Author: Amber Green
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Introduction In April this year, the Lloyd’s market reported record profits of over 800 million pounds1. We enjoyed the best pricing conditions for years. There was little in the way of major catastrophe loss. And at the risk of mentioning a dirty word, even the equity markets stabilised from the stomach-churning freefall we have seen in recent years. So, you might be excused for wondering, what on earth am I doing here today talking about challenges to the profitability of the insurance industry? Certainly, 2003 was a good year for the Lloyd’s market. We finally seem to be getting it right. The economics of insurance are suddenly making sense again for our shareholders. But despite all this good news, it is my firm conviction that 2004 will be the real test, not just for Lloyd’s, but for the entire insurance industry. There are still some dark clouds hanging over the global marketplace . First, the industry is still paying dearly for mistakes of the past. Reserve additions have continued thick and fast with no immediate end in sight. Asbestos and US casualty business underwritten at the end of 90s continued to spur a number of industry reserve additions over half a billion dollars last year2. At the same time, two separate reports published in the US in recent weeks suggest that price competition is now returning to the market3. For property business, the RIMS survey actually suggests the cost fell by 9% in the last quarter of 2003, the first decline for four years. No surprise then, that the rating agencies’ aggressive streak continues. Just in time for the last Monte Carlo Rendez-Vous, Standard & Poor’s chose to shroud the entire reinsurance sector with a negative outlook, and downgrades outpaced upgrades for the third consecutive year4. So, I believe that our actions now will have a huge impact on the future profitability on our industry: indeed, the way the industry behaves in 2004 could decide whether it really has a future at all. Today I want to look at four of the major challenges that I believe all of us working in insurance and reinsurance need to get to grips with in 2004 if we are to succeed. Two relate to external factors; and two to behaviour within the industry. Taken together, they highlight the need for something of a new culture revolution in insurance, and I will explain what Lloyd’s is doing to play its part.


Lloyd’s Global Results 2002


“Reactions”, December 2004 Council of Insurance Agents & Brokers January 2004; RIMS “Benchmark Survey”, January 2004 4 Morgan Stanley, April 2003 3


• • • •

First, I want to look at compensation culture – because in terms of the global risk environment I believe it is the greatest external threat to the insurance industry; Second, I will talk about our collective culture, and suggest that we really must begin to work together better across the industry for several important reasons. Third, I will argue that we need to halt the lemming culture of insurance – this is no time to return to past suicidal behaviour and relax underwriting discipline. We need to prove that we can manage our infamous insurance cycle. Finally, I want to talk about the need to overhaul service culture – because in today’s environment business process reform simply cannot be divorced from our financial performance.

Compensation culture So, let me start with compensation culture. Last month, speaking to the Downtown Association in New York, I described it as a cancer on our industry. Strong words I know. But I am far from alone in this view. Hank Greenberg chose tort reform as his sole topic when he spoke at our Lloyd’s City dinner at the end of last year. In fact, when I joined other US industry leaders at the Joint Property/ Casualty forum in New York a few weeks ago, the issue weighed heavily on everyone’s mind. The message was that the tort crisis is not just an insurance industry problem, but a national economic problem. The cost of the tort system is like a 5 per cent payroll tax. It’s a tax without representation at the most basic level, and it’s growing. Furthermore, we used to like to see it as an American problem. But that too is a short-sighted view, as there is strong evidence that the compensation culture is starting to plunder the UK economy. The compensation culture can start with seemingly insignificant things. Recently, I read that a Wolverhampton postman who pulled a muscle is taking legal action against a university lecturer. What was his crime? He put too many letters in a postbox. The postman’s solicitors said that in posting the 20 kilogrammes of letters, the religious studies professor was “negligent in failing to appreciate the risk to our client of posting so many letters”. The professor has received four warning letters claiming compensation and may have to go to court5. On a more serious note, actuaries predict that this culture is costing UK plc about £10 billion a year – and rising at 15% per annum6. The average cost of an employers’ liability claim has increased by over 100% over the last five years7. Clinical negligence which cost the NHS £6 million in 1975, cost nearly half a billion by 20028. Compensation and legal costs have soared to £100 million in the Ministry of Defence9. And there is concern now too that this blight is spreading to the rest of Europe, where until recently the practice of suing company directors and officers was unheard of.


