2988 lloyd's review cover 2 - Willis Towers Watson · Title: 2988_lloyd's review cover 2.qxd Author: greencz Created Date: 5/24/2005 5:22:55 PM

Lloyd’s – Profile & RealityMay 2005

Lloyd's has put much effort intoimproving its public profile. The effecthas been a much-needed upgrading of external perceptions, which hasundoubtedly encouraged business to flow to Lloyd's.

But does the profile match the reality?The discussion that follows considerskey recent developments to enableWillis' clients to understand the currentstatus in a balanced perspective.

© Copyright 2005 Willis Limited/Willis Re Inc. All rights reserved: No part of this publication may be reproduced,stored in a retrieval system, or transmitted in any form or by any means, whether electronic, mechanical,photocopying, recording, or otherwise, without the permission of Willis Limited/Willis Re Inc. Some informationcontained in this report may be compiled from third party sources we consider to be reliable; however, we do notguarantee and are not responsible for the accuracy of such. This report is for general guidance only, is notintended to be relied upon, and action based on or in connection with anything contained herein should not betaken without first obtaining specific advice. The views expressed in this report are not necessarily those of theWillis Group. Willis Limited/Willis Re Inc. accepts no responsibility for the content or quality of any third partywebsites to which we refer.

Willis Lloyd’s – Profile & Reality May 2005 1

– Section 1: Underwriting Direction ..........................................................................................................2– The Impact and Implications of the Director of Franchise Performance– The Implied Strategy– The Value of a Central Review Process

– Section 2: Repositioning – The Market Adjusts ....................................................................................4– Major Players Develop Options Outside– Motor Finds a Cheaper Home– A New Life for the Private Name?– Central Adjustment at Lloyd's– Enterprise Culture?

– Section 3: Profit & Loss – A Stronger Platform for the Future ..........................................................7– The Ten-Year View and a Peer Comparison– Diminished Damage from the Bottom Quartile– Strengthened Balance Sheet– Strengthened Central Resources

– Section 4: Security – Lloyd's Adjusts ....................................................................................................11– RBC's Rise as Market Falls– Central Fund Strengthens

– Section 5: Equitas ....................................................................................................................................15– Asbestos, Asbestos– Is a Future Call a Possibility?– Is a Past Call a Possibility?

– Section 6: Costs & Compliance ..............................................................................................................16

– Section 7: The External View..................................................................................................................18– The London Stock Market's View– Standard and Poor's View

– Section 8: Licences & Branding ..............................................................................................................23

– Section 9: Summary ................................................................................................................................24

– Appendix ..................................................................................................................................................25

Contact Us:For more information please contact your Client Advocate.

For general enquiries, contact Helen DavisTel: +44 (0)20 7488 8077Email: [email protected]

Contents


The Impact and Implications of the Director of Franchise PerformanceLloyd's has undoubtedly made a bold and important appointment in giving Mr Rolf Tolle his present role as Franchise PerformanceDirector. The recent efforts made to manage the overall marketcapacity centrally have enjoyed very sound press reporting. Marketobservers have been impressed with Mr Tolle's evidently firmleadership in his role.

A natural question follows. Historically, Lloyd's behaviour patternshave been heavily influenced by an older generation of underwriterswho found it difficult to adapt, notably in the later 1980's and early1990's. Has Mr Tolle succeeded in bringing this mentality to a new outlook?

The answer appears to be mixed but favourable. It would besurprising if there were no frustrations at the imposition of disciplinessuch as Mr Tolle's requirement for central approval of business plans.However he appears to have won the great majority around to therecognition that the market has too often suffered from the completeabsence of central discipline of this kind. The overall achievement ofshaping the global market capacity is undoubtedly impressive. Lloyd'sopening capacity for 2005 is £13.72 billion, down 9% on 2004opening capacity of £15.00 billion. Lloyd's states that this, togetherwith the 10% decrease in gross written premium to £14.71 billion, isindicative of the market's discipline in underwriting for profit.

There are several factors influencing this change. In one importantrespect, the impression given by this creditable performance needs to be tempered by wider realities. This arises in the context that asignificant number of major businesses at Lloyd's have (or havecreated) parallel corporate vehicles into which they can channelbusiness that previously was written at Lloyd's. These include Ace,Berkshire Hathaway, Brit, Catlin, Hiscox, XL Capital, and a furtherexample has been the flotation of Aspen Re out of the Wellington Group.

In the bigger picture, what is certainly happening is that blocks ofbusiness are moving out of (and perhaps into) Lloyd's. The overallvolumes involved would very possibly tell a different story than thattold by the elements that from 2004 into 2005 remain continuouslyat Lloyd's.

