David Doe gives his personal view on the current outlook for the London insurance market.

The London market is very well placed to capitalise on the robust trading conditions now prevalent in the insurance industry cycle. But prior to any overindulgence, the market should take a sharp intake of breath and aim to consolidate and to plan long term, beyond the bubble of the current hard market. Alas, this is only likely to happen at few underwriting entities. Most underwriters, wary of professional mortality and management purges, will be only too eager to squeeze and to gouge as much as possible to keep themselves away from any corporate unpleasantness. How can you blame them? For those underwriters who have made it to the Nirvana of the hard market are now too busy to think of anything as mundane as forward planning, let alone building foundations for the future. But they should, for these salad days will not last forever. Although here for at least a couple of years, the hard market will eventually go, and through the present conditions the more prudent underwriters, and their management, should look beyond the current cycle.

This is, of course, a time of much underwriting opportunity and potentially large future profits. But it is also a time to consolidate, and to nurture relationships, some of which will be born out of the white heat of the hard market. Yet a wrong attitude now - and this is certainly a market that can pump up the prima donna's ego - and long-term damage could easily be done.

Wary eye

On a broader basis, London must cast a wary eye on the Bermudian market and its development. Bermuda, with its relaxed regulatory and tax regime, has attracted much virgin capital over the past 18 months - though London did not. Bermuda is a market that `plays' at the top level of reinsurance, but is now broadening out into certain direct lines on a lower attachment basis. Any significant shift in its business focus could ultimately act to take business away from London. In the meantime, London should be safe in the harbour of the current market and enjoy the good times, as it is doubtful there will be any change soon. The current economic (and political) outlook is favourable for the insurance market to remain hard for a while yet.

Economic outlook

The investment fundamentals remain miserable. One has to go back over 60 years to see a time when the world's major stock markets fell for three consecutive years. The economic slowdown following the bursting of the technology bubble and the major terrorist attacks of September 11 had a dramatic drag effect on the large Western economies. Although major economic upheaval, such as high unemployment and raging inflation, has, to date, been avoided, it cannot be discounted completely. The major central banks, led by the US Federal Reserve, have aggressively cut interest rates again and again. This is designed to act as a stimulating influence throughout the economy generally, and, specifically, by maintaining and even increasing levels of consumer spending. However, this effort to revive and to kick-start the economy brings with it its own dangers. By allowing consumers (particularly those in the US and UK) to build up high levels of debt, the downside is the payback of such debt, though it is currently fundable due to the low interest rates.

Any significant increase in unemployment or inflation could trigger a formidable downside in the economy. Indeed, even without any significant increase in unemployment or inflation, consumers will be highly unlikely to maintain such growing debt burdens and eventually they will at some point become `bogged down' and as a consequence, overall consumption will slow. In such a scenario, the major Western economies are likely to yield only anaemic levels of growth, impacting corporate profits and maintaining a depressingly dull stock market. This dreary economic outlook is set to last, and will, in turn, help maintain the hard insurance market. For insurers must rely on pure underwriting profit and not on any investment cushion. Further, the appetite of capital providers will be diminished. So there is no economic reason to see any fatigue of the current market conditions, at least in the short term.

Political outlook

The political outlook is even more difficult to call than the economic one. The potential for conflict in Iraq, and wider conflict throughout the Middle East, is rightly cause for much concern. The West is still highly reliant upon the natural resources of oil, and with some 80% of the world's production generated from the Middle East, any extended or complicated conflict could see oil prices rocket, which could push much of the world's already ailing airline industry into widespread bankruptcy. The threat of al Qa'ida terrorism has also certainly not receded, although hopefully it might be more contained. There are also other simmering concerns for the world, be they how to deal with `rogue' states like North Korea or the lingering threat of confrontation between India and Pakistan. But hopefully the most obviously pressing issue - that of war with Iraq - might be dealt with, if required, in quick order. Indeed, if this particular conflict can be decisively concluded thereafter, with American insistence, pressure can be brought to bear upon the Israelis and Arabs to make a lasting peace. Given such a Utopian outcome, much of the world's pent-up tension could be released. This would likely be followed by a powerful economic recovery induced by a return of confidence. Such is the current economic and political paralysis in the world that if this particular blockage can be flushed away, stability might return and lead to increased growth. An enormous amount of responsibility therefore rests not only with our political leaders, but also with our armed forces.

In the meantime, all of this uncertainty impacts the insurance markets in two ways. Firstly, the financial markets hate instability and this will affect investment returns and capital availability. Secondly, increased fear can generate more need for protection against risk and in turn, more business for insurers. This combination will further maintain the hard market conditions.

