Tag Archives: Lloyds of London

Befuddled Lloyd’s

Lloyd’s of London always provides a fascinating insight into the London insurance market and beyond into the global specialty insurance market, as this previous post shows. It’s Chairman, Bruce Carnegie-Brown, commented in their 2017 annual report that he expects “2018 to be another challenging year for Lloyd’s and the Corporation continues to refine its strategy to address evolving market conditions”. Given the bulking up of many of its competitors through M&A, Willis recently called it a reinvigoration of the “big balance sheet” reinsurance model, Lloyd’s needs to get busy sharpening its competitive edge. In a blunter message Brown stressed that “the market’s 2017 results are proof, if any were needed, that business as usual is not sustainable”.

A looked at the past 15 years of underwriting results gives an indicator of current market trends since the underwriting quality control unit, called the Franchise Board, was introduced at the end of 2002 after the disastrous 1990’s for the 330-year-old institution.

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The trend of increasing non-CAT loss ratios after years of soft pricing coupled with declining prior year reserve releases is clear to see. That increases the pressure on the insurance sector to control expenses. To that end, Inga Beale, Lloyd’s CEO, is pushing modernisation via the London Market Target Operating Model programme hard, stating that electronic placement will be mandated, on a phased basis, “to speed up the adoption of the market’s modernisation programme, which will digitise processes, reduce unsustainable expense ratios, and make Lloyd’s more attractive to do business with”.

The need to reduce expenses in Lloyd’s is acute given its expense ratio is around 40% compared to around 30% for most of its competitors. Management at Lloyd’s promised to “make it cheaper and easier to write business at Lloyd’s, enabling profitable growth”. Although Lloyd’s has doubled its gross premium volumes over the past 15 years, the results over varying timeframes below, particularly the reducing underwriting margins, show the importance of stressing profitable growth and expense efficiencies for the future.

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A peer comparison of Lloyd’s results over the past 15 years illustrates further the need for the market to modernise, as below. Although the 2017 combined ratio for some of the peer groupings have yet to finalised and published (I will update the graph when they do so), the comparison indicates that Lloyd’s has been doing worse than its reinsurance and Bermudian peers in recent years. It is suspicious to see, along with the big reinsurers and Bermudians, Lloyd’s included Allianz, CNA, and Zurich (and excluded Mapfe) in their competitor group from 2017. If you can’t meet your target, just change the metric behind the target!

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A recent report from Aon Benfield shows the breakdown of the combined ratio for their peer portfolio of specialist insurers and reinsurers from 2006 to 2017, as below.

click to enlargeAon Benfield Aggregate Combined Ratio 2006 to 2017

So, besides strong competitors, increasing loss ratios and heavy expense loads, what does Lloyd’s have to worry about? Well, in common with many, Lloyd’s must contend with structural changes across the industry as a result of, in what Willis calls in their latest report, “the oversupply of capital” from investors in insurance linked securities (ILS) with a lower cost of capital, whereby the 2017 insured losses appears to have had “no impact upon appetite”, according to Willis.

I have posted many times, most recently here, on the impact ILS has had on property catastrophe pricing. The graph of the average multiple of coupon to expected loss on deals monitored by sector expert Artemis again illustrates the pricing trend. I have come up with another angle to tell the story, as per the graph below. I compared the Guy Carpenter rate on line (ROL) index for each year against an index of the annual change in the rolling 10-year average global catastrophe insured loss (which now stands at $66 billion for 2008-2017). Although it is somewhat unfair to compare a relative measure (the GC ROL index) against an absolute measure (change in average insured loss), it makes a point about the downward trend in property catastrophe reinsurance pricing in recent years, particularly when compared to the trend in catastrophic losses. To add potentially to the unfairness, I also included the rising volumes in the ILS sector, in an unsubtle finger point.

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Hilary Weaver, Lloyd’s CRO, recognises the danger and recently commented that “the new UK ILS regulation will, if anything, increase the already abundant supply of insurance capital” and “this is likely to mean that prices remain low for many risks, so we need to remain vigilant to ensure that the prices charged for them are proportionate to the risk”.

The impact extends beyond soft pricing and could impact Lloyd’s risk profile. The loss of high margin (albeit not as high as it once was) and low frequency/high severity business means that Lloyd’s will have to fish in an already crowded pond for less profitable and less volatile business. The combined ratios of Lloyd’s main business lines are shown below illustrating that all, except casualty, have had a rough 2017 amid competitive pressures and large losses.

