Lloyd's Overview - Keeping in shape

Despite the threat of significant claims from Hurricane Katrina, Marcus Alcock reports on how Lloyd'...

Despite the threat of significant claims from Hurricane Katrina, Marcus Alcock reports on how Lloyd's seems determined to stay disciplined and reap the potential benefits of market conditions.

Resting on one's laurels just does not seem possible in the London market. On the same day that ratings agency Fitch reaffirmed its 'A' rating of Lloyd's, the market put out a statement that it expected "significant claims" from Hurricane Katrina, which has ravaged the Gulf of Mexico and New Orleans.

Of course, Lloyd's is far from alone in facing a hefty payout as a result of what could turn out to be the largest natural catastrophe to afflict the insurance industry - one which could even surpass the infamous Hurricane Andrew of 1992, which cost the industry $15.5bn (£8.8bn). However, the reality of such an enormous claim reflects the continued fragility of a market that has had to readjust in recent years to a world of spiralling payouts and increased volatility.

It is not just the wider claims environment that the market has been forced to face up to in recent times, however. After a lull during the past few years as the market reaped the bountiful harvest of an extremely hard market, merger fervour has once again returned to Lime Street, with five listed vehicles publicly mentioned in takeover discussions in the past six months and one of these - Cox Insurance - eventually de-listing after a private buyout.

According to Robert Smith, an analyst at ratings agency Moody's and expert on Lloyd's, the fact that merger activity - albeit failed activity - has once against resurfaced is no surprise. He points out that for most investors, no matter how well the listed vehicles may have performed in recent years and how strong their management is, they simply remain too small.

Mr Smith says the possibility of further consolidation remains distinctly viable: "There are 13 listed vehicles, and Cox has just de-listed. To say there would be 13 in five years' time seems unlikely." Achieving any consolidation within the market looks likely to be a tortuous process, he adds. Given the small size of the businesses concerned, relative to other quoted stocks, it seems that the egos of management simply cannot afford to be too bruised by the process of merging two cultures and, perhaps more pertinently, two boardrooms. After all, two into one does not go, and which director is willingly going to forsake their seat at high table in order to achieve a more streamlined business?

Legacy issues

As Mr Smith explains: "With any business you have a distinct culture and when you put two businesses together you find that one culture prevails. So the question that needs to be asked is: is it worth going through the process? You face the prospect of losing some people and there are also possible legacy issues that you might inherit as part of the package. The fact is that Lloyd's is a collection of small businesses and that is one of the attractions of the market."

From the point of view of those small businesses themselves, it would appear that they are one of the attractions of the market but, significantly, that the market also continues to be attractive to them. In the immediate aftermath of the attacks on the World Trade Center, when many commentators were speculating that Lloyd's simply would not be able to foot the enormous £2.2bn claims bill - its largest ever payout for a single event - the talk was whether some of the market's biggest players would really want to remain committed to such a difficult US-orientated property and casualty market.

However, Lloyd's was able to meet its obligations regarding 11 September 2001 and subsequently proved its attractiveness to investors, with a round of significant capital-raising exercises among the syndicates to take advantage of the significantly improved conditions. Since then it has gone on to post record profits, which were dented slightly by last year's hurricane season and, of course, may be dented again by this year's one - which has only just begun.

According to Simon Sperryn, chief executive of the Lloyd's Market Association - which represents the interests of the various managing agencies - even with such claims, the market itself is now a much better place to do business than it was when he took up his position in 2001. "It seems to me that everything is moving in the direction we want it to," he comments. "There is huge competency in the managing agencies and a huge determination to strip out costs. We can take confidence in what has happened."

Positive processes

He appreciates that assessment of change is perhaps not always best conducted when times are good, but concedes that a more accurate appraisal is about to occur: "Rates have fallen off, and people are preparing themselves for more difficult years." However, although the test is yet to come, managing agencies have the confidence that the processes that have been put in place by the Corporation of Lloyd's are the right ones, he stresses.

Key here, he explains, is the existence of the Franchise Performance Board and its relationship with the businesses in the market. Although many commentators have been sceptical about the ability of the FPB to manage the underwriting strategies of syndicates in a rigorous and effective manner, Mr Sperryn believes the relationship between both sides has been a good one so far.