“Postman sues customer who sent too many letter”, Daily Telegraph, 20 December 2003 Actuaries’ Working Party report “The Cost of Compensation Culture”, reported on 17/12/02 7 Association of British Insurers, “Liability Insurance”, August 2002 8 “Making Amends”, Chief Medical Officer, June 2003 6


NAO Report “Minsitry of Defence- Compensation Claims”,18 July 2003


Politicians in Whitehall and in Brussels need to wake up to the problem. And they need to wake up now. Ignoring it and hoping it will go away is not an option. If they need any proof, they need just look across the Atlantic. In the US, some question whether tort reform can now be achieved so close to a presidential election. But it’s wrong to see tort reform as a political issue. It’s not a political issue, but an economic one. We need to see politicians and influencers set aside their political agendas and recognise spiralling litigation impacts all political boundaries and crosses most industry sectors. It demands an appropriate and collective response. Without it, the damage to the economy could become irreversible. But there is much that we, the insurance industry, can contribute to that process. We need to work together, to present a collective position, and to raise awareness of the problem amongst industry at large. We can help rouse those who need waking up. There is no magic wand and no single solution, but by plugging away at the problem at all evels we can step up the momentum for legislative change. Collective culture Which brings me to my second point – our collective culture is not what it should be. Just a few weeks ago, I chaired the Finance Governors meeting at the World Economic Forum in Davos. The stark conclusion was that, as a sector, financial services has a lot to do in order to improve its public image. In banking, a succession of governance scandals has followed successive poor financial service advice and obsession with shareholder value at the expense of wider stakeholder concerns. In insurance, the impact of major insurance insolvencies, volatile insurance pricing cycles and the recent withdrawal or reduction of capacity in some key lines of insurance, has added to the problem. The conclusion was that the financial sector needs to act and speak more strongly as a collective force with its customers, regulators and other stakeholders. Nowhere is that more true than in insurance. Insurance plays a key role both in the economy and wider society, but we have traditionally done a very poor job of communicating these roles, and of working together collectively to advance them. At the heart of insurance is a very social role – the sharing of risk, whereby the losses of the few are borne by the many and individuals gain the psychological benefit of peace of mind. It also encourages greater personal independence, avoiding a culture of dependency on others, particularly important today as support from the family or community declines in many societies. The benefits translate to the economy at large. Businesses have to take business risks in order to make a profit. Insurance acts as a supplier of contingent capital to industry, and encourages it to take appropriate commercial risks. Insurance facilitates international trade and investment across both the developed and developing world. And we provide loss prevention, safety and risk management advice and services to its customers, bringing important benefits to wider society and the economic and social system.


However, we have traditionally done a very poor job at communicating our role and our workings to the outside world. More than ever, we need to work and communicate more, and more forcefully, in at least two main ways. •

We need to provide input to policy in a growing number of areas – international investment, economic and financial stability, the environment, and social security reform, but progress on the global stage has been hampered by the absence of a consolidated industry voice. Regulators in particular are taking an ever closer interest in the financial services sector in the wake of high profile collapses, and the level of insurance regulation and legislation is increasing. It’s therefore vital that we get involved in the debate, so that the regulation matches the business reality. The danger is that without this input, we end up with a series of regulations which are not commercially workable.

Together, we also need together to set an agenda for delivering tangible and greater benefits to society. Terrorism aside, we often fail to explore ways in which we can work together as an industry and with governments to improve economic conditions or reduce the individual’s reliance on the state. Furthermore, we have a great wealth of expertise on risk management and mitigation within the insurance industry, but we have not even begun to harness this expertise and deliver the real gains that we could by acting collectively.

