Lloyd’s returns decline in 2015, efficiency increasingly important

The Lloyd’s of London insurance and reinsurance market suffered a drop in profitability in 2015 as the impacts of lower pricing on re/insurance underwritten, higher competition and lower investment returns all combined to reduce profits.

Lloyd’s reported this morning a pre-tax profit of £2.1 billion for 2015, down from the £3 billion it achieved in 2014.

The market saw an increase in gross premiums underwritten however, growing from 2014’s £25.3 billion to £26.7 billion in 2015, but the combined ratio deteriorated slightly from 88.4% to 90% in 2015.

Alongside the impact of lower pricing, that translated into an underwriting return of £2 billion for 2015, down from £2.3 billion in 2014.

The low interest rate environment and likely financial market volatility hurt the Lloyd’s investment portfolio in 2015, with the market investment return reported as just £400m, down from £1 billion in 2014.

And all of the above has resulted in the Lloyd’s return on capital dropping quite significantly to 9.1% for 2015, down from 14.1% in 2014. That’s a 36% drop in returns, despite underwriting more premiums. Despite the investment returns declining the Lloyd’s market is clearly feeling the effects of lower insurance and reinsurance rates.

Lloyd’s notes that profits remain “significant” despite the impact of pricing pressure in insurance and reinsurance markets and the fall in investment returns, citing “some of the most challenging market conditions the industry has seen for many years.”

Lloyd’s players are suffering steep pricing declines still, across property reinsurance, casualty risks, specialty lines such as energy, marine and insurance lines. This looks set to continue while the market remains free of major losses and competition globally for this business continues to grow.

Lloyd’s Chairman, John Nelson, commented on the results; “Each year brings a unique set of challenges, requiring determination, innovative thinking and solutions. This year has been no different. In a market undeniably tougher than seen for many years, we have had to demonstrate our ability to adapt and take action. In these conditions, these results are creditable and a tribute to the continued skill and professionalism of the Lloyd’s market underwriting community.”

Lloyd’s Chief Executive, Inga Beale, added; “Lloyd’s is pursuing its strategy to deliver risk solutions to a fast moving world. Business looks to the Lloyd’s market to underwrite policies too complex for others to handle. Protection from cyber-attacks, terrorism and climate change are needed now more than ever.”

What this makes abundantly clear for the Lloyd’s market and its participants, is that the returns of the past may not be seen for some time, if ever again. In a year when losses have remained relatively benign the Lloyd’s market has suffered a drop in return that is perhaps more evident than seen in the largest re/insurers.

It perhaps suggests that the Lloyd’s market is particularly exposed to market conditions, with the specialty nature of much of the business underwritten exposed to some of the greatest pricing pressure. The investment decline also perhaps suggests that Lloyd’s cannot be as agile with adjusting its portfolio of assets, perhaps due to the way the central fund is managed, meaning it suffers more due to lower investment returns.

Speculation aside, what the results really demonstrate is that insurance and reinsurance companies operating at Lloyd’s need to worry about capital efficiency. If the returns of the market are down so much, in a year when losses are low and premiums written actually increased, the efficiency of the capital deployed in the market becomes increasingly vital.

Could this play into the hands of the insurance-linked securities (ILS) players participating in the market, with their lower-cost of capital becoming a key advantage in this market? It’s possible, they may find their underwriting capital particularly competitive.

Also the lean nature of entering Lloyd’s as a capital providing investment manager in risk perhaps enables ILS players at Lloyd’s to gain an extra level of efficiency, compared to the much larger footprint of a re/insurance company electing to add a Lloyd’s arm to its operations.

With Lloyd’s set to continue to ramp up the way it embraces alternative capital it may find the pressure on the market return continues. The market points to the importance of innovation in its future and this is where Lloyd’s can position itself in order to boost returns.

By maintaining its position as the world’s leading hub of specialty insurance and reinsurance underwriting, while becoming the center of underwriting excellence for risks such as cyber, Lloyd’s can continue to play a vital role in global risk transfer.

By adding initiatives such as the Lloyd’s Index, which will provide a proxy for losses suffered by the market against which risk transfer products can be structured, the market can attract incremental sources of capital and business, ultimately increasing its importance to the global re/insurance market.

In order to raise profitability and returns the market also needs to become increasingly efficient, when actually expenses keep increasing as a proportion of net earned premiums (according to Lloyd’s). That cannot continue and Lloyd’s needs to find a way to make itself and the syndicates operating there increasingly efficient in order to be competitive.

But most important is that incumbent players at Lloyd’s and the management itself is ready for change. Disruption is coming, in the form of insurance technology (insurtech) which will see the markets business targeted by new entrants and major players.

Similarly the continued growth of alternative capital and ILS will continue to pressure Lloyd’s and no amount of embracing will reduce the pressure significantly, it will remain an issue unless the market can truly convert itself to more efficient models of business.

The annual report explains the outlook for Lloyd’s as; “Pricing in most classes will remain under pressure due to excess capital, competition from Insurance- Linked Securities and a lack of major catastrophes.”

“Innovators and those willing to embrace transformational change, not least in distribution and new market business development, will be better positioned to take advantage,” Lloyd’s explains.

And ILS is seen as an area the market can innovate; “The insurance sector began to embrace alternative forms of capital some 20 years ago and it is increasingly being seen as mainstream, presenting opportunities for innovation and diversification.”

The market needs to be an innovator and be ready and willing to embrace change, as the insurance and reinsurance market continues to transform and whether Lloyd’s likes it or otherwise, it has to change with it.