Accordingly the "controlled market" external appearance could be re-cast to adjust for the rising transfers of business to non-Lloyd'svehicles. Thus in the more complex totality, Lloyd's could be seen asin some respects still growing into a falling market.

1 Underwriting Direction1


The Implied StrategyLloyd's obviously cannot seek to control what is written outside itsfranchise. On the contrary, it would appear that the Franchise Board isnot unsupportive of Lloyd's businesses developing alternativeplatforms that are more suited to carrying certain types of business.The key focus is evidently upon the protection of the core Franchisecapabilities and, with them, the Central Fund.

In the case of the Motor and some Personal Lines insurance products,there is something of an implication that Lloyd's is content to seethese leave the market. To be fair, there is some natural rationale forthis, in that from the FSA's perspective one can easily see that thisarena is already well managed in the UK within the existing non-Lloyd's regulatory framework. But there is also a downside to thisapproach. We discuss some of the strategic disadvantages from theLloyd's perspective on pages 4-6.

The Value of a Central Review ProcessOverall, the good news remains that the business that is beingwritten at Lloyd's remains subject to more careful review processesthan at the comparable stage of any earlier cycle; and theunderwriters writing that business are in general operating withinmore carefully crafted frameworks than previously evident. There maynot be so much of the old "flair and entrepreneurship" thatcharacterised earlier eras, but one has grounds to hope that thegreater current disciplines should deliver a better-managed down-cycle.

1 Underwriting Direction


Major Players Develop Options OutsideThe trend to reposition has continued. Mention has been made ofsome businesses channelling capacity through corporate insurancevehicles. There has been a notable trend to cut back at Lloyd's fromsome significant participants. Why is this happening?

Cost, distributional flexibility and perhaps regulatory flexibility seemto be the key drivers. Lloyd's has added a substantial expenseoverhead which these entities have found acceptable in the pastbut which is increasingly perceived as standing betweenmanagement and a satisfactory return for shareholders. The goodnews here has been the major steps taken centrally to reduce thisburden from 2005 onwards. We discuss this specifically on pages 16-17.

There are obvious attractions to the flexibility of a multi-platformstrategy, although these vary in relevance to specific businesses.The diversity of distribution options has a natural appeal for many.There is the reality that certain types of business may be perceivedto work more effectively through non-Lloyd's vehicles: for somebusinesses there is an obvious attraction to channelling theirPersonal Lines and other simpler business towards their non-Lloyd'splatforms. This is partly driven by the prospect of a cheaper costbase, and partly in some marginal cases that there may be onlylimited pressure to provide security that is as good as that ofLloyd's as a whole. There is also an element of businessespreferring to govern themselves, rather than live with being

accountable to the Lloyd's Franchise Performance Board. We look at"double-decker" compliance on pages 16-17.

The overall picture is undoubtedly one of active management andmaterial change. It makes for a huge contrast with the Lloyd's often and twenty years ago.

Motor finds a cheaper homeThe Admiral Syndicate and the substance of the Service Syndicateare two leading examples of the trend to transfer motor businessout of Lloyd's; but there are others who have found irresistibleattractions in the cheaper costs and lower capital requirements thatare available outside the Lloyd's framework – some of them inGibraltar. Lloyd's might count itself fortunate that the core thatremain continue to do so.

Over the years there have been a number of representations topropose a differential contribution to the Central Fund from MotorSyndicates, who clearly have represented a lower risk to the Fundboth as exposure and as experience. It could still be a positive andprogressive step if Lloyd's were to reconsider this issue; the RiskBased Capital approach may not deliver an attractive environmentfor a long time. See the discussion on pages 2-3 and further belowon pages 11-14.

2Repositioning – The Market Adjusts


Viewed centrally, it might be attractive in some respects to Lloyd'sto try to maintain this element of its franchise – the central costsbecome more widely distributed, which of course is a key issue forthe future, and the open appeal of the market as an "address forall comers" has an undeniable value. But one can see that from theFSA's perspective there might be good sense in Lloyd's becomingconcentrated as a centre of excellence for specialist insurance andreinsurance business; equally one has the anecdotal impression thatthere is limited demand from capital providers at Lloyd's for thereto be any change to this general direction.

A New Life for the Private Name?In the other direction, there is an independent Members' Agentsinitiative to attract new private names to the market. Will thiswork? Good results might appear to make it an attractiveproposition, but there is undoubtedly a legacy of concern. Itremains to be seen whether there is real scope to regeneratecapacity in this way. It should be noted that the number of activeprivate names has continued to fall even as the peak-of-the-cycleyears of 2003 and 2004 move towards maturity and preliminaryresult estimation.

