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Fri 29 Apr 2016 01:34 AM

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Risky business: Lloyd’s of London's John Nelson

For more than three centuries, Lloyd’s of London has been at the forefront of minimising risk while simultaneously earning billions of dollars annually from underwriting it. Chairman John Nelson explains why the Middle East is one of the historic institution’s new frontiers

Risky business: Lloyd’s of London's John Nelson

One of the oldest institutions in the world, Lloyd’s of London evolved in a coffee house popular with marines dealing in the slave trade still prominent in the 17th century. From the cobblestone streets of the historic city, founder Edward Lloyd would not have been able to conceive that in 350 years’ time, slavery would be abolished and Lloyd’s would be dealing with risks cultivated from then-unimaginable threats, such as drones, cyber security and terrorism.

As the world has evolved, Lloyd’s has often been at the forefront, driving regulation in industries as varied as aviation, building and political risk. Unlike other insurance brands, Lloyd's is a market platform where  multiple syndicates share the risk.

Unlike the historical institution, Dubai has emerged in only recent decades. The ratio of insurance premiums to gross domestic product (GDP) in the UAE is still a barely-existent 1 percent. The cost of such high levels of under-insurance is difficult to quantify, with governments often funding some undisclosed losses and others being written off. But the benefits of insurance are more obvious and multi-fold.

“For a 1 percent increase in insurance penetration, you get a roughly 13 percent reduction in uninsured losses [and] you get a pick-up in terms of capital gains relative to GDP in terms of investment of about 2 percent, so it’s pretty attractive,” Lloyd’s chairman John Nelson says.

A recent spate of high rise building fires as well as the economic impact of dramatically lower oil prices has put a spotlight on the Gulf’s significantly high level of under-insurance. Lloyd’s has operated in the Gulf for years, underwriting about $800m worth of business, including $200m in the UAE and $120m in Saudi Arabia. However, that was all via its London headquarters until a year ago, when Lloyd’s opened its first Middle East office in Dubai International Financial Centre (DIFC).

The office is one of several opened across the world as part of Lloyd’s 2025 strategy, launched four years ago.

“As the world has changed and developed it was clear that we needed to be closer to the market – not just in the Middle East but other parts of the world; Singapore too. We have to get closer to the customer, closer to the market,” Nelson says.

With significantly little insurance, there is ample growth opportunity in the region.

“I’d be pretty confident [of growth] because if you look at other countries around the world, that’s what is happening in China, South East Asia, South America, which are all big markets for Lloyd’s,” Nelson says. “We’re seeing greater levels of insurance penetration. Politicians and governments are seized of the importance of it because if you increase insurance penetration you obviously improve the resilience of an economy and you also create more growth.

“If you look at countries prone to natcats [natural catastrophes], which Dubai is not… take New Zealand, Chile, US, they all benefit hugely from having insurance of the type that Lloyd’s provides because we get businesses and communities back on their feet very quickly by pumping capital back in.

Natural disasters, including a flood in Dubai on March 10, have been a key focus of insurance.

“It’s a pretty easy concept to get your mind around and I think most politicians and governments get it, and they talk...

“The question is, how much the DIFC becomes the regional hub, so then it depends on other countries as well.”

Since opening in Dubai a year ago, Lloyd’s has achieved a steady footing and with such a tiny base to start from, it expects to grow rapidly.

“In the first year, we’ve exceeded our own expectations. We now have 10 managing agents on the platform, we have a number of cover holders. Our business directly on the platform last year was about $90m, and 2016 is forecast [to increase] 30 percent to about $120m,” Nelson says.

“These aren’t enormous numbers in the context of the Lloyd’s market as a whole but they’re significant and we think the prospects are very good. Our aim really is to continue to grow the number of managing agents, number of covering holders on the platform, increase our footprint and get our relationships closer than we have had in the past. We are very optimistic, we’ve made a good start.”

While earthquakes and floods make up the core of insurance in many parts of the world, man-made risks such as market crashes and human pandemics, as well as cyber security, drones and terrorism, are more dominant in the GCC. Reliance on oil and gas revenues also puts many regional cities at risk, particularly Tehran, Abu Dhabi, Riyadh and Doha, Nelson says.

In Lloyd’s most recent city risk index, Dubai was ranked seventh in the region.

Historically, the insurance industry has been at the forefront of developing – and often forcing – regulations relating to emerging, typically man-made risks. Nelson says it was the insurance industry that pushed for sprinklers to be compulsory in buildings and it has influenced much of the regulation in aviation and maritime – two other keys industries in the Gulf.

“Building standards are hugely affected by insurance but it’s more a commercial pressure than anything else because if you’re building a big building in a developed country and if you can’t get insurance, you’ve got a massive problem and you’re creating massive liability,” Nelson says. “So the question is an obvious one in a [place] like Dubai, which is full of sophisticated buildings, are the building standards high enough? If they’re not, they’re not going to be insurable so that’s a major problem.”

Lloyd’s is now also producing new products for risks associated with the supply chain, drones, automated vehicles and the like.

Ecuador's president has estimated the reconstruction cost of an earthquake on April 16 at $3bn.

