ALM Autumn Conference - Speeches by Alan Lovell and Sean McGovern

14 September, 2012

Set out below are edited synopses of the speeches made by Alan Lovell, the new Chairman of the ALM, and Sean McGovern, Lloyd’s Director, North America and General Counsel, at the ALM’s Autumn Conference on 4th September 2012

The Future of Names’ Capacity (Alan Lovell)

Alan Lovell took over as the ALM’s Chairman on 1st September, just a few days before the conference. In the first part of his talk, Alan spoke about the ALM’s response to the challenges raised by Lloyd’s Chairman, John Nelson, regarding the future of Names capacity at Lloyd’s, as was reported in the June/July issue of ALM News (page 9).

I start with some facts: in 2003, Names’ capacity comprised £2.9bn, 19% of Lloyd’s total. In 2012, while the capacity has hardly moved and is now £2.8bn, that forms only 12% of Lloyd’s total. This takes us dangerously near to the 10% level at which we lose one of our two Council seats; more importantly, a continuing decline would result in Names being marginalised and potentially – for all the clear advantages that we bring – seen by Lloyd’s as not worthwhile.

The publication of Lloyd’s strategic review, “Vision 2025”, in front of the Prime Minister in The Room at Lloyd’s, contained positive remarks about us, but our challenge is to help to rebuild the proportion of Names capacity. I believe we should set a target to increase our proportion of Lloyd’s capacity to 20%. This would mean doubling the quantum to £5.5 – £6bn. I should be clear that this should be subject to appropriate market conditions. When they are right, it is important that Names are ready to take advantage. So how might this happen?

How to Double Third Party Capacity

First, I believe that most current Names have spare capital which could be deployed when conditions are right so to do. Second, members’ agents manage over £500m of capacity on behalf of Names who have come into Lloyd’s since 2003, and this process should continue. Third, and most significantly, we need to look to private banks and family offices whose clients from around the world collectively are worth an estimated $40 trillion. Just a small proportion of that would be needed to achieve our targets.

Lloyd’s used to be a market unsuited to the very rich. They could incur unlimited losses but were restrained in their underwriting limit. Now, the reverse is the case. The upper underwriting limit has gone, and the downside is limited. So why have inroads into this market been relatively small?

I think it is important not to underestimate the effect of reputation. As Lloyd’s discovered following the losses of the period around 1990, and again a decade later, even a 300 year old reputation can disappear in a short space of time. Rebuilding it has begun very successfully over the last decade. I believe the really notable change is shown not by the results of the good years of 2003, 2006 and 2009, but by the results in the catastrophe affected years of 2005, 2010 and 2011. I believe the Franchise Board will continue its good work.

On the demand side (ie demand for our capital from managing agents), we need to make our capital more attractive to managing agents. I know that many of you are cautious about the attractions of special purpose syndicates (SPS), but they are more attractive to managing agents, and I think we should embrace them. There are other changes which could be made, such as the promotion of mid-year pre-emptions, the facilitation of start-ups and so forth.

Capital Supply

As to supply of capital, it is here that I think the ALM can be particularly helpful. An approach to High Net Worth Individuals (HNWI) needs the backing of investment professionals. The ALM Board comprises many who have spent the majority of their careers in investment management, and our submission to Lloyd’s Chairman today concentrates on this issue. Any approach will need to be supported by the whole of the Lloyd’s community including the Corporation, managing and members’ agents and the ALM.

Lloyd’s will need to provide a more user friendly interface with private banks and other advisers to HNWIs, so that they receive information in a form in which they are accustomed to receiving it from their other investments. The sort of things to help with this include accounting information in a more user friendly format, and trying to deal with both annual and year of account forms of accounting on a more timely and frequent basis.

We need to improve cash flow forecasting so that we can avoid the situation last year in which so many heard rather late that much of their 2009 accounts profits were to be retained for solvency purposes. More information needs to be available online; much has been done already but more is needed. We also need to enable better unitisation structures (collective vehicles comprising a single block of capital supplied by a number of individuals), and some discussions in this area are already underway. You won’t be surprised either that I believe there needs to be a rationalising of documentation. Finally, it is also very important to facilitate the entry of third party capital from new jurisdictions, especially those countries which Lloyd’s is targeting for its own corporate growth as part of its corporate strategy.

