Download Chairman`s Speech to Lloyd`s European

Chairman’s Speech to Lloyd’s European Symposium
THURSDAY 22 MAY
“WHAT’S THE NEXT BIG CHALLENGE FOR THE EUROPEAN MARKET?”
When I started as Chairman of Lloyd’s last year, there were a great many
things about this marketplace that took me by surprise. First, in today’s hi-tech
environment I was taken aback to see so many insurance brokers walking
around this market with files of paper up to their heads. On the other hand it
came as a very pleasant surprise to find that – despite what I had read in
some newspapers over the years – the Lloyd’s market was in such strong,
robust shape.
Perhaps what concerned me most was when I learnt of the quantum of
business that Lloyd’s actually does with the rest of Europe. In the last few
years, we have seen Lloyd’s European income grow, which is helping to
correct that position. In fact, Lloyd’s European business – excluding the UK –
increased by almost 50% over the last two years1. But the fact remains that
while Europe accounts for some 29% of global non-life insurance premiums2, it
represents only 13% of Lloyd’s income3.
And it’s not just Lloyd’s. For fifty years, the entire British insurance industry has
hesitated in Europe. Despite London’s role as a centre for the underwriting of
Source: Lloyd’s Market Reporting & Analysis Department, April 2003
Source: Sigma Global Non-life Data 1995-2001. Direct non-life premiums.
3
Source: Lloyd’s Market Reporting & Analysis Department, April 2003
1
2
international risk, under a quarter of Britain’s total premium is derived from
overseas, and significantly less than that is actually European business.4
By 2004, The EU will consist of 25 nations. I can’t begin to imagine what a GDP
of $30 trillion5 actually feels like, but it means that Europe will soon represent
the world’s largest commercial market6 - and its power can only grow.
Churchill famously spoke of an iron curtain descending across Europe. The
wall that divided Europe has now been removed but barriers still exist, even if
they cannot be seen, such as linguistic and cultural barriers. Our objective is
to overcome those barriers.
This conference is therefore just one of a number of steps that we at Lloyd’s
are taking to try and become more accessible to European brokers. So, I am
delighted that so many of you are able to join us. I hope also that we will see
even more of you and your colleagues in the coming months and years,
because Lloyd’s must be at the centre of Europe.
Today I have been asked to speak on the challenges specifically facing the
European insurance industry. Of course, challenges are not a new thing in
our business. But the situation in the European market today is unique, and its
impact leaves none of us untouched.
4
Source: Association of British Insurers website, viewed 16/05/03
Source: Charles Tannock, MEP, as quoted in press release “Enlargement will make Europe a better
place” 09/04/03
6
FCO website, viewed 16/05/03
5
I want to focus on two particular trends.
Firstly, the risk profile that we face in Europe today is changing. And at the
same time, the structure of the European insurance market is in a state of
radical transformation and realignment.
I believe the combination of these two trends has created an
unprecedented set of challenges. They impact all of us - European insurance
buyers, insurers, regulators and brokers – alike; and dealing with them will
require focus and tenacity. Further I do not expect that all insurers are fit
enough to face the challenges, which will only amplify the demands on the
rest of us.
So let’s start with the changing risk profile. In Britain, we are often accused of
talking too much about the weather, so please forgive me for living up to this
cliché. But it seems pretty clear to me that shifting demographics and
climatic change are interacting, with some frightening implications for the
European insurance market.
There is no question that the cost of natural catastrophes around the world is
rising at an alarming rate, at the same time as weather patterns are
becoming increasingly erratic. Twelve of the world’s thirteen worst storm
losses happened in the last ten years7. Today, half of the world’s population
lives in coastal regions8, of which many are vulnerable to flooding, rising sea
7
8
Aon, “Riding the Wave of Change in the 21st century”, May 2002
World Disasters Report 1999
levels and cyclones. So the risk posed to large numbers of people – and their
property – is immense. And things are going to get worse.
By 2050, mega-catastrophes, which used to occur every 100 years, are
predicted to happen once every 25. The UN predicts that losses will then be
900 per cent higher than they are today9.
