Natural selection

Lloyd's director of worldwide markets Julian James recently told an audience of insurers and brokers that the insurance market was at its most attractive for a decade. Market capacity had risen to a new mid-year high of £12.5bn and additional capital raising could boost basic capacity as high as £12.9bn by the end of the year.

James says: "As stock markets around the world take a beating, insurance premiums are rising and are expected to provide positive returns for several years to come."

Chaucer managing director Ewan Gilmour also comments: "Everyone wants to write business. Rates are very good. It would be criminal to leave money fallow."

Yet as insurers congratulate themselves on the amount of money they are going to be making and ponder over which sports car to buy, businesses are folding because they cannot obtain compulsory insurance cover - and brokers are tearing their hair out because they cannot find carriers for their clients' risks.

If you are a high-risk contractor, it may seem that there is a better chance of winning the lottery than obtaining employers' liability cover.

Each year there is talk of lack of capacity, but this year the problem seems to be much worse. Is there really a capacity crisis, or are insurers just exploiting it to help them justify rate increases and fat profits?

Everyone knows there has been a large amount of money coming into the Lloyd's Market since the events of 11 September.

Of the 12 managing agencies listed on the stock exchange, such as Amlin and Chaucer, 11 have raised substantial sums through share issues. And money has also been coming in from a broad range of corporate investors.

Gilmour says that most syndicates will have sufficient capacity: "The managing agencies which have raised money through share issues should not have an issue with capacity. Neither should those with rich parents, such as Faraday and XL. One or two have yet to raise money, but most will be OK."

Gilmour also points to qualifying quota share arrangements (a form of reinsurance), which have been used to expand capacity.

According to a Lloyd's spokesman, this new capacity is going to a variety of different syndicates.

The capital is going to "the hardest and most profitable markets, such as US property and catastrophe. But there is investment across the whole market".

Nevertheless, behind this optimism and bullish language, there are some markets in which capacity is still an issue.

Atrium active underwriter Christine Dandridge says: "In some sub-classes that are very mature there is a lack of capacity. For example, in the case of facultative North American property, there are problems with reinsurance and terrorism cover.

"Since 11 September there is no capacity in marine and aviation markets, and volatile sub-sets with spiky performance. New capital providers don't want to get involved in volatile markets."

A major area of concern for brokers and their clients has been the availability of cover for liability risks, particularly employers' liability.

But, according to Andrew Holman of Holman Insurance Brokers: "Liability capacity is not running out, although it was one-and-a-half to two months ago. Underwriters are simply being more choosey".

Syndicates have arranged qualifying quota share reinsurance to extend their capacity to write liability risks, says Holman. Nevertheless, the market has still shrunk and the fact that more business is coming in means there is difficulty accommodating all risks.

Market shrinkage
"There are still some classes that are uninsurable, for example high-risk liability businesses such as scaffolders and roofers," he adds.

Holman's comments highlight two important areas lying at the heart of the capacity question. The first is market shrinkage: the enormous losses suffered by Lloyd's as a result of the events of 11 September have caused a contraction in the market. Coupled with this is the increased demand for insurance, which has resulted in capacity problems and a general hardening of rates.

A spokesman for broker Jardine Lloyd Thompson says: "There is capacity available for most risks, if you are prepared to pay the price. But there is a gulf between what businesses are prepared to pay and what the market is asking for."

Second, and arguably more important, there has been a change in attitude to risk and underwriting. Greater returns on capital are being demanded as profits from investment earnings tumble in tandem with the declining stock markets. As a result, the market has become more risk averse, writing only the better risks.

Lack of reinsurance coverage has also forced underwriters to be more careful.

Ascot active underwriter Martin Reith says:"There has been a shrinkage in the reinsurance market. Reinsurers are reducing their aggregate lines and becoming more selective on business."

Not surprisingly, underwriters do not accept that they are exploiting the market and making excessive profits.

Reith argues: "It is a bold statement very early on. The market needs to make a profit after three to four years of massive underperformance."

Nevertheless, it is perhaps not surprising that other markets, such as Bermuda, are becoming attractive to brokers who have become frustrated by high premiums and extreme risk aversion.

Thompson Heath & Bond chief operating officer Frank Murphy says, "the majority of the additional new capacity available worldwide has come from new Bermudian vehicles which have made themselves particularly friendly to local and London brokers".

And Goshawk chairman David Hooker says: "There are a number of indicators that Bermuda is becoming a marker in its own right, whereas historically it was fed business from US and Lloyd's.

"Its development is very interesting. Brokers will begin to focus on it."

Can there be too much capacity?
The answer is yes, if you are a Lloyd's underwriter. "Lloyd's doesn't need as much capital as it thinks. There is a delicate balance between supply and demand," says Atrium active underwriter Christine Dandridge.

The reason is basic economics: if there is too much capital coming in, so that capacity exceeds demands then premiums will tend to fall. And that's the last thing underwriters want. It would spoil their chances of taking that third expensive foreign holiday.

Lloyd's director of worldwide markets Julian James said as much in his speech at the Western Surplus Lines conference in Canada. He said: "... it is not our intention to allow Lloyd's to be flooded with so much capital that a soft market is created."

Raising the cash
In the past year managing agents have become heavily involved in capital raising programmes to take advantage of the hard market. Qualifying quote share reinsurance arrangements have also been used to boost capacity.