“We tend to be in the vanguard of those risks and then gradually they become… more and more normal risks but we tend to be at the forefront when they’re being developed,” Nelson says.

Lloyd’s’ 2025 strategy also includes modernising the market and improving its efficiency and innovation. New offices also have opened in China and business in countries such as Brazil, Colombia, Peru, Mexico and Singapore are rapidly growing.

“In terms of global access, we’re ahead of where I thought we’d be today,” Nelson says.

“We think our addressable market two years ago was about $650bn of premium income, we think in 2025 that number’s going to be over $2tr because of under insurance and growth. So there’s a big job to do going forward.”

However, insurance is closely tied to economies and the slower activity globally has negatively affected Lloyd’s recent financials. Its profit was down a whopping 30 percent last year, albeit still at eye-popping heights of $3.1bn. The return on capital of 9 percent was also relatively decent compared to other forms of investment, but Nelson is flat when predicting the short-term future.

“At the moment the conditions look to me in 2016 as if they’re going to remain very, very tough,” he says.

“The market conditions in general specialist insurance are extremely tough. If you look at the dynamics of it, you’ve got extremely low interest rates, so that’s driving down our investment terms significantly. On the other hand, because we’re still significantly profitable, it’s driving more and more capital markets’ capital into the insurance business - there are few other ways they can put their money to work. What’s that doing? Driving down premium rates. So we’ve got a perfect storm: low investment returns and low premium rates.

“I think the market will gradually adjust to this and premium rates will begin to go up but it’s not helped by the fact interest rates have remained low and look set to remain low.”

Lloyd’s business will at least in the short-term be primarily driven by the growth of insurance in under-served emerging markets such as the Middle East and India. About 90 percent of its capital already comes from outside of the UK - the US is the largest market, accounting for about 40 percent, with Lloyd’s the number one excess and surplus insurer in the country by a factor of two. Nelson says even from such a strong position, Lloyd’s is continuing to grow in the US.

While China is a new market for Lloyd’s, Nelson says it is doubling revenues each year. The institution’s enormous presence in Singapore also has helped catapult the city-state to become the South East Asian regional hub for specialist insurance. Nelson says the platform is also close to securing a licence to operate in Malaysia, another potentially lucrative untapped market. With most of Asia geographically covered, there is one glaring bald spot: India.

Cybersecurity is now one of the biggest challenges facing insurers.

“India has been a longstanding problem for Lloyds because it’s a big economy, very protectionist and difficult [to operate in], but now with the new government in power, finally, just in the last two weeks [end of March], the Indian government and regulator have issued a set of regulations specifically to allow the Lloyd’s market to operate onshore, which is very good news,” Nelson says.

“There’s still some elements which put a bit of a barrier around [operating in India], which we’re working on, but it’s there, so this could be a very important development to us.”

Although Lloyd’s is establishing new bricks-and-mortar bases across the world, Nelson says the insurance market platform has existed in more than 200 countries for years.

“We’ve always been very international, but if you go back historically, a lot of your Tiger economies, your BRICS [Brazil, Russia, India, China and South Africa] and MINT [Mexico, Indonesia, Nigeria and Turkey] economies weren’t operating in a way that lent itself to the kind of risk mitigation that we provide. Now they have begun to, so we have reacted to that in terms of getting onshore access,” Nelson says.

“The other issue is that, historically, and it’s true of Dubai, a lot of the business was written back into London, which worked as a model very well. But there comes a moment when local insurers, local brokers want their carriers in country and that’s been a noticeable trend over the last few years and it’s one that we’ve very much responded to. In a way it’s healthy because, although it adds infrastructure for a market like Lloyd’s, it’s also healthy because it puts you closer to the customer and closer to the risk, so you have a better understanding of the risk, rather than doing it from your desktop in London.”

Speaking of London, Nelson’s decades of experience in banking and, since 2002, in advisory roles, also influences his role as a member of the UK Prime Minister’s Business Advisory Group. Presently, his most pressing issue in this role is the UK’s potential exit from the European Union, or ‘Brexit’.

“Clearly, for me as a businessman and as chairman of Lloyd’s, staying in the EU is important for the UK,” Nelson says, citing three specific reasons. One is that the EU provides businesses and platforms such as Lloyd’s passport rights into the 27 member states. Membership also includes the benefits of trading under bilateral agreements that the EU has with third party countries, of which the number is continuously growing. The UK also has benefitted from its status as a safe base for non-European businesses to operate across the continent, Nelson says.

“We would lose that advantage,” he says. “The UK has attracted more inward direct investment from outside the EU than any other EU country and the reason for that is that the UK is seen as a business friendly place, we have an enterprise regime and we have a competitive tax system. That’s attracting capital.

“For me, it’s very clear cut that we should stay in [the EU]. With any referenda, life can be a bit uncertain, it’s unpredictable, so one has a degree of nervousness about it obviously.”

But uncertainty, unpredictability and risk are all the same thing when it comes to investment and that is something Lloyd’s is all too familiar with. No doubt, with 350 years of experience, it will manage the latest hazard with similar success.

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