By LEN WILKINS
Responding to instructions from the U.K. government, Lloyd’s and the London market imposed sanctions on Russian interests. Aircraft and ships aren’t allowed to land or dock, and insurance of risks, including areas of Lloyd’s expertise, such as marine and aviation, are banned.
Unfortunately, the U.K. has become closely associated with Russian offshore money and with wealthy Russian expatriates. Seen as a politically stable economy and government with respected legal and banking systems, the U.K. attracted many rich Russian investors. The U.K. also has the advantage of experience hiding wealth, which it used to guard for various foreign investors during European civil wars.
Things have changed, and governments throughout the world are imposing sanctions as a means of hitting back at the Russian aggression against Ukraine. Unfortunately, most of the areas being hit by sanctions are the niche, specialist lines heavily concentrated in the London market, particularly Lloyd’s.
Lloyd’s potentially could lose $10 billion if Russian President Vladimir Putin goes ahead with his threat to seize all foreign owned aircraft. There are around 500 aircraft being held hostage. Most of these aircraft are not owned but are leased for tax reasons.
The leasing companies have until March 28 to cancel their deals. If they take this action, a new Kremlin commission will decide if the aircraft will remain in Russia. Meanwhile, the country’s transport ministry will continue to pay the leasing fees in useless rubles. While the aircraft’s operator would buy insurance protecting against damage, the leasing companies also buy insurance to protect their position if the aircraft’s operating company doesn’t pay.
One area where Lloyd’s predominates is marine war insurance. This is a relatively small part of the market but is highly organized at both writing risks and quantifying its exposures. Underwriters cover the risks of war and strikes on a worldwide basis. To protect their position, they identify certain parts of the world as Areas of Perceived Enhanced Risks. Should a vessel enter one of these areas, underwriters would give notice to cancel cover and renegotiate terms of cover. Even though this often involves increased premiums, the ship owner may ask to increase the security precaution.
Earlier this week, London’s marine insurance market widened the area of waters around the Black Sea and Sea of Azov which it now considers to be high risk. These areas are identified by the Joint War Committee (JWC) which is made up of Lloyd’s and company underwriters. They extended their perceived high-risk areas to include waters close to Romania and Georgia after initially adding Russian and Ukrainian waters in the Black Sea and Sea of Azov last month.
So far, one Estonian vessel was sunk, and a Bangladesh vessel damaged by an explosion in the area, while two other vessels have suffered unknown damage.
The political risk insurance market nervously is looking at developments. Insurers are reviewing the capacity they offer, and anxious policyholders are checking their coverages and exposures with brokers. This niche market is mainly written in Lloyd’s and London, and sources suggest up to half of all terrorism policies in Ukraine include war cover. Risks across Ukraine and Russia are at risk. Even though it’s anyone’s guess as to potential losses, the perceived exposure is in the area of one billion dollars. It is believed that none of these policies contain war exclusions.
London expected cyber losses, but Russia’s government-sponsored hackers have remained quiet, and actions to shut down communications and power supplies have not occurred. With most cyber insurance written in the U.S., perhaps Russian activists were told to lay off cyber-attacks.
At times of conflict, governments have used the $2.5 trillion trade credit insurance market to shut down international commerce. This is where exporters buy cover against their buyers not paying for goods. Effectively, it provides a financial safety net for exports and imports. Even though governments may not have acted, insurers have. They are no longer giving cover for exports to Ukraine and Russia as worries about large claims or missed payments increase.
All insurers, wherever they are, are concerned about the loss of investment income. While insurers tended to avoid investing in Ukraine or Russia, according to Moody’s they stand to suffer from financial market volatility and increased cost of energy. London and other major stock markets fell heavily following the invasion, and this will hit investments. After years of little investment return, insurers will not want more financial losses. The conflict will exacerbate inflation, increase the likelihood of a wage-price spiral and put pressure on insurers’ costs.
Patrick Tiernan, the chief of markets at Lloyd’s, commented on the sanctions saying, “We are in regular communications with the U.K. government and international regulators and are working closely with the Lloyd’s market to uphold the implementation, at pace, of sanctions applied by governments around the world. We continue to monitor the unfolding situation in Ukraine, and our thoughts are first and foremost with those people directly affected.
“We are working closely with the entire Lloyd’s market and relevant associations to ensure the efficient functioning of our market through the crisis for all customers and stakeholders,” he said.
Lloyd’s actions on sanctions
Coping with sanctions is not a problem for Lloyds. Lime Street prides itself on its many overseas licenses and has a financial crime (advisory) team which protects its licenses, trading rights and brand from the risks arising from sanctions. The team also protects the market’s good name from money laundering, terrorist financing, bribery and corruption, fraud, market abuse/insider dealing, and tax evasion.
Lloyd’s Financial Crime Monitoring and Assurance team reviews and oversees the market’s management of financial crime related risk. The team conducts thematic and targeted reviews across the above six pillars of financial crime and provides insights and recommendations to support best practice.
The market is committed to complying with the sanctions laws and regulations of the U.K., EU, the UN and the U.S. (the sanctions lists), as well as the sanctions laws and regulations in the jurisdictions in which Lloyd’s operates. Dealing directly or indirectly with parties subject to restrictive measures issued by these jurisdictions is prohibited.
