Lloyd’s trade capital crunch threatens weaker syndicates

Weaker Lloyd’s syndicates with a heavy reliance on trade capital face an uncertain future after a number of reinsurers indicated they would move to remediate their books for 2020.

Around £2bn ($2.5bn) of Lloyd’s capacity – or roughly 6-7 percent of the market – is currently supported by a diverse range of trade capital providers.

Broking sources have speculated that as much as 20 percent of that capacity could be withdrawn from the market in the forthcoming renewal, with limited interest from new carriers and very little appetite from existing players to grow.

As previously reported, Scor and PartnerRe – the biggest and a top-five player respectively – have placed their books under review, and it is further understood that Arig is likely to discontinue its participation, with others such as Labuan Re also likely to pare back.

A year after a number of syndicates were discontinued amid pressure from Lloyd’s and their capital backers, the squeeze on syndicates levered to this type of capital will at minimum worsen economics and at worst make it difficult for them to trade forward.

The Insurance Insider’s key takeaways are:

  1. More expensive/pulled capacity – Previously cheap and plentiful capital that has sustained primarily smaller Lloyd’s syndicates is set to become either more expensive, or unavailable for 2020.
  2. Uneven impact – Although the capital withdrawal is relatively small in the context of the overall market, its impact will be highly uneven due to the different approaches to capitalisation taken by different syndicates, with some likely to be acutely impacted.
  3. Unpredictable outcomes – The outcome is difficult to predict at an individual syndicate level but there is scope for structured capital deals, team sales, de-emptions, distressed sales or even syndicate closures as a result of the change in dynamics.
  4. Rates – It will be impossible to isolate, but the higher cost of capital should provide some additional tailwind to pricing in the market, which is trending up 5-6 percent on the renewal book.

Heavy losses

Upwards of 25 syndicates are believed to secure some of their Funds at Lloyd’s via trade capital delivered through corporate members.

Most is arranged via the brokers, with Guy Carpenter having the biggest market share, and Aon and Willis Re also running meaningful books.

The biggest users of such capital have typically been smaller syndicates, and particularly ones with private ownership, or with parents that have relatively small balance sheets.

Traditional reinsurers have used the vehicles as another means of accessing Lloyd’s business, while non-Anglo-Saxon players, including reinsurers with relatively low ratings, have used them as a means of gaining exposure to international specialty risk they would otherwise be unable to access.

And in recent years, ILS funds have started to use them to access insurance risk.

However, the sharp downturn in Lloyd’s performance after years of compound rate reductions and mounting acquisition costs, which was exacerbated by heavy cat losses in 2017 and 2018, has prompted a rethink.

The market made an underwriting loss of £3.4bn in 2017 on a combined ratio of 114 percent and a £1.1bn underwriting loss in 2018 on a combined ratio of 105 percent.

Although no figures are available, the syndicates that utilise a significant amount of trade capital skew towards the third and fourth quartiles.

As well as delivering weak results, corporate members have been asked to meet recent “cash calls” with cash rather than letters of credit, reducing the effective capital leverage and diminishing the attractiveness of the play.

Trade capital drawback

Scor has told brokers that it expects to trim its £200mn third-party corporate member business, while retaining the allocation to its own Lloyd’s business Channel.

Sources said the carrier is likely to scale back eight to 10 relationships to just three to five for the 2020 year of account.

Meanwhile, PartnerRe’s head of Lloyd’s trade capital Michel Buker is to leave the firm later this year, and the reinsurer is expected to very heavily curtail its involvement.

It is further understood that Middle Eastern player Arig has told brokers it is unlikely to renew its portfolio. Malaysian carrier Labuan Re – a long-time player in the space – is also expected to retrench.

Sources added that they expected a draw-down of capacity from other Asian carriers, reflecting their access to Lloyd’s business via other avenues.

Names cited with potentially reduced appetite included GIC Re and Sompo – both of which have Lloyd’s platforms – and Samsung, a recent investor in Canopius.

Brokers have also questioned whether ILS funds Securis and Stone Ridge will look to renew all of their participations after suffering from high levels of trapped capital and investor redemptions.

Sources have said that established markets Everest Re, Axa XL and TransRe are expected to be shown substantial additional business.

There is said to be only very limited additional capital waiting on the sidelines to enter the market for 2020 despite improving market conditions and positive sentiment about the Future at Lloyd’s strategy.

Unpredictable outcomes

Syndicates do not publicise their use of trade capital and the relationships are opaque.

However, The Insurance Insider understands that some of the syndicates that utilise trade capital include Ark, Aegis, Acappella, Agora, Apollo, Barbican, Brit, Canopius and Dale Underwriting Partners. Pioneer also relies on a capacity deal from Liberty for 100 percent of its capital, with Liberty signalling it is not minded to continue.

The impact on these businesses is likely to be highly differentiated, with stronger performers like Aegis and Ark much better placed, and others like Brit having access to additional capital from its parent company.

Sources have said deals are likely to be restructured to make them more palatable to trade capital providers. Some syndicates could be forced to move to stacked capital deals, while others may even be obliged to pay minimum and deposition premiums. Deficit carry-forwards are also likely to proliferate.

The renewal outcome remains uncertain ahead of the late November coming into line date. Some syndicates will replace the capital with their own capital, Names capital or with alternative third-party trade capital on a quota-share basis, but there is scope for problems.

In these cases, some could be forced to accept punitive capital structures, or to sell on teams as part of de-emption plans. And in the most extreme instances there is scope either for distressed sales, or even full business closures.

However, it is very hard to predict how the individual businesses will emerge from the challenge of the capacity crunch.

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