London Bridge 2 can be ‘silk road’ to more diverse capital: Lloyd’s CFO
The re/insurance industry must evolve opaque processes and the ‘black box’ of underwriting criteria to make itself more appealing to investors and secure more capital, Burkhard Keese (pictured), the chief financial officer of Lloyd’s, believes. London Bridge 2 represents his play to achieve this, describing the insurance-linked securities (ILS) vehicle as the “silk road between capital and underwriting”.
Keese told Intelligent Insurer that the industry has become complacent in its attitude to attracting new capital, taking it for granted. But the current market is proof that this is a mistake. He cites estimates that suggest a $100 billion shortfall in US reinsurance capacity.
“We need to communicate better with investors about what we do.” Burkhard Keese, Lloyd’sOne of the biggest challenges, he said, is the industry’s lack of transparency.
“We have always focused on the client, but we also need to consider the needs of investors,” he said. “Investors have certain expectations around returns, which we have not always delivered.
“But they also expect transparency and a proposition delivered in language they can understand—which they can use to make a case to their own investment committees, who know nothing about insurance.
“The missing $100 billion is an interesting scenario. No-one knows the exact figures on this. But if there were more capital available, there wouldn’t be an underwriting shortage on certain lines in the US. That is because the industry is not making itself attractive enough.
“We need to communicate better with investors about what we do and how we do it, if we are to change that.”
On the size of the potential capital shortfall, exact figures are elusive. Aon estimated that global reinsurer capital declined by 15 percent ($100 billion) to $575 billion as at the end of December 2022, driven by substantial unrealised losses on investment portfolios. While this picture has since changed and capital has undoubtedly increased again, Keese suggested a gap remains that is bigger than many believe or like to admit.
He notes another reason capital has not flowed back into the industry: that most investors have a limited allocation to alternative capital and related asset classes. One of the fallouts of the economic turbulence of recent years was that the value of their more traditional investments plummeted—making investors’ relative allocation to alternative classes higher proportionally—often above their agreed allocations.
Keese calls this phenomenon “a passive asset breach” but, significantly, it means their ability to commit more capital to alternative asset classes, including ILS, has been limited.
“It has made the inflow into alternative capital very tight—and we are competing with other asset classes such as private equity or infrastructure, which are a lot more transparent,” he said.
A new vehicle
London Bridge 2, the Lloyd’s ILS vehicle, is designed to solve many of these problems, and allow investors to participate in the Lloyd’s market more easily. Launched in August 2022, it was created to ease some of the limitations of London Bridge 1 by allowing more flexibility in contract language and facilitating more structures, including stop-loss treaties and the use of sidecars.
The two platforms have successfully attracted some $500 billion of capital to date but, Keese says, the pipeline is bullish to the tune of another $1 billion. He expects a number of firsts via London Bridge 2 including a first ILS deal, a stop-loss, and a first captive as well as some equity raises by syndicates.
“A correction is needed but this does not need to happen in a volatile way.”His overarching point is that the vehicles should allow capital to enter Lloyd’s more easily, giving the industry a much-needed greater diversity of capital and greater flexibility. He notes that some peers in the market boast as much as 40 to 50 percent institutional capital. Lloyd’s currently has 5 percent. “Our job is to grow the market, and there is no target or limit on that ambition,” he said.
“But it is important that we diversify our sources of capital; to do that, we need to understand what the capital markets and the underwriters want. ILS was first in play some 20 years ago. We are very late on this. But our aim now is to enable investors and the underwriting side to transact in the way that works for both. If that means we build London Bridge 3 one day, so be it. We are here to enable the process.”
Keese believes there is no reason Lloyd’s cannot achieve this. He makes the case for the market being one of the most capital-efficient vehicles in the world, on account of several factors.
One is that it accepts letters of credit as capital, another is that the level of risk capital syndicates must hold is lower than that of external competitors due to the market’s structure.
These things mean that the return on capital investors can expect should be very appealing. Even higher costs in some instances, which Keese partly attributes to the lengthy brokerage chain often in play, should be dwarfed by this potential. But, he reiterates, the industry must move to greater transparency and away from so-called black box underwriting.
Its case to investors will be better served as the market holds the line on higher rates in the aftermath of what has been a big correction for the market.
“We must and will keep our discipline,” he said. “The situation we ended up in back in 2015/16 was dangerous. We now have the toolkit to avoid a repeat of such a scenario and we will use it.”
Rate adequacy
Keese said that rates in property, for example, are now adequate. But that is after at least five years of losses. “That means they must stay higher for quite a while—we need to earn back the money the industry lost,” he said.
He flagged concerns over the adequacy of rates in casualty business, especially in the US. But he believes that a sharp correction characterised by volatility can be avoided by good communication. “The key is that we need to be talking,” he said. “A correction is needed but this does not need to happen in a volatile way. We simply need to say no to certain prices, to avoid a hard landing on this.”
He is taking a close interest in how the world deals with emerging risks, such as those associated with a societal transition to net zero carbon, as well as issues such as cyber risks. In some cases, he said, it should be appropriate for the industry to look at means of self-insurance and the use of captives to manage risks too big to be handled by the industry alone, and where an alignment of interests is preferable.
“There are certain risks, for example a cyber cat event, which are very dangerous and difficult to manage,” Keese said. “We don’t have the capital to deal with such a risk but having dedicated pools of capital, perhaps in a captive, is the way to manage this risk so that it is removed from the main balance sheet.
“The risks are so high, an alignment of interests is also needed,” he concluded. With Lloyd’s close to unveiling its first captive via London Bridge 2, watch this space.
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