Lloyd's Strong, But Feeling Foreign Heat

By MARK E. RUQUET

Lloyd's is feeling competition from markets in Bermuda and Asia, where insurers have less regulation and pay less taxes, according to a study released this summer by a leading reinsurance broker.

Indeed, a large amount of new capital is going to Bermuda, which enjoys "tax advantages and a less onerous regulatory regime," Guy Carpenter & Company--a reinsurance broker and subsidiary of Marsh & McLennan Companies--said in its recent financial and operational report on the Lloyd's market for 2006.

The total amount of new capital raised in Bermuda in 2005, by new and existing companies, amounted to $17 billion, according to the report.

However, Guy Carpenter went on to say that Lloyd's retains an advantage over these emerging markets in terms of infrastructure and concentration of expertise, as well as its ability to accommodate business involving extensive claims activity.

To create a more level playing field, the Financial Services Authority--the United Kingdom's regulator--is looking to create a more favorable tax system that could also lead to the creation of special-purpose insurance vehicles--known as sidecars--which are popular among Bermuda carriers.

In its status report on the Lloyd's market, Guy Carpenter said Lloyd's suffered substantial losses from Hurricanes Katrina, Rita and Wilma in 2005, resulting in a combined ratio of 111.8. Net losses amounted to ?3.3 billion (over $6 billion at current exchange rates). The market suffered an overall financial loss of ?103 million (or some $187 million).

The three storms accounted for 28.1 points of Lloyd's combined ratio. All other non-catastrophe lines remained profitable, the report said.

Capital providers added ?1.2 billion (over $2 billion) in new money to the market in the wake of the catastrophe losses in 2005, boosting funds at Lloyd's by 6 percent to ?10.2 billion (about $18.6 billion) and market capacity by 8 percent to ?14.8 billion (nearly $27 billion).

Treaty reinsurance accounted for 35 percent of the whole book of Lloyd's business in 2005, compared with 29 percent in 2004. Reinsurance suffered a combined ratio of 135 in 2005, compared with 95 in 2004, the report found.

Energy business suffered the most, with a combined ratio in 2005 of 147. The report noted that a significant portion of the energy business is located in the Gulf of Mexico, hammered by last year's record hurricane season.

The report also reviewed the activities of Equitas, which was developed to run off Lloyd's non-life liabilities--specifically asbestos and pollution.

Since its inception in 1996, Equitas has settled ?17 billion ($30.9 billion) in claims and generated investment returns of ?908 million ($1.65 billion), the report noted.

However, it has increased reserves by ?1.6 billion ($2.9 billion), primarily because of U.S. asbestos liabilities. Asbestos accounts for 53 percent of reserves--the single largest threat to Equitas financial existence, the report said.

While the company has been successful in resolving a large number of claims, adverse developments are expected to last for many years to come, Guy Carpenter predicted.

Copies of the report are available for download at www.guycarp.com.

Meanwhile, a major rating service predicted over the summer that Lloyd's will see a 5 percent profit in 2007, provided it is not subject to large claims experience.

In its report, the London office of Moody's Rating Service said the market has the potential to realize a profit of 5 percent on capacity in 2007, calling it a "return to acceptable profit."

For 2005, Lloyd's reported a loss of $181 million after a huge claims hit from Hurricanes Katrina, Rita and Wilma, Moody's noted.

Moody's cautioned that profitability will differ by class and by syndicate, subject to pressures to diversify in non-catastrophe lines of business. It further warned that a major catastrophe could have a significant impact. For example, under the scenario for a Los Angeles earthquake, disaster losses could amount to 9 percent of net capacity.

Liquidity remains good at Lloyd's after the 2005 hurricanes, Moody's continued, but U.S. requirements that foreign insurers post 100 percent of their gross liabilities into the U.S. Credit for Reinsurance Trust Fund is tying up capital.

In a speech before a meeting of the Northeast Hurricane Conference, sponsored by the Insurance Information Institute in New York, Wendy Baker, president of Lloyd's America, was critical of the market's treatment in the United States.

She said the Lloyd's market, which has demonstrated its credibility repeatedly over the years, should not be subject to a double standard.

"About a third of the industry's $60 billion loss from last fall's hurricanes was paid by foreign insurers--including Lloyd's," she said. "It is important to note because foreign reinsurers are often treated like second-class citizens."

Assuming a normal loss year, Moody's believes Lloyd's will see a 10 percent return on capacity, with profits totaling ?2.2 billion (over $4 billion at current exchange rates) for the 2004-to-2006 years of accounts.

For its part, Lloyd's remains committed to New York and the rest of the region, according to Ms. Baker.

"Unlike some domestic insurers, [Lloyd's] is not backing away from our U.S. clients," she said. "We remain fully committed to this region and more broadly to this country, our largest market--accounting for over a third of our global business, or more than $9 billion in annual premiums."

She added that Lloyd's has modeled, and prepared for, a $65 billion loss from a hurricane hitting New York and a $100 billion loss from a hurricane hitting Miami.

Last month, A.M. Best affirmed the financial strength and credit ratings of Lloyd's, asserting that its central solvency capital is likely to remain strong through this year.

The Oldwick, N.J.-based ratings agency affirmed its financial strength rating of "A" (excellent) for Lloyd's.

Luke Savage, Lloyd's director of finance and risk management, expressed satisfaction with the action.

"Given last year's record natural catastrophes, we are particularly pleased A.M. Best has recognized the progress that Lloyd's has made in preparing for and dealing with catastrophes," he said.

Lloyd's central solvency capital is likely to stay strong through 2006, remaining at a comparable level to year-end 2005 despite an anticipated increase in Central Fund drawdowns from existing insolvent members, the agency noted.

Best put the capital figure at $3.2 billion.

The rating agency said Lloyd's stable overall position is likely to incorporate a significant increase in Central Fund net assets--about 25 percent--as a result of the increase in the contribution rate to 1 percent, up from .5 percent last year.

Best said there is sufficient tolerance within central assets to withstand a significant stress scenario without threatening the market's solvency.

"The major catastrophes of 2005 have had an impact on earnings and member-level capital, driving an increase in Lloyd's balance sheet liabilities in 2005 of 26 percent, which in turn led to a decline of net resources of nearly 10 percent," Best said in a statement.

However, the catastrophe losses have not had an impact on central assets, other than a modest impact from members already in runoff, Best added.

Enhanced management of risk and performance will help prevent the more extreme downside results Lloyd's suffered in previous cycles, according to Best.