As reinsurance business is commoditised further by ILS, in a prelude to an increase in machine/algorithm underwriting, Lloyd’s business will become less volatile and as a result less profitable. To illustrate, the lower graph below shows Lloyd’s historical weighted average combined ratio, using the 2017 business mix, versus the weighted average combined ratio excluding the reinsurance line. For 2003 to 2017, the result would be an increase in average combined ratio, from 95.8% to 96.5%, and a reduction in volatility, the standard deviation from 9.7% to 7%.

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To write off Lloyd’s however would be a big mistake. In my view, there remains an important role for a specialist marketplace for heterogeneous risks, where diverse underwriting expertise cannot be easily replicated by machines. Lloyd’s has shown its ability in the past to evolve and adapt, unfortunately however usually when it doesn’t have any choice. Hopefully, this legendary 330-year-old institution will get ahead of the game and dictate its own future. It will be interesting to watch.


Epilogue – Although this analogy has limitations, it occurs to me that the insurance sector is at a stage of evolution that the betting sector was at about a decade ago (my latest post on the sector is here). Traditional insurers, with over-sized expenses, operate like old traditional betting shops with paper slips and manual operations. The onset of online betting fundamentally changed the way business is transacted and, as a result, the structure of the industry. The upcoming digitalisation of the traditional insurance business will radically change the cost structure of the industry. Lloyd’s should look to the example of Betfair (see an old post on Betfair for more) as a means of digitalising the market platform and radically reducing costs.

Follow-on 28th April – Many thanks to Adam at InsuranceLinked for re-posting this post. A big welcome to new readers, I hope you will stick around and check out some other posts from this blog. I just came across this report from Oliver Wyam on the underwriter of the future that’s worth a read. They state that the “commercial and wholesale insurance marketplaces are undergoing radical change” and they “expect that today’s low-price environment will continue for the foreseeable future, continuing to put major pressure on cost“.


More and more business is moving to the cloud and, given the concentration of providers and their interlinkages, it’s creating security challenges. In the US, 15 cloud providers account for 70% of the market.

The National Institute of Standards and Technology (NIST) describes the cloud as a model for enabling convenient, on-demand network access to a shared pool of configurable computing resources that can be rapidly provisioned and released with minimal management effort or service provider interaction.

 A cloud solution is typically architected with multiple regions, where a region is a geographical location where users can run their resources, and is typically made up of multiple zones. All major cloud providers have multiple regions, located across the globe and within the US. For example, Rackspace has the fewest number of regions at 7 whereas Microsoft Azure has the most at 36.

The industry is projected to grow at a compound annual growth rate of 36% between 2014 and 2026, as per the graph below. Software as a service (SaaS), platform as a service (PaaS), and infrastructure as a service (IaaS) are the types of cloud services sold.

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Control of the underlying cloud infrastructure of networks, servers, operating systems, and storage is the responsibility of the cloud provider, with the user having control over the deployed applications and possibly configuration settings for the application-hosting environment.

Amazingly however, the main responsibility for protecting corporate data in the cloud lies not with the cloud provider but with the cloud customer, unless specifically agreed otherwise. Jay Heiser of Gartner commented that “we are in a cloud security transition period in which focus is shifting from the provider to the customer” and businesses “are learning that huge amounts of time spent trying to figure out if any particular cloud service provider is secure or not has virtually no payback”.

An organisation called the Cloud Security Alliance (CSA) issued its report on the security threats to the cloud.  These include the usual threats such as data breaches, denial of service (DoS), advanced persistent threats (APTs) and malicious insiders. For the cloud, add in threats including insufficient access management, insecure user interfaces (UIs) and application programming interfaces (APIs), and shared technology vulnerabilities.

Cyber security is an important issue today and many businesses, particularly larger business are turning to insurance to mitigate the risks to their organisations, as the graph below on cyber insurance take-up rates shows.

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Lloyds of London recently released an interesting report called Cloud Down that estimated the e-business interruption costs in the US arising from the sustained loss of access to a cloud service provider. The report estimates, using a standard catastrophic modelling framework from AIR, a cyber incident that takes a top 3 cloud provider offline in the US for 3-6 days would result in ground-up loss central estimates between $7-15 billion and insured losses between $1.5-3 billion. By necessity, the assumptions used in the analysis are fairly crude and basic.

Given the number of bad actors in the cyber world, particularly those who may intend to cause maximum disruption, security failings around the cloud could, in my view, result in losses of many multiples of those projected by Lloyds if several cloud providers are taken down for longer periods. And that’s scary.

