Thank you for inviting me here today.
Private capital is an important part of Lloyd’s so it’s great to have the chance to talk you through my team’s approach to how we are protecting it.
This afternoon I am going to look under the surface of the Lloyd’s 2016 annual results and give a quick overview of the market conditions we are operating in.
I’ll then look at how we are protecting your capital, the central fund and policyholders through our new approach to market oversight, which focuses on improving underwriting performance.
And so long as I talk quickly, there will be time at the end for questions!
But first, for those that don’t know me, some background.
I’ve spent my entire career in insurance – initially as a broker and coverholder, and then holding a number of underwriting roles with RSA in the UK, Europe and further afield in Asia Pacific and across emerging markets.
I’ve held a number of CEO roles, both in the UK and overseas. My last role was leading a big business - £2.5 billion of premium and 2,500 people facing all of the same challenges and opportunities I’m now looking at in Lloyd’s.
And while most of my career has been in the Company market, there’s no institution in the world quite like Lloyd’s. So it’s a real honour to be here playing a part in shaping Lloyd’s future.
And it’s a future that has a lot of uncertainties.
These are some of the most difficult market conditions many of us have faced in our careers. This slide shows some of the forces which are at work.
There are the low interest rates attracting new capital into the insurance and reinsurance markets and driving down premiums.
There’s a changing distribution model, further influenced by M&As and technology, and the rise and rise of new sales vehicles such as broker facilities and MGAs.
New tech-based insurance companies are entering our market and challenging traditional business models: everything from price comparison websites and telematics-based services to sharing-economy and peer-to-peer insurance.
And there’s the rapidly evolving risk landscape, too: risks such as cyber are evolving on an almost daily basis, creating a demand for new products that insurers are struggling to keep up with.
We can see the impact of these challenges in our 2016 results.
Dig under the surface of the £2.1 billion profit and we see a worrying trend.
2015’s results consisted primarily of underwriting profit – almost £2 billion - and only a small investment return.
2016 did deliver overall strong profit levels – this was primarily because of investment returns of £1.3 billion and some one-off foreign exchange gains, driven by the depreciation of sterling.
But in 2016, underwriting profit contributed only £468 million and the combined ratio increased to 97.9% from 90%.
On an accident year basis the market showed an underwriting loss. We are very aware that most major classes showed a loss on Accident Year. Bear in mind Prior Year releases were again very healthy and delivered the underwriting profit.
One final piece of context to share is how Lloyd’s has performed against competitors. Although Lloyd’s combined ratio is slightly better than its competitors in aggregate and has been consistently better over the years 10 out of 11 competitors outperformed the Lloyd’s average.
Not where we want to be, but huge opportunity to improve especially given some relatively strong underwriting performance from the Lloyd’s competitor group.
It is the underwriting performance that my team and I are focused on.
That said it’s worth reminding ourselves that it’s not all doom and gloom.
Lloyd’s is actually in rude health, despite the challenging conditions:
Return on capital has averaged 12% over the past five years.
• Our total resources available to pay claims have increased from £25.1 billion in 2015 to £28.8 billion today.
• Our financial ratings are at A+, AA- and A, depending on which ratings agency you look at.
• And the Lloyd’s platform is still attracting capital from all around the world.
Between 2015 and the start of this year we have seen nine syndicates, eight special purpose arrangements and three managing agents join the platform.
And it is diverse capital too: sources include private capital, a Mexican reinsurer and an investment fund.
This is good news!
But the fact is the market needs to address its decline in underwriting performance because the current trend is not sustainable.
It is also putting your capital at risk and quite rightly, you want to know what we are doing to protect it and help you get the best possible return on your investment.
Before I get into how we are doing this, it’s worth explaining how the Corporation’s oversight function is set up, and the responsibilities of the performance management team and the Franchise Board.
As Performance Management Director, I am a member of both the Lloyd’s Executive Committee and the Franchise Board.
The Franchise Board lays down guidelines for all syndicates, and operates a business planning and monitoring process to safeguard high standards of underwriting and risk management.
Its aim is to improve sustainable profitability and enhance the financial strength of the market.
My PMD team has a number of focus areas:
• We look at syndicate underwriting performance and carry out analysis across the market on a class of business basis.
• We monitor the market’s exposure management, reinsurance and emerging risks. This involves identifying future and evolving risks and stress-testing the Lloyd’s response these risks.
• We authorise and oversee delegated authorities including coverholder approvals and various forms of managing agent reviews.
• We make sure syndicates follow the Lloyd’s minimum underwriting and claims standards.
• And the CPG team approves syndicate business plans and capital requirements at least annually.
So my team’s daily activity is to:
• Agree and monitor delivery of syndicate business plans. This means that every business plan for every syndicate goes through a five-month process to ensure the plan is realistic and achievable, and the capital charge is appropriate.