Valuable work is already being done by important groups in our industry such as the Geneva Association and the Financial Leaders Group. But in this rapidly changing global market, I am convinced we need to do more. I don’t know exactly what the right answer is – yet. But I do know that we need to work together better and take action.

The ‘lemming’ culture For the second part of my presentation, I want to turn to look at two ways in which we need to revolutionise our internal culture. First, we need to sort out our lemming culture. I mentioned right at the start that Lloyd’s posted record profits last year, and that the US industry’s combined ratio finally went south of 100 in 2003. But put that in context and it looks rather less exciting. The Insurance Information Institute estimates that the US industry has collectively lost well over 400 billion US dollars over the past two decades10. To put it a different way, the last time the industry made an adequate rate of return was during the mid 1980s. That rate of return has been sliding dramatically since the 1970s - and averaged just 2.8 per cent in the first three years of this decade11. What investors in any other industry would settle for that I wonder? To start relaxing underwriting discipline now would be financial suicide. It’s a message with which you are all familiar, but it is one that bears repeating.


Insurance Information Institute, 2003 data Frank Coyne, President of Insurance Services Office, speaking at Society of Insurance Research in Florida, November 2003



While I believe there is a genuine desire to learn from our past mistakes, history proves that insurance executives and underwriters have short memories. At Lloyd’s, we are determined to get it right this time and we aren’t taking any chances. We have now taken some very decisive steps to improve the quality of underwriting as we enter the next stage of the cycle. Just over a year ago, we began implementing a new Franchise structure – its key objective is to deliver consistent, strong financial performance, avoiding the staggering peaks and troughs to which we have become accustomed. After our first year of operating under this new structure, we are now confident that our plans for 2004 are now grounded in the reality of external market conditions. Lloyd’s opened this year with a capacity of almost 15 billion pounds12, matching last year’s record. Now that figure certainly proves the continuing attractiveness of our marketplace. It is partly the result of established market players maintaining or increasing their capacity and we have also seen a wave of new smaller “start up” businesses, including a number in the professional indemnity sector. However, in reality it means we have not seen a change in the level of Lloyd’s capacity. That’s because our concern is not market size and certainly not market share. Rather, our concern must be that pricing and terms and conditions are at a level where there is reasonable expectation of an underwriting profit, not just at the peak of the cycle, but every year. So although we entered 2004 in extremely strong shape, we are determined to maintain and improve our position further. And if we are to do that, it means that every business, every underwriter within our market, must ground their underwriting decisions on economic reality. Its’ quite simple: If they do not, they will no longer be allowed to trade within our marketplace. We have already excluded one underwriting business from our market. And another business has decided to trade forward outside of Lloyd’s for 2004 as its business plan did not fall within our guidelines. Going forward, we are likely to see more decisions like these. Not because we intend to apply the guidelines as a strait jacket, because our approach is very much one of flexibility. But because our future success depends upon delivering a strong performance across the full cycle, and these guidelines of best practice have been proven through the test of time. Going forward, a willingness to manage capacity – and to shrink it where necessary - is critical to our future success. The successful underwriters in our market have always shown a much greater inclination to shrink their books of business than the least successful – the evidence from the last down cycle proves it. I am certain there will continue to be lemmings within the insurance industry who continue to miss the point, and who will blindly follow the herd to an untimely death. But we will no longer allow those operating within our market to join them, and I would urge each of you to ensure that you are part of the revolution, prepared to take tough decisions instead of careering over the cliff edge. Service culture


Provisional figure announced December 2003, Lloyd’s Member Services Unit.