London Isn’t Calling

In a previous post, I reproduced an exhibit from a report from Aon Benfield on the potential areas of disruption to extract expenses across the value chain in the non-life insurance sector, specifically the US P&C sector. The exhibit is again reproduced below.

 click to enlargeexpenses-across-the-value-chain

The diminishing returns in the reinsurance and specialty insurance sector are well known due to too much capital chasing low risk premia. Another recent report from Aon Benfield shows the sector trend in net income ROE from their market representative portfolio of reinsurance and specialty insurers, as below.

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It’s odd then in this competitive environment that the expense ratios in the sector are actually increasing. Expense ratios (weighted average) from the Willis Re sector representative portfolio, as below and in this report, illustrate the point.

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The 2016 edition of the every interesting S&P Reinsurance Highlights, as per this link, also shows a similar trend in expense ratios as well as showing the variance in ratios across different firms, as below.

click to enlargesp-expense-ratios

Care does need to be taken in comparing expense ratios as different expense items can be included in the ratios, some limit overhead expenses to underwriting whilst others include a variety of corporate expense items. One thing is clear however and that’s that firms based in the London market, particularly Lloyds’, are amongst the most top heavy in the industry. Albeit a limited sample, the graph below shows the extent of the difference of Lloyds’ and some of its peers in Bermuda and Europe.

click to enlargeselect-expense-ratios

Digging further into expense ratios leads naturally to acquisitions costs such as commission and brokerage. Acquisition costs vary across business lines and between reinsurance and insurance so business mix is important. The graph below on acquisition costs again shows Lloyds’ higher than some of its peers.

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Although Brexit may only result in the loss of fewer than 10% of London’s business, any loss of diversification in this competitive market can impact the relevance of London as an important marketplace. Taken together with the gratuitous expense of doing business in London, its relevance may come under real pressure in the years to come. London is, most definitely, not calling.

Pimping the Peers (Part 2)

In the last post on this topic, I highlighted how new technologies, broadly under the fintech tag, had the potential to disrupt the banking sector, primarily by means of automating processes rather than any major reinventing of business models (although I did end that post with a bit of a rant about innovation and human behaviour). Blockchain is the hot topic that seems to be cropping up everywhere (I’ll leave that for another time). This post is about insurance and new technology, or in the jargon, insurtech.

The traditional business model in the insurance industry is not reacting well to a world of low or negative interest rates. For the life insurance sector, the duration mismatch between their liabilities and their assets is having a perverse impact as interest rates have fallen. Savings returns for aging populations have been sacrificed in Central Bank’s attempt to stimulate economic growth.

In addition, the traditional distribution channel for selling life insurer’s products, and the old adage is that these products are sold rather than bought, has relied too heavily on aging tied agents whose focus is on the wealthy client that can generate more fees than the middle class. The industry is generally at a loss on how to sell products in a low interest world to the mass market and to the new tech savvy generation. As a result, the industry and others are throwing money at a rash of new start-ups in insurance, as the exhibit on some of the current hyped firms focusing on life insurance below illustrates.

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As the exhibit illustrates, the focus of these new start-ups is weighted towards technologies around product development, distribution, and underwriting. Some will likely succeed in trying to differentiate further the existing clientele of life insurers (e.g. real time health data). Many will be gobbled up or disappear. Differing attitudes between those aged under 34 and the older generation towards online distribution channels can be clearly seen in the survey results in the exhibit below.

click to enlargeattitudes-to-life-insurance-distribution-channels

With longevity and low interest rates the dominant challenges for life insurers today, automation of processes will assist in cutting expenses in the provision of products (mainly to the existing customer base) but will not likely meaningfully address the twin elephants in the room.  Citigroup reckons that in 20 of the largest OECD countries the unfunded government liability for pensions is around $78 trillion which compares to approximately $50 trillion in GDP for all OECD countries in 2015. I look forward to conversing with a robo-advisor in the near future on what products it recommends for that problem!

Insurance itself is hundreds of years old and although the wonderfully namely bottomry (the earliest form of marine hull insurance) or ancient burial societies are early examples, non-life insurance really took off with mass markets after the great fire of London in 1666.

The most hyped example of insurtech in the non-life sector is the impact of technologies on the motor business like drive-less cars and car telematics. This paper from Swiss Re shows that the impact over the next 20 years of such advances on motor premia could be dramatic.