2

0

2,000

4,000

6,000

8,000

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12,000

14,000

16,000

18,000

2004(e)

2003(e)

2002200120001999199819971996199519941993

Capa

city

(£ m

illio

n)

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

Perc

enat

ge o

f Mar

ket

Capa

city

UK MotorAll other classes Motor capacity

Repositioning – The Market Adjusts


Central Adjustment at Lloyd'sLloyd's, of its own accord, is working hard to reposition itself, bothin terms of its profile, its branding and in many very importanttechnical ways. Under this last heading the concentrated efforts todeliver contract certainty are long overdue across the market, and itis immensely good to see this initiative taking wing. Other drives for business reform, overseen by the newly appointed SteveQuiddington at Lloyd's, should develop efficiencies in electronicclaims files, accounting and settlements. We discuss branding onpage 23.

Enterprise Culture ?With these issues in mind, it is perhaps worth remembering wheresome of the major successes at Lloyd's have originated. It would beinvidious to single out individual names, but time and again onecan look back into the history books of the better enterprises andremark upon how often these now-great businesses originally setout with tiny stamp capacities and fragile support. Some of thesenow-highly-regarded names spent literally decades as disfavouredentities, and occasionally even as market pariahs.

This is not to say that new entities have not started in recent years,but the issue of "small start-ups" is a challenging one, not leastbecause buyers and their brokers may to some degree prefer towork with smaller entities provided the security is appropriate.It seems that a higher hurdle is being set than in earlier times.

Given the track record of many of the new starts over the past twodecades, this is understandable, but it must be a matter for realdebate as to whether the newly-repositioned central FranchiseManagement approach is going to provide an environment in which these sometimes fragile entities can come to life.

This of course is not atypical of a theme which arises increasinglyoften in many spheres of economic activity – it is a generality of ourage that smaller-scale forms of innovation are finding it harder totake root. The scale required for new reinsurer start-ups outsideLloyd's has multiplied perhaps tenfold in the past fifteen years; itmay well be appropriate that a comparable reality is developingwithin the Lloyd's market.

2Repositioning – The Market Adjusts


The Long Term View and a Peer ComparisonThe table below sets out Financial Results (projections for the open2003 and 2004 "three-year accounting" results) for the Lloyd'sMarket as a whole.

Year Financial Results/ProjectionsAnnually Accounted Three Year Result (Three Year

Basis Accounted Basis) as % Capacity2004 £1,357 million £1,074 million (p) 7% (p)2003 £1,892 million £2,069 million (p) 14% (p)2002 £834 million £1,193 million 9% 2001 (£3,110) million (£2,378) million (21%)2000 (£1,211) million (£2,397) million (24%)1999 - (£1,952) million (20%)1998 - (£1,065) million (10%)1997 - (£209) million (2%)1996 - £606 million 6%1995 - £1,149 million 11%1994 - £1,095 million 10%1993 - £225 million 3%Total: (£590) million (p) (0.4%) (p)

Note: Under annual accounts the whole of the loss for September 11 falls into 2001, whilstunder three year accounting it is split between 2001, 2000 and 1999. (p) = projection

On the above basis, one might feel concern at the market'sachievements over a longer time span. However, for the first time inits history there is a genuine and concerted central effort to avoidthe debilitating losses that have marred the market's down-cyclicalperformance. This merits closer examination.

Lloyd's has taken care to highlight the way that its recent combinedratio compares favourably with its competitor peer groups. Thisgives a very encouraging perspective.

Lloyd’s Combined Ratio Versus Industry

3Profit & Loss – A Stronger Platform for the Future

0

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

130%

Bermuda(Re)insurers

European(Re)insurers

US(Re)insurers

US P/C IndustryLloyd's

2002 2003 2004

Com

bine

d Ra

tio

Source: Lloyd's


Diminished Damage from the Bottom Quartile?The divergence of syndicate performance is again marked in the2002 year of account result. However, based on the 2003 forecast results, this divergence amongst syndicates appears to havenarrowed – it has to be expected at any point in the cycle that

there will be underperformers. It remains to be seen whether theFranchise Performance approach will have real impact, but the earlysignals are encouraging.


-30%

-20%

-10%

0

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4th Quartile3rd Quartile2nd Quartile1st Quartile

Perc

enta

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acit

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Quartile by number of syndicates

-30%

-20%

-10%

0

10%

20%

30%

4th Quartile3rd Quartile2nd Quartile1st Quartile

Perc

enta

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f Cap

acit

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Quartile by number of syndicates

Quartlie Performance – 2003 year Forecast Results as ofQuarter 8

Quartlie Performance – 2002 Year Result


Strengthened Balance SheetLloyd's profits in recent years have contributed to a strengtheningof its collective balance sheet. Net resources of the Society andLloyd's members increased by 20% to £12,169m (2003: £10,145 million).

