Lloyd’s: a battle fought on many fronts

In Greek mythology, Hercules killed the many-headed monster the Hydra as one of his labours. He did so with the help of his nephew Iolaus who cauterised the wounds of the beast as he severed each head, preventing two more growing back in its place. After removing the Hydra’s final, immortal, head he buried it under a large rock.

John Neal, who has been chief executive of Lloyd’s for a year, might ponder such a strategy as he grapples with the many moving parts of what has become an increasingly dysfunctional Lloyd’s of London.

He is no longer fighting just one battle, but facing multiple challenges simultaneously all big, elusive and often with surprisingly sharp teeth. Where one problem appears solved, another seems to grow in its place. And whether chairman Bruce Carnegie-Brown and performance management director Jon Hancock can fulfil any role similar to that of Iolaus remains to be seen.

“You have to feel for John Neal for the scale of the task he has taken on,” says one market commentator speaking to this publication at the Monte Carlo Rendez-Vous.

“There are so many problems he needs to tackle simultaneously, from its antiquated culture to its high cost base to its lack of profitability.

“He can’t focus on just one problem they are all interlinked. And even where he does get a strategy right, it will take time.”

Overall, few market commentators question that the actions and strategy of its senior member are misplaced or that they will make a positive difference. But there is also a sense that Lloyd’s has so many different problems to solve, that it is impossible to tackle them all, and that the market is simply too big and too cumbersome to turn around at least quickly.

Smoke and mirrors
Neal faced the press in Monte Carlo, supported by Carnegie-Brown and Hancock, where he answered questions and outlined some of the market’s strategic plans, including its The Future at Lloyd’s initiative. The mood of the three senior executives was relaxed jovial even as they described their vision for the market’s future and willingly debated some of the challenges they will face.

Perhaps they knew the gist of the market’s first half results, revealed the week after the reinsurance conference, which showed the market posting a significant profit of £2.3 billion in the first half a welcome respite after two years of heavy full-year losses totalling £3 billion and a big increase on the £0.6 billion it made in the same period a year earlier.

Yet that headline figure revealed a much bleaker picture for the market. In fact, it achieved that profit only thanks to £2.3 billion of investment income, a big increase on the £0.2 billion of income this delivered a year earlier, and much of this was due to unrealised gains due to lower US and UK bond yields, as well as robust returns from equities in the first six months of 2019.

In other words, the underwriting side of the business had broken even almost. This side of the business delivered a profit of £0.1 billion, compared with £0.5 billion a year earlier. Its combined ratio for the period also deteriorated to 98.8 percent in the period compared with 95.5 percent in the same period in 2018.

Major claims added 1.4 percent to the combined ratio compared with 0.6 percent in the equivalent period last year, predominantly driven by claims within aviation lines of business. Conversely, the property lines of business experienced lower than average catastrophe losses in the first half of 2019 and was the only sector to experience an accident year ratio below 100 percent.

Prior year releases for the period were £0.1 billion (June 2018: £0.5 billion), reducing the overall combined ratio by 0.4 percent (June 2018: 3.8 percent).

“While efforts to address performance continue across the market, the impetus to improve underwriting results must prevail. Specifically, the high operating costs and attritional loss levels remain particular concerns,” Lloyd’s said in a statement in its interim report.

Perhaps vindicating some of the comments about business being moved away from the market, the growth picture did not look much better in its H1 results. It posted gross written premium (GWP) of £19.7 billion, up 1.8 percent from £19.3 billion for H1 2018. However, this again disguised the true picture. If foreign exchange rate movements and growth from new syndicates are taken into account, GWP would show a reduction in premium of 2.6 percent.

The market said this was the net impact of a 6.5 percent reduction in business volumes “as underwriters adjusted their books to improve performance” plus average risk-adjusted rate increases of 3.9 percent.

Cutting its cloth
Neal and his colleagues may not mind this last statistic if indeed the retraction is for the right reasons. The market’s strategy of focusing on the “Decile 10”, the worst-performing 10 percent of business at Lloyd’s, will remain its primary focus in its next round of planning, while it starts to introduce a more nuanced risk-based approach to regulatory oversight, the executives explained at the Monte Carlo briefing.