• Carry out effective underwriting performance oversight. This means that if a syndicate is not performing well, or if we see signs it may not perform well in the future, we will intervene to restrict or improve performance.
• Improve and develop underwriting by promoting best practice. We do this by having detailed minimum standards for all areas of underwriting, claims and conduct. We are monitoring compliance with these standards by conducting over 300 standards reviews this year.
• Maintain and raise underwriting standards across the market, for example by conducting reviews of the performance and trends of specific areas of business. The review we conducted recently for offshore energy resulted in us calling in the market underwriters, presenting the findings to them and asking them to implement strong underwriting discipline.
Overall, I report back to the Franchise Board on the progress of the activities I have mentioned.
There is a lot of oversight, and a lot of checks and balances.
As a result, Lloyd’s oversight function works well.
If you look at Lloyd’s headline results over the past 60 or 70 years, it shows that prior to 2000, while investment results were strong, underwriting results were generally not good and generally followed the fortunes of significant losses and cat events. Not overly surprising given the nature of the business Lloyd’s traditionally writes.
On the plus side there has been a marked improvement in underwriting results since the early 2000s - evidence of much greater underwriting discipline in the market. It also shows the benefit of strong business planning, monitoring and oversight.
But, as I said earlier, the figures show that underwriting performance has been declining over the past three years.
Now, more than ever, it is the time for strong market oversight so let me explain what my team is doing to protect your capital and ensure the market improves underwriting performance.
The first thing to note is that the market needs to trade itself to better underwriting results – and only by making bold and brave business decisions will they achieve this.
There are some early signs of correction with some premium levels being pulled back and some managing agents choosing to withdraw from certain portfolios they cannot make successful.
And revenue plans are not being delivered where it’s not financially sensible to do so – which is a good thing!
Lloyd’s typically writes around 8% less than its premium forecasts - and in 2016, it was around 12% less.
This year, premiums must surely continue to reduce for performance to noticeably improve.
It’s good – and essential – that managing agents are making these tough decisions because we are entering a Darwinian environment where only the fittest will survive.
But there’s a lot more to do and that’s where market oversight comes in.
I’ve taken the opportunity over the past six months to talk to literally hundreds of people in the market to hear how my team can work with them to make the market better.
We’ve taken on board what they told us, have added plenty of our own ideas and we are indeed changing our approach.
Today we rolled out our account managers pilot to six managing agents giving them dedicated points of contact within the Corporation.
By September every managing agent will have account managers. This will deepen the understanding between the market and the Corporation, and mean all of our oversight activities are completely joined up.
We are adopting a more risk-based approach to the way we work with the market. This means we will spend more time focusing on the syndicates and issues we’re worried about, and where we can have most impact or where we need better understanding.
I know some of you are concerned about the impact a few poorly performing syndicates can have on the overall results.
I can assure you that our new risk-based approach will identify poor performers earlier and will allow us to intervene harder and faster where we see divergence from plans or outlying performance.
What this means in practice is that is that we will spend more time on the worst-performing syndicates – those that are in the fourth quartile now and, by using strong key risk indicators, those that have the potential to perform poorly in the future.
Where we do not see evidence of performance improving we will restrict or remove authority.
And we will not allow syndicates to begin writing business we do not believe they have the capability to do, or where we have evidence the rest of the market cannot do successfully.
This also means we will spend less time on the best performing syndicates which will allow managing agents more time to focus on running their businesses – and, of course, make your capital work harder for you.
All of this will allow us to improve our oversight and make it easier for the market to do business with and within Lloyd’s.
Now, more than ever, these tough market conditions demand the greatest underwriting discipline from the market and the strongest oversight from us.
As you may know I addressed the market recently to set out this new approach.
I also told them there are five other key areas we are focusing on this year.
First, market growth: as I mentioned earlier we expect the market to shrink this year and next year. Premiums must surely reduce for performance to noticeably improve.
Because doing the same thing is not an option for underperforming syndicates.
Doing more of the same is only an option if a syndicate is performing well, and better than market average.
The market cannot simply grow exposures in order to maintain premium levels.
We do expect to see growth in some syndicates but only if they are doing something different - be that new footprint, products, propositions, acquisitions.
But overall – as I said - we do expect the market to shrink in these competitive conditions.
Second: Catastrophe exposure
Cat exposures have been steadily climbing in what we all know is a low-earnings, low-profit environment.
We have a catastrophe risk appetite at Lloyd’s that we passed last year and the market’s exposures are still increasing.
Why is that?
In part because of some exchange rate movements.
Partly because some syndicates are seeing relatively better profits on cat - albeit in a recently very benign cat environment.
