Lloyd's: Can the market fully recover from the losses in 2011?

It came as no surprise to the insurance industry when Lloyd's reported a £516m pre-tax loss in its 2011 full-year results. Given the scale and frequency of catastrophes in Australia, Japan, New Zealand and Thailand - with Lloyd's' interim pre-tax loss of £697m, and the millions of pounds insurers such as Hardy lost to global disasters - it was inevitable that the market, known for underwriting catastrophe risk, would be affected.

Although Lloyd's prides itself on its robust approach - from its disciplined underwriting and adopting of the latest version of the RMS catastrophe model, to its suite of realistic disaster scenarios - it could not escape the events of 2011.

Its stringent approach did not buffer the £13bn net of claims it incurred, nor prevent the combined operating ratio from deteriorating from 93.3% in 2010 to 106.8%. Nor did it stop investment return falling from £1.3bn to £955m, nor underwriting contributions plummeting to a £1237m loss from a £1143mprofit.

Despite the poor figures, Lloyd's chief executive Richard Ward said the market remained "well capitalised", taking the stance that things could have been worse, although he added that rates had not responded to the catastrophes as much as he had hoped.

Significant catastrophes
After such unpalatable results, will Lloyd's revisit its tough market approach in a bid to make 2012 a better year, or will it see the rate rises necessary to improve performance? Lloyd's Corporation believes there was little more it could have done to safeguard against the events of 2011, as it continues to enforce market discipline.

A spokesman says: "Insurance is here to help businesses and communities rebuild after a catastrophe and, while we can't predict or prevent catastrophes, we constantly monitor and model the market's exposure to them.

"Last year was an exceptional one for the industry, with catastrophe claims of $107bn (£67.1bn) the second highest level on record. And the fact that Lloyd's came out with a £516m loss, despite net claims of about £13bn, is testament to the underwriting discipline in the market and our robust oversight."

Graham Clarke, chief executive of Lloyd's broker Miller Insurance Services, also believes Lloyd's has been proactive.

"Lloyd's writes a catastrophe-oriented book of business. You would expect it to get a large loss from the second costliest year for insurance on record. There is no question we are in a downturn. The catastrophes across all markets have been significant," he says.

However, Clarke stresses that Lloyd's' full-year pre-tax losses of £516m, which included the Thailand flood losses, were less than the interim figure of £697m. "It goes to show there is some balance and the catastrophes did not eat into the capital or market assets," he says.

Gavin Phillips, a partner at PwC, adds: "Last year was an exceptional year. You can't guard against catastrophes. Lloyd's shares a lot of gathered information with managing agents and spends a lot of time meeting with agents. It undertakes a thorough and robust business planning review process."

Markel International concentrates on writing business in Europe, the US and Japan, where "they are paying the right prices", according to Jeremy Brazil, president of Markel International.

But it too was unable completely to escape the knock-on effect of the catastrophe losses. Its full-year 2011 results revealed a combined operating ratio of 108.4%, deteriorating from 77.5% in 2010, while it made an underwriting loss of $18.8m (£11.6m) (2010: $45.1m profit).

In explaining the loss, Markel said the total number of catastrophes exceeded the company's risk appetite for market events of that size. Brazil believes Lloyd's could protect itself from catastrophe losses by ceasing to underwrite the risk, but admits the business can often be profitable.

"If the question is: ‘Should the market be writing catastrophe business?' then I believe the answer is, ‘Yes.' So then the question is: ‘How should it write catastrophe?' When writing this risk, the right controls have to be in place, and the book must be monitored," he says.

"Businesses must also make sure the catastrophe is within their risk appetite, gross or net, after reinsurance. Most people's losses are as expected. They are not a surprise. The surprise is how many events there actually were."

As questions emerge about how Lloyd's will fare in 2012, some Lloyd's brokers are predicting that the corporation will reassess catastrophe risk in some countries. Citing the 2011 losses, Lloyd's has re-emphasised market oversight as its "number one priority".

Clarke suggests that, after the unexpected Thailand flood losses, the corporation will certainly examine the risk underwritten in that specific country more closely, in an effort to improve 2012 results.

"Thailand was not deemed to be a catastrophe region or flood risk and, therefore, had not been modelled. Aggregate exposures were not modelled in the same way for Thailand as for Japan. Clearly, the market had disproportionate losses from the catastrophe and people will be flood modelling a lot more closely in Thailand from now on," he says.

Rigorous approach
After the losses some players sustained, Brazil is prepared for Lloyd's to be even more rigorous in its approach to business plans.

"Following losses emanating from the US, some cat writers in the last few years decided to focus on non-US catastrophe business and, unfortunately, as a result of the international losses over the past 18 months, have had poor results," says Brazil.

