Changes ahead in London?
When we talk about the London market let's parse the definition a bit. There are a number of people and companies who have moved out of the Lloyd's market because of cost and regulation and set up shop across the street from 1 Lime Street. When we use the term London market broadly it usually is construed to include those expats and the Lloyd's market.
That's why we were surprised to see a few comments lately. It's no secret that the Lloyd's market (the 94 syndicates) are about as close to the definition of a "traditional reinsurer" as you can get when arguing the merits of "new ILS carriers" vs "traditional reinsurers".
Lloyd's itself has shown its flexibility by allowing Nephila Capital, Securis and Credit Suisse to back Lloyd's regulated underwriting vehicles with ILS capital. As we've observed before in this space Lloyd's is nothing if not practical and will follow the money.
Validus Re, XL, Munich Re and Hannover Re all said or did things in the past month that showed they are practical too and have no compunction about using ILS funds when it makes sense to use lower cost capital to underwrite less profitable business.
So far so good one would think? One can almost see the goal of a warm cozy resting place in the future with ILS and traditional capital living together melded into one underwriting market to go after these $2 trillion in new premiums everyone is talking about.
Not so fast. We have people inside the glass houses who seem to be throwing stones out of them!
First we saw Tom Bolt lauding the efficiency of the ILS market in comparison to the Lloyd's market. In a talk given during our stay Bolt said the cost base of alternative carriers run by "fund managers is between 1-2 percent of capital managed, compared to the 10-12 percent cost of delivering a unit of cat risk in the traditional (re)insurance industry."
He went on to say that the London market takes about 30% of the premium just to deliver the product, including brokerage fees, with around "70 points of benefit baked into the product."
He was specifically referring to the CAT reinsurance market where the ILS carriers have jumped in with both feet and seemed to think that the London market is inevitably going to write less CAT business in the future because of the cost advantages the ILS carriers have.
For those who still believe in the "today we're down but tomorrow we're up nuances of the cycle" this observation was bad enough but he went on. He said Lloyd's can no longer rely on wholesale brokers to secure the business Lloyd's needs to maintain its position in the global specialty market.
He said that the days of underwriters sitting in London and waiting for wholesale brokers to bring in the business were "long gone and I don't think they're coming back". He said his biggest fear is that someone else would find a way to bring the kind of low-cost, high-speed model provided by companies like Amazon to the specialty insurance world.
He said you "look at Amazon.com --they're doing same day delivery. And we don't get the policy out and it's just an ephemeral promise to pay and it's evidenced by an electronic thing and you can't get it to somebody the same day. And the cost is somewhat expensive to deliver."
Bolt seems to be talking about a future need for a sea change in the way Lloyd's will need to do business if it wishes to compete. His last word on the subject was "I'm just really worried that someone will come along --Samsung or someone --and figure it out."
Now, in addition to having won not one but two Insurance Personality of the Year awards in 2014 Bolt is also known as "Mr. Doom and Gloom." (Counter-intuitive we know). He's certainly quite personable when you're sharing a meal with him but there are those in London who liken him to the Charlie Brown character Linus who walks around with a black cloud over his head.
He would tell you that the ratings agencies and the PRA require him to be gloomy. He needs to see trouble coming before anyone else does and the trouble he looks for is the kind that could cause very big problems if he is right only part of the time. So he isn't going to change --why should he --as he's been right a lot more than just part of the time.
But....ouch and ouch on a lot of levels. Ouch if you are Xchanging Insurance Services and you are have been charged with modernizing the London market.
Ouch if you are a syndicate thinking that you've come to grips with alternative capital and are considering taking the plunge to use the more cost effective capital to underwrite lesser priced business. That won't be enough in itself --Bolt is saying that the expenses baked into your product are too high and can't compete not only in CAT but in areas well beyond it.
And ouch, maybe most of all, for the brokers. The poor brokers --everyone always looks at them first when it's time to extract costs from the equation. (It's unfortunate when one's remuneration is broken out as a line item on a contract). There is no administrative expense curtain to hide behind.
Catlin COO Paul Jardine picked up on this immediately. He said that brokers calling for the removal of traditional "Londonisms" to make the city easier to access are like turkeys voting for Christmas. Certainly when Tom Bolt was talking about the high expense of London he was talking about removing the so-called "Londonisms". Jardine's point seemed to be that if "the push to remove the Londonisms to make it easier to do business with is taken to its natural extreme, it is undoubtedly turkeys voting for Christmas."