Recent losses here in Europe only emphasise the point. When the Storms
Lothar and Martin hit France and Germany in rapid succession in December
1999, they were followed by the Danish storm Anatol only a few weeks later.
More recently, we have seen two so-called ‘hundred-year floods’ in the
Czech Republic in just a five year span. Of the top ten global catastrophes in
2002, four occurred in Europe, and all four were weather-related, involving
either storm or flood10. The trends are clear, and as an industry, we have
gravely underestimated the potential of such events and need to look closely
again at our modelling tools and approach to underwriting.
The second way in which I see the European risk profile changing relates to
liability, or what we sometimes call civil responsibility. We all own these risks,
whether as an employer, an organisation, a professional, or even a private
citizen. However, what we are seeing is a clear shift in responsibility for third
party losses. It is moving steadily away from European states - to companies
and their insurers; from the public to the private sector. This presents both
9
All statistics in this paragraph Global Climate change threatens the insurance industry, The
Environmental News Network, August 2002.
10
Source: Swiss Re “Natural Catastrophes and Man-made Disasters in 2002”, March 2003
buyers and the commercial insurance markets with greater, and sometimes
less familiar, exposures.
One example is last year’s decision by France’s highest court, the ‘Cour de
Cassation’11. It found that 29 employers were guilty of ‘la faute inexcusable’,
or gross negligence, in relation to employees’ asbestos-related illnesses. As a
result, compensation for the victims and their families is likely to be paid by the
companies and their insurers, and not by the state. At the same time, here in
the United Kingdom, the government has taken steps to recover from insurers
the costs of treating road accident victims in state-owned hospitals. It is the
equivalent of adopting a user-pays system for hospitals, and is set to be
expanded to workplace accidents.
Even taken alone, this shift of responsibility from the public to private sectors is
a significant one. However, it is further exacerbated by a creeping culture of
litigation which is spreading across the world, and which is beginning to have
an impact on the European insurance market.
In an infamous US case a few years ago, McDonald’s was successfully sued
because it did not warn customers that the coffee they sell is hot, and a
consumer was burned. Recently, a very similar case was brought in the UK.
The UK courts ruled – more sensibly in my view – that buyers of coffee actually
expect it to be hot, and would probably be upset if it wasn’t. But the fact
that the case even made it to court is symptomatic of the trend I am
describing.
I find the evolution of compensation culture in Europe to be deeply worrying.
To see why, you only have to look across the Atlantic. In the United States,
where litigation has become almost a way of life, the cost of tort totalled over
$200 billion in 200112. That’s equivalent to a 5 per cent tax on wages for every
citizen and it is beginning to threaten the very spirit of American enterprise13.
Furthermore, it is an ineffective way to make redress to those who need it.
The system there returns less than 50 cents on the dollar to people it is
designed to help, and only 22 cents to compensate for actual economic
loss14.
I sincerely hope that European courts will remain reasonable and prevent us
from travelling down the same road as the US. We cannot allow ourselves to
create a culture in which you have everything to fear, unless you are covered
by insurance and have a good attorney.
But as if this weren’t enough, at the very time when the European industry’s
risk profile has been changing and expanding, the whole fabric and structure
of the market itself has undergone massive change. This has come about in
three main ways.
First, we have witnessed a process of deregulation and opening of markets
that began in the 1990s, with the European Union insurance directives. Old,
11
Asbestos Intelligence, February 2002
Source: Insurance Information Institute, quoting Tillinghast Towers Perrin in website presentation,
viewed 16/05/03
13
Source: Insurance Information Institute, quoting Tillinghast Towers Perrin in website presentation,
viewed 16/05/03
12
profitable tariff regimes are gone. The practice of subsidising poorly
underwritten commercial business with profits from personal lines has been
halted. State-owned insurance institutions have been privatised, shifting
assumed risk to investors. And as old business relationships started to be
unwound, global business expansion became the new opportunity. The
result? Multiple small insurers have been replaced by European giants,
companies with a reach that spans European and international borders.
Second, as the underwriting environment changed, we began to see a
degree of experimentation with new business models. Unfortunately they
have not always been successful, and in some cases they have failed
miserably.