"Ironically, there have not been any US cats over the last two years, and that is where most cat premium is generated. For example, no one expected Thailand would be a major catastrophe area. People tend to focus on the windstorm and earthquake perils, less so on flooding.

"Lloyd's is likely to be more challenging on exposure, and the controls and management in place. It will question risk versus reward ratios and scrutinise realistic disaster scenarios."

However, Brazil adds, Lloyd's insurers also need to revise how they assess risk, as they have arguably become too reliant on RMS and AIR catastrophe models.

"Those models have not performed well in previous events, so there is scepticism surrounding them. They are the key models people use on the basis there aren't other models available, but one must not exclusively rely on the models to dictate one's risk appetite and exposures. One must use other ways to model and assess exposure," he says.

Rates have long been highlighted as a reason for poor results, and there is concern that, despite the catastrophes of 2011, they are unlikely to improve in 2012. UK motor, property catastrophe and energy have seen modest rises, but aviation, casualty and marine remain flat.

This view was reinforced when Lloyd's released the full-year results. Ward said he was "disappointed" rates had not hardened as a result of the catastrophes. And even where prices have risen, namely in catastrophe-exposed regions, market leaders do not believe the upward trajectory is significant or wide-reaching.

"The rates have gone up considerably in some parts of the world, but there are places such as Chile and New Zealand that are rarely exposed to catastrophes, so the prices were low to start with," Brazil explains.

"When there is a catastrophe such as the New Zealand earthquake, one looks at the exposure versus the premium received to see whether it is unbalanced or not. With a low starting point on rates, even a material increase means it takes a long time for a business to get back its money.

"Hindsight is a wonderful thing, but the risks were probably insufficiently priced to begin with and probably still are in light of the losses, and notwithstanding the rate increases."

Using New Zealand as an example, Brazil suggests that, even if the country saw a 200% rate surge, in reality it is an increase from 2% to 6%.

"Japan, however, pays better prices to start with because every year there are typhoons, and earthquakes are active there. The perception is it's priced on catastrophes that are likely to happen, whereas New Zealand is priced on catastrophes being unlikely to happen."

Others suggest rates will substantially harden only if the wealthier economies suffer a major event. Last year the US and Europe largely escaped major events compared with past years, whereas the US has previously suffered substantial losses from the likes of 2005's Hurricane Katrina, and Europe from big freezes.

Biggest buyers
Robert Childs, group chief underwriting officer at Hiscox and Council of Lloyd's board member, says: "The biggest buyer of property casualty is the US, followed by Europe and then Japan, but only Japan was affected by catastrophes.

"New Zealand, Australia and Thailand were affected by the losses, but they are small economies on the world scale. Obviously, they were very tragic losses, but if the losses happened in the bigger economies that would affect a bigger share of the insurance premium.

"The prices in New Zealand may have gone up because of the losses there, but it does not follow that prices everywhere else will rise substantially. If there was a significant run of losses in the US, then prices would increase significantly there."

Clarke believes that, as the market is unanimous in the belief that 2011 was an exceptional year, it was right not to introduce rash rate rises.

"It would be wrong to expect a knee-jerk reaction because catastrophes of this kind are unlikely to happen every year, and if losses have come as a result of the catastrophes, as opposed to attritional losses, we would be doing our clients a disservice. A lot of our clients are suffering as it is, and the market needs to be mindful of that."

First-quarter results are currently being reported, with a number of insurers posting profits, and Phillips is optimistic about the rest of the year.

"If you look at the claims activity in the first three months of this year compared with last year, it is night and day. Last year they were horrific. There have been claims this year, but it has not been horrific," he says.

And Clarke adds: "The underwriting environment is better, so Lloyd's' performance depends on whether there are disasters around the world. The Q1 results for insurers and reinsurers look quite positive."

But Childs cautions against being overly optimistic. "Hurricane season starts in July in the US - a big risk and a big economy," he says.

"The UK is exposed to European windstorms from October onwards. You can have an earthquake at any time. We have had a good Q1, but there is plenty of time to have lots of other losses. It could be as bad as 2011. It could be worse."

And Lloyd's itself is gearing up for a difficult year. "2012 will be challenging, with tough global economic conditions and low investment returns," it has said.

Brazil adds: "2012 could well be a better year. Rates have increased in the classes and territories that have suffered losses, but are otherwise flat. The US has seen some rates increases because of the recent bad weather, such as tornadoes and the impact of RMS version 11, and we are still seeing rate increases in offshore energy on the back of Deep Water Horizon.

"But, despite the losses, there is still too much capacity in the market, and until capital withdraws there is not a lot of scope for pricing to go up."