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Execs See Greater Opportunities, Challenges in Shifting Markets
Lloyd's, the legendary, 300-year-old insurance market, endured hard times through the 1990s, having been hobbled by massive asbestos-related claims. In the fallout from the Sept. 11, 2001 terrorist catastrophe, Lloyd's was hardest hit among insurers, with $3.5 billion in losses to date. It might have seemed the last straw for the institution, but it now appears the opposite is the case.
In 2000, Lloyd's management embarked on an ambitious overhaul of its operating structure, in an effort to streamline governance, make the market's operations and financial position more transparent and attract more brokers from around the world. Those reforms were well under way when Sept. 11 hit, and although Lloyd's had discouraging results in the two years leading up to the disaster, the market has since surged with record profits.
Earlier this year, Lloyd's reported pro forma 2002 results that showed a profit of 834 million pounds, compared with a 2001 loss of 3.1 billion pounds. The market's combined ratio improved to 98.6 from 140.3 a year earlier, and capitalization is at record levels.
Two of Lloyd's top executives--Julian James, director of worldwide markets, and Winifred A. Baker, president of Lloyd's America Inc.--spoke with BestWeek at the market's Manhattan office about how Lloyd's views the global insurance market in 2003 and the issues that concern them most.
One of those issues is the ongoing debate over Lloyd's status as an alien reinsurer in the United States, a designation that allows U.S. insurance regulators to require Lloyd's to put up 100% of the value of its U.S. exposure as collateral. "We had put a proposal before the National Association of Insurance Commissioners some time ago, suggesting the existing law should be amended to allow regulators the flexibility for reducing the funding requirement to 50% of gross premium for certain categories of reinsurers who meet certain standards," said James.
An NAIC committee on June 21 recommended that the association reject the request from foreign insurers such as Lloyd's to allow more flexibility on the issue. The NAIC said it would continue to study the issue. For James, the ongoing debate over alien status and its costs to Lloyd's in tied-up capital goes beyond the idea that any compromise by the NAIC would throw more risk exposure on U.S. insurers and insureds.
"It's interesting, because some U.S. trade groups, when they talk to non-U.S. governments about collateralization requirements, argue very strongly against these types of trade barriers," he said. "U.S. trade groups made that position quite clearly when they talked to Brazil, and certain U.S. trade groups made that position very clear in China. It's ironic when they argue to defend an existing trade barrier in the United States. Our position is very simple--the existing law is a trade barrier, it's discriminatory, and most importantly, it adds costs to the price of reinsurance, which ultimately gets passed on to consumers."
Baker said the treatment Lloyd's is getting as a company with alien status hasn't affected its underwriting strategies in the United States, which is, after all, Lloyd's' biggest market. "But I think it has made it more expensive," she said. "And it will make it more expensive going forward."
"Right now we have, in a bank vault just down the road in Manhattan, $9 billion sitting in our reinsurance trust fund," said James. "That's just for our U.S. reinsurance liabilities. Within that, we have reinsurance recoverables of about $4 billion. If we were a U.S. company, we'd be allowed to take credit for that--but we're not allowed to."
James insists that U.S. regulators haven't made their reasoning clear with regard to the rigid rules governing funding for alien reinsurers. "They want to satisfy themselves that they understand the accounting, and we continue to provide them with a lot of information on the differences between U.S. GAAP and U.K. GAAP," he said. "They continue to study the impact of having a variable funding level. They've been studying the regulatory regimes in other areas. They're not defending the current system, they're just going through their own due diligence."
On the accounting front, Lloyd's is working hard to keep up with global changes in practices, said James. Over the past two years, the market has begun to implement a one-year standard side-by-side with its unique three-year accounting method. At the same time, Lloyd's has to keep an eye on the shift to an international accounting standard that will be adopted by most companies in continental Europe by the end of 2005.
"For some time, we have felt that, although our three-year system is very good, no one else uses it. In the interests of transparency--to be able to compare our financials with others--we need to change to a more recognized accounting system," James said. "We've been in discussions with the European Union, and we've agreed that Lloyd's will change to U.K. GAAP as of Jan. 1, 2005, and will be treated the same as any U.K. insurer."
James said the Lloyd's market is "very pleased" with the idea of using the same accounting methods as everyone else, because the market believes it will compare very well with the competition, using the same standard of financial measurement. "We believe that comparison and openness will be of benefit to the Lloyd's market," he said.
