London Correspondent

Turning in a profit last year was tough, but the true test for Lloyd's–the biggest insurance entity in London–will be saying no to business as markets continue to soften.

And cutting capacity is exactly what Lloyd's is prepared to do to achieve its top priority of maintaining a gross underwriting profit, according to Julian James, Director of Worldwide Markets.

“All things being equal, I would expect to see a [capacity] reduction again in 2006,” Mr. James said, adding that Lloyd's executives “continue to believe that good cycle management is the most critical component of future success.”

They will be spurred on in this regard by last year's success. Time was when one of Florida's worst-ever hurricane seasons would have dashed any hopes the 300-year-old market entertained of showing a healthy profit surplus. Yet, in 2004, Lloyd's reported an annually accounted profit of ?1.36 billion and a combined ratio of 96.9.

Just 10 years ago, the venerated City of London institution was fighting for survival after losses of more than ?8 billion in the early 1990s.

Now it is winning plaudits from rating agencies and brokers for its financial strength and discipline in the face of falling rates. In a recently published report titled “Improving Performance,” for example, researchers at broker Benfield concluded that Lloyd's is in better shape than it has been for a long time.

And Lloyd's, a major player in global specialty markets such as liability, marine, aviation and transport, says it aims to maintain that progress and discipline as rates head south, even if it means less time for traditional British summertime sporting events.

“We are not sitting back and saying we've got where we want to be and therefore we can go and watch Wimbledon and cricket for the rest of the year,” said Mr. James.

Lime Street's underwriters have already cut their combined capacity for this year by 9 percent to ?13.7 billion. And Mr. James believes a further cut for 2006 is almost inevitable, since rates–as well as terms and conditions–on most lines of business are still easing.

He is well placed to know, since in recent years Lloyd's has stepped up its influence over the managing agencies that run the Syndicates and, in particular, their plans for future business volume. The Franchise Performance Directorate (FPD) is already scrutinizing underwriters' plans for 2006,and Mr. James expects “a lot of them will be subject to challenge and further consultation as happened last year.”

However, he rejects the idea that increased scrutiny of underwriters will curb their ability to innovate. He gives two examples–he availability of terrorism cover at Lloyd's just two days after 9/11 and the amount of direct and reinsurance capacity provided to the challenging U.S. medical malpractice market.

“Putting in tighter controls and proper risk management discipline does not change the fundamental characteristics of the Lloyd's underwriter,” Mr. James said. “He or she is prepared to make a market in particular risks and is willing to take on risk where others fear to tread.”

In particular, the FPD should improve the performance in the bottom quartile of Syndicates, the biggest source of losses in the last two downturns. That will put Lloyd's in a stronger position as the current downturn gathers pace, according to Moody's Analyst Dominic Simpson.

“If a Syndicate wants to increase its capacity for next year, it will have to come up with a good reason, because I suspect that the majority will be keeping their capacity at the same level or reducing it.”

Apart from the challenge of managing the downturn, Moody's drew attention to two other risks in a recent Special Comment on Lloyd's titled “Policyholder security remains good, but downturn looms.” These are Equitas and pressure from runoff Syndicates on the market's Central Fund.

Still, Moody's noted that Equitas–set up in the mid-1990s to manage Lloyd's pre-1993 long-tail liabilities–has already settled a large part of its asbestos liabilities. As for the Central Fund levy, which covers losses failed Syndicates can't pay, Moody's argues that this is not deterring companies from staying in Lloyd's.

Consequently, the rating agency forecasts a profit for Lloyd's in 2006 as long as underwriting discipline is maintained. Beyond that, Mr. Simpson doesn't rule out a market loss at some point in the downturn but is optimistic that the FPD's actions will curtail the size of any deficit.

United States crucial

What the new FPD controls will also help Lloyd's do is buck the industry trend and allow it to deliver a gross underwriting profit over the long term, Mr. James said. For an industry which in the United States has collectively only made a profit once in the last 25 years, “that has to be the real opportunity,” he said.

Despite its challenging risks, the United States remains a crucial market for Lloyd's. “We know we must continue to have a compelling proposition for people to want to send their business 3,500 miles across the Atlantic,” Mr. James said.

Elsewhere, Lloyd's is working to obtain an onshore reinsurance license in China, where it believes massive industrial expansion will present long-term opportunities. By long-term, Mr. James explains that Lloyd's is working to a time horizon of 10-to-15 years.

Meanwhile, Lloyd's is confident of benefiting from the projected rapid growth in demand for insurance in the rest of Asia. The market's underwriters also see opportunities in continental Europe, where many of its 62 Syndicates are investing with a view to writing more profitable business.

Reputation

With its finances restored and reform underway, Lloyd's also has made its image a priority–and after recent investigations by New York Attorney General Eliot Spitzer, that of the industry as a whole.

Mr. James conceded that Lloyd's reputation has taken a knock over the past 15 years. Consequently, issues such as confidence and openness figure largely in speeches given by Chairman Lord Peter Levene, CEO Nick Prettejohn and Mr. James himself.

For example, speaking at the Philadelphia Club in April, Lord Levene commented that if the insurance industry is to retain the confidence of its customers, “we need full disclosure and complete transparency about who is doing what exactly, for whom, on what terms and at precisely what cost.”

As part of its contribution toward greater openness, Lloyd's is pressing the FSA to mandate the disclosure of broker commissions. “If you strip away the mystery that surrounds some of our activities and shine a spotlight on the economics of this industry, it will accelerate change and assist buyers in understanding what goes on,” explained Mr. James.

One weapon adopted by Lloyd's in an attempt to combat the deluge of negative news is to talk up the contribution insurers make to the world economy. For example, Mr. James points out that Lloyd's pays out approximately $8 billion in claims in the United States each year, or around $33 million every working day.

Lloyd's knows that restoring people's faith in insurance is a long-term challenge and will need more than a few sound bites.

“We believe that part of our role is to encourage and promote best practices, and we will continue to spend a lot of time and effort trying to do that,” Mr. James said.

“Putting in tighter controls and proper risk management discipline does not change the fundamental characteristic of the Lloyd's underwriter. He or she is prepared to make a market in particular risks and is willing to take on risk where others fear to tread.”

Julian James, Lloyd's Director of Worldwide Markets.

Worth Noting!

Lloyd's pays out approximately $8 billion in claims in the United States each year, or around $33 million every working day.

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