2004 was a significant year for Lloyd’s. It was a year of choice when businesses had to decide whether to follow a business strategy that responded actively to external market conditions or become hostages to the fortunes of the insurance cycle.

Discipline in the market, combined with strong underlying conditions, helped to ensure that it was another high performing year for Lloyd’s with profits of £1,357m.

We realised a number of key objectives and made continued progress in our drive to build a strong competitive platform which earns and retains the confidence of capital providers, regulators and customers by:

• delivering consistently good financial results;
• improving business processes; and
• protecting, strengthening and promoting the Lloyd’s brand.

This progress did not go unnoticed. The ratings upgrades from A.M. Best and Fitch and Lloyd’s successful debt issue were testimony to the greater confidence with which Lloyd’s is now viewed.

Strength and security

A combined ratio of 96.9%, despite the worst year for natural catastrophes on record, is an excellent underwriting performance, comparing favourably with our peers. With the support of the Franchise Performance Directorate the market focussed on delivering an underwriting profit rather than chasing market share.

This trend has continued into 2005. The reduction in capacity to £13.7bn from £15bn, was widely recognised as a disciplined and prudent response to softening market conditions.

The financial security of the market was further strengthened with the success of the subordinated debt issue and the introduction of a new syndicate loan scheme which started on 1 April 2005.

In January 2005, we received the first partial decision of the tribunal in the Central Fund arbitration. The tribunal found in favour of Lloyd’s on the issue of the proper interpretation of the wording of the policy. However, on the basis of its findings with respect to the presentation of the risk to Swiss Re, the tribunal held that Swiss Re was prima facia entitled to avoid the policy. This finding was subject to the Panel further considering the issue of whether Swiss Re had affirmed the contract and was therefore bound by its terms. In the circumstances, we considered it sensible to reach a commercial settlement with all of the insurers for £152m. We are continuing to examine the implications of the settlement and the options for funding the consequent Central Fund shortfall.

The financial position of the Society remains strong. The solvency ratio at the end of 2004 is estimated to be 299% (206% for 2003), with Central Assets of £1,184m, excluding the callable layer.

During 2004 and into the first part of 2005, a great deal of work has been done to review our risk–based capital setting methodology in light of the FSA’s new Individual Capital Adequacy Standards (ICAS) regime. This work will result in a new approach, which will be agreed and implemented over the course of the next 18 months. Setting capital requirements at the right level is key to the health of the Lloyd’s franchise – allocating capital properly to risk, while allowing a competitive return on capital to be achievable. The market’s return on capital in 2004 was 12%. This was lower than the 21% achieved in 2003 primarily due to the impact of the catastrophe losses but also reflects the additional capital held by the market in 2004. Achieving an adequate return on capital across the cycle is vital.

Franchise performance

The Franchise Performance team focussed on the ability of businesses in the market to manage their pricing and exposure in the light of prevailing market conditions. In a number of cases, syndicate growth plans were substantially modified. The team continued to apply the underwriting guidelines that were developed as part of the Chairman’s Strategy Group proposals.

The intensive annual syndicate Business Plan process was the cornerstone of the Franchise Performance effort. It was supplemented by a programme of detailed visits and meetings with individual syndicates throughout the year as well as market meetings. All of this work paid dividends in 2004, but it should be noted that the availability and quality of up to date performance information needs to improve further to realise the full benefits of the new Franchise Performance approach.

Risk management

During the year under review, we continued to invest in upgrading and developing the sophistication of the market’s risk management capability to ensure the effective management of all critical risks. Throughout the market all risk management plans were reviewed against new risk levels set out by the Franchise Board. Visits were made to 38 Managing Agents and key themed reviews of personal lines, insurance intermediary regulation, overseas licences and Members’ Agents were also carried out. The series of 17 realistic disaster scenarios that model the potential impact of a range of catastrophes were updated. The spate of natural catastrophes during 2004 demonstrated just how important these tools are in strengthening the market’s resilience and profitability.

In addition to the ongoing risk management activity, new Byelaws, rules and codes of practice, and binding authority wordings were introduced to help reduce and manage the risks of delegated underwriting; and an education programme was introduced to help spread best practice through 8 forums and training sessions.

Reinsurance and open years: reducing exposure

Significant collection and commutation work was undertaken during 2004 to reduce the market’s exposure to low rated reinsurance security.

Further work was undertaken during the course of last year to increase supervision of open and run–off years to minimise future calls on the Central Fund. A dedicated team was created to facilitate the economic closure of run–off years by working closely with Managing Agents and Run–Off service providers.