£m 2002 2003 2004Cash & investments 24,512 27,893 31,362Reinsurers' share of technical provisions 13,693 11,180 9,876 Other assets 11,091 9,830 9,010 Total assets 49,296 48,903 50,248 Total liabilities 41,787 38,758 38,079 Net resources 7,509 10,145 12,169Balance due to/(from) members (2,022) (295) 1,363Funds at Lloyd's 8,968 9,659 9,622Central assets 7,509 10,145 12,169

One solid step towards improved performance is observable in thereducing dependency upon reinsurance, both in balance sheet termsfor past losses and in exposure terms for current risk management.At the balance sheet level, Lloyd's reinsurers' share of technicalprovisions decreased to £9,876 million (2003: £11,180 million) torepresent 81% (2003: 110%) of net resources.

The Franchise Board's encouragement – including reducing thepermitted levels on qualifying quota share (QQS) reinsurance – to

the market to underwrite for a gross profit has contributed towardsthe decline in Lloyd's reinsurance spend. Also contributing towardsthis declining trend will be managing agents' desire to retain moregood business at this point in the underwriting cycle. At 19.8% ofgross written premiums, Lloyd's reinsurance spend is the lowest for a decade.

Lloyd’s Reinsurance Spend as % Gross Written Premiums


0

5%

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15%

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35%

200420032002


Strengthened Central ResourcesLloyd's decision to increase the level of long-term central assetsresulted in the announcement of two initiatives in 2004. One ofthese was a genuine innovation; the second was perhaps moredesigned as a cost management issue.

Firstly, the Society successfully raised approximately £500 million of subordinated debt, thereby helping to increase central assets to£1,184 million in 2004, up from £781 million. This is discussed inmore detail below.

The second element, which commenced in 2005, was the reductionof the Central Fund Levy from 1.25% to 0.5%, accompanied by theintroduction of syndicate loans from syndicates' Premium TrustFunds. Syndicate loans are currently charged at 0.75% of thesyndicate's capacity each year. The loans will be repaid to syndicatemembers after three years, assuming Lloyd's has not been requiredto use this capital. Central assets were supplemented by £102 million of syndicate loans in 2005, but this should beconsidered against the background that income from the premiumlevy on members ceased in 2004 as a source of capital for Lloyd'scentrally. This gives the good outcome that the Market's centralassets are being strengthened whilst minimizing the impact onsyndicate returns.



RBC's rise as Market falls One of the first questions asked by students of solvency theory is "Why is Solvency measured in terms of Premium?". Solvencynaturally should be measured as a function of liabilities, notincome. It is only the long-standing inability of practitioners to reach a more accurate alternative that has left premium as a pragmatic substitute measure.

It is therefore all the more striking and impressive that the Financearm of Lloyd's has implemented a regime since 2002 that hasgradually adapted their Risk Based Capital ("RBC") model. Theimpact has consistently raised the market's capital requirements in a manner that with hindsight might be viewed as contracyclical.

As the market rose to a peak, solvency requirements werematerially lower than they are today. In addition, surplus facilitiessuch as the Qualifying Quota Share scheme were created. Thesewere extensively used at the peak of the cycle; regulators at Lloyd'shave acted to phase them out since then.

4 Security – Lloyd’s Adjusts


It is not clear whether the following table emanates from an activeobjective to manage the market's behaviour with a contracyclicalRBC requirement pattern, or whether it derives from a need toposition Lloyd's at a capital adequacy level which would at leastmatch that previously evolved under the auspices of the FSA forcomparable corporate insurers in the UK. Whatever the reason, it isan impressive pattern, and is likely to be an active contributor toimproved prospects for the Lloyd's market.

Year RBC Ratio (% of Stamp Capacity)2002 44.3%2003 46.4%2004 50.7%2005 55.2%

The effect of this pattern is that as pricing pressures mount, the use of capital is simultaneously being made a more serious issue for underwriting management teams. This in turn acts to raiseunderwriting discipline at precisely the cyclical point where it ismost needed. It may well prove to be a key factor in the minimizingof poor results in any coming down-cycle.

In Detail …For several years, the capital each Member has had to deposit in trust as capitalto support its underwriting (Funds at Lloyd's, or FAL), has been calculated usinga risk-based capital (RBC) approach, depending on each syndicate's businessmix and track record.

RBC is determined at individual Member level, depending on the business mix of the individual Member's individual syndicate(s), and can vary from amarket minimum of 40% of the syndicate's stamp capacity for a low volatilitysyndicate, to well in excess of 100% for a property catastrophe specialist.

