Trip Report18th August, 2014
These are some brief comments on my recent business trip to the UK which was from July 7 to 17. During that period we (being a mixture of Tony, William, Marion and me) met with a wide range of management and underwriters in or close to Lloyd's, including the recently appointed CEO Inga Beale, Tom Bolt and key managers/underwriters from Amlin, ARK, ASTA, Atrium, Beazley, Cathedral, Hiscox, Kiln, MAP, Meacock and Randall & Quilter. William and I also took the time to visit the supplier of a new computer system which should dramatically enhance the efficiency of one of our preferred syndicates.
On underwriting, the consensus opinions reflect considerable and growing caution about the state of the property casualty market. On investment returns, although Lloyd's syndicates almost invariably invest their funds in very short dated securities it is worth pointing out that those insurers which have been holding bonds of up to, say, 10 years’ maturity going back to 2004/5 are having to replace them with bonds which yield a fraction of those original securities. Even within Lloyd's it would be wrong to ignore the strain of producing investment returns which for the most part are in no way comparable to operating expenses. It is not so many years back when we could assume that those returns would exceed expenses. In the current environment we must assume that the net position is almost invariably negative.
It therefore becomes all the more critical for syndicates to produce combined ratios which are measurably below 100% if profits are to be delivered to us Names. After all there are managing and members’ agency fees to bear plus our own personal expenses. Margins are very thin and it is unwise to assume that the remarkable period of profitability which we have enjoyed since 2002 will continue unchallenged. It would also be wrong to treat the Franchise Board as a form of panacea. The priorities are to protect the Central Fund and Lloyd’s status with the rating agencies. There is no doubting the importance of the Franchise Board’s influence on the quality of business planning but it does not profess to be Managing Agents’ nanny.
NFP has been taking a cautious view about risk/reward since 2008. We did this in response to our appraisal of trends in underwriting rates, terms and conditions and in the face of very modest investment returns. We were supported in our thinking by underwriters whose views were steadily becoming more cautious after the exceptional returns achieved during the period from 2002 till 2006. Nothing has emerged in the past 6 years to make us feel that the cautious approach we have been adopting has been wrong. It is true that profits have continued to be earned. However, I think it is fair to say that we have been fortunate not to have faced the kind of catastrophes which might reasonably have been anticipated to have driven the market into loss when the underlying risk/reward was not favourable.
I make these comments because I am only too aware of being accused of ‘crying wolf’. Of course in hindsight we wish we had not been so cautious but would like to remind our clients that we were bolder than almost anyone else in encouraging you to increase your commitments immediately following the World Trade Center disaster. Even after the reductions we have encouraged you to make in your participations since 2008 most clients are still underwriting significantly more than they were in 2001. Underwriters are now almost invariably comparing market conditions to those prevalent in the late 1990s even though the atmosphere is rather different since we are not now suffering millennium hysteria. Furthermore, we do now have the comfort of the Franchise Board working to maintain, indeed improve, standards which we regard as pro-active interference rather than reactive regulation which typified the last decade of the 20th century.
To some extent we are the victims of remarkable complacency resulting from this exceptional period of profitability by those who have enjoyed the benefits. We are also seeing inevitable comparisons made by the new capital which has been invading insurance in the past 5 years or so between the yields which can be earned on traditional safe securities such as bonds and the returns which these new investors believe can readily be expected from their underwriting commitments.
There is a continuing debate about what circumstances are required to change the perspective and dramatically improve risk/reward. I have my own views which include the opinion that no one major catastrophe (even a hurricane or earthquake generating insured losses of $100 billion) would turn the market. This is because the capital committed by new investors is frequently only a fraction of what might be available following such a major disaster and so inhibit a substantial recovery in rates.
More likely we will need two similar events of considerable substance following each other in a short space of time. Think of the storms which hit Europe in October 1987 (arguably a one in 200 year event) followed by the storms in January/February 1990. How then should underwriters have assessed frequency of loss of this substance? In addition we probably need interest rates to rise to the point at which new investors rightly revisit the comparative returns which might be earned from typical historic investments and from their commitments to insurance.
Personally I cannot see the likelihood of any change in the immediate future. I am thinking of writing a blog which begins “The good news is that the first half of 2014 has traded with minimal catastrophe experience. The bad news is that the first half of 2014 has traded with minimal catastrophe experience.” Those of you have read my first two blogs on our website should, I hope, have absorbed the implications of Michael Meacock’s decision not to increase his agency charges in view of the current very unsatisfactory state of the market. You should also have taken account of my reference to ‘black cygnets’. Most recently these have turned into black swans in the aviation world with the loss of the two Malaysian Airlines planes. These disasters alone have turned the aviation war insurance market into substantial loss.
Finally, I would like to think that we may expect better conditions in 2016 but I fear that it may take longer to create the combination of circumstances needed to undermine, if not destroy, the current investor optimism, almost certainly in an environment of important macro-economic fluctuation.