Both projects are essential to protect our policyholders, capital providers and the Lloyd’s brand.

Business Process Reform

There is a clear recognition in the London market that, both for commercial and regulatory reasons, real progress must be made on reforming the business processes of the market and improving contract certainty, enabling greater transparency, consistency and efficiency.

Good progress was made during 2004. A new London Market Principles (LMP) slip to document the key data about the substance of a transaction was mandated in January 2004. The slip is the cornerstone in the drive to deliver improved contract certainty. By the end of the year the number of slips reaching the agreed standard had reached 90%, 5% short of our target but encouraging nonetheless. Further progress has been made on attaining this target in 2005 with 93% of slips meeting the agreed standard in January.

The LMP team is now publishing more guidance to help organisations to implement the slip requirements effectively and league tables which compare the performance of market participants. We are working with Xchanging Ins–sure Services to codify and streamline checking processes and improve the quality of submissions.

The market's commitment to the reform process was evident in its participation in the Market Reform Implementation Board (MRIB) and in its support of Kinnect. The Board, which comprises representatives from across the market, was formed to oversee the delivery of the Accounting and Settlement System, and Electronic Claims files. The Accounting and Settlement system, which is expected to become operational in 2006, will ensure that our standard electronic messages carrying payment and accounting information are compatible with standards in other international markets, greatly reducing costs for brokers and underwriters. The electronic claims infrastructure, also using international standards, will make claims available to relevant parties and speed up their processing of new claims from 2006.

Kinnect, which provides technology and supporting services that enable brokers and underwriters to exchange placing data electronically to international standards, began to handle increasing volumes of live risks. Kinnect is now routinely handling North American property business from two of the world's largest brokers, Willis and Marsh. Four more managing agents joined, alongside the four who started Kinnect with Willis and Marsh more than a year ago. Kinnect will build on these foundations in 2005 to produce a product that encompasses the entire lifecycle of a risk, from original placement to renewal and move into two new risk classes.

Claims

Significant progress was made in the effective management of the market's biggest cost, claims. A clear strategy and vision for claims handling was developed which identified and agreed controls to successfully manage significant claims–related market risks. It focussed on aligning processes, systems and behaviour to improve indemnity accuracy, expense management and reduce processing and reinsurance costs.

A series of claims management principles and minimum standards were introduced which set clear benchmarks for performance. Work was also undertaken to re–establish an effective claims agreement process for followers. These initiatives will lay the foundations for a more integrated approach to claims management.

Such progress should not be underestimated. It demonstrates what can be achieved when the market recognises that there is a problem and works together to solve it.

The challenge in the next 12 months will be to maintain this momentum with all businesses recognising the importance of claims in managing the market's performance.

Lloyd's brand

We have long recognised that, in a competitive global market, one of our greatest assets is the unique strength of the Lloyd's brand. Our name is instantly recognisable, synonymous with the stability and dependability of over 300 years of history as well as the innovation, creativity, agility and unmatched underwriting expertise - that come from being a dynamic and diverse marketplace.

Last year we recognised that there was a need to find a common language to describe the Lloyd's brand. As a result we carried out a detailed analysis in order to define more clearly what the brand stands for, and how we can use it for maximum advantage.

In 2005, we will build on this work by exploring how the newly defined brand idea can be applied across the wider aspects of the business, from our working environment to behaviour and communications. Crucially, this will involve engaging all members of the Lloyd's community in understanding and actively supporting the brand.

Operating costs

Continued cost discipline remains a clear priority and we are committed to maintain our rigorous attitude to containing increases to our cost base, while constantly improving the efficiency of our infrastructure and internal processes. Operating expenses from continuing activities have remained at a constant level over recent years and in 2004 were £161m.

Appointments

Both the market and Corporation were delighted that Lord Levene accepted an invitation from the Council of Lloyd's to serve a second term as Chairman. His experience, vision and pride in Lloyd's have been invaluable since he joined us in 2002. We are fortunate that Lloyd's will continue to benefit from his passionate championing of this market.

I was pleased to welcome Luke Savage who joined Lloyd's as Finance Director in September 2004. Luke has an outstanding record in investment banking, and is already playing a vital role in our key initiatives.

The future

We are under no illusions about the challenges that we face in the future. The business we are in is highly competitive. Most businesses that operate at Lloyd's have a choice as to where they write business. Policyholders and brokers have a choice about where to put their business. Capital providers certainly have a choice as to where they invest.

We must offer a platform which is unambiguously and sustainably the best for underwriting specialist insurance and reinsurance business. This has to be our guiding principle.

Nick Prettejohn, Chief Executive Officer 6 April 2005

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