And also because a number of syndicates have been writing above plan.
And so - continuing our risk-based approach - these are the ones we are focusing on.
We have to close the gap to ensure that cat exposures are at the right level, that we understand and are comfortable with the levels of volatility at a market and a syndicate level.
And we are taking action to ensure we do.
To be clear Lloyd’s will continue to be a leading underwriter of catastrophe insurance and we will expect every syndicate to operate within appetite.
This year, we must tackle syndicates writing significantly above 2017 CAT plans and we have begun some of those conversations already.
We will agree actions with the market to return to plan.
Looking ahead to 2018, we will agree plans with everyone.
We are requesting full CAT plans and volumes through CPG conversations, and will require all syndicates to stay within plan throughout the year.
The third area of focus is market facilities.
Facilities – broker and otherwise - are an important and growing part of the market.
And it’s fair to say they elicit very different reactions from different people.
They can be a good source of business if written well:
• They are efficient and simple
• They can provide strong security for “hard to place” business
• strong data on customers and exposure
• And they allow syndicates to make underwriting decisions and exercise control
But written blindly, they can be an uncontrolled and lead to unknown exposure, and they can be expensive to operate.
We need to understand better what is written at Lloyd’s through facilities. We want to know:
• What types of facilities the market intends to write
• The underwriting control they have
• The cost of participation
• And how they will track performance
We will be addressing this through the day-to-day discussions, business planning and the CPG process.
The fourth area of focus is operating expense.
Not one person I have spoken to over the past six months believes that a total cost base of around 41% of net premiums is sustainable - or desirable.
Lloyd’s needs to reduce expenses in order to compete and the Corporation is taking a number of actions in this regard.
The London Target Operating Model – the TOM - is critical. It will help reduce frictional costs, improve efficiency and speed up processes in the Lloyd’s and London markets.
In the Corporation we know we must also reduce our costs to the market. We have cut the market levy this year by 10% and we are currently going through the Corporation Operating Model – the COM – to make us more efficient and cost effective.
And finally, acquisition costs – a subject which is in the news and in the market almost every day.
We hear the market’s concerns that acquisition costs are unjustifiably high but the data they report to us is not always clear on that.
Providing us with accurate data will help us understand where acquisition costs are justified – and where they are not. That’s why we have recently written to the market CEOs challenging some of the data on the returns they have given us.
When we receive accurate data, we will have individual conversations with managing agents to agree and understand any actions required.
We will discuss:
• Transparency and fairness to policyholders
• Any prudential concerns regarding sustainable business performance
• And where levels payments are not justified and where they do represent value for money
We will have these conversations as part of CPG.
This focus on adapting and changing – the products we sell, the way we distribute them, our cost base - is vital because the history of commerce is littered with businesses that have failed or been slow to adapt.
Take Kodak as an example - a famous and marque brand, at one time synonymous with quality and innovation.
In its heyday in the 1960s and 70s Kodak was one of the most powerful companies in the world.
But just 40 years later it filed for bankruptcy, and after reinventing itself, today it has a market capitalisation of less than $1 billion.
So what happened?
Kodak’s story is a salutary lesson in taking heed of what is going on around you – and then of acting on it in the right way.
Kodak actually invented the first digital camera – in 1975.
It invested billions in developing a digital camera range.
It even bought an early version of a photo-sharing site called Ofoto.
In short, the company did everything right – except for one key thing: it failed to truly understand the implications of the new world it was investing in.
It didn’t understand that this new world was the future of the industry, not just a way to drive sales of its core business of film photography and photo printing.
It didn’t understand that people weren’t bothered about replicating the quality of print film with digital technology; greater convenience was what customers were after.
And it didn’t understand that people wanted to share their photos digitally, not print them out.
The lessons for the insurance sector are clear.
Companies often see the forces affecting their industry and when they do, frequently invest so they can compete in the new markets.
But despite this, they can often fail because they do not fully embrace the new business models that disruptive change creates.
No organisation, including Lloyd’s, is immune to this fate.
While the Lloyd’s market is changing in response to the evolving business landscape, we all must guard against only dangling a toe in the water. Instead, we must dive in and fully immerse ourselves in the waters of change.
Let’s avoid our own “Kodak moment”.
So, I hope this morning I have shown you how important our oversight work is in making sure we remain the global centre for specialist insurance and reinsurance.
The conditions we are facing are tough - and we have to assume that this low interest, highly capitalised, competitive environment is here to stay.
My team’s job is to make sure that we can help the market do what they do best: running their businesses and delivering growth that’s sustainable and profitable, and where performance dips - help them get back on track.
Not only does that protect the central fund and our ability to pay claims, it will also maintain Lloyd’s reputation as an attractive place for capital providers like you to invest your money.
Thank you for listening.