Insurance outlook

Of course, during times of such uncertainty, be they politically or economically driven - or both - many industries falter, but the insurance industry doesn't necessarily follow suit. The need for insurance protection is, in reality, increasing and not decreasing, and this need will grow as the world becomes an even more uncertain and dangerous place. However, that said, the particular problem that insurers face is the `double whammy' of not only recent catastrophic losses such as the vortex of September 11 and the European floods of last year, but also the beating that their investment funds have suffered with the dramatic three-year bear market. The insurance sector worldwide has seen a staggering figure of nearly $100bn wiped off its combined stock market capitalisation.

In order to rebuild damaged balance sheets, numerous insurers have had to go cap in hand to capital markets with rights issues, often on a highly discounted basis. Some major insurers have noticeably failed in efforts to gain market backing and now look decidedly shaky. It is interesting to note how some of the smaller, more lighter-footed specialist insurers in Lloyd's have succeeded in raising capital where some of their monolithic peers clearly have not. This is of itself a testament to the Lloyd's market, and that `size' and `critical mass' are not necessarily king. Hopefully, those investment bankers and private equity investors who hold an almost irrational, unfair prejudice against investing at Lloyd's will think again. In the current investment climate, and given estimated gross domestic product growth predictions of only 1%-3% for the UK and Euro area economies, where else but with specialist publicly quoted insurers is there the possibility of double digit returns? In the past soft market - ironically driven by high investment returns and abundant naïve capital - insurance stocks were very much out of vogue. An industry that was much maligned as drab and boring has become, in certain areas, highly exciting for stock pickers scouring the market for opportunities for `real' growth and dividend-bearing stocks. There appear to be some excellent short to medium-term buys among the quoted `boutique' Lloyd's insurers. These companies, while small in size, have excellent management coupled with outstanding individual underwriting talent. They are the quick-moving `Artful Dodgers' of the market, while their larger peers may lack innovation and speed, hampered by tiers of bureaucratic management that unintentionally stymie the individual in favour of the company culture.

Good business practice

It is an undeniable truism that the insurance business is essentially a `people' business; capital is king, but key people are vital. This is something that the Lloyd's market, often derided as an archaic institution, has understood for more than 300 years. Face-to-face trading in the `Room' at Lloyd's sets the place apart from other markets. It is a unique part of a unique market; it is not just `old fashioned' - it is nothing to do with fashion - it is just good business practice. It is most welcome to see the growing confidence within Lloyd's manifested in the recent string of successes of market businesses obtaining increased capacities. At £14.5bn this year, Lloyd's market capacity has never been greater. But currently, and despite some pockets of successful capital-raising, there is still a lack of underwriting capacity in the world insurance market, that will further extend the life of the current hard market. The fact is, there is still substantial undercapitalisation in the market.

The world demand for insurance protection has expanded enormously and this trend will continue, as fundamental economic, political and demographic movements continue. These include, but are not limited to, the following significant factors:

  • an enormous increase in the need for people to purchase personal insurance protections, for both healthcare and retirement. This is particularly prevalent in the major world economies and those in Europe, where central governments cannot possibly afford to provide universal social benefits at an adequate level for their ageing populations. This will not only be an enormous challenge to Western insurers, but also a major opportunity;

  • world political instability will increase. As such, so will the need for, and cost of, business interruption, political risk and credit protection insurance - all of which are vital products that underpin much of the world's trade;

  • the unrelenting march of globalisation, and all the ensuing increased liability issues with it, will go on unchecked. As cost-conscious Western-orientated companies go more global in terms of production (and employment), so too will the spread of awareness of individual and corporate rights, thereby increasing liabilities and thus the need for more protection;

  • the increasingly liberal `pro-consumer' culture developing within the European Union will without doubt (albeit at a glacial pace) see a move towards US-style litigation and court awards in Europe. Insurers will have to meet the challenge of these changes;

  • the major issue of climate change, coupled with the continued movement of population to exposed coastal regions, will add further pressure to insurers' already sensitive aggregate exposures. This trend shows no sign of slowing down; and

  • an increasing reliance upon high technology in everyday life will become ever more pronounced, indeed, to a level of extreme vulnerability for the world economy. This increasing dependency will magnify the risk potential of major interruption or failure, which will require a growing level of protection.

    All in all, and despite many complicated issues, the world insurance industry is well placed to grow, especially in our uncertain world. For although undoubtedly the world has become a much riskier place, so too has the need for risk protection increased. As such, the risk business of insurance is well suited to the current world scene, and no other insurance market is as well placed as London.