Alex Foster, manager of the Hiscox Insurance Fund tells MoneyWeek where he'd put his money now.
There was an uptick in property/casualty underwriting just before September 11th, and it has been on a strong upward trend since. However, results just out from the Lloyd's insurers are the first to fully reflect this: most firms delivered 2003 earnings well ahead of expectations. This was down to the fact that 2002 and 2003 were excellent years for underwriters given increased rates, tighter terms and conditions, and the low level of catastrophe losses'. And the good times are not over yet: I think this year should be at least as strong. Underwriting discipline has stayed good and, although some rates have eased, in certain classes they remain at high levels. The Lloyd's firms should therefore see strong double-digit earnings growth until 2006.
More good news comes in the form of dividends, which were increased in 2003 and should rise again this year. Under Lloyd's rules, cash from an underwriting year is only released after three years - that bodes well for a significant rise in dividends in spring 2005.
One of the reasons the Lloyd's companies are doing so well is that they can capitalise on the strong market with their favourable solvency margins compared with US and European companies. They can therefore gear up their underwriting more easily to maximise returns. Other insurance companies, particularly in Europe, have in the past relied too heavily on good investment returns and high interest rates to cover underwriting losses and produce bottom-line profits. They can't do that in today's low-interest environment; instead, they are making profits through successful underwriting, which, after all, is what they were created for in the first place.
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And as Lloyd's companies have always had to rely on underwriting as their only means of making money, they are particularly well placed to take advantage of today's strong conditions - much of the rest of the industry is struggling to start underwriting for profit. A simple measure of the profitability of an underwriting account is the combined loss ratio (CLR), which is simply the sum of losses and expenses divided by premiums. Break-even is 100%; above that suggests a loss and below it a profit. Most Lloyd's insurers have CLRs in the low 90% range. Some, such as Kiln (83%), come in much lower. Another significant advantage for Lloyd's companies is that its past liabilities (asbestosis, etc) were transferred in 1993 into Equitas, a stand-alone company.
Looking forward, the big question is, when will the present cycle turn down? The answer, I think, is not yet. With historically low rates in America and reduced returns across the world, property and casualty companies can still only make money from underwriting. New capital has been a threat in the past as naive investors ride in to capture perceived riches, and in doing so compete with existing insurers. At present, there is little sign of this. The Hiscox Insurance Portfolio has 20% of its £80m in Lloyd's companies. I have lifted our exposure recently and we now hold Amlin, Atrium, Beazley, Hiscox and Kiln.
There is an old saying in this business that bad years get worse and good years better. Today we are in the middle of the good times: shareholders with a two-year time horizon should be well rewarded.
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