Lloyd's Continues To Perform, But Faces Challenges

Lloyd's is in an increasingly strong competitive position, with record results reported for 2006 and underwriting capacity at an all-time high, according to a report from a reinsurance broker.

Reinsurance broker Guy Carpenter & Company, LLC, a subsidiary of New York-based Marsh & McLennan Companies, made the point in its fifth annual review of the market, titled "The Lloyd's Market in 2007."

"In 2006, leading players demonstrated once again that it is possible to achieve outstanding returns on equity at Lloyd's, which is crucial to the continuing strength of the market," said Nick Frankland, chief executive officer, Guy Carpenter in the UK, in a statement. "In addition, the significant strengthening of the balance sheet over the last five years provides a good platform for the future."

"Substantial mitigation of legacy issues has resulted in a reappraisal of the market's competitive advantages, with the result that new investors are being attracted to [Lloyd's]," said Mike Van Slooten, senior vice president and author of the report. "Lloyd's focused efforts to reduce the cost of mutuality, widen access to the market and improve service standards can only be to the benefit of policyholders."

Among the report's findings:

o Record results: Driven by rising rates on U.S. catastrophe-exposed business, favorable claims experience and improved returns on investment, Lloyd's reported a pretax profit of ?3.7 billion (U.S. $7.5 billion) for 2006--a 31 percent return on capital employed.

o Reduced uncertainty: The shadow of Equitas (Lloyd's runoff for asbestos and other environmental claims) has been lifted with the completion of the first phase of its transaction with Berkshire Hathaway.

o Capacity: Underwriting capacity increased by 8.9 percent to ?16.1 billion ($32.7 billion) for 2007, with six new start-ups since contributing a further ?217 million ($440.7 million).

o Balance sheet strength: Reinsurance recoverables have reduced by a third, with no collection issues reported on the 2005 hurricanes. Net resources (defined as total assets less policyholder and other liabilities) have increased by 21 percent to ?13.3 billion ($27 billion).

o Reduced central charges: The issuance of ?500 million ($1 billion) of debt in June 2007 has allowed syndicate loans to be repaid and discontinued and will facilitate an expected halving of the Central Fund contribution rate for 2008.

o Improvements in client service: Business process reform has significantly improved controls over placement and is continuing to improve the control environment for claims and accounting and settlement.

o Market Access: Lloyd's continues to focus on enhancing local distribution platforms in emerging markets and streamlining the broker accreditation and cover-holder approval process.

o Catastrophe Exposure: Lloyd's reports that, based on its Realistic Disaster Scenario output, U.S. windstorm exposure has been reduced by one third since 2005.

o Cycle Management: The Franchise Performance Directorate is expected to be successful in limiting the downside of underwriting in softening market conditions.

"The primary threat to Lloyd's remains the possibility of a marked downturn in the insurance cycle," added Mr. Frankland.

He continued, "In the absence of a major loss, we expect underwriting conditions to become difficult in most classes as we move into 2008, presenting a significant challenge to the Lloyd's franchise model."

Mr. Frankland noted that Guy Carpenter is "already seeing leading players returning capital to shareholders and proposing sizable capacity cuts for next year, but it remains to be seen whether the same degree of discipline will extend across the broader market. There is no room for complacency if Lloyd's is to emerge in a position to fully capitalize on the next upswing."