Some chose the bancassurance route – in search of the so-called one-stop
shop for financial services. The integration of banking and insurance
corporations has by no means been a total failure, but neither has it been the
panacea that some had hoped. In the US, the pioneering merger of CitiBank
and Travelers has been unwound. And some European corporations are now
clearly regretting their actions too.
For others, experiments in expanding into capital markets have backfired, in
part because the counterparties were too clever. Many insurers opted to
expand their risk-taking by assuming credit risks. This trend is now being
reversed: Rating agency Fitch tells us that insurers are executing a “strategic
14
Source: Tillinghast - Towers Perrin (Tillinghast) in U.S. Tort Costs: 2002 Update
drawback” from this market following “an unprecedented level of defaults15”
Insurers have learned that they are not masters of all risks after all, as many
had tried to convince themselves.
But the third structural shift is probably the most damaging. Enriched by the
ballooning value of equities, many insurers began to focus on life insurance
and savings products, and then used the wealth to make significant
acquisitions overseas. This model’s most serious vulnerability is only so obvious
with hindsight: it was built on equity investment. Companies had created for
themselves a dual exposure to the stock markets – which now ruled both their
risk profile and their asset base. When global markets imploded, so too did the
new strategy of many insurers.
So where does all this leave the stakeholders of the European insurance
industry today? What is the combined effect of the shifting risk profile and
structural change on each of us?
First, insurance buyers. Buyers in Europe today face many new uncertainties
about risk carriers, brought on by the upheaval in the market and the
changing perceptions of risk.
Where once many insurers offered gold-standard, triple A security, those days
are now over. As assets have been bled away from Europe’s insurers, triple A
is a thing of the past.
15
Source: “Fitch Global Credit Derivatives: Risk Management or Risk?” 10/03/03
At the same time, many other insurers have disappeared, sometimes
because they have been merged into a larger pan-European entity. For
others, their capital strength is being called into question, raising doubts
about their longevity. Some have withdrawn from lines of business or
territories, while many have a reduced risk appetite and shun volatility.
It all adds up to a diminished choice for buyers, and a dampening of the
creative solutions that they seek.
Second, the challenges for Europe’s insurers.
They face new uncertainties not only about increasing claims costs as risk
profiles change, but also uncertainties about funding and reinsurance.
Many insurers are reeling from erosion of their capital base, as billions in assets
have been wiped out through the arrival of the bear market. This has
affected not only the reserves and resources that insurers have to pay claims,
but has also reduced their own financial strength, and the strength of
counterparties - such as reinsurers – on which they rely.
As a result, many are seeking fresh funding, and not always getting it easily.
Just recently, Europe’s largest insurance company launched a fundraising
totalling more than five billion euros16, demonstrating the scale of the
problem.
Many insurers cannot find the kind of reinsurance they once enjoyed, with the
supply remaining sufficient, but constrained. One of the world’s top ten
reinsurers, located here in Europe, has ceased operations within the past
twelve months. Other leading European reinsurers have downsized
considerably, or restructured.
Third, regulators too face new challenges. Having created a liberalised,
deregulated European insurance marketplace, our regulators, hand in hand
with the industry, must work with their peers around the world to meet the
challenges brought about by changing risk profiles and the new, international
environment.
Nowhere is this more plain to me than with the US reinsurance market. The
current situation, which needlessly ties up European reinsurers’ precious
working capital, can only be solved thorough increased exchange between
regulators on both sides of the Atlantic. It demands a robust and cooperative
approach.
So where does it all leave you, the European insurance brokers?
Undoubtedly you share the uncertainty of your clients, and face increasing
difficulty in finding the solutions they need.
But there are some positive challenges too. With fewer alternatives available
to them, insurance buyers may not presently be able to muster the cover
necessary. Buyers’ traditional direct relationships are fading and that means
16
Press release, 20/03/03,, Moody’s Investor Service
that, at last, many more good, well-priced risks are in the hands of European
intermediaries. Now, more than ever, you have a set of skills and connections
that European insurance buyers desperately need.