They suggested that the result would be that more unprofitable business will be forced from Lloyd’s as a consequence of this year’s performance review. They said that, as they move into the 2020 planning cycle, they will continue to focus on the poorly performing bottom segment of the market, which is dragging the whole down, while encouraging syndicates that are performing well to do more of what they are good at.

“We lost £4 billion of business last year; this year’s planning process will be more nuanced but there remains plenty of work to do,” Carnegie-Brown said. “We will give the top-performing end of the market less oversight and focus on the bottom end.”

He admitted that last year’s planning process had been tough and a shock to some in the market. “There was support from the market, but it was also a case of people saying: ‘it’s the other guy, not me’. We encouraged people to look in the mirror. We lost £4 billion of business, but that was to create the opportunity for £7 billion.”

He added that it was not the market’s intention to drive rates up through that process.

“That was an output rather than an aim, but it coincided with other big players doing the same thing and that has been helpful.”

Hancock added that losing £4 billion of business was never a target, rather it was the natural outcome of the business planning process. Removing poor business will remain a continued focus for the market, he said.

He explained that while the market’s overall combined ratio for 2018 was 104.5 percent, this disguised a very wide range in performance: the top 20 syndicates posted a combined ratio in the low 90s; the worst 20 performers posted a combined ratio of more than 130 percent.

“It is a question of getting syndicates to do more of what they are good at and less of what they are not good at,” he said.
“Yes, more business will be removed that is a continuous process of improvement. We are not focused on portfolios that have had one bad year but those that drag the market down year in, year out.

“If they do not improve, we will remove them while encouraging the top end as well. The bottom decile is destroying value in the market and having a disproportionally negative effect on the whole market.”

Hancock confirmed that the regulatory approach will reflect performance.

“We will be taking a risk-based approach to oversight. Where syndicates are performing well, if they deliver on what they promise, we will look at what appropriate regulation should look like.”

The market is receiving credit for its actions. S&P Global Ratings, for example, recently revised its outlook on the market and its core subsidiaries to “stable” from “negative”, following the changes it has made to improve its overall underwriting performance.

S&P noted that the market has taken significant actions to remediate its portfolio and improve its performance in 2019–2021.

“Management’s focus on the worst-performing 10 percent of business at Lloyd’s demonstrates that it has started to deal with Lloyd’s worsening underlying performance. We expect this process may take some time the extent of the remediation may not become clear until year-end 2020 but we anticipate that Lloyd’s will continue to manage its business tightly to ensure that underwriting performance improves,” the rating agency said.

The root cause?
Some market observers have suggested that one of the causes of Lloyd’s problems has been a drive to diversification in syndicates.
Vicky Carter, chairman of Global Capital Solutions, International, for Guy Carpenter, believes this drive towards diversification to achieve greater capital efficiency has been partly responsible for the poor performance of some syndicates at Lloyd’s in recent years, as carriers have looked to write lines of business without the appropriate expertise.

Carter, who is a member of the council of Lloyd’s, suggests that the benefits diversity offers in terms of capital efficiency have had an undesirable effect on the performance of some syndicates.

“I remember the days when syndicates specialised in certain lines of business,” she says. “They have now had to diversify but that has partly contributed to their poor underwriting results.

“Everyone has been under pressure to find new areas of business to write but that is not always a good thing.

“Look at the extent to which syndicates are moving to write cyber business—do they understand the exposures in that field and do they have the expertise to do it properly?”

She also commended the work done by the senior management of Lloyd’s in the past year to improve the performance of syndicates, which will lead to a healthier and more profitable market, she believes. She described the market as being on the cusp of one of the most exciting chapters in its history, as a result.

“The market’s results in recent years have been far from acceptable or sustainable and they had to act,” she says.

“It was a thankless task but, for the most part, people now see that it was absolutely the right thing to do. It will lead to a bifurcation in the market where the best-performing syndicates will get more freedom and an easier ride, while the worst performers will have a tougher time. But it will make for a much better market as a result.”

When the point around the negative effect of diversification was put to Neal, he was quick to dismiss the notion.

“That is utter rubbish,” he said. “People have a responsibility to write for profit. I get the intellectual point but to me it is a weak excuse. At the end of day, you need to be writing profitable lines of business.”

