Tough year for UK specialty underwriters

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The UK specialty insurance market suffered the costliest year on record in 2017, according to EY’s Annual Specialty Results analysis, due to a combination of natural and man-made catastrophes including Hurricanes Harvey, Irma and Maria and the Californian wildfires. While this was felt at an overall market level, performance was mixed within Lloyd’s syndicates as the impact was focused on a few large exposures. The overall result was that major claims rose by just under 10% to £4.5bn and return on capital (ROC) at Lloyd’s fell from 8.1% in 2016 to -7.3 in 2017, moving from a £2.1bn profit to £2bn loss.

Downward trend for return on capital

Even adjusting for major claims, ROC still showed a downward trend in 2017 – a 9.3% fall. While there was a slight increase in investment returns over the course of the year from 2.2% to 2.7%, which equates to £1.3bn to £1.8bn, there was a great deal of volatility during the period. US and UK monetary policy divergence led to mixed returns in the bond markets, and equity and growth assets had a slow first quarter, though recovered later. Growth assets, however, only accounted for around 10% of Lloyd’s aggregate assets.

Gross premium grew but underwriting performance continued to deteriorate

Gross premium increased by 12% from £29.9bn to £33.6bn, however, underwriting profit dropped from £0.5bn to -£3.4bn – driven by large losses (£4.5bn vs £2bn in 2016) and smaller reserve releases. In fact, reserve releases were down significantly in 2017; 2 percentage points – from 5.1% (£1.2bn) of net premium in 2016 to 2.9% (£0.7bn) in 2017 – the lowest level since 2006.

Accident year losses across all business lines

All of Lloyd’s classes of business reported accident year losses for 2017, and the accident year attritional net loss ratio increased significantly from 53.3% in 2016 to 58.9%. The ratio deteriorated across property, casualty, marine and energy, but improvements were seen in motor, reinsurance and aviation.

Andy Worth, UK Head of Specialty Insurance at EY, comments: “2017 was characterised by hurricanes Harvey, Irma and Maria, the Californian wild fires, an earthquake in Mexico, monsoon flooding in Bangladesh and a mudslide in Colombia. Global catastrophe losses were over $130bn. This greatly affected the specialty market which experienced its costliest year on record. While this was of course felt at an overall market level, the level of exposure wasn’t uniform and some individual managing agents were impacted to a much greater extent than others. Our analysis shows that while some of the variance in performance amongst managing agents is due to portfolio mix, the better performers use better risk selection and pricing discipline to out-perform.

“The business environment remains challenging, and even discounting for these catastrophes, underlying performance and return on capital was down, as were the reserve releases. Despite some rate hardening in specific lines of business, we expect ongoing margin pressures and a focus on underwriting discipline and cost management.

“Taking a step back, 2017 demonstrated the robustness and purpose of the London Insurance Market. Lloyd’s alone paid out over £18bn to help get the impacted communities, in many different parts of the world, back on their feet. The events of 2017 epitomises the global social and economic role that London fulfils. Since 2008, Lloyd’s has nearly doubled in size in premium terms, and it remains an attractive platform for global players from around the world.”

Global insurance transaction volumes have fallen but further M&A activity expected

Global insurance transaction volumes have declined between 2015 and 2017. However, excluding deals worth more than $5bn, global transaction values during this period remained relatively flat. In 2015, just eight transactions made up 50% of total global insurance transaction values.

Rodney Bonnard, UK Insurance Leader at EY, comments: “While overall transaction volumes were down in 2017, just five months into 2018 we’ve seen some big global deals in the specialty market and we expect this trend to continue.

“Acquisition of course provides growth opportunities, and at a time when organic growth is challenging, given the current rating environment and competitive pressures from third party capital, this is a key focus for many. There can also be benefits from moving into different geographical markets where there is greater growth potential and moving across business lines to allow for capital efficiency opportunities and the ability to enhance margins.

“Interestingly, we are not only seeing Global players buying access to Lloyd’s and specialist products, but also mid-sized specialist insurance carriers looking to gain scale.  There’s also been a renewed interest from private equity firms.”

Brexit uncertainty continues for UK specialty insurers

There is increasing alignment of Brexit plans across the insurance market between brokers, insurers and reinsurers, however, uncertainty still exists about how EU27 regulators will ask firms to interpret the transition agreement.

Rodney Bonnard continues: “Despite the potential Brexit transition period – which is awaiting ratification as part of ongoing political negotiations with the EU27 – a great deal of uncertainty still exists for (re)insurers and brokers. To address this uncertainty most UK headquartered insurance firms are still planning for a March 2019 deadline, and have Brexit programmes well under way to meet this date and provide their policyholders with confidence.”

The BEAT affect – UK specialty market heavily impacted by US Tax Reform

The introduction of the Base-Erosion Anti-Abuse Tax (BEAT), created through the US Tax Cuts and Jobs Act, and passed at the end of 2017, could have significant and market-changing implications for cross-border affiliate reinsurance – especially groups with US and/or Lloyd’s platforms which reinsure to off-shore affiliates. These measures, applicable to entities above certain thresholds, could impact any Lloyd’s member which writes US binder business that is then reinsured from the syndicate or corporate member to an off-shore affiliate.

The BEAT is a corporate income tax but essentially operates as a levy on gross premiums ceded out of the US to affiliates (or commissions payable from US reinsurers to affiliates). For 2018, the rate of the tax is broadly 5% of gross premiums, rising to 10% in future years. The insurance industry is disproportionately impacted since other industries are permitted to deduct cost of goods sold from BEAT’able payments made to off-shore affiliates. 

Other measures of US Tax Reform may present opportunities. For example, it is now possible to acquire subsidiaries and investments under US companies, which was previously not possible without punitive tax implications. 

Rodney Bonnard concludes: “It’s vital that insurance groups understand the new tax reform and prepare for its commercial implications. The BEAT is a significant concern for many groups that are still working through options for restructuring reinsurance programmes. Overall though, US Tax Reform should be seen as an opportunity to carefully assess structural and business changes and identify new ways to grow business.”