State of the Nation: Lloyd's and the London Market: The march of Globalisation

globalisation

For Post’s third research project of 2016, Michèle Bacchus asks Lloyd’s and London Market players for their views on globalisation, diversity and the future of the market.

London has been – and hopefully will continue to be – synonymous with insurance for many centuries. When the London Market opens its doors to the world each morning, Australia has been awake for hours and the US will remain asleep for many more. This is the world we inhabit, one where markets flow across borders, trade has no barrier and time possesses no real meaning. This is globalisation, and the London Market is fighting a global revolution poised to overturn its very existence. It is time to act.

“We see the world as our market anyway”

With a workforce of 48,000 people, annual premiums of £60bn and a contribution of nearly one-tenth towards London’s gross domestic product, London is fondly referred to as the “insurance capital” of the world. More than 80% of London Market business comes from overseas and while London continues to service that business, local markets are springing up around the edges. The 2015 London Matters report, an analysis of the pivotal issues facing the market published by the London Market Group, stated that 30-40% of London premiums were at risk of being written locally, and listed the new insurance hubs around the world vying to compete with London.

Hailed as “the economies of the future”, Asian and Latin American markets are fast emerging, impressing upon London an urgency to “stay relevant” to its global base. Explaining the environment of protectionism and “competitive tension” present in these local markets, a respondent in the research commented: “One of the things they are writing up on the flipchart is ‘How can we get a slice of the £60bn that Lloyd’s writes in our market? Oh I know, we have to provide an equivalent service that can be delivered globally but more effectively and at a more efficient cost’.”

Eliminating local protectionism is vital for London’s survival as the “worldwide epicentre, the spiritual home of insurance”, and although creating partnerships with local financial companies around the world may well permit an increased free trade, this can sometimes come at a price, one paid by the customer. According to one respondent: “It is right to deal with local people but they should use proper firms and not cut costs by using backstreet one-man-band operators. It causes one hell of a problem because you can never get hold of the people and they take days to attend an incident. The insured just doesn’t get the right service and attention because if they break their leg tomorrow, the insured doesn’t see anybody for the next two or three weeks. It doesn’t help the speed and the smoothness of the process.”

But the cost of placing business with London might well be a deterrent. “London is complicated and that complexity builds in cost,” noted one participant, which presents “quite a danger that it will become less relevant, particularly at the commodity end”. Another respondent stated: “Make no mistake, the Lloyd’s platforms are very expensive to set up and run, and part of that will damage profitability in certain areas. I’m not going to buy my house insurance at a higher price just because it’s got Lloyd’s of London above the door. If the guy over the road is doing it cheaper, of course, I’ll go there.”

With ‘guys over the road’ increasingly opening for business, localisation is “a very real risk” for the London Market, and over one-third of the respondents are worried. “If people can get their risk underwritten locally, there is an increasing propensity to do so and, if the market doesn’t respond, it runs the risk of losing market share and/or losing out to local markets.”

A local presence in new markets is of paramount importance to attracting new clients, especially as these new businesses “won’t necessarily come to London because they are developing their own insurance markets”. This shouldn’t be perceived as a threat however, but “as a huge opportunity to just change our model and happily coexist.”

Methodology

We spoke to 33 members of the insurance industry across the London Market, both in the UK and abroad. Between June and August 2016, all participants were interviewed either face-to-face or over the phone, answering questions on the issues raised in the 2015 London Matters report. Organisations involved in the research include: Lloyd's of London, London Market Group, International Underwriting Association, London & International Insurance Brokers'Association, LLoyd's Market Association, and young insurance group members under the age of 35. Sectors that took part in the research include: syndicates, brokers, managing general agents, loss adjusters, coverholders and members of the High Premium Group.

Problems at home

The London Market certainly is seizing this new momentum as an opportunity: in Singapore, an emerging market with a 13% growth rate compared with London’s 4%, there are now 22 service companies of Lloyd’s managing agents writing business, the US has seven Lloyd’s offices, and 10 managing agents have permanently settled in Brazil. “They get the fact that a broker based [abroad] doesn’t want to send all his client information via someone in London just to act as an underwriter,” said one respondent.

Yet another participant worried about the disparity stemming from the creation of a London presence in international markets such as Singapore, China and New York: “A lot of business people are trying to place business domestically to them, which is obviously much more cost effective, so as other economies try to join in the globalisation party it’s actually making things difficult for London to retain its international status. It’s minimising diversity of business that we see in the London Market and that’s only going to continue as other economies go from strength to strength, building their own domestic industries.”

