Lloyd’s is well-poised to seize opportunities in a hardening reinsurance market, discovers Helen Yates.
Paul Jardine, CEO of Catlin Underwriting is in bullish mood about next year– at least more than he was 12 weeks ago. “The market is poised to take advantage – as it always does – of the upturn following a major event,” he says.
In the six weeks between the Rendez-Vous de Septembre in Monte Carlo and the next round of industry conferences – the PCI Annual Meeting in Scottsdale, Arizona, USA and the Baden Baden Insurance Meeting in Germany – the industry went full circle. From Monte Carlo and the prediction of a continued softening of reinsurance rates, the talk became of “market-changing circumstances” and a hardening market in the run-up to the 1 January renewals.
So what happened? Rather than being just one loss – as was the case with the 9/11 attacks and Hurricane Katrina – this market-changing event is the combination of a series of losses. According to revised estimates from Risk Management Solutions, Hurricane Ike is now likely to be the third most costly US hurricane ever, after Katrina and Andrew, and is expected to cost $13bn to $21bn, significantly higher than its initial loss estimate of $7bn to $12bn.
“The models missed a trick in terms of the width and impact of a storm that is a category two,” Jardine explains. Despite its low category, Ike did as much harm to offshore oilrigs and installations as Katrina and Rita in 2005. Onshore losses were also widespread. Combined with Hurricane Gustav, Lloyd’s is expecting net claims of $2.34bn. The market says there will be a negligible impact on Lloyd’s capital and no Central Fund exposure.
The market – well-capitalised after relatively benign catastrophe years in 2006 and 2007 – would have found it difficult to justify price rises as a result of the storm losses. But the crash of the major investment banks and ensuing panic has added another dimension. Insurers and reinsurers are feeling the effects on both sides of the balance sheet.
“It has been an extraordinary sequence of events,” says Jonathan Turner, CEO of Brit Reinsurance. “We will respond in the only way we can; by looking at how much aggregate we take in the front door and how much we charge for it.” He describes it as a transformational time and, after his return from Scottsdale, notes that his peers at the PCI conference agree that rates are going up.
Jardine estimates that more than $50bn of capital has left the industry – he result of a combination of actual investment loss, unrealised losses on fixed income portfolios and hurricanes. “Eight weeks ago we were looking at further rate reductions – even as much as 10% through 2009,” he says. “Our view today is that we probably expect a modest positive rise.” Reinsurance prices could go up by 10 points or more overall, he predicts, adding that it’s tough to know when this will happen. He thinks offshore energy prices could jump by as much as 50% or even 100%.
Broker Benfield – soon to be part of Aon Re Global – agrees with the assessment that prices will rise. In a report published in October – Capital Consequences: Billion Dollar Question – it confirms the outlook is now for a hardening market. “Losses and loss of confidence are a potent mix for changing behaviour,” the report says. “The onset of global recession and associated increase in cost of claims could act as a catalyst for both insurers and reinsurers alike. As always in the (re)insurance market, only significant removal of capital will harden the market.”
Capacity up or down?
At the AM Best Review & Preview in London in October, Rolf Tolle, director of franchise performance at Lloyd’s, said that Lloyd’s “will grow when the time is right and shrink when the time is wrong”. Lloyd’s was well-shielded from the financial crisis. “Our investment policy has never been as aggressive as the investment policy of our competitors. Therefore we don’t get hit to the same extent on the asset side.”
On 27 October, Hiscox announced that it will not decrease the capacity of Syndicate 33 to £550m, but increase it to £750m for 2009. It has also applied to Lloyd’s to start a new wholly-owned Syndicate 3624, which will have a capacity of £60m. The decision to up its capacity, it says, is due to “the recent turmoil in the financial markets” which “has provided opportunities”.
Jardine says that the trick always has been having access to capital when you need to put your foot to the floor and grow. He thinks now is the time to seize. Some of that opportunity will come from beleaguered insurance giant AIG, bailed out by the US government for $152bn. But what is bad news for the US economy is likely to be good for the Lloyd’s market. “The icing on the cake – depending on where you sit in all this – is the AIG situation,” adds Jardine. AIG, via Lexington, is the largest writer of excess and surplus lines business in the US and Lloyd’s is the second. Should clients seek to defect, Lloyd’s is the obvious choice.
AIG’s demise has also made the subscription market a more attractive place for many cedants.
At the two October conferences, market participants predicted that insurers increasingly will seek to spread their risk among several reinsurers. It’s a case of not putting all your eggs in one basket, Turner says. “Clients want strong, stable counterparties with solid security ratings. Lloyd’s should be a very
significant beneficiary of the turmoil.”
Market observers agree that Lloyd’s is better placed today to capitalise on an upturn. A £3.8bn ($7bn) deal with Berkshire Hathaway in October 2006 saw the resolution of Equitas, the organisation formed to handle the markets 1992 and prior-year liabilities. The deal, along with the market’s business process reform efforts and Central Fund strengthening, saw Lloyd’s upgraded to “A+” by Standard & Poor’s in April 2007. “Lloyd’s has become a better place to do business,” says Turner.
