Play the long game

While the world's economy battened down the hatches in readiness for the final leg of the recession-gripped 'noughties', Lloyd's and the London insurance market entered 2009 on a wave of cautious optimism. It had a lot to live up to. After all, 2007 was a record year, producing — on the back of low catastrophe activity and a strong US dollar — profits of £3.9bn.

That 2008 would produce similarly strong results was never on the cards. Hurricanes Gustav and Ike coupled with the credit crunch ruled that out and, in the event, profits halved.

In March of this year, Lloyd's reported that 2008 investment return was down as expected at £957m (2007: £2.01bn) and chief executive Richard Ward observed at the time: "In these testing times, it will be those businesses with clarity of vision and purpose that will stand the best chance of success." And, as the year moved on, listed Lloyd's companies reported reasonable half-year results with a benign hurricane season in the second half suggesting 2009 will probably be considered a success, all things considered.

This year also saw Lloyd's chairman Lord Levene dutifully touring the world as the corporation continued its ambitious growth strategy, setting up outposts in Rio de Janeiro and Dublin. It also claimed a number of firsts in its drive towards creating a paperless marketplace, notably the launch of the Lloyd's Exchange, supported by IBM.

The long game

While 2009 was a good year for Lloyd's internationally and it gained buy-in from underwriters and brokers to its reform programme, both sets of initiatives are part of the market's long game.

In the here and now, market players are focused on how to make money in a market with an abundance of capacity while rates — in the main — refuse to budge. For a brief moment in 2008 it looked to some insurers like AIG's problems alone could drive up the cycle. Many felt confident that even if the woes of AIG couldn't do it, the combined effects of the recession and the 2008 windstorms might do the trick.

But, in the end, the reality was far different and the 'too big to fail' mantra that saw AIG dragged back from the precipice by previously unimaginable levels of federal government bail-out was a bittersweet one for the industry.

AIG's property and casualty business became one of the safest places to put your risk, much to the chagrin of the market, which queued up to accuse AIG — now rebranded as Chartis — of aggressive pricing to retain market share. This claim was vigorously denied by AIG UK managing director Lex Baugh in Post ('The difference a year makes', Post, 17 September 2009, p12).

As Barbara Merry, chief executive of Hardy Underwriting, says: "Everything was going to start moving in the right direction as far as we thought, this time last year. But, in the event, movement has been patchy.

"We felt it was quite likely AIG would collapse. Had that happened it would have had enormous effect across the industry and XL would have looked a bit wobbly. Customers would have taken a long hard look at where they bought their cover — but, of course, none of that happened."

In fact, recession-related losses have failed to turn into the waterfall of claims that many anticipated, perhaps due to tough lessons learnt in the early part of the decade through exposure to the Enron and Worldcom blowouts.

Lloyd's finance director Luke Savage comments: "Insurance has been largely uncorrelated to the financial crisis. Obviously we have substantial asset bases and have suffered the same as everyone else with falling bond and equity prices last year and at the beginning of this but, on the back of Gustav and Ike, rates held up.

"At the start of the year people expected rates to steadily improve; now you're more likely to hear that there were modest improvements early on, with rates then going pretty flat."

In fact, claims on the whole were fairly low — bar some exceptions such as the Air France crash in Brazilian waters, the full brunt of which may not be known for some time, although estimates have put the total loss at as much as a $1bn (£612m).

Most syndicates had been able to release reserves, having shored them up after the 2005 hurricane season, so they were prepared for Ike. A benign hurricane season this year suggests little change in 2010, unless recession-related litigation claims do flood through.

While capacity has increased, investment income has dropped off the balance sheet, although undoubtedly the blow to losing this income stream is softened by the knowledge the competition are all suffering too.

Ms Merry observes: "With capital depleted from balance sheets there has been more focus on how companies have deployed their capacity and reinsurance expenditure has reduced."

However, Mr Savage adds: "Although cash investments have struggled to make any money, people are talking about investment income being better than they would have imagined due to the fact the market has a substantial bond portfolio."

In April, Lloyd's made the canny decision to buy back £102m at a time when bond prices were low, which bolstered its central fund — the emergency pot that deals with claims in the event a Lloyd's business goes under. Mr Savage comments: "In doing so, we crystallised the gain for the central fund by about £36m. We timed it perfectly — I'd like to say it was judgement rather than a degree of luck. It turned what was £100m of tier-two capital into £36m of tier-one capital."

