The Lloyd's chief executive defined a leaner and more cautious underwriting climate, but warned of inefficiencies. Elliot Lane and Jason Woolfe report

Lloyd's chief executive Nick Prettejohn walked to the podium at the CII conference last week and gave a defining speech. Whether it was a career-defining speech, history will tell. But its fundamental premise that an "effort of will" is needed from the market to accept some harsh realities was backed by statistics, and not the usual tertiary rhetoric.

CII president Andy Homer had joked that Prettejohn's first class honours degree in philosophy, politics and economics (PPE) from Balliol College Oxford "made him the perfect candidate for a job at Lloyd's".

All three disciplines were applied to effect in Prettejohn's speech, which tackled the fundamental philosophy of Lloyd's business, against the backdrop of the political will to challenge the economic consequences.

It was summed up in this point. It was "extremely heartening", he said, that Lloyd's businesses had walked away from business. Those sentiments should be applauded and echoed loudly across the whole insurance and reinsurance market place. This was in the best interest of everyone - policyholders and investors, he said.

This, he said, was because underwriters needed to make a profit. "While rock bottom rates may sound attractive to policyholders in the short term, in the long term they are the road to nowhere."

The upshot is that the landscape at Lloyd's over the next 12 months will be dramatically different. Smaller syndicates are predicted, and desired. The franchise board has its watchlist - and those in the glare of franchise performance director Rolf Tolle can be found in this year's S&P assessment published this week (see page 10).

Inevitably, the bumper £14.4bn capacity figure the market has coveted will soon fade. Lloyd's executive board is split on the future of qualifying quota share (QQS) as a viable source of future capacity. It is great for the hard market but what happens when the market softens? A more realistic capacity figure for 2004-2005 could be £12bn without the added pressure of managing agents and syndicates writing classes of unprofitable business.

Prettejohn told journalists last week: "I don't think the effective capacity of the market, which includes traditional capacity and QQS, will change greatly year on year.

"I would not be disappointed if capacity were the same next year as it is this year. "

But he added the caveat: "At this time."

Lloyd's is preparing to introduce a new underwriting advisory committee which would provide a view on the state of the underwriting cycle.

Lloyd's continual arbitration battle with Swiss Re over the reinsurance agreement surrounding the Central Fund is another pressure on the franchisor. Prettejohn is seeking new options which could involve other reinsurers, alternative offshore funding and/or banks.

The aggregate balance sheet of the market had strengthened hugely over the course of the past 18 months to two years. The extra profitability generated this year through strong trading conditions meant that individual businesses were in a much stronger position to withstand catastrophic loss than they were two years ago, he said.

And on the subject of buying reinsurance for the Central Fund, he said: "We've not ruled out the possibility of purchasing some additional protection for the Central Fund so I would not assume automatically that we won't, but it's a finely balanced argument."

The decision (on whether or not to buy) would be taken in the next few months, he said. The dispute with Swiss Re would make Lloyd's "cautious" about buying reinsurance, he admitted.

Prettejohn added that it was "entirely natural and usual" for some Lloyd's managing agencies to go "right to the wire" on their capital raising exercises up to the November deadline.

Costs and the inefficiency of the Lloyd's and London Market are still dragging the marketplace down.

"It's a sobering statistic that the Lloyd's market spends in excess of £500m a year on lawyers as part of the claims process. This figure understates the full cost, for instance, by not including the cost of E&O claims," he said.

He cited the latest figures, taken on a global basis, from Bain & Co that the savings from process change in the insurance industry could equate to a prize of $39bn.

Prettejohn's theme was what the industry can learn from the lessons of history. He quoted the economist Thomas Malthus who described his chosen profession as the "dismal science".

"The same epithet might be applied to the study of our industry's history. High cyclicality, lack of underwriting profit and hence undue reliance on investment return, inadequate returns on capital, increasing risk, uncertain risk, a tendency irrational and unprofitable growth often fuelled by excessive use of reinsurance, vulnerability to management failure, and seeming inability and/or reluctance to deal with manifest inefficiency."

So said Prettejohn. A long list which encapsulates the Lloyd's market since its inception. Strong words.

Time the market listened.