Much of the focus from insurtech innovation is on reducing expenses, an item that the industry is not light on. The graph below shows examples of the level of acquisition and overhead expenses in the non-life sector across different jurisdictions.

click to enlargenonlife-expense-ratios

A recent report from Aon Benfield went further and looked at expenses across the value chain in the US P&C insurance sector, as below. Aon Benfield estimated overall expenses make up approximately half of gross risk premium, much of which represents juicy disruption targets for new technology in the insurtech world.

click to enlargeexpenses-across-the-value-chain

Insurance itself is based upon the law of large numbers and serves a socially useful function in reducing economic volatility by transferring risks from businesses and consumers. In 1906, Alfred Manes defined insurance as “an economic institution resting on the principle of mutuality, established for the purpose of supplying a fund, the need for which arises from a chance occurrence whose probability can be estimated”.

One of the issues identified with the current non-life insurance sector is the so-called protection gap. This is in effect where insurers’ risk management practises have got incredibly adapt at identifying and excluding those risks most likely to result in a claim. Although good for profits, it does bring the social usefulness of the transference of only the pristine risks into question (for everybody else). The graph below from Swiss Re illustrates the point by showing economic and insured losses from natural catastrophe events as a % of GDP.

click to enlargeinsurance-protection-gap-uninsured-vrs-insured-losses

It’s in the context of low investment returns and competitive underwriting markets (in themselves being driven by low risk premia across asset classes) that a new technology driven approach to the mutual insurance model is being used to attack expense and protection gap issues.

Mutuals represent the original business model for many insurers (back to burial schemes and the great fire of 1666) and still represent approximately a third of the sector in the US and Europe today. Peer to peer insurers are what some are calling the new technology driven mutuals. In fact, most of the successful P2P models to date, firms like Guevara, Friendsurance, and Inspeer are really intermediaries who pool consumers together for group discounts or self-financing of high deductibles.

Lemonade, which launched in New York this week, is a peer to peer platform which issues its own insurance policies and seeks to address the protection gap issue by offering broader coverage. The firm has been heavily reinsured by some big names in insurance like Berkshire Hathaway and Lloyd’s. It offers a fee based model, whereby the policyholders pay claims through mutualisation (assumingly by pools determined by pre-defined criteria). Daniel Schreiber, CEO and co-founder of Lemonade says that the firm will be ”the only insurer that doesn’t make money by denying claims”. Dan Ariely, a big deal in the world of Behavioral Economics, has been named as Chief Behavioral Officer, presumably in an effort to assist in constructing pools of well behaved policyholders.

The graphic below tries to illustrate how the business model is evolving (or should that be repeating?). Technology offers policyholders the opportunity to join with others to pool risk, hitherto a process that was confined to associations amongst professional groups or groups bound by location. Whether technology offers the same opportunity to underwrite risks profitably (or at least not at a loss) but with a larger reach remains to be seen.

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It does occur to me that it may be successful in addressing areas of dislocation in the industry, such as shortfalls in coverage for flood insurance, where a common risk and mitigant can be identified and addressed in the terms of the respective pool taking the risks on.

For specialty re/insurers, we have already seen a bifurcation between the capital providers/risk takers and the risk portfolio managers in the ILS arena. Newer technology driven mutual based insurers also offer the industry a separation of the management of risk pools and the risk capital provided to underwrite them. I wish them well in their attempts at updating this most ancient of businesses and I repeat what I said in part 1 of this post – don’t let the sweet scent of shiny new technology distract you from the smell of the risk…..

Naive Newcomers

The insurance sector has been hit by the Brexit fallout on worries about macro-economic impacts; albeit not to the same extend as the banks. Swiss Re has their latest Sigma world insurance report out. The impact of investment returns on the life insurance sector is obvious but it is interesting to see the contribution from investment income on the profitability of the aggregate of the eight largest markets in the non-life insurance sector, as per the graph from the report below.

click to enlargeNonLife Insurance Sector Profit Breakdown

The insurance sector faces a number of challenges as a recent FT article pointed out. The reinsurance sector also faces challenges, not least of which is a competitive pricing environment and the destabilising influx of new yield seeking capital through new innovations in the insurance linked securities (ILS) market. I have posted my views on the ILS sector many times (more recently here) and in this post I offer more similar thoughts. It is interesting to compare the ROEs in the Sigma report from the non-life insurance sector against those from the reinsurance sector (with the ROEs since 2005 coming from the Guy Carpenter composite index), as per the graph below.

click to enlargeGlobal Insurance & Reinsurance ROEs 1999 to 2016e

The graph is not exactly comparing like with like (e.g. non-life insurance versus composite reinsurance) but it gives the general idea of higher but more volatile ROEs in the reinsurance side compared to more stable but lower ROEs on the direct insurance side. The average since 1999 for insurance is 7% and 9% for reinsurance, with standard deviations of 3.6% and 4.6% respectively. It also confirms that ROEs are under pressure for both sectors and as capital markets continue to siphon off volatile excess catastrophe exposed business, the ROEs of the more proportional traditional reinsurance sector are converging on those of their direct brethren, although a differential will always exist given the differing business models.

