For those able to navigate the complexity inherent in the Lloyd’s insurance and reinsurance market, the conditions for investing there are looking increasingly favourable, according to Dirk Lohmann, Chairman, and Peter Brown, ILS Originator and Structurer, Schroders Capital ILS.
The pair explained in a recent white paper that the investment opportunity at Lloyd’s of London is a good example of the “complexity premium”.
Here, they mean, that accessing insurance and reinsurance linked returns from Lloyd’s can seem a more complex proposition, while certain skills are required to source, select, negotiate, develop and importantly exit the investment.
“Insurance Linked Securities (“ILS”) by their very nature are complex,” the pair explain. “Lloyd’s as a subset of ILS, even more so. It is an insurance market like no other. It has its own unique terminology, market structure and regulatory framework.”
But, the opportunity is compelling and worth navigating the complexity for.
As they wrote that, “For those that can negotiate the complexity, there is a fundamentally compelling investment thesis. Here, we explain the capacity a Lloyd’s strategy has to generate double-digit return on capital that exhibits low correlation to other asset classes.”
Along with the firming of insurance pricing through recent years and the significant hardening of reinsurance at the January renewals, Schroders Capital ILS now believes, “The arguments for investing in insurance underwriting at Lloyd’s have rarely been so strong.”
Saying that, “With a market structure that uniquely caters for investors seeking to access insurance risks, we believe that the current market conditions are increasingly favourable towards investing at Lloyd’s.”
The Schroders Capital ILS team believes that syndicates at Lloyd’s may be looking for additional capital in 2023, not least due to the impacts of hurricane Ian last year.
In part that is to ensure they have sufficient capital to meet Lloyd’s stringent requirements, but it’s also to ensure syndicates can capitalise on the opportunity presented by the hard reinsurance market environment.
Interestingly, Lohmann and Brown explain how the Lloyd’s market can deliver returns that, like other insurance-linked securities (ILS) opportunities, are relatively uncorrelated to broader asset classes.
But Lloyd’s returns do exhibit a correlation with catastrophe bonds, as you might expect, although in heavy catastrophe loss years cat bonds have tended to beat Lloyd’s performance.
“The fact that cat bonds were able to generate positive returns despite heavy industry losses caused by the very thing they are intended to protect, highlights their benefits,” the Schroders Capital ILS pair explained.
But they also highlight that the return potential of investing in Lloyd’s can be much greater.
“Both Lloyd’s and cat bonds achieved outsized returns in the five years following the last period of insurance market dislocation. In the five years that followed hurricanes Katrina, Rita, Wilma in 2005 Lloyd’s generated an average annual return on FAL of 26.7% while the Swiss Re Global Cat Bond Total Return Index delivered average annual growth of 10.9%.”
In the wake of hurricane Ian and in the context of a hard reinsurance market, the opportunity to invest at Lloyd’s therefore looks particularly attractive now.
On a forward-looking basis, Lloyd’s entities have reduced their catastrophe exposure, at the market’s request in recent years.
Because of that, Schroders Capital ILS believes that the “relative prospective correlation between a Lloyd’s investment and an investment in ILS will reduce,” which could serve to make investing into Lloyd’s opportunities more attractive as well, especially for those investors already allocating to other ILS opportunities and looking to deploy more capital to insurance.
With the reinsurance market having undergone a major correction in terms of pricing, Schroders Capital ILS says the opportunity right now is particularly attractive and believes the upwards trajectory in pricing is “unlikely to stall in the short to medium term.”
As a result, they conclude, “Over the last twenty years there has arguably never been a better time to be an underwriter of insurance risks.”
That goes for providing underwriting capital as an investor too.
Of course, we’re already seeing numerous ways that private capital is accessing returns from Lloyd’s, from the more traditional funding of syndicates, to dedicated specialist investment vehicles that allocate to multiple players at Lloyd’s, to the market’s London Bridge ILS structures.
In addition, we’ve seen ILS fund managers backing funds at Lloyd’s (FAL’s), or even establishing their own syndicates in the market, for example Nephila Capital has two.
The range of access points is quite wide and if the UK can make its ILS regulations more attractive to investors, the range of options for accessing Lloyd’s business could expand further in years to come.
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