The principal aim of the RBC system has been to equalise the expected loss to the Central Fund, per unit of premium accepted by each Member. It iscurrently determined as a percentage of the Member's capacity, stated net of acquisition costs, although this is expected to change within the next twoyears as part of a range of significant modifications that are planned to reflect the FSA's new approach to setting regulatory capital.

The RBC regime was amended in 2003, and this has had the effect ofincreasing FAL by approximately 25% between 2002 and 2005; the averageRBC scores across the whole market, measured as a percentage of StampCapacity, have increased as shown in the table opposite.



Central Fund StrengthensThe New Central Fund was established to be available – at thediscretion of the Council of Lloyd's – to meet policyholders' claimsin the event of members being unable to meet their underwritingliabilities relating to 1993 and later non-life business, and all lifebusiness. It therefore forms the last line of security once anindividual Member's Funds at Lloyd's have been exhausted.

The fund is increased annually by means of a levy on eachunderwriting Member – currently 0.5% of capacity for continuingMembers, and 2.5% of capacity for new Members. From 2005Underwriting Year, Members are now obliged to lend 0.75% ofcapacity (interest bearing) from their Premiums Trust Fund on athree year rolling basis; at the end of each three year cycle, thisloan will be returned to the Member provided it has not beenimpacted. Additionally the Council has the authority to levy a"callable layer" of up to 3% of capacity in any year.

Syndicate Loan Repayment Structure


Source: Lloyd's

*Based on current assumptions, reviewed annually

Syndicate Lloyd's Central Fund

Funding is from syndicate premium working capital progressive build up 2005-2008

Syndicate XCapacity £m2005

Loan Layerinvested in a

low-risk largelyFixed Income

Portfolio




0.75%

0.75%*

0.75%*

0.75%*

Interest

Interest

Interest

Interest

Repaymentof 2005 loan


During the year, Lloyd's made its debut in the international debt markets, raising approximately £500m of long-termsubordinated debt.

The debt, which was issued in a mixture of sterling and euros, israted BBB+ by Standard & Poor's and Fitch Ratings, and bbb+ by A.M. Best, and is listed on the London Stock Exchange.

This bond follows after the five year stop loss facility, which expiredat the end of 2003, and which was the subject of dispute with thereinsurers. This contract was finally settled in arbitration during thefirst quarter of 2005.

The balance on the Central Fund, including the subordinated loanissue, and after taking account of the reinsurance arbitration,amounted to £1,184 million at 31 December 2004.

Central Fund £556mCorporation assets £122mSubordinated debt issue £506mTotal £1,184m

In addition a 3% call on the 2005 Stamp Capacity of £13,720 million would deliver £412million.



EquitasWhilst Lloyd's does not own Equitas (which is an independentcompany, separately regulated by the FSA), there is undoubtedly alinkage in policyholders' minds. As such, the following commentsare included here.

Asbestos, AsbestosThe most serious development for Equitas in recent months hasbeen the publicity that has made plain that there is a real possibilitythat Congress may enact Asbestos legislation that would give scopeto non-Equitas entities to enter special pleadings relative to theircircumstances. Naturally Equitas feels that any such arrangementscarry an aura of unfairness if they expressly exclude Equitas. As atdate of going to press, it appears probable that Equitas will avoidunfairness of this nature. However, the scope for the Asbestoslegislation initiative to come to fruition is still wholly unclear.

Is a Future Call a Possibility?It remains an open question whether the recent escalation inAsbestos litigation could seriously imperil Equitas' solvency.Certainly the scale of free surplus that currently supports Equitaswould not be sufficient to withstand a reappraisal of reserves thatwas so serious as to require a doubling of existing asbestosreserves. Perhaps Standard & Poor's assessment is worth quoting:"In the medium term, Standard and Poor's currently considers thata £500 million [$942.6 million] capital deficiency at Equitas couldbe managed by Lloyd's".

Is a "Past Call" a Possibility?Original policyholders are thought to have some potential toachieve residual value by virtue of applying to the Names whoissued the original policies. These Names of course paid a premiumto "reinsurance to close" their liabilities, often many years ago,but the fact remains that they were the original security behind theoriginal policies, and the policyholders retain rights of recourseagainst their original security. Obviously the great majority of theNames who issued policies in the 1950s and 1960s are likely to be deceased, and claims against their estates or their executors arecommonly thought to be far-fetched. More recent policies may havea larger proportion of extant Names. In this context it may be worthconsidering the extent to which the economics would be attractiveto claimants, if it might be that the cost of pursuing claims couldexceed the individual amounts recoverable for the individual Namesthat are still alive.

