As Lloyd’s of London seeks to develop initiatives to attract more third-party, ILS and alternative reinsurance capital to it, rating agency A.M. Best warns of a number of considerations it feels are key for the market to consider.
Lloyd’s recognises that if it doesn’t modernise and adapt to the changing insurance and reinsurance market environment, including the interest of investors in insurance-linked securities (ILS), it could risk becoming less relevant on the global stage.
As a result, Lloyd’s launched its long-awaited BluePrint One, which details a high-level strategy to “build the most advanced insurance marketplace in the world,” part of which includes a set of new rules for capital to access the market and its returns, as well as an ambition to make it simpler for ILS investors to access the insurance and reinsurance market.
Rating agency A.M. Best noted in a recent report that for London market re/insurers and Lloyd’s participants, ILS and third-party reinsurance capital is beneficial, enabling them to, “increase the capacity they can offer clients, increasing their relevance in a competitive market, whilst earning them fee income.”
While Lloyd’s has structures that have enabled ILS capital to get access to the market, including funds at LLoyd’s, the special purpose syndicate (SPS) and full syndicates for a few of the major ILS players, the rating agency believes that these have not provided diverse or flexible enough access.
Because of this, “Lloyd’s has so far not been able to fully exploit this growing source of capacity,” A.M. Best says.
Which is what the Blueprint One initiatives as part of the Future at Lloyd’s hopes to change.
The Blueprint proposes leveraging insurance-linked securities (ILS) structures and investor appetite to bring new and competitive sources of capital into the Lloyd’s market.
Part of this is in leveraging the UK’s fledgling and currently underutilised ILS legislative and regulatory regime, to enable a tighter integration between these structures and Lloyd’s.
Another angle of the Blueprint is in creating cost-effective follow-only market structures, so capital can choose to back the underwriters of its choice,
Finally, the Blueprint also details a potential market tracker solution, like an ETF for the returns of the Lloyd’s insurance and reinsurance market.
As we’ve said a number of times, a lot of this seems focused on capital making itself available to be used by Lloyd’s players, as following or supportive capacity. Rather than in developing new ways for capital to participate more fully at Lloyd’s.
Hence the success of these initiatives is not assured and they won’t be for everyone in the institutional investor community, particularly when you consider the performance (or lack of it) of the Lloyd’s market over recent years.
The real trick for Lloyd’s is in finding a way to integrate the UK ILS structure and its marketplace, perhaps allowing the multi-use iSPV vehicle to attach itself to the Lloyd’s market as a transformer, for getting capital in and risk out.
But that could well prove a step too far and the eventual capital solutions may prove more suited to following capacity, than that seeking to underwrite the cycle itself in search of alpha generation.
A.M. Best lays out what it believes are the key considerations for Lloyd’s as it looks to bring third-party ILS capital more deeply within its marketplace.
First, underwriting standards must be maintained, A.M. Best notes. Here access to lower-cost capital could both help and hinder, depending on the discipline levels of the underwriters leveraging it.
Second, the rating agency warns on the potential for volatility in the availability of capacity at Lloyd’s. Here, it’s likely A.M. Best fears that alternative capital could prove more fickle than traditional, meaning it could exist as quickly as it enters if Lloyd’s creates truly flexible access points for it.
It’s also worth considering how traditional capital could find Lloyd’s less appealing as alternative capital comes in, given the cost and return ambitions of the ILS structure entry may prove lower than the return hurdles of more traditional forms of capacity.
Finally, A.M. Best highlights the need for the Lloyd’s Central Fund to be protected, as this really is part of the market’s differentiator.
There is a lot more to be considered as well. Lloyd’s needs to focus on the alignment of capital sources, ensuring that investors don’t feel like they are just being encouraged into the market as cheap capacity to support syndicates and their owners goals.
Capital wants to access Lloyd’s for the quality of the business opportunities, but it also wants to ensure those opportunities are underwritten properly and that it’s not just treated as retrocession and reinsurance to enable syndicates to do more.
In a market like Lloyd’s, with so many mouths to feed and costs to pay, getting the alignment right could be the single most important consideration, so matching the different initiatives to the right investors is also going to be key.
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