Another positive change currently taking place at Lloyd's, according to the LMA, is the move towards contract certainty - a move forced upon the market by the comments of the Financial Services Authority to a great extent but one that the market is now, after years of deliberation and vacillation, taking seriously. Of course, this transition will not be entirely painless but, according to Mr Sperryn, will ultimately work in the best interests of Lloyd's: "Brokers will have to present business much earlier and will have to present a fully cleared slip, while underwriters will have to discipline themselves."

Discipline appears to be one of the watchwords at Lloyd's as it approaches the tail-end of 2005 with a softening market a possibility, at the same time as a vicious claims environment looks set to cost syndicates dear - with more hurricanes unfortunately looming.

Despite the myriad of negatives that one could focus on, the reality appears to be somewhat different, according to Robert Miller, spokesman for the Association of Lloyd's Members. In his opinion, the nature of the cycle this time round will mean a much less volatile experience for syndicates: "The cycle looks slightly different from previous ones, and does not appear to be as precipitous as previous years. The current signs are good, though it could always turn out to be more similar to previous ones.

"However, remember that conditions are very different in the capital markets this time. Hurricane Katrina will clearly have an effect on results this year, which will not be as profitable as they otherwise would have been but it may act to sustain rates and stop them from sliding. Whether it will or not is impossible to answer."

Indeed, Lloyd's insurer Amlin, for one, has already hinted that Hurricane Katrina could reverse the softening market and that, having planned to write less business in 2006, it may increase capacity. Other Lloyd's insurers, such as Beazley and Wellington, have indicated they too will follow suit.

Mr Miller agrees with the LMA that the establishment of the FPB is working in Lloyd's favour in 2005: "The FPB has made a significant difference. It is worth bearing in mind that, had it not been for the hurricanes last year, Lloyd's would have made a record profit in 2004 and, to an extent, that is the result of the creation of the FPB, which is making syndicates adopt a more disciplined approach."

As far as the ALM is concerned, the market, whether it is able to maintain the discipline that everyone craves at this vital time or not, is structurally in a much better shape than it has been for some time. "There's a certain amount of stability now," Mr Miller explains. "We have a much clearer idea of how it is going to look in the future, with a tripartite capital structure of private capital, quasi-corporate and insurance industry capital. It is quite a successful structure and one that is good because it makes for a degree of stability, as diversity of capital is a good thing."

In particular, and hardly surprisingly, he blows the trumpet for Names, claiming they have been able to make money recently and that their performance has been superior to other investors because of their careful selection and support for well-run businesses.

Not everyone is convinced that the capital issues that once plagued Lloyd's are entirely resolved, though. Mr Smith predicts that if the market softens further we can expect some interesting action when it comes to the trading of capacity. "You have still got a lot of issues regarding capacity," he says. "Many vehicles want to be totally corporate because it gives them more flexibility. The raging battles of the past have died down a bit but the overall picture is that you have entities that would prefer to be 100% corporate."

Given this desire, and the prospect of either reduced profits or the spectre of returning losses in the coming years, the market could well see a continued shift away from private to corporate capital. "Names are likely to want to downsize going into a downturn, so some of their capacity will get bought up, and there will be an increase in corporate capital," he adds.

Techological change

Capital issues aside, another topic that has vexed both brokers and underwriters alike at Lloyd's recently has been that of technological change - in particular, the corporation's decision to press ahead with trading system Kinnect at a cost, so far, in excess of £50m. Despite failing to win the support of Aon, which has pressed ahead with its own system, Aon Broking Connections, Lloyd's itself has maintained its faith in the project. Perhaps, though, this might prove to be the technology platform that finally delivers.

Roger Foord, a technology consultant to the London market is optimistic: "It has recently signed up Jardine Lloyd Thompson and, although Aon will probably stay independent, Willis and Marsh are on board - so for Kinnect they are doing well, as far as brokers and underwriters are concerned."

They need to be, as Mr Foord explains Kinnect is going to be independent financially at the end of the year, so brokers and underwriters who use the system will have to fund it.

However, he voices some concerns: "The downside of what is happening this year is that accounting and settlement has been put aside with the focus being on contract certainty - but Kinnect is redefining things."

Clearly the corporation, which has pressed ahead with significant change already in the past couple of years, is keen to steer even more change through the market with regard to technology and contract certainty. Whether the market can respond by weathering the current downturn in a more reasonable manner than previous downturns, however, remains uncertain.

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