The Lloyd's market shows resiliance despite facing the second worst year for catastrophe claims in 2004, says Kaveri Niththyananthan

Another year, another billion-pound topping pre-tax profit for the Lloyd's market. Despite the best efforts of nature's darker side, Lloyd's managed to weather the storms of 2004, reporting a pre-tax profit (for the third year in a row) of almost £1.36bn. Chairman of Lloyd's, Lord Levene, said, "These results, achieved despite significant losses from natural catastrophes, are testimony to the continually improving quality and strength of the Lloyd's market. A few years ago, such a performance would have been unthinkable."

Hurricane force

In total £1.2bn was swept off the market's books in net claims, with hurricanes Charley, Ivan, Frances and Jeanne accounting for the majority of the 28% decline in pre-tax profits compared to 2003. The hurricanes added 11% to Lloyd's combined ratio for 2004, up dramatically from the 1% which catastrophes represented the previous year. Julian James, director of worldwide markets at Lloyd's, explained, "Interestingly, when the 2003 results were released we mentioned that the year was abnormal due to the absence of major catastrophes. However, if you look at 2004, this was again an abnormal year, but this time due to the excessive costs resulting from catastrophes, which, if we exclude 9/11, resulted in the biggest cost to Lloyd's experienced in a decade. But you can see how excessive these costs are when you consider that the second largest payout was in 1999, when Lloyd's paid out £640m. In fact the average payout over the past 10 years, again excluding 9/11, has been between £350m to £400m."

However, with three years of consecutive underwriting profit, despite the impact of the storms, combined ratio remained below 100, though increasing 6.2% to 96.9%. This was, however, still lower than 2002, one year on from 9/11, where the ratio stood at 98.6%. In comparison, the incurred losses resulting from the devastation caused by the Tsunami on Boxing Day did not have any major impact on Lloyd's results, with the market recording a net loss in the region of £100m.

Capacity

During 2004, there was a move towards greater restraint reflecting market conditions, with capacity coming down 3.1% while gross written premium dropped 10.4%. For 2005, the Franchise Board granted an underwriting capacity (including qualifying quota shares) of £13.7bn, a decline of around 9% compared to 2004. Facing a softening market, director of finance and risk management, Luke Savage said, "the reduction in capacity is a positive sign that we are focusing on profitability and not just on maintaining headline premium figures, given where we are in the insurance cycle."

Results also indicated that syndicates were retaining a greater degree of risk with a reduced reliance on reinsurance. Overall reinsurance spend as a percentage of gross written premiums fell from 25.4% in 2003 to 19.8% in 2004, the lowest the market has experienced in a decade. The reduction in reinsurance spend could also partially reflect a general reduction in reinsurance rates, in particular on property lines, with rates dipping from the highs reached in the aftermath of 9/11 to a more "reasonable" level, though Julian James explains that while some rates are declining, others are increasing with no clear trend across business lines. "No doubt there are some of the Fortune 1000 US property risks which are under greater pricing pressures than others, but there are areas around the world where property rates are rising, for example, look at Florida, which was affected by the hurricanes."

Spitzer

Commenting on the ever-developing Spitzer inquiry into bid rigging and its impact on the London market, a spokesperson at Lloyd's said, "We have said that the FSA should move to make disclosure compulsory, and we have been vocal about the need to increase transparency in the London market. There is a fundamental distinction between the use of commission arrangements in the insurance market, and the very serious allegations of price fixing and market rigging which underlie the complaint in the Spitzer action. We have not seen any evidence of bid rigging going on in the Lloyd's market."

Lloyd's has confirmed, however, that it is one of a number of re/insurers which have been subpoenaed by the Georgia Insurance Department. A spokesperson said the information requests relate to "reinsurance contracts in force in 2004 bought by US insurers from the Lloyd's market".

Central Fund

Events surrounding the Central Fund have received much interest, flowing the announcement on 14 March that Lloyd's had reached a settlement agreement with those insurers involved with the arbitration proceedings relating to an insurance policy supporting the Fund. The agreement reached with Swiss Re, St Paul, Hannover Re, XL Re, Federal Insurance Company and Employers Re amounted to £152m and included sums previously paid. Sean McGovern, director and general counsel at Lloyd's, said, "This agreement with the insurers involved in the Central Fund arbitration demonstrates a desire on all sides to draw a line and resolve the uncertainties of this dispute."

The Society of Lloyd's began its arbitration action with six insurers in April 2003, in an attempt to recover sums claimed under a five-year insurance contract to support the New Central Fund.

The financial impact of the arbitration resulted in a 2.7% increase in the market's combined ratio in 2004, nearly three times the impact on its combined ratio of catastrophes in 2003.

Whilst this matter helped reduce the Central Fund by £324m (pre-tax), central assets increased by 52% with the aid of the £506m long term subordinated debt issue in November, which marked Lloyd's debut into the international debt market. In addition, from this year onwards, the fund will benefit from loans made by syndicates, and will be dependent on the capacity of the individual syndicate. The pool will build up over three years with Lloyd's repaying the loan on a three year rolling basis, ie 2008 will repay 2005 loans made.

Emerging Markets

The capacity for growth afforded by emerging markets remains attractive to Lloyd's, particularly China. In March, Lloyd's commissioned Acritas to carry out a survey of market underwriters. When asked which regions they considered offered the greatest opportunity for growth, 25% of the 102 underwriters questioned cited China as the foremost area for business opportunity; while 59% believed that the country also provided the best source of new specialist insurance opportunity during the next five years. Lloyd's filed a submission plan to set up an onshore reinsurance branch in China in July 2003. If approved, the branch would provide Chinese insurers access to the Lloyd's market and permit Lloyd's to reinsure local currency business - currently, Lloyd's is only permitted to offer offshore capacity in foreign currency.

Lloyd's is also monitoring developments in India, which as with China, it sees as a long-term project (although only 3% of underwriters surveyed flagged it as the country offering the greatest opportunity for growth).

"Lloyd's performance compared well with our global competitors," said Lloyd's chief executive, Nick Prettejohn. "However, we must remain vigilant if we are to continue to deliver a strong underwriting performance. Market conditions remain profitable but increasingly competitive in a number of lines."

- Kaveri Niththyananthan, Global Reinsurance.