The London market can no longer rely on its global distribution channels, warns Luke Savage. The rapid development of local insurance markets around the world is providing new competition
The days of one global, specialist centre such as London getting all the business are coming to an end. Wherever you turn in this industry you can hear someone talking about globalisation. The world is, after all, becoming a lot more accessible, and governments in countries with rapidly developing economies such as China, India and Brazil are now recognising the importance of foreign investment.
It may seem a contradiction, but this globalisation of capital is supporting the localisation of insurance markets. Governments are developing their domestic insurance industries to support their countries' development. In turn, the growth of their economies is increasingly feeding into regional insurance hubs. Insureds are quite simply, and understandably, attracted to local expertise and local currency.
We are increasingly seeing Asian business flowing to Singapore or Hong Kong, while European business is flowing to Dublin, Zurich and London. In the Middle East, potentially either Dubai or Qatar could become the epicentre for insurance business. And this is all business that traditionally would have travelled to an international, specialist insurance market like London. The world is changing and it is vital that we change with it.
The trend towards favouring local expertise is largely because of the importance attached to culture. At Lloyd's, more than half of its business comes from what is called "home-foreign markets", such as America and Australia. These are parts of the world that have four key ingredients - they are English speaking, have Anglo-Saxon economies, follow contract law and are led by brokers.
This shows that when the culture, language and laws are familiar, an insurance market is more attractive. As more local markets open up, providing all the familiarity that potential customers need, competition will become much greater for well-established markets like London.
This move towards greater localisation is not a sudden step change but a slow, ongoing trend. As with many aspects of insurance, it is complicated, but three key contributing factors can be identified:
“It may seem a contradiction, but this globalisation of capital is supporting the localisation of insurance markets
• The "push" factor - high taxes and a longer processing and distribution chain is effectively pushing business away from London;
• The "pull" factor - the increasing attraction of local markets; and
• Price - a simple case of capital providers wanting to maximise their returns, and therefore going where the price is right, regardless of whether it's local or on the other side of the world.
When it comes to the push factor, just look through the newspapers and you will see a wealth of coverage saying that people are leaving London for lower taxes. It is worth stressing that while a small number of Lloyd's firms have now set up their headquarters in Bermuda - which currently has a zero percent tax rate - this has in no way affected their business at Lloyd's. They have simply moved their base for tax reasons.
It's also worth remembering that tax is not the only factor when deciding where to do business. Return on capital is just as important, and this is where Lloyd's strength truly comes into play. Morgan Stanley recently found that lower capital requirements could drive a stronger return at Lloyd's. It found that a Lloyd's syndicate had the potential to get a return on capital of 35.5%, compared to 29% for an equivalent-sized Bermudian reinsurer and 18.4% for a European reinsurer.
But that is not to say that we don't need lower taxes. At Lloyd's, we welcomed the 2% cut in corporate tax announced by the UK Government earlier this year, but more is required. An uncompetitive tax rate, along with a longer distribution chain, is certainly a factor when it comes to business going elsewhere.
While people are being pushed away, they are being attracted to doing business with someone locally - someone who understands their language and their culture. Customers want to do business with someone they can speak to easily, face-to-face if necessary, in an environment they are comfortable with. This is partly why local markets are opening up at such an amazing rate.
“London simply cannot take its right to exist as a specialist insurer for granted any more
The most obvious example of such a market is China. Over the past ten years, Chinese non-life premium has more than tripled, growing at an annual compound rate of 12.5%. It is certain that this growth will continue to outstrip that of the economy overall and that presents a significant opportunity to insurers. But to access this business, it is necessary to have a presence in the local market now.
That is why Lloyd's opened its onshore reinsurance operation in Shanghai in April, setting up a reinsurance company for the first time. It has been providing reinsurance in China on an offshore basis for 30 years, but the new company ensures it can trade in local currency and build the local relationships it needs to become part of China's growing insurance landscape.
Whether looking locally or globally, one factor will always be top of the list for capital providers - price. Wherever business is "stateless", or tends to be conducted remotely, it will migrate to the location that supports the best returns, whether that is because of low capital, low tax or light regulation. For example, US property catastrophe business can be drawn to Bermuda because of low tax, while UK personal lines motor business often goes to Gibraltar because of the low capital requirements.
Standard & Poor's has pointed out that many business lines, particularly those of a specialist nature, can be underwritten anywhere today, and there are a growing number of international insurance centres keen to give them a home. People will simply go to where they can get the best deal.
London's big challenge
So what does all this mean for London? The worst case scenario is that we will have a shrinking share of the world's insurance market. London simply cannot take its right to exist as a specialist insurer for granted any more. The challenge isn't deciding whether to become a global business or to set up local operations, it's finding a way to do both, becoming the most attractive platform for customers throughout the world.
“The challenge isn't deciding whether to become a global business or to set up local operations, it's finding a way to do both
To be successful, it is necessary to play to the pull factor. London must develop global licences that meet insureds' needs and their desire to do business locally. This should include employing local staff who are sensitive to the cultural issues in a particular part of the world, and for whom language is not an issue.
London also needs to directly challenge any elements that might be pushing business away. Encouragingly, the government has appointed a high-level working group - which includes Lloyd's chairman Lord Levene - to look at the city's competitiveness and further strengthen London as a leading financial centre. This is an important step in ensuring London's future.
The market must reform its processes and make London an easier and more efficient place to do business. This is a key priority for Lloyd's, which is why, working with the Market Reform Group, it has introduced an electronic filing cabinet that enables all appropriate claims, premium and policy documents to be handled electronically. This will speed up the entire process in the market, making it far more efficient and secure.
The market has also introduced pre-bind quality assurance (PBQA) - the next phase of contract certainty. These changes mean that the checking of documentation is now done pre-bind. Other initiatives include reviewing the impact of the operating structure and timetable - otherwise known as the annual venture - to ensure it is as efficient as possible. The early release of profits, meaning that members get their money when they make it instead of having to wait three years (as was the case previously) has also been introduced.
Such moves are vital if London is to survive. If the market doesn't change its ways, it will lose out to the ever-growing competition that capital providers and customers are finding right on their doorsteps.
It must also be competitive on price, and that doesn't mean softening rates. It means having processes and a good capital structure in place that affords the best return on equity. London is well positioned on this, as the diversity of the market helps to reduce capital requirements generally. At Lloyd's, diversity and mutual structure creates an unbeatable model, which is why capital requirements can be 45% of a standalone Bermudian or European insurer.
London has a lot in its favour. To remain competitive, it is necessary to develop a local presence with a global capital pool. To borrow a phrase from a famous bank, we have to become the world's local insurance market.
Luke Savage is finance director at Lloyd's.