of Hannover Ltd (part of Hannover Re), XL Mid Ocean Reinsurance Ltd and Federal Insurance Co (part of Chubb). While the claims paying ability of the participants in the policy is not in doubt, the same cannot be said about their willingness to pay.

The Central Fund policy was purchased by Lloyd's for a five-year period, starting in 1999. Last year, Lloyd's confirmed it expected to make a £350m claim against the policy in respect of its WTC losses, which fell in the 1999, 2000 and 2001 years of account. For £78m total premium, the insurers meet Central Fund losses over £100m, up to £350m per year, with an aggregate £500m maximum payment over the lifetime of the policy. It is thought unlikely the contract will be renewed when it expires.

Vital safety net
The Lloyd's Central Fund is an important backstop to Lloyd's security, stepping in to pay the losses of Lloyd's members unable to meet their commitments. It grew from £280m in 2001 to £476m last year. Lloyd's had hoped to grow the Central Fund to £700m by the end of this year, according to Fitch's Mr Wharrier, but this is now subject to arbitration between Lloyd's and its insurers. Swiss Re is disputing some claims made by Lloyd's, saying they were used to protect members' solvency positions and fund liquidity requirements. According to Swiss Re, this was never the purpose of the cover, which, it asserts, was designed to pay out in the event of insolvency. The insurers have paid out £134m relating to 2002 losses, and are disputing up to £290m of cover, but it is currently not particularly worrying Lloyd's watchers.

"As with many arbitration proceedings, Standard & Poor's expects a commercial settlement to be the most likely outcome, and this is unlikely to have a material impact on the rating," said Stephen Searby, a credit analyst with Standard & Poor's in London. "The worst case scenario for Lloyd's would be for the arbitration to result in a full contract rescission. In this scenario, the impact on the rating would need to be determined as and when rescission became the most likely outcome, and by analysis of the various actions that might need to be taken by Lloyd's management at that time to meet any resulting financial requirements." In the meantime, however, S&P has maintained Lloyd's rating at 'A', while AM Best Co has kept its Lloyd's rating at 'A- (excellent)'. Lloyd's itself has said it is confident of its position in the arbitration, and that it is aiming for a full recovery.

Over the past five years, Lloyd's has seen its central assets strengthen substantially, up from just £36m in 1998 to £563m in 2002. The latter figure comprises £476m in the Central Fund (up from £280m in 2001) and £87m in Corporation of Lloyd's net assets (up from £83m the previous year). As Lloyd's points out, if the arbitration fails and the market does not recover the £290m at stake, it still estimates Central Fund assets of £522m by the end of this year.

At this point in time, Lloyd's is pretty bullish about the future. Between the beginning of 2000 and the end of last year, rates have risen, more than doubling in some classes such as aviation and direct property, while the market has been using a higher proportion of its capacity. Last year saw substantial equity raising initiatives undertaken by Lloyd's participants, with a number of companies such as Amlin, Chaucer and Wellington aiming to raise more than £800m. In addition, Catlin has not only upped its capacity in 2003, to £450m from £275m in 2002, but also is now writing qualified quota share business of its Lloyd's operations in its new Bermudian operation. The qualified quota share business effectively contributed another £1bn of capacity to the market in 2002, a large proportion of it from Berkshire Hathaway. Few of the qualifying quota share arrangements for 2003 have emerged as yet, though they are likely to be significant for the year as a whole if the current market conditions continue.

In the meantime, all eyes are turned to Equitas, the reinsurer of Lloyd's pre-1993 liabilities, waiting for its next set of figures. Equitas recently trumpeted its $472m policy buy-back settlement with Honeywell International relating to the asbestos claims of North American Refractories Co, which had been sold by Honeywell back in 1986, and Honeywell's Bendix business. In an announcement, Equitas' claims director, Glenn Brace, said: "Our settlement with Honeywell demonstrates our commitment to resolve claims, including our largest liabilities, at the right price and at the earliest possible opportunity. This settlement with Honeywell provides significant benefits for both parties. For Equitas, it provides finality for reinsured names exposed to claims by Honeywell and its related entities. For Honeywell, it provides certainty as to the amount of claims that will eventually be covered by Lloyd's of London names. In addition, while the amount of the settlement reflects the commercial realities posed by potential litigation between the parties, these benefits were achieved without the expense or delay of such litigation." Equitas has long been pursuing a course of commutations and early settlement, though last year it set firm that it would not pay out on asbestos-related claims unless there was medical evidence of impairment, a stance which, by some estimates, means that it could be throwing out up to 85% of new claims.

By Sarah Goddard

Sarah Goddard is the editor of Global Reinsurance.