5 Equitas


Costs & ComplianceCompliance continues to figure in managements' minds as asubject that is demanding of resource and open-ended as to itsrequirements. This works against Lloyd's in the context of all marketparticipants who have any kind of non-Lloyd's alternative, in thatthe non-Lloyd's alternative already has its own set of complianceand reporting demands. For these businesses, the prospect ofkeeping within the (non-Lloyd's) guidelines for the non-Lloyd's partsof their business, whilst doubling up for the Lloyd's element with asecond layer of compliance requirements for the Lloyd's elements,must be a matter of concern. Against this there is evidence ofsubstantial support among businesses at Lloyd's, many of whomsee the Franchise Performance regime as being key to the reductionof the costs of mutuality through its more effective protection of theCentral Fund.

There is no simple solution here. Lloyd's absolutely has to maintain avigorous compliance regime. For a range of good reasons it is boundto vary from the Bermudian, the NAIC's and the other regimes openfor consideration. Market forces are inevitably going to gravitatetowards the easiest option, albeit that this may carry exposure tobeing at the expense of security issues. The current context ofregulation at Lloyd's unfortunately may mean that these pressuresare not helping develop Lloyd's as an optimally attractive frameworkfor business in the coming years – but this may well serve to assistLloyd's in managing the down-cycle in the best way possible.

Turning to costs, Lloyd's should be applauded for its efforts to bringsome of the central charges under control. However it is undeniablethat many businesses feel the weight of these overheads veryacutely. Wherever there is scope to avoid these charges, there iscontinuing pressure to move business away from the market,although this pressure has reduced considerably as the centralcharges have fallen (see table on page 17). If the customer seeksthe additional security of the Lloyd's Central Fund, then of course tosome degree the customer has the choice to pay for that extrasecurity by using Lloyd's-based security. But it is not clear howmany customers feel the value of this choice where it is available.

Entities at Lloyd's have long enjoyed a notable advantage over theircorporate counterparts in their freedom to use Letters of Credit inlieu of subscribed capital and surplus. Not every Member uses thisfacility by any means, but for some it is a key attraction. Cost isoften discussed in very loosely defined terms (it may be noted thatwe have deliberately avoided this issue here) but, in the broadersense of the subject, we observe that the scope to win efficienciesin relation to cost of capital is widely underestimated. We expect to see this issue gaining wider appreciation in the near to mediumterm future, and as this happens, we would hope to see Lloyd'sbeing perceived as having real cost advantages.

6 Costs & Compliance


Lloyd’s Costs Structure for Underwriting Members

Percentage of Capacity 1997 1998 1999 2000 2001 2002 2003 2004 2005Members’ subscriptions 0.70 0.50 0.35 0.25 0.25 0.25 0.25 0.50 0.50Central Fund Contributions 0.60 1.00 1.00 1.00 0.75 1.00 1.00 1.25 0.50Premium levy 1.10 1.10 1.10 1.10 1.10 2.00 2.00 NIL NILTotal 2.40 2.60 2.45 2.35 2.10 3.25 3.25 1.75 1.00

Syndicate/Member Loan NIL NIL NIL NIL NIL NIL NIL NIL 0.75Callable Central Fund contributions <2.00 <2.00 <3.00 <3.00 <3.00 <3.00 <3.00 <3.00 <3.00

Note: Central Fund contributions for 1997 were 0.6% for individuals and 1.5% for corporates (1998: 1% and 1.5% respectively). Contribution rates were bought into line in 1999.

It will be seen from the above that fixed central costs at last have been reduced to a genuinely manageable level.

6 Costs & Compliance


The London Stock Market's ViewThere are thirteen LSE/AIM-listed Lloyd's operations, with a totalstock market capitalisation in mid May 2005 of £4.6 billion. Ofthese, the largest is Brit, which has a stock market capitalisation ofapproximately £750 million, or about one-third the size necessaryto get into the FTSE 100 index. Four others (Amlin, Catlin, Hiscox

and Wellington) are included in the FTSE 250 index, whilst the rest of the sector is largely off the radar screens of most stock analysts.Of these five, all except Amlin have significant insurance operationsor investments outside the Lloyd's market, but all save Brit writewell over half their business at Lloyd's.