However, this twofold concentration of business and reduction in diversity may be London’s major opportunity and its saving grace, according to some respondents. “I actually see some risks finding their way more readily back to London,” prophesied one participant. “Every day we see evidence of the increased risk environment that is around us – not just natural catastrophe but geopolitical risk as well. If you are an insurer and you want to stay in control of that sort of environment, that means bringing risks back to where they are best understood and can be placed.” This will create “a sharper focus on the true purpose of London” in the global market, added another respondent. “Where London has done quite a lot of run-of-the-mill insurance, that will stay in local markets, and it’s only truly speciality lines that will come here and make use of the centre of excellence.”

To facilitate a route for risks to find their way “back to London”, stations must first be created at the source. “[Lloyd’s] is heavily involved in building out in Latin America and that’s all about responding to localisation,” explained a respondent. “What it wants to encourage is the syndicates to actually respond and put offices and underwriters in those territories as well.”

Other capital

What the London Market thinks of alternative risk capital

“It's going to happen: deal with it, innovate yourselves, get more modern, get better data, get more efficient systems, all of which the market is trying to do.”

“It's kept us lean really and kept us having to challenge ourselves, so it's a healthy thing.”

“ARC is part of the picture but I don't think it's by any means the single driver. We're still talking single digit percentages of reinsurance capital.”

What the London Market thinks of insurance-linked securities

“This is just another form of capital and you're not going to be able to fight capital, the way it transmutes itself around the world.²

“I'm in the camp that sees long-term stable capacity being introduced as being healthy. I include ILS in there.”

“It's another way to think about capital and risk, which is good, and they bring their own way of doing things, which is innovative, into the market.”

Coverholder arrangements

While the market waits for syndicates to take the leap across the waters to new lands, a growing cluster of coverholders is softly gaining ground and paving the way, just as the first global explorers did 500 years before them. Finding ways to access the local business is a key priority. “Writing business through coverholders clearly helps in terms of keeping it within local jurisdictions and gaining access to markets you might not be able to gain access to directly,” enthused one respondent.

Coverholders, or managing general agents as the US prefers, are cost-effective and considered “a good channel for SMEs” as risks are underwritten much closer to their source. The only concern voiced frequently was the question of management. “How do you ensure they are adhering to the regulations that they need to?” pondered several respondents. “You don’t have that direct relationship with customers, you are reliant on third parties,” bemoaned one. “You have to absolutely make sure that they are writing to your rules and your risk appetite.” Management machinery must, therefore, be implemented and processes such as “coverholder audits and compliance become critical” to ensure companies are represented accurately to the end client.

Representing “a very significant proportion of the way business is done at the moment – the broad average often quoted is about one-third,” local coverholders offer a glimpse into the innovative nature of the market. “Lloyd’s is now primarily corporate capital and so the coverholders and binders are where ambitious people are looking to do their creative work,” said one participant. “If Lloyd’s then provides the capital, those individuals will bring it to London. So you just move the creativity one step away from the corporates.”

london-market-organised

Alternative risk capital

Capital is unquestionably a challenge at a time when one respondent claimed a “tsunami of alternative risk capital” is entering the market. That London is attracting such attention is a sign of confidence. However, another respondent claimed companies must “adapt and change the way we write business in order to accommodate that”. They added: “If this implies widen[ing] the product suite we offer to our corporate and commercial customers, the more ARC, the better.”

“I see a happy marriage between historical capital risk transfer vehicles and alternative capital,” predicted one respondent. “If correctly used, it will bring greater stability and perhaps sharper, more appropriate pricing in some areas.”

An additional benefit of alternative capital is that it acts as a key to other markets. “When you have something like that coming in and getting off the ground, you need to engage in it because it’s a competitor but it doesn’t have to be. It could bolster the London Market. It’s something you have to adapt to rather than push back on,” suggested one respondent.

Capital providers bring with them new territories into the market, as one respondent said: “Even if they are not in a primary underwriting role, they are beginning those footsteps.” These tentative steps into foreign territory are described by many as something “that’s not going to go away”. New investment can be a healthy addition to a market because, as another respondent said, “it keeps existing players on their toes to be innovative and look at things in a different way”.

This optimism surrounding alternative risk capital is broadly echoed by several other respondents. “There’s a lot coming from the Eastern world,” said one, who wanted to “harness it in a way where we are accepting that capital via a Lloyd’s platform.”

