While the losses of 2005 have certainly scorched its balance sheet, Kiln is looking to turn up the heat in 2006, says Nigel Allen

Kiln achieved a slender profit of £8.5m (down 80% on the £37.9m recorded in 2004), during a 12-month period when, as chief executive Edward Creasy put it, "our risk management approach was pretty fully tested". This testing environment saw the Lloyd's underwriting group report gross storm losses of some £203m, which when filtered through Kiln's reinsurance programme resulted in a net loss of £77m. Catastrophe losses for the 12 months accounted for some 36% of the group's 114% combined ratio. This compares to 2004 net catastrophe losses of £37m, with a knock on combined ratio hit of 17%.

Counting capacity

Gross written premiums increased 13%, mainly as a result of Kiln's capacity push, which has seen its overall ownership of capacity for the four syndicates managed by RJ Kiln (308; 510; 557 and 807) rise from £280m to £353m, as the group seeks to take advantage of the underwriting opportunities available in 2006 and beyond. The total gross capacity for the four syndicates for the 2006 year of account increased by £99m from £704m to £803m.

In order to finance the capacity growth Kiln turned to its shareholders. "We were able to successfully raise in excess of £72m following the hurricanes in a very well-received rights issue," explains Creasy, "specifically for increasing Kiln's shareholders' capacity in Syndicate 510" - 96% of shareholders took up their entitlement.

Syndicate 510 is the company's flagship syndicate, which focuses on accident & health, aviation, marine and special risks and reinsurance. Following the rights issue, Kiln succeeded in upping its ownership in the syndicate from £226m to £295m, representing a rise of 6% to 47% from 41%, while overall capacity for 510 rose by 14.5% taking it to £625m for the year from £546m in 2005. However, addressing analysts during the 2005 financial results presentation, Creasy admitted they were only partially successful in terms of raising their ownership share in 510, but added that, "Whilst we would have liked to have acquired more capacity in the auctions last year, we would be very surprised if we didn't fully use the capital we raised in support of our underwriting plans for 2007." Confident that rates have not topped out and will continue to rise this year, Creasy continued, "We made it clear that when we raised the money we would be able to finance our foreseeable future capital requirements, which include increasing Kiln's participation on the underwriting, without further recourse to shareholders in the ordinary course of business," and expressed his firm belief that 2007 would prove a lucrative year.

Prior to the late arrival of Wilma, Kiln was expecting to record a general rate rise of 13% during 2006, a figure which Creasy now believes is a little conservative. "If you look at the overall book at the moment, we have already achieved rate increases of 13% at this stage of the year." Breaking the percentage rate increase down, Robert Chase, director of underwriting, explained that in a normal year Kiln would expect to experience catastrophe losses on Syndicate 510 of approximately 9% of gross loss ratio. However, in view of increased storm severity and frequency, this figure has now been revised to over 12%. "The increased hurricane activity alone requires an increase of 33% in our total catastrophe allowance for the so-called 'average' year," said Chase. "Translated into what we've been saying about our prices, that then means that 3% of the 13% rate increase goes towards coping with this increased loss activity and the remaining 10% represents the true price increase."

Creasy points out that in the context of difficult years for the industry the 13% price increase means that pricing is now ahead of that achieved in 2003 and 2004, "and if you look at Kiln's return on equity in those two years, it was north of 22% in both." However, he warns, the "joker in the pack" will be the degree of storm frequency and severity experienced in 2006, "and we have worked hard in the last six months to make sure that we are controlling the quality of the risks which we accept in the catastrophe prone areas."

Looking at catastrophe rate rises being achieved in 2006, the opportunities are clearly there to make profits after the winds have blown, but Kiln, like many other market players, is seeking to restrict its catastrophe exposure. In contrast to its strategy in relation to 510, Kiln has markedly reduced its share in Catastrophe Syndicate 557 from 23.2% to 5.2% as it seeks to re-evaluate its risk appetite and reduce potential volatility in line with its expectation that 2006 will offer up another active hurricane season. The group has also started cutting back on its US coastal exposure and in particular, is putting those areas most likely to experience extreme storm surge under the risk microscope.

The role of reinsurance

As mentioned earlier, the impact of the insured losses resulting from catastrophes in 2005 was mainly absorbed by Kiln's reinsurance programme, with over 62% of the gross loss bill being picked up by the reinsurers. In its comments following the affirmation of the "A" (Excellent) syndicate rating on Syndicate 510, AM Best cited the "comprehensive reinsurance programme" in its ratings decision, highlighting the fact that much of the programme had been in force for in excess of 40 years and adding that, coupled with the syndicate's underwriting discipline, it had played a key role in 510's ability to achieve a consistent track record of outperforming the Lloyd's market.

In terms of a rating breakdown of the reinsurers involved in Kiln's reinsurance programme, 90% are rated "A" or above, with the "A" rated constituting almost 80% of that figure. From an outstanding claims perspective, some £194.8m of the total reinsurers' share of outstanding claims (including reinsurers' IBNR) of £215.6m as at 31 December 2005, lies at the door of the "A" rated or above, a fact which should clearly help allay fears of recoverability issues.

"In terms of our reinsurance recoverables," adds Creasy, "we are less concerned than many, because we have always followed a strategy at Kiln of making sure that we can collateralise our recoveries at a very early stage in the event of a major loss. We did that following the World Trade Center and we did it for Katrina." While he points out that this is not something which Kiln does "as a matter of course", it does make recoverables much more secure in times of a major loss.

Return to form

Over the last 24 months, a period which has seen the industry experience five of the eight worst natural catastrophes ever, Kiln has managed to achieve a weighted average return on equity of 12%. However, Creasy is adamant that the low return on equity achieved in 2005 of 4.3% will not be repeated in 2006. "Producing low returns for Kiln shareholders is not acceptable," Edward Creasy wrote in his chief executive officer's report, "unless the immediate future presents us with opportunities to make good the shortfall." While, as previously mentioned, 2006's storm season forecasts could prove troublesome, Kiln is confident that it currently stands in a choice position to avail of the opportunities afforded by the developing rate environment this year and beyond.

- Nigel Allen is editor of Global Reinsurance.

Kiln Edward Creasy, chief executive officer

Edward Creasy began his career in 1978 as a political risk broker for Investment Insurance International (Managers) Limited, part of Hogg Robinson, a company which pioneered the development of political risk as a commercial insurance product. In 1982, he moved to Cassidy Davis Underwriting, first as deputy underwriter of Syndicate 582. He progressed to be director of underwriting in 1992, and was managing director from 1993 until 1998, when the company was sold to the St Paul. He retained the role of MD of Cassidy Davis, and was chief operating officer for St Paul at Lloyd's until the end of 1999.

Creasy joined the Kiln group in January 2000 as managing director and director of underwriting of managing agency RJ Kiln & Co Limited, and a director of Kiln plc. He was appointed chief executive officer of Kiln in July 2001. He is also a director of the Lloyd's Franchise Board and of the London Market Association.