May 13th, 2009

Lloyd’s 2008 Results – Resilience in a Tough Market

Posted at 1:00 AM ET

Mike Van Slooten, Senior Vice President
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Lloyd’s of London (”Lloyd’s”) competitive position strengthened in 2008, largely because of effective risk management oversight and relatively conservative investment allocation. The capital structure has proved resilient in the face of the worldwide financial catastrophe and financial strength ratings remain strong and stable. As a result, Lloyd’s is well-positioned to benefit from current market dislocation.

Operating Performance

Lloyd’s reported a pre-tax profit of GBP1.9 billion (USD3.5 billion) for 2008, half the figure of the previous year but still the third best result in the market’s history. This lower profit reflected weakening market conditions, an increase in catastrophe events after a period of unusually low claims, and exceptionally challenging financial conditions.

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The key results driver over the past five years, underwriting performance, was impacted heavily by U.S. hurricane losses in 2004, 2005, and 2008. However, only Hurricane Katrina in 2005 forced the technical account as a whole into deficit. By contrast, investment performance has been relatively consistent. The 2008 result was flattened by GBP853 million (USD1.6 billion) of foreign exchange gains and GBP1.3 billion (USD2.4 billion) of prior year reserve releases, which kept the overall underwriting result positive, despite the effects of Hurricane Ike.

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Underwriting Result

Lloyd’s underwriting performance again compared favorably with peers in 2008. The headline combined ratio stood at 91.3 percent (compared with 84 percent 2007), with higher levels of attritional and catastrophe claims partially offset by prior year releases and currency gains.

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The 2008 accident year combined ratio stood at 103.2 percent (90.5 percent in 2007) but improved by 2.7 points to 100.5 percent after GBP370 million (USD688 million) of exchange gains on non-translation of non-monetary items (which will reverse in 2009). A further 9.2 points from GBP1.3 billion (USD2.4 billion) of reserve releases, mainly on the 2002-to-2006 years, brought the calendar year combined ratio down to 91.3 percent. Lloyd’s has indicated that, prior to exchange effects, the level of redundancy was in line with 2007’s GBP856 million (USD1.6 billion), but will fall from last year’s peak.

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The level of catastrophe claims in 2008 was above the long-term average of GBP971 million (USD1.8 billion) at GBP1.8 billion (USD3.3 billion) — from GBP420 million (USD781 million) last year — with net losses from Hurricanes Ike and Gustav reserved at GBP1.4 billion (USD2.6 billion). The underlying loss ratio was impacted by claims inflation flowing from record high commodity prices in the first half and by a general increase in attritional claims frequency, which is expected to continue into 2009 due to the economic downturn. 

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Class Commentary

Gross written premium rose by 10 percent to an all-time high of just under GBP18 billion (USD33.5 billion) in 2008, with growth seen in all classes except Motor. The reinsurance account showed the fastest rate of growth, expanding by 15 percent to GBP6.3 billion (USD11.7 billion).

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Underwriting performances for all classes other than Marine weakened in 2008, with Property, Casualty, Energy, and Aviation reporting technical losses before releases from prior year reserves. The Energy result was particularly poor, reflecting significant Hurricane Ike losses in the Gulf of Mexico.

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Lloyd’s expects the underwriting impact of the financial crisis to be within the normal course of business. There is said to have been no significant shift from the 200 claims notified by September 2008, when the total exposure was placed at GBP150 million (USD279 million). The market pulled back from providing wide insurance cover for financial institutions in the wake of the Enron and WorldCom scandals, and the writing of financial guarantee business is heavily restricted.

Investment Result

Lloyd’s reported an overall investment gain for 2008 of GBP957 million (USD1.8 billion), compared with GPB2 billion (USD3.7 billion) in 2007 — representing a yield of 2.5 percent (versus a 5.6 percent in 2007). The risk profile of the market’s invested assets is relatively conservative, with strong cash balances and the high credit quality of fixed income securities offsetting falls in value of many corporate bonds and equities.

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Syndicate premium assets form the largest element of the portfolio at Lloyd’s. Managing agents are free to invest these funds within the scope of the FSA’s regime for general insurers, with Lloyd’s seeking to capture investment risk through the capital-setting process. These assets are used to meet insurance claims as they become payable, and this need to ensure sufficient liquidity (often at relatively short notice) has traditionally led syndicates to adopt conservative investment policies, using cash and high-quality fixed interest securities of relatively short duration. More recently, a number of syndicates have diversified their investments to include more volatile asset classes — such as equities, hedge funds, and lower rated debt. Exposures to these riskier asset classes, however, generally remain limited and are less than 5 percent in aggregate. Investment returns varied significantly between syndicates in 2008. Some experienced negative returns, driven by exposures to more volatile asset classes, while many benefited from significant government bond exposures. Overall, syndicate investments returned GBP521 million (USD969 million) — versus GBP1.2 billion (USD2.3 billion) in 2007 - representing a yield of 2 percent (compared with a yield of 5.2 percent in 2007).

The second component of the investment result is the notional return on funds at Lloyd’s (FAL), which is the equivalent of the yield insurance companies generate on the capital they hold to support their underwriting. For 2008, this was calculated at GBP271 million (USD504 million), compared with GBP653 million (USD1.2 billion) in 2007, or 2.7 percent (6 percent in 2007). Where Lloyd’s is the investment manager for FAL, the actual return achieved has been included. For other assets, the return is based on indices yields on each type of asset held. The typical investment return on bank deposits has been applied to FAL provided as letters of credit or bank guarantees.

The final component of the investment result is the return on Lloyd’s central assets which, in 2008, stood at GBP165 million (USD307 million) — compared with GBP128 million (USD238 million) in 2007 — or 7.8 percent (6.6 percent the year before). The increase reflected strong returns from the Lloyd’s fixed interest investments.

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At least half of the investment return was generated in the last five or six weeks of 2008, which simultaneously saw equity markets begin to rally, credit spreads start to tighten, and interest rates being cut (boosting government bond prices).

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