January 14th, 2011

Industry Issues and Trends: Lloyd’s Market: New Year, New Strategy

Posted at 1:00 AM ET

141x141jan1thumb10The new year follows a challenging renewal season for the bellwether Lloyd’s Market, which, despite losses incurred during 2010, showed that rates continued to soften. Lloyd’s enters 2011 focused on its new market-level strategy plans and preparation for Solvency II, now less than two years away from implementation.

2010 in Review

The Lloyd’s Market started 2010 with record high capacity, driven partly by new entrants and by the impact of foreign exchange, principally between the US dollar and the British pound. With capacity at over GBP23 billion and the market gradually softening, the challenge was to maintain underwriting discipline and focus on risk management.

The first major loss of the year occurred on February 27, when an 8.8Mw earthquake struck off the coast of Chile, with an estimated cost to the Market of USD1.4 billion. Further large losses were incurred during the year, notably the April Deepwater Horizon oil rig explosion and subsequent associated losses (forecast to cost up to USD600 million) and the 7.0Mw earthquake in New Zealand.

Throughout 2010, the Market has also endured depressed investment returns, and despite the loss activity, softening primary and reinsurance pricing across the majority of business lines, a situation which continues into 2011.

Nevertheless, Guy Carpenter expects that the full year 2010 results for the Lloyd’s Market will remain positive, with a combined ratio of 95 percent or better.

A Fresh Approach in 2011

Toward the end of 2010, Lloyd’s announced a new one-year and three-year strategy centered around the need for continued underwriting discipline while maintaining the flexibility for growth though expansion in profitable lines of business and new entrants to the market.

The strategy also includes a particular focus on determining the impact of and preparing for the upcoming Solvency II regulatory changes. This adds an element of uncertainty to the future prospects for Lloyd’s, although the current security offered by the Market places it in a strong position to weather any adverse impact to capital requirements.

Capacity for 2011 is expected to be broadly flat compared to 2010, as some syndicates lower capacity and others increase or enter the Market. Operating margins will be squeezed in 2011, although the overall Market profitability will remain driven by the catastrophe losses which may or may not be incurred.

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Solvency II - Opportunity and Threat

Lloyd’s considers the successful implementation of Solvency II (in particular, the approval of the Lloyd’s internal model) to be its biggest challenge - and, indeed, opportunity - over the coming years. The Market must obtain FSA approval for its model and demonstrate that all managing agents meet the required standards.

The potential impact of failing to obtain approval is considered severe, as the alternative - the Solvency II standard model - would be penal to Lloyd’s capital requirements, with an average capital raise forecast to be over double the current Individual Capital Assessment (ICA) requirements for each syndicate.

Lloyd’s has been monitoring the readiness of the Market, and Guy Carpenter believes that the majority of it is regarded as ‘On Track’ or better. Concerns do exist over a minority of syndicates that need to make significant progress, despite all market participants now being fully engaged in the progress.

Rating Agency View

Lloyd’s enjoys favorable ratings and published opinions from both Standard & Poor’s (A+/Stable “Strong”) and A.M. Best (A/Stable “Excellent”). Notably, both these ratings are at the same level as prior to the terrorist attacks of September 11, 2001, a significant difference with respect to all major peers that have failed to restore their ratings to those historic levels.

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Both rating agencies highlight similar strengths and weaknesses for Lloyd’s, notably strong capitalization, operating performance and competitive advantages offset by potential volatility in results (principally related to catastrophe losses) and the challenges of the current soft market.

Overall Outlook is Positive

While challenges exist, the overall strength and competitive position of Lloyd’s remains supportive to the global reinsurance industry, particularly brokered risks. Lloyd’s strategic plans establish a framework for ensuring underwriting discipline and clear targets for maintaining the competitive advantages of Lloyd’s in the post-Solvency II environment. While rating agency upgrades are not expected, the potential weaknesses of Lloyd’s have been addressed, and the propensity for downgrades appears lower than during previous soft cycles.

Click here to read the Executive Summary of Guy Carpenter’s report: Global Reinsurance Outlook: Points of Inflection; Positioning for Change in a Challenging Market >>

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