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Lloyd's underlying result exposes soft market damage

Lloyd's 2017 results demonstrated the struggles of a cat-heavy market which has battled with falling rates and thinning profit margins for the best part of a decade.

Last week, Lloyd's posted a full-year 2017 loss of £2bn ($2.83bn) after it absorbed about £4.5bn in net claims from major catastrophes during the year.

The major claims pushed the market to a £3.4bn underwriting loss - its first in six years - as the combined ratio worsened by 16.1 percentage points to 114.0 percent.

Lloyds loss ratio

The majority of that £3.4bn underwriting loss was weighted to the reinsurance and property insurance segments, which together accounted for £3.1bn of the deficit.

However, the deterioration in the performance of the underlying book at Lloyd's means that even in a normalised cat year, the market would have made an underwriting loss.

Normalising the cat experience for Lloyd's five-year average and including the 2.9 points of reserves released in 2017 brings the calendar-year combined ratio to 102.8 percent.

On a 15-year average basis, the calendar-year combined ratio ticks up to 103.1 percent.

Lloyd's accident-year ex-cat combined ratio for 2017 stood at 98.4 percent, a 4.5-point increase year on year. This was driven predominantly by a 5.6-point increase in the attritional loss ratio, which came in at 58.9 percent.

Lloyd's said in its annual report that the underlying claims inflation, lower deductibles and general weakening of pricing and other terms and conditions largely contributed to the year-on-year increase in the accident-year ex-cat ratio.

Within its overall business mix the Lloyd's market wrote more consumer and small and medium-sized enterprise business, which typically carries a higher attritional loss ratio. Management cited this development as another contributor to the weakening accident-year ratio.

When questioned on the deterioration in the attritional loss ratio during the results press conference, finance director John Parry said "clearly remedial action needs to be taken" to improve the underlying performance.

The accident-year ex-cat loss ratio was reflective of where the market stood after years of falling rates, Parry explained.

"It is just a sign of the pricing challenge that the market has had for a number of years coming through [in the numbers]," he said.

All classes of business in Lloyd's reported an accident-year combined ratio of over 100 percent for 2017.

Lloyds los vs return on capital


The Lloyd's market has been suffering from declining underwriting profitability since 2013, when the market made an underwriting profit of £2.6bn.

The challenges of the soft market and the inevitable impact on underlying profitability are well documented. However, for the past two years, the market has also drawn out fewer reserves as a percentage of net earned premium (NEP).


Lloyds reserves

This was the 13th successive year of prior-year releases for the market. In the past decade, the most Lloyd's has chosen to release are funds equivalent to 9 percent of NEP, back in 2008. This fell sharply to 5.6 percent the following year, before recovering to 8.1 percent in 2014.

Since then, the amount of reserve releases has dropped dramatically to 5.1 percent in 2016, and just 2.9 percent in 2017.

The figures come at a time when there is nervousness in the wider (re)insurance market about the adequacy of industry reserves, particularly in casualty lines.

"Lloyd's continues to engage with managing agents writing material casualty business in order to test reserving assumptions in further detail," the Corporation wrote in its annual report.

"The actual level of claims payments ultimately made compared with the provisions held is an area of inherent uncertainty," it continued.

"Oversight of this area is a key focus for Lloyd's to ensure that the processes underlying these estimates are robust, provisions are adequate and any release of provision is appropriate."

Parry gave additional detail during the results press conference.

"If you look at our broad book and you split it between casualty and non-casualty, we are very comfortable with the shorter-tail lines in the reserves," he said.

In casualty, Lloyd's is "very comfortable" on the level of reserving on the older years, but this reserving is a "bit more marginal" on current years, Parry explained.


The battle against soft pricing conditions and dwindling reserves has been fought against a backdrop of a creeping expense base. This has further eroded Lloyd's profitability and makes the marketplace uncompetitive in the face of its peers.

Lloyds expense ratio

The Corporation has come under fire for its inability to tackle the market's expense burden, which in recent years has hovered at around 40 percent of NEP. This is around 8 points more expensive than that of Lloyd's peers, according to performance director Jon Hancock.

Cost and efficiency initiatives have been rolled out, including London market modernisation programme the Target Operating Model (Tom) and the Lloyd's-specific Corporation Operating Model (Com). In 2017 Lloyd's targeted savings of £10mn from the Com, which it said it had achieved.

Some progress in administrative expenses can be seen in the 2017 figures, with the cost ratio down by 1.5 points to 12.5 percent for the year. This was partially offset by a 40 basis point increase in the acquisition cost ratio.

Overall Lloyd's total expense ratio fell by 1.1 points to 39.5 percent. However, some of this improvement will have been driven by a higher NEP base for 2017.

"There has been a slowdown in the rate at which expenses have been increasing relative to growth in premium, resulting in a small improvement in the expense ratio," Lloyd's said in the report.

"However, the Lloyd's market's expenses continue to be higher, as a proportion of net earned premium, than those of our competitor group, particularly in relation to acquisition costs, reflecting Lloyd's more extensive distribution chain."

This will continue to be an area of focus in 2018, with plans to realise some of the benefits of the Tom and other initiatives, it said.


Lloyds investment return
On a bottom-line basis, in the past five years Lloyd's has stayed in the black due to a combination of good cat fortune and, more recently, a strong investment return.

This was never more evident than in 2016, when £1.35bn of investment income provided the lion's share of the £2.11bn pre-tax profit booked for the year.

In 2017, Lloyd's improved its investment return year on year, from 2.2 percent in 2016 to 2.7 percent. This was equivalent to £1.80bn of investment income.

The primary drivers of this result included an allocation, albeit conservative, to equity and risk assets as well as a large allocation to investment grade corporate bonds, Lloyd's said.

GWP growth

Meanwhile, 2017 also marked a year of premium growth for Lloyd's, with gross written premium (GWP) increasing by 12 percent year on year, or 6 percent on a currency-adjusted basis.

Growth continued in most lines during 2017, although the rate of expansion slowed throughout the year, Lloyd's said.

Lloyds GWP

Of all lines, casualty showed the most growth in GWP year on year, at 18.7 percent. Meanwhile, reinsurance and property both grew by 12.2 percent year on year.

Marine posted only a small increase of 1.5 percent for 2017, while motor business grew by 1.0 percent.

The US continues to be Lloyd's main market, contributing more than 40 percent of the market's premium. In 2017, US excess and surplus lines grew by 7 percent, while US reinsurance premiums grew by 2 percent.

In 2017, rates at Lloyd's declined by an average of 2 percent, which was slightly lower than planning assumptions, Lloyd's said. The Corporation added that pricing reductions had slowed in the second half of the year.

Finance director Parry also pointed to some positive rating momentum towards the end of the year. He said during the press conference that in the fourth quarter, pricing had increased across the board by around 2 percent, and then 3 percent at the 1 January renewal.

"It's a question of momentum. We will now see if that does continue for 1.4 and 1.5," he said.

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