And the good news is you can be sure that Lloyd’s, firmly committed to broker
distribution, will want to work with you.
But I have talked enough about challenges. Action is the important thing.
Faced with this new, daunting risk environment, what must we do?
I spoke earlier about how we, the British insurance industry, have hesitated in
Europe for over 50 years. We have stood back – following and not leading.
But this is not a time for British caution or reserve. This is a time to be out in
front; open; creative; willing to take bold decisions.
It is vital that we work more closely together and take action to get our house
in order. That translates into two directions in which we need to change our
mindset.
First, the industry must focus on profitability. The scale of underwriting losses
has been too great for too long. We can no longer rely on investment
income to compensate for shoddy performance at what is supposedly our
core competence – underwriting. That means that the way underwriters,
intermediaries, and buyers all view the insurance relationship must change.
If the insurance cycle cannot be halted, we can at least take some clear
steps to ensure a ‘soft landing’ when next down-cycle arrives. As insurers, we
can for example, ensure that we have reserved sufficiently in the good times,
so we need not stretch small profits even more thinly during the lean times.
And we must remember, repeating it as a mantra if necessary, that we must
stick to our core strengths, focus on our core expertise whether we are
underwriters or intermediaries. We must also work together to communicate
more regularly and more clearly with our buyers, so they understand the
actions we are taking, when we are taking them.
In short, the responsibility we must grasp going forward is to ensure discipline is
maintained, in order to preserve a healthy, robust industry able to meet its
future obligations. At Lloyd’s, we have taken that responsibility very seriously.
I am not going to discuss this in detail now as Rolf Tolle, recently appointed as
Franchise Performance Director, will address you in the Underwriting Room.
But right at the centre of our changes is a reasonable expectation of an
underwriting profit every year, and that is a goal that we will pursue
relentlessly.
However, there is another part to the equation. There has been much talk
and plenty of tangible action about discipline in underwriting, but attempting
to superimpose a more disciplined culture onto the old, inflexible insurance
approaches is not enough.
In today’s market, it seems that many insurers have lost their appetite for risk.
Suddenly, European carriers seem to be risk averse, shying away from the
challenges they once embraced. If the European insurance industry is going
to play a meaningful role in today’s rapidly changing economy, there needs
to be change of attitude.
Today’s changing business culture, evolving investor attitudes, social and
political trends, governance trends, and technological change all require
creative risk solutions. Our approach must be flexible enough to handle the
challenges that emerge, and we must be innovative enough to be able to
anticipate and respond to these demands.
A focus on underwriting performance. Flexibility to respond to the new and
the complex. In short, the European industry needs creative discipline.
At Lloyd’s that is exactly what we believe. Lloyd’s has in the past made
mistakes – we all know about them. But we have not tried to correct our
mistakes by changing our spots, adopting a new identity, a new business
model, or by rethinking our core business.
Lloyd’s has not changed its risk appetite. We remain hungry for risks from
which others shy away. We have retained our broker-based distribution
strategy, which relies on you and your colleagues to bring risk to us.
Critically, we have not wavered from our dedication to flexibility, and our
commitment to innovation. Lloyd’s is changing, but it will evolve only enough
to allow us to continue to exercise our core strengths.
There is more to our offering. In the context of an industry which has
experienced wholesale downgrades by rating agencies, Lloyd’s provides a
stable financial strength rating and sizeable capacity. The Lloyd’s market is
hardly exposed to equities at all, and under the new Franchise structure
underwriters are keenly focused on the bottom line.
We are here, now, to help European brokers deal with today’s new risk
challenges as they arise, whether they take the form of increased
catastrophe exposures, liability risk moving from the state to private sector,
new exposures, or the very real challenge of insufficient capacity.
Throughout history, Lloyd’s has always been a trail blazer, covering the risks
that others feared to touch. So we are happy to lead the way in Europe.
Today, Lloyd’s is becoming more efficient, but our market’s core competency
– creative underwriting – is the same as it has always been. Combined with a
new focus on performance and profit, I believe we are stronger and better
placed than ever to meet the needs and requirements of our European
brokers and their clients.
Thank-you, and enjoy the Symposium.