© Lloyd’s 1 © Lloyd’s 1

Current Underwriting Challenges Markus Gesmann Lloyd’s Analysis

7 June 2016

© Lloyd’s 2 © Lloyd’s 2

Agenda

► Review of Lloyd’s historical results

► Overview of Lloyd’s approach to challenge

underwriting

► Ideas for monitoring pricing and underwriting

► Conclusions

© Lloyd’s 3

-60%

-40%

-20%

0%

20%

40%

195

0

195

2

195

4

195

6

195

8

196

0

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0

201

2

201

4

%

Net U/W Profit % NEP Investment Income % NEP Lloyd's Pre-tax Profit % NEP

Lloyd’s historical results 1950 - 2015

Source: Lloyd's Annual Reports, Statistics relating to Lloyd's 2001; Lloyd’s data for 1950 – 1999 on three year accounting (assuming

written=earned premium and 18% brokerage), and from 2000 onwards on annual accounting basis.

Major losses: Hurricane Betsy (1965), 1974 Super Outbreak 148 tornados in one day, Piper Alpha (1988), Hurricane Hugo (1989), the San

Francisco Earthquake (1989), Exxon Valdez (1989) North European storms (1987 and 1990), Typhoon Mireille (1991), Hurricane Andrew (1992),

Northridge Earthquake (1994) , WTC (2001), Hurricanes Charlie, Francis, Ivan (2004), Hurricanes Katrina, Rita, Wilma (2005), New Zealand,

Chile Earthquake (2010), New Zealand, Japan Earthquake, Thailand Flood (2011)

Hurricane

Betsy Super

Outbreak:

148 tornados

in one day

Piper Alpha

Hurricane Hugo, San

Francisco EQ,

Exxon Valdez

WTC

Attacks

NZ, Japan

EQ, Thai

Flood

Establishment of business planning

and new entrance process

Hurricanes

Katrina, Rita

& Wilma

© Lloyd’s 4

Lloyd’s Underwriting Results since 2000

Source: Lloyd's Annual Reports, NEP = Net Earned Premium

40% 39% 38% 37% 36% 35% 35% 30% 34% 34% 31% 32% 33% 36% 36% 32%

46% 45% 44% 44% 46% 46% 49% 49% 46% 49% 50% 54% 56%

60%

78% 91%

4% 4% 4% 10%

25% 13% 2% 13% 4% 0%

31% 11% 1%

2%

27% 2%

90% 88% 87% 91%

107%

93% 86%

91% 84% 83%

112%

97% 91%

99%

140%

125%

-7.9% -8.0% -8.0% -7.2% -6.5% -5.9% -5.6% -9.2% -6.5%

-2.1% -0.1% 2.7% 5.7% 5.9% 11.5% 10.5%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

2015201420132012201120102009200820072006200520042003200220012000

% o

f N

et

Earn

ed P

rem

ium

Financial calendar year

Net Operating Expenses % NEP Attritional Net Loss % NEP Major losses % NEP Prior Years % NEP

© Lloyd’s 5

Analysis of Lloyd’s operating expenses

Source: Lloyd's Annual Reports, NEP = Net Earned Premium

Since 2009 operating expenses increased from 35% to 40% driven by:

• Higher acquisition costs (28% - 30%) by and large due to increased Coverholders business (25% to 32% of

Lloyd’s income)

• Higher administrative expenses ratio (9% - 11%) driven by

- Softening market environment, i.e. lower premium income for the same risk exposure

- Weakening exchange rate (business predominantly sourced in US$, while admin expenses are

predominately in GBP£ (2009: $1.61 = £1, 2015, $1.47 = £1)

- Increased regulatory requirements, e.g. Solvency II

£853 movement

in exchange rates

0%

0%

1% 0% 0%

-1%

0%

-6%

-1%

2%

-1%

1% 0%

4%

30% 30% 29% 29% 28% 28% 28% 28% 27% 26%

25% 24% 26% 25%

11% 11% 9% 9% 8% 9% 8%

9% 9% 7% 7% 7% 7% 7%

40% 39% 38% 37% 36% 35% 35%

30%

34% 34% 31% 32% 33%

36%

-10%

0%

10%

20%

30%

40%

20152014201320122011201020092008200720062005200420032002

Profit (Loss) on Exchange % NEP Acquisition Costs % NEP

Admin Exp % NEP Net Operating Expenses % NEP

© Lloyd’s 6

Lloyd’s Premium Rate Index

0

50

100

150

200

250

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Accident & Health

Aviation

Casualty

Casualty Treaty

Energy

Marine

Overseas Motor

Property (D&F)