It is important to note that these ROEs are returns on equity held by traditional insurers and reinsurers, the majority of which are highly rated by external agencies, who hold a small fraction of their total exposure (if measured as the sum of the policy limits issued) as capital. For example, the new European solvency framework, Solvency II, requires capital at a 1 in 200 level and it is generally assumed to be akin to a financial strength rating of BB or BBB, depending upon a firm’s risk profile.

As I argued previously (more recently in this post), these (re)insurers are akin to fractional reserve banks and I still struggle to understand how ILS structures, which are 100% collaterised, can offer their investors such an attractive return given their fully funded “capital” level in the ROE calculation. The industry argument is that investors have a lower cost of capital due to the uncorrelated nature of the pure insurance risk present in ILS.

My suspicion is that the lower cost of capital assigned by investors is reflective of a lack of understanding of the uncertainties surrounding the risks they are taking on and an over-reliance on modelling which does not fully consider the uncertainties. My fear is that capital is been leveraged or risks are been arbitraged through over-generous retrocession deals passing on under-priced risk to naive capital newcomers.

The accelerating growth in the so-called alternative capital in insurance is shown in the graph below from Aon Benfield, with growth in the private collaterised reinsurance being particularly strong in the last four years (now overshadowing the public CAT bond market). ILS funds, managed by professional asset manager specialists, are largely behind the growth in private collaterised deals with assets under management growing from $20 billion in 2012 to over $50 billion today. Private collaterised deals are usually lower down the reinsurance tower (e.g. attach at lower loss levels) and as such offer higher premiums (as a percentage of limits, aka rate on line or ROL) for the increased exposure to loss. On a risk adjusted basis, these don’t necessarily offer higher ROEs than higher attaching/lower risk CAT bonds.

click to enlargeAlternative Insurance ILS Capital Growth

Property catastrophe pricing has been under particular pressure in the past few years due to the lack of significant insured catastrophe losses. In a previous post, I crudely estimate CAT pricing to be 25% below its technical rate. Willis Re is the first of the brokers to have its mid-year renewal report out. In it, Willis said that ILS funds “were more aggressive on pricing during the second quarter as spreads declined for liquid reinsurance investments”. I also find it interesting that the collaterised ILW volumes have ticked up recently. Pricing and lax terms and conditions in the retrocession sector are historically a sign that discipline is breaking down. Asset managers in the ILS space must be under pressure in maintaining their high fees in a reduced CAT risk premia environment and this pressure is likely to be contributing to the potential for market indiscipline.

I therefore find the graph below very telling. I used the figures from Lane Financial (see here) for the annual total return figures from CAT bonds, which closely match those of the Swiss Re Total Return Index. For the ILS fund returns I used the figures from the Eurekahedge ILS Advisors Index which I adjusted to take out the not unconsiderable typical ILS fund management fees. The 2016 figures are annualized based upon published year to date figures (and obviously assume no major losses).

click to enlargeCAT Bond vrs ILS Fund Returns

The graph shows that ILS fund returns have broken with historical patterns and diverged away from those of CAT bonds as the prevalence in private collaterised deals has grown in recent years. In other words, ILS funds have moved to higher rate on line business, which is by definition higher risk, as they push to service the larger level of assets under management. The question is therefore do the investors really understand the significance of this change? Have they adjusted their cost of capital to reflect the increased risk? Or are some ILS funds representing the higher returns as their ability to get higher returns at the same risk level (against the trend of everybody else in the industry in a softening market)?

Innovation is to be encouraged and a necessary part of progress. Innovation dependent on the naivety of new investors however does not end well.

I can’t but help think of Michael Wade’s comment in 2009 about the commonality between the financial crisis and problems at Lloyds of London (see this post on lessons from Lloyds) when he said that “the consequence with the excess capital was that underlying risks could be underpriced as they were being passed on”. My advice to ILS investors is the next time they are getting a sales pitch with promises of returns that sound too good, look around the room, and ask yourself who is the greater fool here….