London Market Still Has Much To Prove

The demise of Reliance in the United States, Independent Insurance in the United Kingdom and HIH Insurance in Australia could lead to a sustained period of rate increases as capacity falls. Rates are not only increasing but policy wordings are being tightened, coverage is being restricted and deductibles are increasing.

However, as companies strive to achieve much-improved combined ratios, Fitch believes that peaks in the underwriting cycle are likely to be shorter in the future. This is because capital can be moved quickly around the globe to support those business lines that are showing any signs of profitability. Underwriting profits, therefore, might only be enjoyed for a brief period at the peak of the market.

In London, the majority of the larger global players are exposing themselves to a "double whammy" by operating both as London market companies and Lloyds syndicates, especially as both tend to operate close to, or even compete with, each other. These include ACE, CNA Re, Markel, QBE and St. Paul.

Underwriting controls have to be coordinated and extremely tight to ensure that business rejected by one part of the group is not written by the sister entity.

The table with this article highlights some of the suffering now being experienced in London, either in the company market or Lloyds. But while Lloyds operations do appear to be suffering less, they have a track record of underestimating pipeline losses and so results tend to deteriorate over their three-year accounting period.

So why do companies operate out of London? Companies believe the main benefits of the market include the good flow of business that comes into London, the specialist underwriting skills and the ability of London to offer greater capacity to insure larger risks.

Furthermore, Lloyds offers its global licenses and its "A-plus" financial-strength rating. Those operating in Lloyds benefit from a lower cost of capital through the provision of letters of credit, although syndicates must be large enough to support dedicated management and system functions.

Sound regulation is key, but it is sometimes seen as intrusive in Lloyds. Others would prefer to see greater market discipline being installed, thus reducing the need for regulators to act as the ultimate safeguard.

So what does London need to change? London needs to show that it is a more efficient place to do business. Historically, it has been perceived as very inefficient with the slow processing of policy documentation–with, in some cases, policyholders never receiving a signed wording.

The London Market Principles reform process–a joint initiative between Lloyds of London and the International Underwriting Association in London–aims to boost Londons reputation for service provision through changes to the placing process and the issuance of a single document that will provide the insured with evidence of coverage by the IUA and Lloyds insurers.

The changes were expected to be piloted during July 1 renewals, with a number of brokers wanting to achieve a target of 20 percent of contracts signed on the new slips. However, that has now been put back after questions were raised about example slips circulated to brokers and a few key underwriters.

The new slip is now expected to be implemented by fall. This would still permit the market to achieve its major goal of having virtually all business signed on LMP slips at 2002s main renewal season in January.

What is the future for Lloyds?

As expected, Lloyds syndicates produced an overall market loss in 1998 in excess of 1 billion ($1.5 billion, in current exchange rates) and are likely to announce an even higher loss when the 1999 underwriting year closes at the end of 2001. Early indications are that the 2000 underwriting loss could be as poor as 1999 and in the region of 1 billion.

Lloyds recent losses, therefore, have drained many corporate members of their pledged capital. Rumors circulating in the market suggest that some corporate members are not willing to pay additional funds into Lloyds once their own capital has been exhausted, particularly if their syndicates are no longer trading. As limited liability members they are in their right to do so, although they run the risk of damaging their corporate brand should these details be made public.

Early estimates suggest that losses amounting to 150 million ($216.9 million) will go unpaid by certain members and will have to be paid by Lloyds Central Fund should these members not replenish their funds. The Central Fund stood at 323 million ($467.0 million) at the end of 2000 and is supported by a five-year insurance contract that will meet unrecovered losses up to a ceiling of 350 million ($506.0 million) per year where such calls exceed 100 million ($144.6 million) in any single year. The aggregate amount payable by the insurers under the five-year policy is 500 million ($723.8 million).

Fitch believes a significant earmarking of the Central Fund may lead existing members to reconsider their Lloyds membership for 2002. This, together with Lloyds syndicates inability to forecast their results, does not inspire confidence.

Premium rates, however, are certainly on the increase and many underwriters are optimistic that 2002 could be a bumper year. Many syndicates are planning to increase their capacity to take advantage of large rate increases.

Further consolidation is also likely in the market, as capital providers are not easily able to increase syndicate capacities once an underwriting year has started or switch capital to support more profitable lines of business.

For example, Markel International recently announced that it is to merge its four syndicates into one for next year, thus consolidating teams of underwriters writing similar business, instead of having similar products written in two or three different places in the group. Capital efficiency will improve as funds are held to support one well-diversified book of business.

Lloyds is also awaiting feedback from consultants Bain & Company regarding the future structure of the market. They are unlikely to call for an end to mutualization through the Central Fund mechanism, where members can end up paying for the losses of others.

The pressure is mounting, however, from the top 20 groups that control approximately 80 percent of the markets capacity to take some radical action. Many argue that too many Lloyds businesses take a short-term view due to the annual venture structure that exists.

What is next for London?

Many observers would argue that the innovation once provided by Londons underwriters, particularly those in Lloyds, has disappeared under the scrutiny of their U.S.- or Bermuda-based management teams. So far, the majority of the capital providers that arrived in the mid-1990s to take advantage of Lloyds troubles have stood by their significant investments.

We have witnessed, however, some internal management struggles that have resulted in the likes of Mark Brockbank and John Charman leaving their Lloyds entities as parent companies seek to take more control over underwriting decisions and the underlying results.

The next two years are going to be critical for companies and Lloyds syndicates to produce some pure underwriting profits that will persuade their capital providers that London is the place to be. They must start producing returns to investors that are not only greater than their peers, but also other financial markets as well.

David Wharrier is a director in the Insurance Division of Fitch Ratings in London.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 10, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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