Property Treaty

UK Motor

Source: Lloyd’s Statistics (2016 Edition)

© Lloyd’s 7

Benchmark price Conditions

Limits

Perils

Claims

inflation

Regulation Marketing

Brokerage /

Commission

Expected Loss

T&C

price

waterfall

Rising tide of

Cost-to-Serve

Bound Profit

Discounts

Compression

Expenses

Cost of

Capital

Price Leakage: Profits compressed from both sides

© Lloyd’s 8

BCG Growth-share Matrix

?

Share

Growth

$

Visit: https://www.bcgperspectives.com/content/articles/corporate_strategy_portfolio_management_strategic_planning_growth_share_matrix_bcg_classics_revisited/

© Lloyd’s 9

BCG Growth-share Matrix

?

Share

Growth

$

Invest

Profits

© Lloyd’s 10

BCG Growth-share Matrix Life Cycle

?

Share

Growth

$

© Lloyd’s 11

Which line of business would you put where?

Question marks

Dogs Cash Cows

Stars

Share

Growth

© Lloyd’s 12

-1%

5% 3% 11%

7%

-9%

-28% -36% -38%

-26%

0%

13% 12% 7%

-6%

-19%

-35%

-23%

-71%

14% 21%

13%

-1%

31% 29%

14%

24%

12%

-3%

15% 16% 15% 9%

-100%

-50%

0%

50%

100%

150%

200%

%

Lloyd's Return on Capital Capital / Net Earned Premiums

Lloyd’s return on capital 1983 - 2015

Source: Lloyd's Annual Reports, Statistics relating to Lloyd's 2001; Lloyd’s data for 1983 – 1999 on three year accounting (assuming

written=earned premium and 18% brokerage), and from 2000 onwards on annual accounting basis. Capital = Total Net Resources

of the Society of Lloyd’s and its members less subordinated debt

Boom and bust phases. After profitable years, capital

flows into the market, driving prices down

Lloyd’s loses 71% of capital: poor pricing, prior

years deterioration, WTC and weak capital

Establishment of business

planning and new entrance

process

Ratio stays constant,

demonstrating a more

disciplined market

© Lloyd’s 13

You can only be proven wrong

Karl Popper Black Swans

Good tests kill flawed theories;

we remain alive to guess again.

© Lloyd’s 14

You make money until you don’t

© Lloyd’s 15

► A Lloyd’s syndicate is planning to enter a new

class of business, where historically only 15% of

the syndicates met its planning loss ratio and

85% failed.

► The syndicate has a track record of meetings its

business plan loss ratio 4 out 5 years.

► How much confidence would you have that this

syndicate can achieve its planning loss ratio in

the new class of business?

Chances of entering a new class of business successfully

© Lloyd’s 16

► There are two kinds of casualty underwriters, the

skillful ones and the ones who run away from their

tails.

► Reviewing the historical market data reveals that

only 15% of casualty underwriters are skillful and

85% are running away from their tails.

► A CEO employs a new casualty underwriter.

► The CEO believes that she can identify the skillful

underwriter with 80% confidence.

► What is the probability that the CEO actually

employed a skillful underwriter?

Hit and run … away from your tail

© Lloyd’s 17

► Market submits data to

Lloyd’s

► Lloyd’s analyses the data

► Bespoke management

information is generated

► Agent specific reports and

tools are played back

internally and externally

► Lloyd’s and agents use the

MI to review and improve

their performance

Performance review cycle at Lloyd’s

Plan still

sensible?

© Lloyd’s 18

Predict Correct

In a nutshell

© Lloyd’s 19

► Underwriting performance

benchmarks vs. notional market

and plan

– Top performing syndicates or

classes sit in the top right

quadrant

– Bottom performers sit in the

bottom left quadrant

– Movements over time highlight

changes in performance

Example: Benchmarks vs. peers and plan

better

Performance vs. peers

Perf

orm

ance v

s. pla

n

worse

wors

e

be

tte

r

Source: Quarterly Performance Information reports from Lloyd’s

© Lloyd’s 20

Relative Renewal Price Movements

Ab

so

lute

Pri

ce A

deq

uacy

0 +10% -5%

100%

50%

125%

150%

75%

-10% +5%

Write as much as

you can

Focus on future

growth

Attention required,

prices becoming

marginal

Do not write

-15% +15%

Original diagram by David Bracewell, Deutsche Bank

Illustrative example for price monitoring

© Lloyd’s 21

Signal and Noise

© Lloyd’s 22

Signal and Noise

© Lloyd’s 23

►Monthly data feed from syndicates’ underwriting

systems

►Information on premium income by risk, including

– Price changes for renewals

– Price comparison against business plans

►Key tool to monitor syndicates’ business plan and

performance oversight

Since 2009: Performance Management Data Return (PMDR)