Paul Jardine (Insurance Journal TV)
What are Londonisms you ask? They are legion and not even all known to any one person. We can name a few though. For example the requirement that accessing a Lloyd's market requires a Lloyd's broker to place the business. This is the proverbial "third rail" at Lloyd's and you won't ever find anyone in authority at the Corporation even hinting that maybe looking at expanding this access to include cedents and or non-Lloyd's brokers is a good idea.
Another Londonism we know about is that Lloyd's brokers typically receive a 15% comission on business placed into the market. In the US that comission is 10%.
A Londonism you hear about often is the requirement for all Lloyd's business to be transacted through Xchanging which functions essentially as a utility with a monopoly. (It would be a tough spot for anyone to be in). After all how often do you hear people bragging about how good their gas or electric company is when the only option they have is to start burning the furniture in the hearth?
So, let's look again at what Jardine might have meant. Jardine said that if London were to become like any other insurance market in terms of distributionit would be accessed directly. By definition it is precisely these "Londonisms" that distinguish London from other insurance markets and he likened the brokers calling for the removal of the Londonisms as being the "turkeys voting for Christmas".
Think this through then. We have Tom Bolt telling markets "You need to be ready to get out of your chair, find the business you want, find the broker who has it and convince him to give it to you."
You have a quote from a Latin American risk manager buried in an LMG report saying "I have found it hard to maintain my relationships with the London market, they are overly reliant on me going to them versus others who are more willing to come to me."
The same LMG report identifies the biggest challenge (Bolt's baked in metaphor again) as being London's expense ratio at 9 percentage points higher than its peers in 2013 driven by higher transaction costs and acquisition costs.
Then there is Aon's Steve McGill saying the time when Lloyd's was the "only show in town" for international specialty risks has long gone and the London market operates in a world where the barriers are breaking down. He said that "connectivity to the client" is all important now as much of what formerly went to London is being written locally.
McGill did not say that those "baked in" expenses were a cause of this deterioration --he didn't have to because of what he said next. He warned that "We might think we are winning the battle but in fact we are in danger of losing the war."
He said "London is not the only viable subscription market in the world" anymore and "Lloyd's/London is not the undisputed leader in innovation anymore."
Maybe in a signal that one of those turkeys, and the biggest one at that, might not be voting for Christmas McGill said there is "no real differentiation in the value proposition in London. In fact, relative to the local markets, it has declined and in some cases substantially --hence the decline in London's market share."
Aon may have 6,000 employees in the UK, and their new corporate headquarters across the street from Lloyd's, but you can bet they are placing business in markets globally when they get the right price. Smaller brokers may not be so lucky.
There is only so much that can be done until substantive changes come into play in London and it's possible that the first one --after addressing the usual suspects of better technology and more automation -- is going to be on those "baked in" expenses. There is one that sort of sticks out...in fact you can almost see the sparks shooting off its third rail.
What's at stake here? More than we can guess we think. We looked at this comment from Catlin's Jardine who said that even more capital might be needed in the reinsurance market to cope with the growing risk demands of clients. More capital? Now?
Yes. Remember the additional $1.4 trillion in new premiums Lloyd's John Nelson talks about? Jardine says that the influx of new capital is needed now to meet the increase of demand in emerging economies such as China mature and begin to seek more protection against CAT risk. He said that the rise of "mega-cities" will also contribute to increased concentrations of exposure that challenge the reinsurance industry.
This is what's at stake. There is an explosion in the numbers of risks and amounts of premium that can be written just around the corner. If London doesn't get ready soon the warnings seem to be saying it will risk being left behind.
One final note on this. If what Evan Greenberg and Ace are being rumored to be planning comes to fruition they will set up an internal hedge fund reinsurance platform that will participate on Ace's outwards reinsurance (reports indicate as much as 20% may be pushed through it).
It is understood that Ace's net underwriting returns would benefit from the disintermediation of its reinsurance business placed into the new internal platform.
Ace cedes about $5 billion in risk with about 50% of that going to the NFIP and the US crop insurance program. So if 20% of the remaining $2.5 billion is to end up in the new facility that is about $500 million in premium or about $50-$75 million in savings to Ace's net underwriting return.
Back to that "baked in" cost again....