“If we are going to be best in class globally, we need to be rigorous in seeking poorly performing businesses and promoting good performing business—while also demonstrating innovation and performance.

“Underwriting is a complex business and price is only one factor. We want to get under the skin of what makes good underwriting and how to manage the cycle.”

Carnegie-Brown added: “Solvency II probably has pushed people to diversify and we are aware that the market’s strength has always lain in its specialised underwriting. We are thinking thoughtfully about that.”

Structural change
Underlying the challenge of unprofitable syndicates, there remain significant structural problems at Lloyd’s that could be even harder to solve. On the issue of business being moved away from the market, some brokers are clear that they are using the market less due to its cumbersome nature and the rise of alternative jurisdictions.

Michael Papworth, head of Miller’s property/casualty business unit and head of Asia, believes Lloyd’s needs to adapt to become more relevant to its clients—and he is clear that the broker is placing less business there until it does.

“We are doing significantly less business with Lloyd’s than we used to and finding that to service our clients we have to throw the net out wider,” Papworth says.

“We would like Lloyd’s to recalibrate and become more relevant to our business like it was a few years ago: across our global portfolio we used to place some 30 to 40 percent of our business; today it’s probably less than 10 percent.”

Another senior executive with a broker suggested business is being moved from the market at the behest of companies operating through Lloyd’s. He said that some carriers use the market’s rating to initially win business before later moving it to lower-cost jurisdictions—effectively cheating the market in the process.

“The real problem that Lloyd’s faces is that its own carriers are moving business away from the market—never mind the brokers. The new management are doing many good things to turn it around, but the cost of doing business there remains so high that the global carriers that operate there are moving business away, so it is underwritten from different divisions,” the executive said.

“That is the real problem they need to get a handle on. They are doing all this work around the sides but that is a core problem—the cats are flying out of the sides of the bag.

“They know this, but they can’t grasp how to fix it. Unless they find a way, the market will shrink and, bit by bit, lose its relevance,” he said—another challenge for Neal.

Others tend to agree that structural change is a necessity. Lloyd’s is at a “pivotal moment” in its evolution, according to Aon’s 2019 Lloyd’s Update report Redefining the Future. It described the proposals as “ambitious and designed to result in a much more efficient and responsive market”, and suggested that, structurally, the goal should be to create better connectivity between capital and risk in the market.

Aon said the initiative could result in separate placement methods for complex and standardised risk, easier entry to the market for high-performing innovative businesses, more flexibility in the way that capital participates, a next-generation claims service and the creation of an “ecosystem” of data and services.

“Lloyd’s retains core strengths, but it is increasingly recognised that structural issues must be addressed to allow them to come to the fore in today’s global marketplace,” said Mike Van Slooten, the report author and head of business intelligence for Aon’s Reinsurance Solutions business.

“The key to success is bringing costs down. Technology can be an enabler in that area, but ultimately people and behaviours drive progress and that is why the inclusive approach offers the best chance of success.”

A flawed approach?
That strategy is a point of contention in the market—and is one area where it runs a real risk of losing business if it gets things wrong, some believe. Darren Wray, chief executive of IT consultant Fifth Step, says Lloyd’s must get a better grip on its digitisation plans, or it will potentially lose ground to other jurisdictions.

“We’ve all seen the recent coverage of the future of Lloyd’s and the latest high level plan of how Lloyd’s will support digitisation,” Wray says.

“But it seems to me that Lloyd’s is going through a cycle every few years of coming up with new digital transformation initiatives, which they execute to some extent before they change their minds slightly, or they get another one of the big four consultants to come in who come in with a slight variation—and around we go again.

“Another £50 million is piled into the spending pot, to be spent over the next couple of years. I’m not sure that the market can sustain that and I’m not sure that London as an insurance centre can sustain it either.”

Wray believes the approach that Lloyd’s is taking is flawed. He thinks Lloyd’s is trying to give the market services it doesn’t necessarily want. He claims market participants simply want to be able to work in a standard way to maintain efficiencies, ideally keying data in only once at the start of the full lifecycle of a policy.

“Placing Platform Limited has done well; it’s further along than any of the other executions, but it’s still not anywhere near as far along as it should be at this stage, especially for the amount of money that’s been spent,” says Wray.