Past Present Future

Quarterly Monitoring Return Syndicate Business Plan PMDR

© Lloyd’s 24

► PMDR highlights potential issues before loss ratios have

to deteriorate.

PMDR in practice

Example with dummy data

Syndicate No /

COB

PMDR

Written

Premium

(000's)

Current

Year

PMDR %

of

Approved

Plan

Lapsed

Premium

%

New

Premium

%

Current

Year Pure

Rate

Change %

(RARC)

Previous

Year Pure

Rate

Change %

(RARC)

% of Total

Premium

with

Benchmark

Price

Benchmark

Price Overall

Plan

Loss

Ratio %

Loss Ratio %

with

benchmark

price applied

Latest

Actual

Loss

Ratio %

xxx yyy 51% 18% 25% -1% 3% 100% 94% 68% 72% 74%

xxx yyy 66% 18% 18% 0% 2% 100% 95% 68% 72% 67%

xxx yyy 51% 13% 19% -1% 4% 85% 117% 73% 62% 78%

xxx yyy 62% 30% 30% -2% 5% 100% 111% 72% 65% 71%

xxx yyy 52% 23% 17% -1% 8% 46% 115% 65% 56% 67%

xxx yyy 59% 32% 34% -1% 5% 87% 111% 67% 60% 82%

xxx yyy 53% 26% 11% -1% 3% 47% 100% 64% 63% 75%

Overall: 10,743,532 53% 23% 26% -1% 4% 67% 105% 70% 66% 73%

Premium and policies Rate Change Benchmark Price Loss Ratio %

© Lloyd’s 25

Calibrating pricing models takes time …

Incurred

loss ratio

Pricing

loss ratio

Updated

reserving

loss ratio

Development Quarter

Underwriting Year

2010 2011 2012 2013 2014

© Lloyd’s 26

0%

20%

40%

60%

80%

100%

40% 90% 140%

Casualty

40% 90% 140%

MAT

Worst case

Best case

0%

20%

40%

60%

80%

100%

40% 90% 140%

Motor

40% 90% 140%

Property

… but can enhace better monitoring of risk appetite

Loss ratio Loss ratio

Exce

ed

an

ce fre

qu

en

cy

Range of prices Portfolio Mix

© Lloyd’s 27

Cycle Management Decision Tree

• Does our current portfolio deliver targeted return on

equity over the cycle?

• Can less cyclical (sub-)segments be identified?

• Is focusing on these segments a valid strategy?

• Does our business model support a flexible exit/entry?

• Can we gain customers back when re-entering the

market?

• Can we preserve underwriting expertise during exit

periods?

• Can an active price management compensate for the

expected price decrease over the next cycle?

• Can we establish the required skills/tools for systematic

price management?

• Can we align the mindset and behaviour of individual

underwriters?

No

No

Follow the

cycle

Flexible

exit/entry

Active price

management

Value-

maximising

exit

No

Yes

Yes

Yes

Source: “Three strategic approaches to active cycle management”, Thomas Sepp and Oliver Bäte,

Cycle proficiency. Post Magazine, 1 July 2004, pages 22 – 23,

© Lloyd’s 28

► Underwriting conditions are challenging

► Business planning and monitoring are essential

► Better data and risk modelling should allow for better

portfolio cycle management

► Solvency II capital models should allow for better

allocation of capital to risk appetite

Conclusions

© Lloyd’s 29

► Directory of data and reports from Lloyd’s:

– www.lloyds.com/data

► Lloyd’s Statistics:

– www.lloyds.com/stats

► PMDR framework and examples:

– www.lloyds.com/pmdr

► Guidance on claims inflation

– www.lloyds.com/claimsinflation

References

© Lloyd’s 30 © Lloyd’s 30

Thank you

► Questions?

► Contact:

– Markus Gesmann

– markus.gesmann@lloyds.com

– +44 (0) 20 7327 5694