Finally, then, let me touch on our service culture. We have talked a lot about the need for high quality underwriting, but it becomes clearer by the day that we cannot improve our industry’s performance without radical change to our business processing. Having worked in a wide range of different industries, one of the first things that struck me when I came into insurance was – frankly – how inefficient it is in terms of its processing and service delivery. As you know well, in London our service standards have not always been up to expectation, in part because of the subscription market structure. But now, at last, I believe that things are changing, in a number of ways. There is something of a service revolution under way in London. We recently appointed Lloyd's first head of business process reform. It’s a landmark appointment, indicative of the fact that we are prepared to tackle the service issue head on. His remit is to co-ordinate and drive through business process across the market, which has perhaps two main elements aimed at improving efficieny and deliver higher standards for our brokers and clients. For the first time in over three centuries, we managed to introduce a standardised form to record all deals done in the Lloyd’s market. Tried and tested over the last year throughout London, this new ‘slip’, if used properly, can make an important difference to quality of service. It ensures that the terms of insurance contracts are agreed and clear before they come into force. A small step for mankind but an important one in the London insurance market, where certainty has often been missing in the past. This clarity will make quicker and more efficient the whole process of placing insurance – and also, critically, the business of agreeing claims. It has the power to raise the standards of insurance documentation, and result in important gains for brokers and policyholders. The second initiative relates specifically to technology. A major problem for today’s insurance technology is the plethora of different computer systems that it has to cope with. Those used by the different carriers and brokers all vary widely, and dealing with each of then drives up costs and takes time. But the new Kinnect platform is compatible with these systems, and allows them, for the first time, to communicate and to exchange data electronically. It reduces the enormous scope for errors, and the delays which mean a claim can take too long to be settled. So far, Lloyd’s has invested over 40 million pounds in this initiative13. It’s supported by some of the very largest brokers – Marsh and Willis, and by a number of quality underwriting businesses who share our enthusiasm for change. In December, Willis passed the first risk through the Kinnect platform. Again, a small step. But a tangible and important one. And our vision? We look forward ultimately to its adoption right across the London market saving time and money on the processing of risk. Of course, you can make all the system and process changes you want, but these reforms will only succeed if you, and the rest of the London market want them to. In the end, successful 13

Kinnect website, viewed January 2004.


change is less about technology and more about behaviour. But are we really prepared to sit back, stagnate and allow the London market to write itself off to the annals of history? To these business process reforms I should add one other. We desperately need to get our claims handling process right. Claims payments and their associated costs represent the Lloyd’s market’s single biggest expense and are critical to our brand and reputation. In 2002, we paid out some 10 billion pounds in claims and spent 550 million pounds on associated fees to advisors14. Whilst the initiatives I have described will go a long way to improving our claims performance, there is currently no formal strategy for claims at Lloyd’s, and we need to develop and define a fully integrated approach. We have therefore begun a two-stage process. The first will assess the claims opportunity for Lloyd’s, establish the business case for change, and propose new ways of working. This should be complete by the end of the first quarter. The second phase will then develop the agreed proposals into a detailed implementation plan. So, as they say, watch this space. There is certainly more to come. Conclusion In conclusion, ladies and gentlemen, I have no doubt that 2004 will prove to be a challenging year. Today’s business environment is changing rapidly and if those of us in the London market are serious about playing a leading role in the global market, we must act now and join the new culture revolution. I do sense a real desire for change, and as I look around the market see evidence of the revolution well under way. But our pursuit of high quality underwriting, high quality financial performance, and high quality service must be relentless. This is not a time to sit back. It is a time for cultural change; change of our business processes and of our lemming approach to underwriting. Time too, for us to embark on a new era of working together in communicating with those who need to understand us better and to lobby more powerfully on the issues that affect us all, from tort reform to free and fair regulation. If 2003 was the year in which Lloyd’s recorded record profits, then I hope 2004 can be the year in which we lead the insurance industry in this new culture revolution. I sincerely hope that each of you will join us in that quest, and thank you for listening.


X-Changing Ins-sure services, November 2003


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