Predictions that premiums will finally rise over the next few years have brought a sigh of relief to the insurance market as a whole. But as rates begin to harden, brokers and underwriters will face a new threat – capacity.
The enormity of the situation is now beginning to shake Lloyd's, as underwriters start to turn down business. Some syndicates are issuing warnings that capacity is drying up and the mismatch between supply and demand is allowing a number of insurers to dictate prices considerably higher on this year's business.
Last week, a key player described the situation the 300-year-old market was facing.
“Lloyd's is on the brink of a capacity crisis,” he said. “For a lot of people, the situation is absolutely desperate. People cannot find the business or the reinsurance”.
Recent premium hikes are the main cause of the shortage. Earlier this month, Insurance Times revealed rates had risen four-fold on certain lines of business.
The marine sector had been struck particularly hard, with well control shooting up 400%, hull cover increasing by 25% and energy insurance doubling. Cover for American risks is also reported to be up by 20%, while the Far East is seeing price jumps of 100%.
Rising rates are not the only reason for the shrinkage in the amount of business syndicates can write. Following the collapse of Independent Insurance and HIH Australia earlier this year, underwriters rapidly wrote more business, leaving few opportunities to take on risks for the rest of the year.
Some syndicates have realised the market is on the brink of a capacity crisis and are attempting to increase capital for next year.
In July, Wellington Underwriting decided to put 11.4 million of its shares on the stock market. This move aimed to raise a cash injection of approximately £15.6m to fund its syndicate 2020.
Coping strategies
Earlier this month, Markel also made attempts to cope with the possible shortfall. It announced it would merge into one syndicate, allowing it to spread capacity among different risks, rather than allocate a particular amount to certain lines.
In anticipation that rates will continue to rise, private investors are also trying to boost their capacity.
Association of Lloyd's Members (ALM) chairman Michael Deeny said: “It is clear that capacity will rise substantially, possibly by 25% to 30% for Names in 2001. Premium per transaction is an indicator and, in the first quarter of this year, it was 42% higher.
“The underwriting cycle has always moved in a classic wave, so it is a very reasonable assumption that rates will be higher next year”.
Some of Lloyd's 108 syndicates have similarly followed suit and requested increases in the amount of business they can write for the 2002 year of account. And, if all pre-emption is approved, next year's capacity will reach a new high of £13bn, compared to 1991's £11bn peak.
For Lloyd's, these requests are welcome.
“We have been talking about hardening rates for a long time and this shows an increase,” says spokesman Adrian Beeby. “This will be the highest capacity Lloyd's has ever had, which is clearly very positive news for us. It shows the confidence among the market's capital providers is running quite high for the 2002 account. Capacity will go up significantly. It is simply a question of how much it is going up by.”
Despite Beeby's optimism, the feeling in the Lloyd's underwriting room is low. Many syndicates are worried they will not be given sufficient capacity and there are market mutterings that several will consequently feel the pinch.
The long-established HIH Cotesworth syndicates were among the first to find funding an issue. Two weeks ago, its syndicates 535 and 1688 ceased trading after HIH Australia withdrew its 85% capital backing and a new sponsor failed to emerge.
Some syndicates may resort to a high bidding strategy in Lloyd's capacity auctions during the next three months. The process lets members sell all or part of their right to underwrite capacity for the 2002 year of account and members can also buy access to syndicates where capacity is available.
But insurance analyst at ABN Amro, Nick Haskins, said those that fail to get enough capacity will struggle next year.
“There are a handful of syndicates that will have problems,” he said. “Underwriters may have to turn away business they would like to write in the future.
“If the costs of insurance are high, companies may choose self-insurance or pass it on to other insurance markets through alternative risk transfer (ART) or to captives”.
Across the board
But the potential problem is not only limited to Lloyd's. Global reinsurers could also be affected.
According to Stuart Shipperlee, managing director of European operations at rating agency AM Best, under-reserving was one of the main factors contributing to Independent Insurance's demise.
“Today, we know those reserves were inadequate for its long-tail liability business,” he said. “This means the company's apparent financial strength which was represented in its year 2000 audited accounts was grossly overstated.”
Morgan Stanley Dean Witter says there are lessons to be learnt from the difficulties faced by some of the world's largest insurers. It estimates CNA Re, which this month put its London subsidiary on sale, requires reserve strengthening of $560m (£385m).
Global insurance analyst Espen Nordhus said: “Even if CNA Re was worse at reserving than other broker market reinsurers, it is likely that its reserve strengthening indicates a significant market reserve deficiency. Observations of other reinsurers suggest to us reserves are not adequate.
“US broker market reinsurers may be up to $5bn (£3.4bn) under-reserved on our calculations. This would have significant capacity implications”.
If Morgan Stanley's figures are correct, the consequences could be devastating for some reinsurers.
“Most of these players are small to medium-sized players and this could lead them to being downgraded by a rating agency,” said Nordhus.
“They would be unable to write new business and take advantage of the upswing in the cycle. This would then benefit the larger players like Swiss Re, that have the ability to write new business.”