Lloyd's doesn't anticipate any unique problems with implementing U.K. GAAP accounting that would relate to its unique structure as a market, encompassing interacting agencies and companies, said James. For the past two years, Lloyd's has had its syndicates keep two sets of books--one based on Lloyd's accounting and the other based on U.K. GAAP. "That process has worked very smoothly, and I'm not aware of any difficulties that anyone has had," he said.
Along with changes in accounting, over the past year Lloyd's has been looking more closely at opportunities in markets outside the United States. In 2002, 35% of Lloyd's business was in the United States, another 32% in the United Kingdom. Only 14% of the market's business is represented by the rest of Europe. In a recent speech, Lloyd's Chairman Lord Peter Levene said he was somewhat mystified by the seeming under-representation of Lloyd's in continental Europe, and he called for the market to build a bigger presence there.
"It's not a question of regulatory barriers, because there are none," said James of Europe. "It's more a question of cultural barriers. There are several languages. Traditionally, French businesses have gone to French insurers, and German businesses to German insurers."
Baker added that the cultural ties to local insurers in Europe have been a long time in the making. "When you look at the small mutuals that are so much a part of the French insurance market, you can see that they go back a long way," she said. "French buyers are accustomed to that local service. It's a very difficult market to compete in. It's a big cultural change for the people buying the insurance, rather than for us."
"It's our thinking that as the EU develops, and people look more across the depth of the EU, those barriers will start to be reduced," James added. "Partly because of the language, we would naturally gravitate toward the U.S., when right across the English Channel there's a healthy insurance market."
The interest is there for Lloyd's to take advantage of, said James. The event at which Levene gave his speech on Europe, the Lloyd's European Symposium, drew more than 250 insurance brokers and risk managers from France, Germany and elsewhere in Europe. "We were staggered that that many people came to the event," said James. "And what they said to us was that the Lloyd's expertise and security are greatly valued. A lot of the conversation was about how to access Lloyd's underwriters."
Among the differences in market opportunities between the United States and Europe, liability lines appear more promising in Europe, said Baker. "Europe doesn't have the tort system we have in the U.S.," she said. "At least not yet."
Baker wasn't sure the current Congress would enact meaningful tort reform, but looking back on 25 years of effort to get some kind of tort reform enacted, "this is the closest I've ever seen it come," she said. "With the current administration and the makeup of the Senate, we might have some chance of getting some sort of reform, which would help every line of business."
The litigation culture in the United States has mostly driven Lloyd's out of the general-liability business in that market, said Baker. "If you look at our U.S. book of business, it's predominantly property, marine, aviation, professional liability and medical malpractice," she said. "But we don't write much general liability anymore, because you can't price it. You can look at a hospital, and price the liability there. But you can't look at Joe's Hardware, and price the risk that somebody will sue because they were injured by an axe they bought there 10 years ago."
One impact of the Sept. 11 disaster on U.S. markets has been the approach insurers and reinsurers take to business interruption and contingent business interruption, said Baker. Pricing for those lines has become clearer since the disaster, as insurers took a closer look at the aggregate exposures of businesses such as hotel chains and began to use real estate data to model commercial exposure to large-scale events.
James added that a sharper focus fell on terms and conditions, and the use of deductibles in forming commercial policies, in the wake of Sept. 11. "Pre-9/11, insurers wrote all-risk perils and said, 'anything that happens, we'll pay,'" he said. "Now, underwriting has become more specialized and specific."
Tighter underwriting naturally leads to a greater emphasis on specialty underwriting, said Baker. In a sense, the market cycle has come full circle to where it was about 30 years ago, she said. "Back then, people had specific policies for specific exposures," she said. "Then the brokers started grouping everything together, and ended up with global catastrophe covers, which included general liability. And that's where the asbestos lawsuits hit many insurers--in policies that were supposed to be property covers but had the general-liability component.
"The same thing happened with these all-risk policies, where insurers threw in everything but the kitchen sink but didn't price it," said Baker. "Then they woke up after Sept. 11 and found they had obligations they didn't price."
In the ensuing hard market, admitted carriers began to strip out the unpriced risks from their policies. Those risks were picked up by surplus-lines writers, including Lloyd's. But those writers began to take those risks separately, and price them individually, said Baker. "Of course, 10 years from now this will probably all be forgotten, and everyone will start lumping everything back together again," she said. "For now, we'll continue to see these things splitting out."
The financial strength of Lloyd's is rated A- (Excellent) by A.M. Best Co.
(By David Pilla, senior associate editor, BestWeek: David.Pilla@ambest.com)<<BestWire Services -- 07/07/03>><< >>
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