We are also asking Lloyd’s to make this a serious project, as they did with the entry of corporate capital in the 1990s. It should be led in Lloyd’s by a senior director, and we would be pleased to work alongside such a person to bring in the concepts and practices of the investment world. There will be a need to pull together all the various submissions for a comprehensive review involving all interested parties, including managing and members’ agents, the HPG and the ALM, in order to co-ordinate the effort and take the appropriate action both on the demand and supply side. The ALM is keen to play an important part in that endeavour.

Role of the ALM

I expect the general role of the ALM to remain much the same. We will continue to put on conferences as long as you like to attend them in such numbers and we will continue with ALM News, which is much commended. We will work as before with members’ agents in a common direction, although I hope we can do something about duplication of some of the more basic data. We’re proud to offer Names a second opinion, to provide a different slant on underwriting. Members’ agents themselves appreciate that, as it can enhance the value of discussions which their Names have with them.

We shall work closely with members’ agents to ensure the most sensible allocation of responsibilities; for example, our role will continue to be particularly focussed on issues well suited to being handled centrally, such as regulation and tax matters.

But in one important aspect the ALM will change. It has been seen very much as a protector of Names. Now it must be seen as the promoter of Names’ capacity in a positive sense. It is important to provide a single voice for Names, and to maintain and grow their share of the market, so that they remain an important part of the Lloyd’s community. The ALM is proud to play that role alongside the Corporation and members’ agents. I hope that you will support us in our endeavours where possible.

The Challenge and Opportunity of Change (Sean McGovern)

Sean McGovern is the director at Lloyd’s responsible for North America and is its General Counsel, responsible for legal and regulatory matters. He is also the only non-US appointee on the new US Federal Advisory Committee on insurance. His talk provided further evidence both that the Corporation of Lloyd’s is a high calibre organisation and that the day to day issues that it manages are formidable.

For me, two fundamental changes that have come to define Lloyd’s have been changes to the capital base and changes to the way we manage underwriting risk.

When I first joined Lloyd’s in 1996, I spent the vast majority of my time helping Names convert to limited liability, then working with the corporates as they moved to align the capital on their syndicates and buy out Names. During my time, we have moved from a position where 70% of the capital was provided by unlimited names to a position where they now account for only 3%, and private capital overall accounts for only 12%. That shift was driven by market forces, was not easy to achieve and inevitably caused tensions – a subject I will return to later.

The second fundamental change, which has benefited all forms of capital, has been the change driven by our experience of 9/11. Whilst we were frankly distracted by the debate about Names versus corporates, we had collectively lost sight of what was really important – the need for underwriting discipline and a focus on underwriting for profit.

In this room in January 2002, Tony Markel held a mirror up to the Lloyd’s market pointing out its failings and calling for “gut-wrenching change”. This was already being focused on by the Chairman’s Strategy Group but the need for change was given new urgency by 9/11. As you know, this led to the development of performance management at Lloyd’s and a fundamental change to the role of the Corporation and its relationship with managing agents and syndicates.

These were very challenging times for the Corporation, the market and the capital providers – certainly the most difficult period of my career to date, but our collective response to those challenges brought great results - year after year of record profits, underpinned by significantly enhanced financial strength and responsible management of underwriting exposures. Just a few figures to illustrate my point:- Profit – average of 14% ROC over the last 5 years – if you ignore 2011, that would rise to 21% Financial strength – a Central Fund that has grown is size from £280m in 2001 to £2.3bn in 2011 And the ability of the market to absorb net claims of over £16bn in 2011, our biggest ever year on record for catastrophe claims, speaks for itself.

Performance management remains central to our role in the Corporation and whilst it is not a zero failure regime, we will continue our resolute focus on underwriting discipline. Given current market conditions, low investment returns and a nervous business environment the near term threats are all too real.

Vision 2025

However, we do need to look beyond the immediate horizon of the current stage of the underwriting cycle and the question of whether the market will turn – we need to look to the future, as seismic shifts take place in the world economy.

Most of you will be aware that, earlier this year, we set out a new long term strategy for Lloyd’s, Vision 2025. Since the launch – with the Prime Minister in the Room (see page 17 of the June/July issue of ALM News) – we have been working hard to think in more depth about how to achieve this strategy.