Tiernan: Keep feet on rates accelerator
Lloyd’s holds regular market meetings with underwriters to discuss market changes via video link. During the March meeting, Tiernan told the market that, when rating risks, Lloyd’s wants underwriters to take into account the current risk exposure and factor in the cost of inflation and environment exposure from climate change when arriving at a rate. He said that this “risk-adjusted rate change” is a floor not a target. He also warned that catastrophe loss picks in business plans must be realistic, and syndicates should adopt a scientific and forward-looking approach to climate change on catastrophe exposure.
Tiernan said the market is now moving through remediation (reversing underwriting losses) to a sustainable performance and underwriting profit. To achieve this, managing agents need to build resilience in their portfolios for the opportunities and challenges ahead. He said the 2021 underwriting results will show how the market demonstrated improved underwriting performance, albeit in a year without major outsized loss activity. It mustn’t make the mistake of believing remediation is a once-and-done exercise. Maintaining underwriting and pricing discipline is vital to ensure that Lloyd’s is well positioned to deal with short- and long-term factors, from inflation through to climate change.
Any poor performing syndicate who believed Decimal 10 was over is in for a shock. Tiernan expects to have further “difficult conversations” with these poor-performing syndicates. He said, “We have set clear indications for syndicates that have had poor performance over the years. They know what we expect from them if they do not deliver on those. We will have difficult conversations.”
Recently, a hard market saw underwriters dash for cash and concentrate on profits. Tiernan warned that rather than looking to optimize profits, Lloyd’s wants to establish a solid underwriting foundation to grow in an ever-riskier world.
It seems the days when Lloyd’s underwriters scribbled down a rate on the back of a piece paper have gone. Tiernan wants the maximized use of models for both price and exposure, using the most up-to-date data and available science so underwriters get a better understanding of the volatility in their existing portfolios. Underwriters need to be able to correctly rate the innovative and complex risks which will be found in the areas of emerging and immature risk.
Tiernan’s other major concern is inflation, particularly claims inflation. He is concerned that underwriters are not considering inflation. His concern is that the rate and speed with which inflation could hit can erode the progress the Lloyd’s market made. For the last 10 to 15 years, he said, inflation has been relatively contained and fluctuated around the one to three percent target set by central banks. There are now inflationary factors in the system, so managing agents need to consider those. Get it wrong and loss ratios will be higher.
Perhaps one of the most interesting parts of the meeting came when Tiernan introduced Kirsten Mitchell-Wallace, Lloyd’s portfolio risk management director. She said the market expected to generate a gross profit of $32.5 billion during 2017 and 2021 based on managing agent’s business plans using Lloyd’s benchmark achievement ratio. The market, however, achieved profits of $15 billion and then a number of catastrophes and Covid wiped out those profits. The simple reason for the $17.5 billion gap was inadequate pricing and the lack of techniques in producing this pricing.
Lloyd’s is concerned about the ability of some syndicates to assess natural catastrophe exposures and the threat posed by climate change. Lloyd’s expects catastrophe losses to continue increasing in the future. There is more exposure, and more of that exposure is in riskier locations. So Lloyd’s is increasing its focus on how syndicates assess and price such risks in their business plans. Climate change is seen as its biggest challenge and more work is required to understand this risk. Nonetheless, Lloyd’s does not plan to reduce its appetite for natural catastrophe risk, according to Tiernan. “Our appetite for cat, in proportion to our portfolio, hasn’t changed.”
New special advisor
Even though Lloyd’s is concentrating on the way it does business with its Blueprint advances, it hasn’t lost sight of its need for the market to be backed by sufficient capital. To help, Lloyd’s announced that Des Potter, formerly of Guy Carpenter, has been appointed as special advisor to Lloyd’s CFO and COO Burkhard Keese to focus on enhancing Lloyd’s capital framework and how investors can support underwriting at Lloyd’s.
Potter is well known in the market having spent 10 years at Guy Carpenter as the managing director of GC Securities and chief executive officer of investment advisory firm MMC Securities Ltd. He was also a member of the London Market Group’s ILS taskforce that worked on the development of the U.K. risk transformation legislation. Prior to this, he held senior management positions at Aon Benfield Securities Ltd. and Benfield Advisory. Potter spent the early part of his career in the corporate and investment banking divisions of Barclays Bank.
As an advisor for Lloyd’s, Potter will focus on making it easier for investors to access Lloyd’s, including through the risk transformation vehicle London Bridge Risk PCC, which was sponsored by Lloyd’s as part of its Future at Lloyd’s strategy.
Brexit boosts available capital
Many Brits have been unhappy with the U.K. government following Brexit over failure to remove EU legislation. The Lloyd’s and London insurance market is likely to benefit from new laws. Financial services minister John Glen said the U.K. will unlock “tens of billions of pounds” of insurance sector capital that should boost the economy through infrastructure investment and allow new investment in insurers.
Glen was referring to the six-year-old Solvency II capital requirements that were inherited from the EU when Britain left the bloc’s orbit at the end of 2020. The reform is seen by insurers and Brexit supporters as an early test of how Britain can exploit its freedom to write its own financial regulations, and the government is keen to show tangible benefits from leaving the EU.
Policyholder protection will remain a top priority. Solvency II always was seen as overprotective. The U.K. will make changes to the way risk margins, matching adjustment and reduced reporting requirements are calculated and will unlock $129.25 billion of capital.