7 The External View

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HardySVBAtriumChaucerKilnCoxBeazleyOmegaHiscoxWellingtonCatlinAmlinBrit

£ m

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Capitalisation of Lloyd’s Operations – May 2005


These companies, which have a significantly better profitabilityrecord than Lloyd's as a whole, tend to be treated by stock marketanalysts as all much the same. However, they have widely varyingmixes of business. For example, Cox and Chaucer are heavilyweighted towards Motor business, SVB towards claims-madecasualty (D&O and professional indemnity), and Hiscox, Kiln and

Wellington towards short-tail business. They vigorously defendedtheir independence when their competitors were selling out in themid 1990's, and rely heavily on the personal skills of key staff. Therehas been a huge divergence of share price performance since thesector was knocked by the World Trade Center atrocities inSeptember 2001 (entities shown are those listed on 11.9.2001):

7 The External View

-100

0

100%

200%

300%

400%

500%

GoshawKSVBCoxChaucerHighwayBRITHiscoxHardyWellingtonKilnAmlinAtrium

Growth in Share Price Since WTC


During 2004, Capital Insurance Holdings was set up in London,aimed at consolidating some of the smaller listed Lloyd's of Londoncompanies. The company was due to be launched on the AlternativeInvestment Market, but the public issue had to be withdrawn,apparently because there was insufficient support for the plan fromU.K. investors to meet AIM rules, despite strong backing frominvestors in the United States.

Lloyd’s “FTSE-250”The comparison below highlights the superior performance of thefive entities with FTSE-250 listings.

7 The External View

-40%

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2003(p)

200220012000199919981997199619951994199319921991199019891988

Capa

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Market Average ResultFTSE 250 Aggregate Syndicate Results

Source: Moody's

Performance of Lloyd’s “FTSE-250” versus Lloyd’s Market Average


The following table shows how the companies that are listed withinthe FTSE-250 have taken steps to manage their own positionswithin the market relative to the insurance cycle. It is unlikely to becoincidental that as results improved, the respective share of marketcapacity rose; and as the market fell, there is evidence of discipline

as the respective shares of market capacity declined. It is undeniablyinteresting that even with the restraint shown by the table below,the FTSE-250 group nonetheless suffered four years of underwritinglosses – but equally it is notable how modest these losses werewhen compared with those of the remainder of the market.

7 The External View

-40%-35%-30%-25%-20%-15%-10%

-5%0%5%

10%15%20%25%

2003(p)

200220012000199919981997199619951994199319921991199019891988

FTSE-250 Result Lloyd's Market Result FTSE-250 Share of Capacity

Resu

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(% o

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nd S

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y)

FTSE250 Capacity/Result Correlation


Standard & Poor's ViewWhen Lloyd's reported its earnings for the financial year ended December 31, 2004, Standard & Poor's Ratings Services stated itsrating and outlook on the Lloyd's Market ("A"/Stable) as well as its "BBB+" rating on the subordinated debt issued by the Societyremain unchanged.

Lloyd's reported:– strong net profits before tax of £1.4 billion ($2.6 billion)

(£1.9 billion in 2003) – combined ratio of 96.9 percent (90.7 percent in 2003)

S&P noted that the figures were generally better than their lastpublished operating expectations of £0.8 billion-£1.2 billion[between $1.5 and $2.26 billion] and 93 to 97 percent. Thesefigures did not take account of the impact of a Central Fundinsurance arbitration settlement, which has reduced the size of the Fund by £226 million ($426 million) and contributed 2.7 pointsto the Market's combined ratio.

However, performance was lower than the original expectations setfor the Market in September 2004 (net profits before tax of £1.8 billion-£2.2 billion [$3.4 to $4.15 billion] and a combinedratio of 87 to 90 percent) due to the impact of a series of largecatastrophes. The net impact of significant catastrophe claims in2004 equate to £1.3 billion [$2.45 billion] or 11.3 combined ratio points.

Amounts relating to reserve strengthening on prior years and costs relating to run-off syndicates, net of releases on initialreserves set for the 2002 and 2003 accident years are in aggregate£300 million [$565.6 million] or 2.6 combined ratio points.

The strength of the underlying profitability, aside from a strongoperating performance, is based on:– the main capital providers remaining committed to the Market

(the 8 percent decline in capacity for 2005 to £13.7 billion[$25.83 billion] being consistent with prudent underwritingcycle management)

– there being no material deterioration in the solvency of EquitasLtd. in the short term. (In the medium term, Standard & Poor'scurrently considers that a £500 million [$942.6 million] capitaldeficiency at Equitas could be managed by Lloyd's.)

– the Franchise Performance Directorate remaining proactive inguiding the Market, particularly if underwriting conditionsdeteriorate more significantly

– material progress before 2006 in business process reform with, inparticular, improvements in policy production and claims handling.

7 The External View


Licences & BrandingLloyd's enjoys two extraordinary assets in its remarkable range ofglobal licences and its renowned brand as a specialist insurer.

The licences are of course a source of enormous appeal to marketpractitioners. A minority of entities have sufficient global reach tomake this aspect of the market's capabilities less relevant, andsome of the Motor syndicates would operate equally smoothlyoutside Lloyd's. However the great majority regard the instantaccess to business across a truly global licence range as a keyfeature of operating at Lloyd's.