Testament to Lloyd’s attractiveness is the large number of recent M&A deals, particularly by Bermuda players looking to buy up Lloyd’s businesses. Class of 2005 firms, Validus and Ariel, bought Talbot and Atrium respectively, both at multiples to book value. Jardine says that the hard work since the shocks of 9/11 have paid off for Lloyd’s. “It’s got enormous value from a capital efficiency perspective and it’s got licensing advantages. And it has regained its position as one of the premier insurance brands in the world.”
Flood of claims
At the AM Best conference Tolle warned delegates “not to look out of the back window”. He said: “We had some great years, but now we need to be prepared for claims and be forward looking.” While there may be opportunities for the market, there will also be claims to contend with as prices rise – both from the US hurricanes and as a result of the credit crisis.
Lloyd’s has cut back on its professional liability exposures in recent years and, as such, should not feel the full brunt, says Jardine. “If you went back 10 years, you might have seen a much bigger participation in financial institutions. But are you going to get zero claims? Of course not.”
Even without the expected fallout from the financial crisis, claims activity is expected to rise as a result of recession as cash-strapped policyholders are more likely to seek compensation. The incidence of fraud could increase. “We have to be very cognisant of the future claims environment we are likely to be walking into, and to adjust underwriting and pricing to reflect that,” says Turner. “It’s no good using past experience to predict future claims activity.”
Helen Yates is a freelance journalist
Keeping the idiots out
Despite the credit crunch there is still cash looking for opportunity. But will it opt for Lloydâ€™s or Bermuda and will the market seek to control what comes in?
Liquidity is hard to come by as banks stop lending and the cost of capital grows daily. Capital is not expected to flow into the industry as it did post-Katrina or 9/11, but the experts say that there is still cash around looking for opportunity. With reinsurance rates expected to rise, could Lloydâ€™s see an influx of new capacity?
Investors favoured Bermuda after Hurricane Katrina, and most of those â€“ the hedge funds and private equity firms â€“ are being squeezed in the post-credit crunch
climate. Despite the illiquid market, Ian Clark, an
insurance partner at Deloitte, thinks Lloydâ€™s in looking more attractive to investors than it did after Katrina.
As evidence he points to the private equity money sitting behind 2007 Lloydâ€™s start-ups like Barbican. â€œIn 2005, Lloydâ€™s... still had the Equitas overhang,â€ he says. This has been resolved and there also has been a total restructuring of the Lloydâ€™s capital base. â€œThe way the Central Fund is structured now is much easier to understand for investors,â€ he says. Continued interest is also expected from high net worth investors, despite the high cost of entry. Investors must have a minimum of Â£350,000 in assets and about Â£200,000 in cash. Despite this, opportunities that are not correlated to
the troubled equity markets look attractive in the
Paul Jardine, CEO of Catlin Underwriting, doesnâ€™t see private equity money flooding into the market. â€œCapital has gone and itâ€™s not being replaced. Once people understand that, prices will move.â€ Hedge funds in particular have suffered enormous losses and he thinks this will affect the appetite to invest in insurance-linked securities and start-up ventures. â€œUnlike in 9/11, when the industry took an enormous loss but actually recapitalised itself very quickly, I canâ€™t see where new capital is going to come from,â€ he says.
One solution could be consolidation. Being nimble has always been an advantage at Lloydâ€™s, but the longer-term trend is towards larger players, Jardine says. â€œThere are risks and threats on the horizon that suggests to me that the average unit size needs to be bigger.â€ The risks placed in the market are getting bigger while the cost of compliance is a considerable drain on smaller entities.
If new capital does come into the market, existing players will want to see evidence that they have been put through their paces. As Chris Hitchings, an analyst at Keefe, Bruyette & Woods, asked at an AM Best
conference: â€œIs Lloydâ€™s doing enough to keep the idiots out?â€ The market has been criticised in the past for allowing in too much capacity during a competitive market, accelerating the downturn as a result.
Jardine says: â€œItâ€™s well known that we as an organisation, along with some others, have had some issues with the way in which these syndicates have been admitted into the marketplace. We share concerns over making sure that the quality of the market is not diluted by the desire to admit new players.â€ While there are robust checks and balances, he thinks that the best
situation is where a new player brings in business the market would not see otherwise.
Jonathan Turner, CEO of Brit Reinsurance, concedes that Lloydâ€™s has a difficult line to tread. â€œOn the one hand they express strong views to existing participants about the need to reduce capacity in what has recently been a falling market and on the other, they are tasked with running an open market which means entertaining and occasionally accepting new participants. These two positions are difficult to reconcile but the selection process for new entrants is rigorous and only a fraction of applications make it through.â€
Given strict regulatory guidelines, the last thing the market wants is to fall foul of the competition laws by restricting people coming in, said Lloydâ€™s chairman Lord Levene the World Insurance Forum in March. â€œAll we can do is try to get it under some reasonable control and ensure shareholders get a reasonable return.â€