First, we need to understand the changes in the global economy and how that will affect Lloyd’s business. Second, we need to identify the opportunities that those changes will bring to the world insurance market and to ensure we are ready and able to exploit them. Closer to home, an additional challenge is to create the environment in which private capital can be part of that future vision.

In some ways, the first challenge - which simply involves mastering the art of futurology – is the easiest. This involves predicting where the global economy – and hence business - is likely to be in 2025. There are endless reports from economists and think-tanks which set out projected GDP levels. All vary on details, but there is a clear consensus that the relative share of GDP will undergo fundamental changes, with economic strength, and particularly growth, moving from the West to the Rest.

Between 2010 and 2030, GDP growth is expected to be 273% for emerging economies versus 44% for developed economies.The largest growth is expected to be in China (433%), India (300%) and Brazil (200%)i. The statistic which always gets the most attention is that China is predicted to overtake the US as the largest economy in the world.

So how should Lloyd’s respond to these changes in the global economy, both in terms of how much business it writes, and where that business originates from?

This opportunity requires us to change how we think in one fundamental respect – to focus on the long term, and the investments which we need to make, in terms of knowledge and partnerships, as much as capital, in these new markets.

With the changes in the global economy, the Vision 2025 challenge is to ensure that Lloyd’s can still rightfully claim to be the global centre for specialist insurance and reinsurance in 2025. Unless we have taken meaningful steps to improve our penetration of emerging markets such as China, India, Turkey, Brazil and others, we will not able to lay claim to that title with any credibility.

Let me reassure you that performance management remains central to the realisation of this strategy. It is, deliberately, a long-term view, and whilst we want to grow, we expect the growth to be sustainable, which means growing sensibly across the cycle.

Names Capital

What will the Lloyd’s capital base look like in this new world? It is a part of Vision 2025 that we need to see continued diversity in our capital base and in particular we need to attract new emerging markets capital into Lloyd’s to grow our strategic relationships in those markets so that capital accompanies people and business.

But where does this vision leave private capital? This is the challenge that faces you and those that represent your interests at Lloyd’s. We have set out a long term vision for the market and so we have challenged the member’s agents to think about the long term vision for private capital.

Back in 2006, under the Chairmanship of Lord Levene, I led a piece of work which thoroughly reviewed the participation of private capital in the market. We published a report in October 2006 which put to rest many of the myths and misconceptions and I am pleased to say that something of a truce descended on the market – no doubt helped by bumper profits in the years that followed.

Whilst debunking many theories its high level conclusions of this report were that:-

Private capital was an efficient, loyal form of capital that should be a source of competitive advantage to the Lloyd’s market;

Some features such as security of tenure and the agency relationship were the source of tension between managing agents and Names and were regarded negatively;

Ways needed to be found which made private capital more attractive to a wider group of managing agents and it proposed Special Purpose Syndicates and a more modern agency agreement as ideas for the future;

Finally, without change and evolution, private capital was likely to continue to decline in importance.

Since then, we have seen some progress in the use of SPSs. There are currently nine SPS syndicates many of which are supported by private capital. Other than that, we have not seen a great deal of innovation in the way that private capital is attracted into the market and deployed to support underwriting.

We certainly do see private capital being part of Lloyd’s in 2025 and we say so explicitly in Vision 2025. We do however believe that the traditional method of participating with security of tenure, coupled with onerous agency obligations on the managing agent, is not sustainable in the long term. We believe SPSs offer an opportunity to deploy Names’ capital in a way that is more attractive to a wider range of managing agents.

At present, only 24 syndicates operating in the market (excluding duplication through SPSs) currently take in Names’ capital. This is, of course, less than 30% of the market. Over the longer term, the market will grow and there will be new syndicates. What you need to be asking yourselves is how do you ensure that you are best positioned to be part of that growth rather than being marginalised?

How can you best support the next generation of entrepreneurial underwriters who wish to strike out on their own and build a business? How can you ensure that you can make your capital more attractive to existing syndicates so that they naturally turn to you when they need capital to grow their business? How can new private capital be attracted to the market in an efficient and modern manner to support profitable growth in new markets?

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