Much more subtle is the question of the Lloyd's brand. MORI hasexplored the status of the Lloyd's brand and surprised nobody whenit reported that Lloyd's has "the most famous brand in insurance",most obviously as the par excellence insurer of unique risks,whether they be satellites, political exposures, pianists' fingers oreven Egon Ronay's taste buds. But Lloyd's Syndicates are allindividual businesses with individual sub-brands – a number havebeen active in spending large sums of money specifically promotingtheir individual brand independently of the main "mother" brand.This gives difficulties for any central brand development initiative.

It is therefore much to be applauded that Lloyd's has instigated a major overhaul of its brand and has closely examined theexpectations associated with its name. Good brands create trust,and trust is one of the quintessential elements in providinginsurance products. A complexity for Lloyd's here is that branddevelopment to some degree erodes the need for personalinteraction. This of course has been a central feature of Lloyd'ssuccess – the market thrives upon an exceptional web of long-standing personal relationships.

Key early findings include that Lloyd's is suffering from having nobrand custodian. Further, while Lloyd's enjoys high brand awarenessand while customers perceive Lloyd's to offer a genuinely differentproduct, these advantages are being eroded.

This initiative is in its early days as regards its medium term impact,but one can only welcome the freshness of the approach.

8 Licences & Branding


SummaryInevitably the assessment above has looked hard at both the goodand the less good in the figures and endeavours of the world'slargest insurance market. Some inferences may be drawn.

There are issues that should be addressed, just as there are manygrounds for real confidence for the future.

– If we consider the Franchise Performance efforts, we can admirethe much-needed central cohesion but we need to be aware of the movement of business in and out of the sphere of central control.

– If we review the way that the market has adapted, we aregratified to see the vigorous enterprise that is active on so manyfronts. We should be wary of an environment where there maybe restricted scope for embryonic development, albeit that thisis becoming a reality in many spheres of commercial enterprise.

– If we look to past profit and loss experience, both the last twodown-cycles have seen the market absorb unprecedentedly largelosses, which the subsequent up-cycles have scarcely beensufficient to make good. This should be cautionary, and indeed ithas ushered in the Franchise Performance model. The hugerange of changes that have swept the market over the pastdecade or so have undoubtedly been strongly for the better, andthe collective balance sheet has taken very real positive strides.

– If we consider the security underpinning the market, there is no doubt that the reservations expressed five and ten years ago have been substantially rebutted.

– The upward ramping of the RBC ratios has transparentlystrengthened both the market's financial platform and theresolve of underwriting management teams to deliver realreturns on the capital employed.

– If we look at fundamental problems like central costs, there is evidence that Lloyd's is making strenuous efforts to address these.

– Lastly the external views of both the Rating Agencies and theLondon Stock Market continue to be supportive.

This should all bode well for the future. But as so often in life,simply being well positioned is never enough of itself. Lloyd's, as all the above shows, will need the full depth of its remarkablerange of skills to navigate the pressures ahead.

9 Summary


AppendixThe diversity of Lloyd's capital base continued in 2005 with no one capital provider accounting for more than 6.2% of the market's total capacity. The overall division is illustrated below.

Lloyd’s Capacity Profile

Appendix

0

2

4

6

8

10

12

14

16

2005200420032002

Capa

city

(£ b

illio

n)

Trade Capital UK Listed Individual Members (Limited Liability)

Other Corporate UK Non-Listed Names (Unlimited)


The following table contrasts the steady use of capital from largepresences such as Amlin, Limit, Hiscox, Brit and Catlin, with the continuing contraction of Ace, Berkshire Hathaway and XL Capital.

Appendix

0

200

400

600

800

1000

1200

Talism

an

St Pa

ul Tra

velersCoxKiln

Talbo

t

XL Cap

ital

Mitsui

Sumito

mo

Berks

hire H

athaw

ayACE

Chauc

erSVB

AIG (Asco

t)

Welling

tomCatlin

BRIT

Beazl

ey

Hiscox

Libert

y Mutu

al

QBE (L

imit)

Amlin

2005 2004 2003 2002 2001

Capa

city

(£ m

illio

n)

Lloyd’s Top 20 Capital Providers – 2005

Willis Limited

Ten Trinity SquareLondon EC3P 3AXTelephone: +44 (0)20 7488 8111

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REI/2988/05/05

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2988 lloyd's review cover 2 - Willis Towers Watson · Title: 2988_lloyd's review cover 2.qxd Author: greencz Created Date: 5/24/2005 5:22:55 PM