“If the activity exists, it should exist in London”

It’s a complicated time for London. Foreign companies and new markets are entering London, therefore obliging the market to successfully incorporate the new capital into its fold while guarding against it through some form of protectionism. Meanwhile, on the other side of the world, the London Market must itself penetrate new markets, combat local protectionism and bring new capital back to the City.

Herein lies a paradox of sorts. Yet, the market is resolutely determined to explore ways to harness the capital. “London has a pitiful penetration rate in emerging markets, so if you grow that market by having representatives there, it’s not really taking away business from us because we haven’t got it,” mused one participant. “But as it grows there’s the ability to be able to grow with it. If you’ve got representatives there, they need to be able to pass large chunks and get large capacity off London.”

As emerging markets and new business decide whether to meander towards London, market leaders have been duly preparing for the influx: “The London Market has been doing a lot of work to understand those growth drivers and where we need to be positioned. We have to make sure that our customer proposition and products are still relevant to the new emerging markets and potential clients. So that really is a very significant challenge.”

London must rise to this challenge that new and alternative capital presents, because “it [capital] is there and is finding a route to market” regardless. “International capital understands the value to connect to an industry which has demonstrated innovation capability and profitability, so it’s really about us, the regulator and the lawmaker to make sure we continue to build up London as a good marketplace,” stated one respondent.

The journey towards private capital

“We wondered when the first corporate vehicles appeared back in 1994, what was going to happen, but it didn't make a difference to the unlimited name, you could still have all this spread of syndicates. But gradually as you went through the 90s into the 21st century, more and more syndicates became corporate and they were brought by other corporate bodies. 

“There are now only three members agents catering for 2000 names, not many of whom are still unlimited ­ everyone is now encouraged to go into limited liability. It just gives people a lot more comfort. It made very little difference because if you had a bad year and you made losses, if you wanted to continue whether you were unlimited or limited you still had to put more money up, so that was the crutch.

“What in practice happened, 1998, 1999, 2000 and 2001 saw quite a lot of losses in the market and again in 2005, and we saw a lot of corporate vehicles getting themselves into trouble. Since they started, the Central Fund has inherited liabilities of over £1bn. Of those liabilities, only about £20m comes from private names because private capital have tended to refinance themselves as they would do if they were an unlimited name. “There's every chance the names are going to be squeezed out. One of the problems at the moment is finding capacity. There are only about 10% of it that's really worth looking at and you've got to buy them in the auction which is, I won't say scandalous, but when you've been a name for as long as I have, and your capacity was free and you now have to go out and buy it, and pay as much as 80p in the pound for it ­ and that can just go very quickly. I mean it's a big gamble.”

Action not reaction

Part of that building process involves embracing new capital vehicles as they emerge and remaining at the centre of innovation. A not-so-new phenomenon, insurance linked securities, is a current example of the industry exercising this mentality. The Chartered Insurance Institute describes ILS “like industry loss warranties, cat bonds and cat swaps”, and as a means of “ceding insurance-related risks to the capital markets” and while some “would prefer ILS to shrink as it depresses the prices in conventional business”, the London Market is wholeheartedly in favour of creating an onshore UK hub to attract these new capital markets products.

“We’ve been very heavily involved in work with HM Treasury to try and change the tax and legal framework to attract more ILS business to London, and that is essential because that is the innovative end of the industry and it needs to happen here if we are going to fulfil our role in the global market,” explained one respondent.

The LMG has been running the ILS project on behalf of the market for the last 18 months “because it’s new capital for new products doing new and innovative things”, and together with Liiba, Lloyd’s and the International Underwriting Association, is in talks with government to “get the ILS regulation to an end”.

Sitting alongside traditional reinsurance and insurance, ILS could allow “certain players to price more competitively, to give customer solutions”. One respondent admitted: “It’s certainly something Lloyd’s is looking at quite closely but it is quite different and it is a bit of a shift from the more traditional sources of capital that the market is used to. It’s quite a big educational process.”

The London Market has never been known to shy away from that which is new or different, and strong collaboration with the regulators and lawmakers will keep the insurance industry at the forefront of their agendas. For there is work to do. The sheer concentration of human capital and expertise available within the square mile is certainly overwhelming: nowhere else does this organically grown abundance of choice exist which has led inevitably to London’s title as the “true centre” of global insurance, with various hubs that “hang on to that centre”. It is a pretty picture, but one London will have to work harder than ever to maintain. That task has already begun, with a refreshed look at the talent needed – and available – to drive the London Market into the future.

Look out for part two of our Lloyd's and London Market research on talentpart three on innovation and modernisation, or part four on the future

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