As a consequence there is a danger that Lloyd’s, and by extension London, might lose ground to other jurisdictions that may steal business, he adds. This business might not seem consequential at the time, but with the uncertainty of the UK’s departure from the EU looming, this could further weaken London’s position.

The culture problem
The problems outlined above would be enough to test any executive team. Yet on top of all this, they must attempt to tackle what is arguably their biggest challenge: the culture of the Lloyd’s market.

Whether you emphasise the laddish behaviour, the consumption of alcohol or the lack of diversity, what is clear is that the market has at its core a distasteful culture that is deeply engrained, but tackle it they must.

In September, the results of a survey commissioned by Lloyd’s in the wake of reports of sexual harassment in the Lloyd’s market, were revealed—along with the market’s plans to tackle some of the problems that emerged.

According to the findings of what was the largest-ever culture survey conducted in the insurance sector, four key themes emerged.
First, the experience of women in the Lloyd’s market was much poorer than that of men: women rated the culture more negatively than men across the survey and one in five respondents do not believe people have equal opportunities regardless of gender.

The second was around having the confidence to speak up. Some 8 percent of all respondents said they had witnessed sexual harassment over the previous 12 months; just 45 percent said they would feel comfortable raising a concern, however.

Wellbeing emerged as a big issue, with 40 percent of survey respondents saying they felt under extreme pressure to perform at work, while 24 percent had observed excessive consumption of alcohol during the past 12 months.

Finally, in what the survey categorised as “leadership”, some 22 percent of respondents said they had seen people in their organisation turn a blind eye to inappropriate behaviour.

The findings of the report did not trigger the backlash the Lloyd’s team seemed to expect. Speaking in Monte Carlo, the Lloyd’s executives were pulling no punches in what they expected the review to deliver—and in their commitment to tackling the market’s culture.

Carnegie-Brown suggested the review was likely to place the market on the back foot, and that more negativity would emerge before things could move forward. But it could be a cathartic process, he suggested.

“The results will not be surprising, but we want to call out and address these issues. I suspect, as we do that, we will experience a few bumps and certainly more negative sentiment.

“It may appear we will go backwards before we go forward, but that will be part of the healing process,” he said.

He added that he believes the process of change would be helped by dealing with some cases very publicly—to warn the rest of the market that certain behaviour will not be tolerated. In a somewhat surprising comment, in front of the gathered press, he stated: “It would be good to find a few to hang—that would change the mood.

“We want a proper process and it needs to be fair, but we want to send a powerful signal to the market.”

Neal backed him up. “If we do not take tangible action, I am not sure we will make the difference we want to make,” he said.

“When the scandal first broke, there was regret but there was no sense of denial—we want to set the right tone now. That is essential because we want to attract the right talent; if we do not do that, we will not succeed.”

Whether the plan to “hang a few” comes to pass remains to be seen. In the market’s official response to the report, it detailed a programme of measures that build on its five-point action plan put in place earlier this year, intended to further accelerate the pace of change.

The actions include forming a Gender Balance Plan, which would set clear and measurable targets for improving the representation of women at senior levels within Lloyd’s; developing Standards of Business Conduct requiring every person and every organisation operating in the Lloyd’s market to act with integrity, be respectful and always speak up; and introducing a Culture Dashboard to monitor progress in the Lloyd’s market against key indicators of a healthy culture.

The market said it would form an independent advisory group comprising leading experts with experience of successful cultural transformation. This group will be chaired by Fiona Luck, a Lloyd’s board member and non-executive director responsible for talent and culture.

Neal said: “I am determined that we create a working environment at Lloyd’s where everyone feels safe, valued and respected. Cultural change takes time, but we have to accelerate progress and the measures announced today are intended to do just that.”

So that is another goal to add to Neal’s list. In its 330-year history, Lloyd’s has endured its share of problems and, to be fair, has always come through. Is its current predicament as severe a challenge as others it has faced? Perhaps not, but it is certainly up there.

The insurance market seems to be behind the intentions of Neal and his team but whether they can win so many different battles, on so many fronts, remains to be seen. Significant change is coming, however. As Aon states in its 2019 Lloyd’s Update report, “The Future at Lloyd’s may result in the biggest changes in the market since the Reconstruction and Renewal process of the mid-1990s.” Sit back and enjoy the ride.