Trading below value

Whether next year will be any different is anyone's guess but 2010 will likely be another period where investment income cannot be relied upon, while return on equity and profitability cannot be taken for granted.

It also depends on whether the US government calls in its loan to AIG, although the expectation is that it could take two years or more before the market improves enough for the retail business Chartis to be floated.

Over-capacity in the Lloyd's and London market is not a new problem but the push by certain Bermudian insurers to write more premiums has taken its toll.

As many continue to trade below their asset value and shareholders get shirty, more consolidation among the Bermudian players seems inevitable. And both Ariel and Harbor Point from the 'class of 2005' are being viewed as likely candidates for acquisition. Having lost out to Validus in July in a drawn-out battle for IPC, Max Capital may yet be a buyer.

Ironshore has had a different strategy, recently recruiting Kevin Kelley from Lexington Insurance as its new CEO, in a move that Seb Kafetz, relationship director at Lloyds Banking Group Corporate Markets, points out makes it a more likely candidate to float. "Ariel and Harbor Point would find it harder to do an IPO as they are not doing anything much different from a lot of their listed peers — for example, Endurance," he says.

Whereas 2008 was the year in which Bermudian players looked to secure a foothold in Lloyd's — and with it the opportunities to build a more diversified book of business — in 2009 these players seem to have been more focused on scale.

In London, mergers and acquisitions have been few and far between. While Chaucer was courted, first by Novae and then perhaps more seriously by Brit, the fact nothing happened suggests a stagnant market.

This year saw the polarisation of the Lloyd's market with some of the syndicates pushing ahead with their diversification plans in a trend that, Mr Kafetz says, has created a two-tier marketplace: "Lloyd's is becoming much more polarised. The likes of Amlin, Hiscox and, to an extent, Catlin that are big, diversified insurance and reinsurance businesses are really pressing ahead. The mid-tier consists of six or seven public companies and three or four private companies that have £200m to £300m in net assets, such as Beazley, Chaucer, Novae and probably Brit. Strategically, all those guys will have to think about what they do over the next couple of years in a softening market with probable low investment income."

He adds: "They will start moving in different directions. For example, Novae has set up a European reinsurance business and Brit's decision to redomicile to the Netherlands should add £30m to £40m to its bottom line. Strategically, they realise if they stand still they will fall behind. Valuations are drifting and seeing that Chaucer, Novae and Brit are trading below book, that can't be acceptable to shareholders. They could well sell out and buy into Amlin and Hiscox."

2009 has also been the year in which the impact of impending Solvency II regulation was felt. David Gittings, chief executive of the Lloyd's Market Association, considers the successful formation of nine working groups focused on different aspects of the regulation as a key success of the year.

Despite only getting off the ground in the last quarter, Mr Gittings says up to two-thirds of the managing agents have signed up.

He adds that achieving market buy-in for the reform programme has also been a significant achievement. "In terms of being clear about what we want to do and getting the market to agree the costs involved took significant effort." He also cites securing buy-in to the Lloyd's Exchange as a major success for the marketplace.

Wider interest

According to Sue Langley, Lloyd's director of market operations and North America, interest in the Exchange has been wider than expected.

"In terms of capacity, we have around 80% of managing agents and around 60% of top-30 brokers now using it. We changed tack a bit this year and decided to do an endorsement pilot — which is not to say all the rest of the information cannot be carried on the Exchange but we decided to start with something simple."

She adds that use of the electronic claims file is now in full swing. "People no longer talk about why should they use it, they talk about how to make it better. We still have legacy issues — because the ECF is for new claims, we have people now asking if they can use the ECF to do legacy claims. But it is up to underwriters and brokers how much they want to back scan."

Another issue that has fallen under the radar has been the European Commission on pricing, which has seen the LMA take responsibility for ensuring brokers and underwriters don't fall foul of a set of guidelines regarding market pricing.

Mr Gittings explains: "The broker needs to take instruction from his client about whether the client wants the risk placed on a traditional basis, where the leader established the prices and the followers adopt, or whether the client wants each underwriter on the slip to price the risk independently. Those principles were established a year ago but the important thing has been to make sure they are being adhered to."

While the market can be proud that it has now been pulled with some kicking and screaming into the modern age, the overload of capacity and low-level cat activity can only mean one thing for 2010 — except of course that, given the year the economy as a whole has had, nothing is a foregone conclusion.