December 2019
The number of Lloyd’s underwriting entities is steadily falling.
The closure of a sequence of syndicates – most recently Acappella, Vibe and Pioneer – has been the most prominent cause of that drop.
But over the last two weeks, developments at Arch-Barbican and China Re-Chaucer have thrown the spotlight on mergers as a driver of the contracting number of underwriting entities.
Canopius and AmTrust at Lloyd’s were already on this path, along with Hamilton and Pembroke following deals earlier this year.
The previous situation, with 60 managing agents running around 100 syndicates writing only £35bn ($46bn) of business at a 40 percent expense ratio, was clearly not sustainable.
Mergers or fold-in acquisitions make a huge amount of sense given current pressures and the potential benefits on offer.
Most obviously – as demonstrated this week by pending redundancies at Barbican and China Re – the mergers generate cost synergies.
Where there are two managing agencies, one can be closed down. Two marine teams writing similar subscription books do not need to be retained. Operational staff are also duplicated.
These cutbacks – often of very expensive staff – can make a dent in the expense ratio.
But alongside this, there are two further important Lloyd’s merger benefits.
The first is capital synergies, with complementary books potentially unlocking substantial capital benefits for merged syndicates.
The second is a kind of escape card on growth. By merging two syndicates, management can ease top-line pressure, creating scope for an axe to be taken to the worst performing parts of each portfolio.
And there is still lots of remediation work needed to purge the ills of the soft market.
Following a rocky coming into line process for a number of syndicates, it is reasonable to assume that closures and mergers will continue through 2020.
As much as it is always sad to see individuals lose their jobs, the firms that are making roles redundant as they pass through integration processes are doing the right thing.
Because just as there needs to be fewer underwriting entities at Lloyd’s, there also needs to be fewer underwriters.
Headcount in the London market must fall if it is to address its cost problem. And fewer of the people who work for Lloyd’s businesses need to be located in prime EC3 real estate.
Figures from last week’s Lloyd’s presentation show pretty limited progress on expenses, with admin expenses actually projected to rise 20 bps year on year to 12.5 percent – albeit after an expected 110 bps improvement this year.
I think these mergers represent one answer to the fundamental question that Lloyd’s is grappling with in so much of its blueprint thinking.
That question is: how do you maximise the benefits and minimise the challenges of being both many and one?
There are many different ways into this question.
But among the crucial benefits of the manifold nature of the market are the capital spread that can be offered to clients, and among the key disadvantages are the duplication of cost – and associated complexity – of having many underwriting businesses appraise then write the same risk.
The Canopius-AmTrust deal – which saw AmTrust take a mid-teens stake in Canopius and Canopius take on direct management of the merged business – is one model for consolidating underwriting while maintaining a capital spread.
Whether through paper deals or simply in-market sales, M&A is one answer to a fragmented Lloyd’s structure which does not make sense
But M&A is not the only way to achieve this. The Lloyd’s modernisation plans create scope for other structures which achieve this outcome without shareholder changes.
New approaches to the way that subscription business is placed, with follow-only syndicates and turbo-charged consortia, open the door to a situation where underwriting work is concentrated in a smaller number of hands, but capital diversity is retained.
However the market gets there, it needs to find a way to drive to an outcome where regardless of how fractured the capital is on the front end, the number of entities underwriting on the front end must consolidate down.
