A lot of buzzing the past day or so about Lloyd’s of London’s first-half profits. Business Insurance was typical:
LONDON—Lloyd’s of London said its pretax profit fell by more than half during the first six months of this year due to significant claims and reduced investment returns.
Lloyd’s said Tuesday that its pretax profit was £628 million ($994 million) for the first six months of this year compared with £1.32 billion ($2.09 billion) for the first half of last year.
Lloyd’s, remember, is not an insurance company. It’s a consortium of independent underwriters – these days usually backed by a major insurer or reinsurer. The results are a pro forma aggregation of those underwriters, meaning all the results are added together to show how Lloyd’s would be performing were it a single company. (Lloyd’s releases on results are here.)
But are those results really so bad? Reactions, in one of its always welcome free articles, does the sanity check:
OK, profits were halved but otherwise the important numbers were as good if not better than their peers. Compare the Lloyd’s market’s results to the Aon Benfield Aggregate for example. Aon Benfield’s index of reinsurers saw their combined ratio lift to 100 from 89.8, where Lloyd’s managed to keep theirs under the psychologically critical break-even point.
I’d add that the first six months were a tough time for international catastrophes. So far this year, Lloyd’s has been hit by:
- Chilean earthquake: $1.4 billion
- Deepwater Horizon oil rig disaster: $300 million to $600 million.
- Winter weather in Europe and the United States: $100 million.
It’s not clear from what I’ve read whether those losses are gross or net of reinsurance, but $2 billion (£1.33 billion) of claims looks like about 10 points on the loss ratio. And 2009 was a light year for catastrophes. So the disasters almost bridge the difference in 2010 vs. 2009 results.
Of course, nothing is perfect. Return on equity is kinda low, under 8%. And Lloyd’s is captive to the same excess surplus issues the rest of the industry suffers under. Too much capital = too low rates. And with low interest rates in place for a couple of years now, insurers are rolling their bond portfolios into low-yield investments. So these days, investment income won’t bail out a poor underwriting result.
This is when Reactions’ analysis turns, to my mind, a bit too rosy, saying that Lloyd’s unique structure will keep its underwriters from a race to the bottom, rate-wise. Lloyd’s has a performance directorate, basically a board that reviews each agent’s underwriting plan. This is similar to a company’s executive review of budget proposals by department heads.
There’s such a level of uncertainty around the market now that Lloyd’s performance directorate is unlikely to accept any assumptions in a business member’s business plan. They’re going to challenge on loss ratios, premium rates and business volumes across the board. They’re going to raise very big question marks over new business ideas. They’re going to expect exposures to rise because terms and conditions do get stretched in a soft market and accumulations build up.
But this is where the Lloyd’s franchise comes into its own – or ought to do. The pressure can begin to tell on insurers’ executive management at times like this; they want to believe they can rise above the competition, buck the trends. They pass that down to the underwriters and mistakes get made.
That doesn’t happen so much at Lloyd’s anymore.
Lloyd’s has evolved in a way that market competition is both self regulating and is overseen. The market’s herd mentality means that individual underwriters are reluctant to stand out from the crowd – they know that schadenfreud is a plentiful commodity at Lloyd’s.
At the same time, management and individual underwriters at Lloyd’s have someone to watch over them – like it or not – in the shape of the performance directorate.
The assumption here is that the performance directorate lacks the agency problem that dogs most executive decisions. Recall the agency problem occurs when the interests of senior management (to maximize their pay) differ from the interests of the company (survival and profitability).
The directorate, in theory, is most invested in Lloyd’s long-term survival, so it will act to keep underwriting standards prudent. At a company, executives may sacrifice short-term results to boost their bonuses. So the structure at Lloyd’s would work to the institution’s advantage.
Perhaps – this is the first run-through for the directorate in a soft market. The concept was introduced around 2003, when rates were rising.