Reasons to be cautious

After a difficult 2008, there is contentment in seeing the broad successes in the 2009 results season. Yet, among the number of record profits, there is a note of caution for the year ahead.

2009 in review

A benign year for catastrophes, 2009 was just what the doctor ordered. However, broadly positive results were still tempered by hits on individual business lines, while this year’s Chilean earthquake and Windstorm Xynthia are reminders of how quickly things can change.

Political risk and, in particular, trade credit books, bore the brunt of recession-related claims. Add the issues in the eastern European banking sector and many participants saw increasing political risk losses and reserving requirements.

Yet no one reported further deterioration in trade credit claims, despite the lingering recession. The resultant boost to pricing is giving something of a ‘business as usual’ feel.

Political risks disaster seemingly averted? Perhaps not; a number of reinsurers, including Munich Re and Swiss Re, have retracted from their trade credit exposure. And, of course, the state of the global economy continues to be unnervingly difficult to call.

Let’s not forget aviation – a third consecutive year of business class losses and insufficient hardening of rates doesn’t look attractive and may tarnish otherwise sound whole book results.

Renewals and capacity

Market commentary suggests that the January renewals appear mixed. Observations from the big brokers, such as ‘disciplined softening’ and ‘a market that softened but that is not soft’ are reassuring.

Over-capacity could exacerbate a softening market; early estimates indicate that Lloyd’s has seen a 25% increase to £22bn, although foreign exchange movements have contributed to this.

Despite the difficulties in 2008, no significant London participants stopped underwriting nor consolidated to reduce capacity. How this apparent excess of capacity influences pricing during 2010 will prove important to profitability.

Capital for 2010 and beyond

Despite the capital and capacity boons of 2010, a sense of uncertainty remains for both the London market and international underwriters. Those that could avoid refinancing bank or public debt in the highly priced 2009 market did so, but my sense is that this attitude has changed for 2010 and companies are likely to arrange their capital structures for the next three years earlier than would have been the case.

Balance sheets from banks that view the insurance sector as ‘non-core’ look like being reined in during refinancing. Filling the gap with capital from the remaining banks looks challenging as management of individual counterparty exposure increases.

Banks have been ‘recycling’ the low return lending of 2006-07 into more sensibly priced facilities, providing good liquidity right now. Yet with as much as $5bn (£3.3bn) of insurance sector bank debt to be refinanced, firms that delay their refinancing risk finding that the well has run dry.

Foreign exchange

Lloyds TSB Economics forcasts sterling to fall to $1.44 by the end of this year. Given Lloyd’s stance that a 10% fall could trigger a re-rating of the Lloyd’s common rate of exchange from $1.50 and required funds at Lloyd’s to cover dollar-denominated underwriting, there is significant value in hedging dollar exposure. Syndicates with more limited access to additional capital should consider such protection essential.

In summary …

Maintaining sensible pricing will be core to underwriting success. Efficiently managing capital structures (bank debt in particular) while liquidity remains, as well as foreign exchange exposures, should be high on priority lists.

If any underwriters wander into one of these traps, the market may look right for some consolidation. IT

Dan Broome is relationship manager, insurance, at Lloyds TSB Corporate Markets.