Lloyd’s “structural revolution” forecast, as ILS capital increases share: Analysts
A “structural revolution” is forecast for the Lloyd’s of London insurance and reinsurance market, as increasing quantities of alternative and ILS backed capital become the pre-dominant underwriters of the more standardised and commoditised risks in the marketplace.
The forecast comes from analysts at Macquarie Research, who believe that the innovative steps taken by insurance-linked securities (ILS) funds, as well as the growth of binders, facilities, MGA’s and special purpose syndicates, will all conspire to drive increasing amounts of premium from the more commoditised business underwritten at Lloyd’s to sources of lower cost capital.
We’d agree entirely, and there is certainly evidence to suggest that this forecast is an accurate vision of the future for insurance and reinsurance markets worldwide.
Lloyd’s of London is certainly not immune to the effects of ILS capital and the efficiency of the capital market model. It has done well to fend off a more wholesale entry of alternative capital into the market in recent years, with the barriers to gaining access to Lloyd’s business still remaining some of the highest in reinsurance.
But, while interest from capital continues to increase, there are increasing mechanisms by which it can be deployed into Lloyd’s business. At the same time many traditional Lloyd’s underwriters are no longer able to make sustainable profits on some standardised or commoditised lines of business, suggesting that a lower-cost approach to providing capacity must be found.
This has been becoming increasingly evident across recent renewals, that a tipping point may be emerging which could force the hands of the Corporation of Lloyd’s to become more welcoming to ILS capacity from the capital markets.
If its traditional syndicate players are no longer able to underwrite certain lines of business at a margin, Lloyd’s would either have to face relinquishing a lot of that business to the major global re/insurance players or find a new and more efficient way to get capacity into the market to assist its core underwriting members.
“In a world where insurance is increasingly viewed as an asset class, a range of innovations (e.g. broker facilities, MGA’s, binders, SPS, ILS funds) have opened the market to lower cost capital,” the analysts at Macquarie explain.
This led them to expect that the future of Lloyd’s of London will be one where increasing amounts of standard underwriting business is written at lower margins by ILS and alternative capital, as has already been witnessed with the growth of binder business.
Macquarie forecasts that the Lloyd’s insurance market will itself tier, with two tiers of capital and underwriting expected by 2025.
The first, driven by alternative sources of capacity, will be the standardised business.
“We anticipate that highly commoditised business will be underwritten through broker facilities, MGA’s, binders, Special Purpose Syndicates and ILS funds,” Macquarie’s analysts explain.
The second is the more customised, or specialist underwriting business, where significant experience and sometimes deep knowledge of counterparties is required and this will be driven by traditional equity capital.
“We expect syndicates will limit use of their higher cost equity capital for bespoke products requiring expert underwriters and R&D but commanding a higher margin,” the analysts forecast.
This tiering of capital is already being seen in many global reinsurance firms, particularly the Bermudians, where traditional equity balance-sheets are increasingly focused on the type of underwriting business that can deliver the necessary returns, while third-party capital from investors is utilised for many of the lower-margin catastrophe risks.
It’s a sensible split, as it allows underwriters to get paid for what they are good at, the technical analysis, pricing and structuring of risks, while the equity capital is put to work backing business that meets its cost-of-capital.
Meanwhile more efficient third-party capital, from capital market investors and ILS funds, can still make margin on many softened areas of the market, such as in property catastrophe risks.
Macquaries analysts say that the pressure for change in Lloyd’s is likely increasing this year, as the market’s performance gap from its peers is now negligible, meaning investments in the market for the traditional equity holders are no longer as attractive as they used to be.
Underwriting performance has deteriorated, the analysts say. This is partly due to the dilution of underwriting results, through the continuation of writing this more standardised business. So shifting that business to third-party capital may actually benefit the Lloyd’s market, we’d suggest.
At the same time Lloyd’s costs are particularly high, 40%+ versus peers 30% to 35%, which puts underwriters at Lloyd’s at an immediate disadvantage on an efficiency basis....MUCH MORE
