Lloyd’s Nelson: £3.2bn profit, pressure from new capital to continue

The Lloyd’s insurance and reinsurance market has announced a pre-tax profit of £3.2 billion with a combined ratio of 86.8% this morning, but Chairman John Nelson warns that competitive pressures from new capital are set to continue.

For the Lloyd’s insurance and reinsurance market the 2013 annual results are the markets most profitable year since 2009. In 2012 the market made a profit of $2.771 billion and its combined ratio was higher at 91.1%, showing that the low catastrophe loss year in 2013 was a major factor in the results.

Alongside the low-level of catastrophe losses, Lloyd’s 2013 results benefitted from an increase of 2.4% in gross written premiums, with £26.106 billion written in 2013 compared to £25.5 billion written in 2012. The Lloyd’s markets return on capital was also up in 2013 at 16.2% compared to 14.8% in 2012 and its capital position improved with net assets of £21.1 billion, up on £20.2 billion a year earlier.

Chairman John Nelson explained the results in context of the market environment; “Good as these results are, they should be seen in the context of a year which was low in terms of major claims for the Lloyd’s market, with little exposure to the typhoon in the Philippines or the severe flooding and windstorms in the UK and the rest of Europe.”

On the positive side the Lloyd’s market achieved these results despite a still challenging economic environment. Nelson said; “This result was, however, achieved despite investment returns being historically low, caused by continued exceptionally low interest rates. While there are encouraging signs of the UK and the US economies showing stronger GDP growth, the wider global recovery remains subdued. We do not expect interest rates to rise in the short term.”

However, the Lloyd’s insurance and reinsurance market has not been immune to the influence of alternative reinsurance capital, the capital markets interest in insurance linked investments and the well-capitalised traditional reinsurance sector. Just like the large, globally diverse reinsurers, Lloyd’s has felt the competitive pressures in 2013, which Nelson said he expects will continue.

He said; “As well as reducing investment income, low interest rates have also led to the insurance market attracting substantial levels of capital, some coming from capital market sources, which historically have not invested in the insurance industry.”

It is perhaps a little surprising that Nelson has not mentioned the fact that traditional reinsurers are extremely well-capitalised at the moment, which is likely causing more pressure on Lloyd’s due to the specialty nature of much of its underwriting. In fact, the insurance-linked securities market and capital markets investors allocating finances in reinsurance are likely a very small amount of the overall competition for the Lloyd’s markets core business.

Nelson continued; “This additional capital, combined with a relatively light claims experience, has caused significant and increased competitive pressure over the year end and into the early part of 2014. We expect this increased pressure to continue for the foreseeable future.”

The upcoming renewals throughout 2014 are set to be challenging for Lloyd’s, as they will be for all reinsurers and even for the alternative capital players who are also under competitive pressures. Lloyd’s could respond to this if the market chose to embrace the capital markets and make it much simpler for new capital from investors such as pension funds to enter, thus lowering its own cost-of-capital.

Nelson noted that the challenge faced by Lloyd’s is significant; “While the Lloyd’s market is in a strong position, we are facing significant challenges and significant opportunities which require the market to evolve in order to maintain and reinforce our position as the global centre for specialist insurance and reinsurance.”

Nelson does acknowledge the need for Lloyd’s to capitalise on the current interest in reinsurance from both traditional and non-traditional capital, making a comment which perhaps suggests that the market is beginning to realise that there is an opportunity as well as a threat here.

He commented; “Lloyd’s, as a market, has the opportunity over the medium and longer term to harness capital, from traditional and new sources, to meet the growing demand for specialist insurance. This will require imagination and innovation in developing the right structures – blending this new capital with the right approach to underwriting discipline, risk modelling and measurement, and appropriate pricing.”

Nelson is correct that imagination is required to take advantage of this opportunity. Pension fund investors that Artemis speaks with regularly express a desire to access the returns of the Lloyd’s market, but this is currently seen as a difficult and opaque market by the investor community with no easy way to enter directly.

A variety of vehicles exist which accept capital from third-party investors such as pension funds, but some of these investors want a much more direct route to access the returns of the diversified market-wide business written at Lloyd’s. With some imagination and innovation a variety of structures could make this possible, so it is encouraging to see Nelson explicitly refer to facilitating the entry of new capital into Lloyd’s.

One of the goals of the Council of Lloyd’s is to make it simpler for Names capital to participate in Lloyd’s, by using the special purpose syndicate structure. Perhaps this goal should be focused more widely on how to bring new capital from any source into the Lloyd’s market more simply and with lower frictional costs.

The next iteration of Lloyd’s strategic plan will look closely at how the market responds to the increasing interest of alternative capital into insurance and reinsurance, what the market’s response should be and what actions to take.

The challenging  reinsurance market environment is not going to go away any time soon and Lloyd’s will likely find the pressure increasing over the rest of 2014, as will the rest of the reinsurance market. No player is immune and the competition is running both ways now, with alternative capital also pressured by abundant traditional.

The low catastrophe loss environment will not last forever. Hence underwriting discipline is key, but at the same time the Lloyd’s market stands uniquely placed to capitalise on current market trends meaning a focus on innovation in terms of products and market structure is also key.

Read some of our other recent articles on the Lloyd’s of London insurance and reinsurance market:

– Lloyd’s can evolve to suit reinsurance market dynamics: Nelson.

– New reinsurance capital, a challenge to Lloyd’s or an opportunity?

– Lloyd’s Nelson: Alternative capital can help insurance grow to $2tn by 2025.

– Lloyd’s Nelson warns on ‘systemic’ risk of alternative reinsurance capital.