Fresh challenges ahead for Lloyd's after 1st underwriting profit in years

Lloyd's of London should be able to maintain its performance after posting a full-year underwriting profit for the first time since 2016, but the market still has work to do on cost cutting, tackling inflation and retooling unprofitable syndicates.

Lloyd's underwriters reported a collective combined ratio, which measures nonlife underwriting performance, of 93.5% in 2021. That is a sharp improvement from the 110.3% logged in 2020 when including COVID-19-related claims and the 97% it would have reported had those claims not occurred.

"That's a big achievement in itself," Ali Karakuyu, director and lead analyst of insurance at S&P Global Ratings, said in an interview. In a wider global reinsurance context, the underwriting result "is at the top end."

Large claims and natural disasters added 11.2 percentage points to the 2021 combined ratio, compared with 9.7 percentage points in 2020 when COVID-19 claims were excluded. A key component of the total improvement was a reduction in the attritional loss ratio, which measures the effect of business-as-usual noncatastrophic claims. That figure fell to 48.9% in 2021 from 51.9% in 2020.

The result comes after a four-year underwriting profit drive, which has seen the market jettison about £5 billion of premium and increase rates by 27% on the business it has kept, Lloyd's CEO John Neal told journalists. Those efforts look likely to continue.

"I don't think they are letting up any pressure on the syndicates, the managing agents in terms of underwriting discipline," Carol Pierce, senior director at Kroll Bond Rating Agency, said in an interview. The shift to a principles-based system of managing agent oversight from the current rules-based approach will help managing agents who can maintain underwriting discipline grow and achieve better results, Pierce said.

Cost-cutting challenge

Lloyd's has made progress cutting its expense ratio, which it said is out of kilter with its peers in the global insurance and reinsurance markets. The ratio fell to 35.5% in 2021 from 37.2% in 2020 and 39.2% in 2018, when the remedial work began.

The market wants to trim a further 4 percentage points from the ratio, CFO Burkhard Keese told journalists. Most of this would come from acquisition costs, which include the commissions and fees underwriters pay brokers for bringing them business, Keese said.

The 3.7 percentage points Lloyd's has shaved from its cost ratio since 2018 is "quite substantial," said Ekaterina Ishchenko, a director covering Europe, the Middle East and Africa insurance at Fitch Ratings. Lloyd's is pinning a lot of its cost-cutting hopes on its modernization program, which is designed to cut central processing costs by 40%, Ishchenko said.

The Fitch analyst does not expect any significant cost reductions in the next couple of years, but the relative success of the digitalization program could change that.

Inflation and war

As with other insurers and reinsurers, Lloyd's faces rising claims costs from economic inflation. Keese told journalists that Lloyd's has built explicit inflation assumptions into its reserving and pricing.

The market also must contend with a number of some syndicates that consistently have loss ratios above 100%. The bottom quartile of syndicates have improved their combined ratios by 17 percentage points, Keese said, which is "quite good, but not quite good enough."

Lloyd's tolerance for unprofitable syndicates is "low," according to Ishchencko. Some syndicates will probably decide to exit if they cannot deliver on Lloyd's plan, but those departures will be marginal, the Fitch analyst added.

A big unknown facing Lloyd's in 2022 is its exposure to potential claims from the war in Ukraine. Lloyd's said the Russian invasion will result in a "major claim" for the market, but that claims would fall within manageable tolerances and not cause solvency problems. Neal told U.K. newspaper The Times that the claims bill for Lloyd's could be in the "low single-digit billions."

The war is "probably more of an earnings event than a capital event at this point," Peter Giacone, senior managing director at Kroll Bond Rating Agency said in an interview.