Prettejohn Stresses Underwriting Discipline, Reforms in Keynote Speech to ACORD Forum

October 21, 2005

Lloyd’s CEO Nick Prettejohn, in what may be his last major address as Lloyd’s CEO (See IJ Web site Oct. 17 and 18), told those assembled for the ACORD Forum in London that underwriting discipline continues to be essential if the London market in general and Lloyd’s in particular are to maintain their current leading position in the world of insurance.

“The London market is the most significant single concentration of insurance talent in the world. It is the single place where insurance talent – underwriting, broking, advisory talent – meets capital in sufficient quantities that you can meaningfully call the result ‘a market’. It is also the only genuine subscription market worthy of the name,” Prettejohn noted.

He then warned against complacency and the necessity to make a profitable return on capital investment. “It simply isn’t possible to make an adequate return if you don’t make an underwriting profit – the arithmetic doesn’t work,” he stated. “To exceed the cost of capital, you have to make an underwriting profit – otherwise you are destroying capital, which is what the industry has been doing for the last quarter of a century (by, in the US, an average of over 6 percent per year) until good old 2004.”

He then noted that the 2004 hurricanes and this year’s storms present challenges for the industry, which cannot be met simply by calling them “exceptional events.”

“The best businesses in Lloyd’s have an honourable track record in meeting the underwriting challenge, but they are some of the relatively few exceptions in our industry,” Prettejohn continued. “So what can we do about it?
My list of actions and issues includes:
1) Stop talking about the cycle, start doing something to avoid it.
2) Resist the temptation to grow, even when the capital markets are looking for that growth story. And persuade the capital markets not to back start ups.
3) Question models (not – I hasten to add – a reference to Kate Moss). They are extremely valuable aids to decision making but not decision makers.
4) Realise that profit can turn into loss with startling speed, given small movements in pricing, costs and terms and conditions.
5) Discover and deal with unprofitable business quickly which means understanding claims data fast.
6) Make return on capital the key performance measure.
7) Ensure that you have strong underwriters and strong managers, and that the information flow between them is open, fast and granular: transaction level understanding feeding into portfolio management.

As I said earlier, I don’t want to labour the point about the need for underwriting profit, even though I could be accused of being clinically obsessed with it.”

He pointed out the link that exists between “underwriting excellence and process reform,” which is a major focus of the ACORD Forum. “Only by the adoption of data standards will we reliably get good quality, timely data being shared by trading partners,” he noted. “So, the London Market needs underwriting excellence. Without it, we are nothing. We would cease to be a magnet for underwriting talent, but worse, cease to be a magnet for broking talent and therefore the policyholder.”

“I have said before, and say again: The world needs our expertise, but it doesn’t need our cost base or our complexity,” Prettejohn stressed. “And if we don’t address them, the world will channel its risks elsewhere. That does not mean getting rid of the London broker or the subscription market,” he continued. “What it means is changing or removing the unsatisfactory aspects of the way we do business. And, if necessary, it means organising ourselves to perform tasks that have been done in one way, in a completely different way if necessary. If brokers are seeking to jettison activities, then underwriters will and should pick them up. Preferably achieving cost savings and higher levels of performance as they do so. Only then will we be able to preserve the London and Lloyd’s market remotely as we know it.”

Later in his remarks Prettejohn said that in addition to the “commercial imperative, we can now add the spice of regulatory interest. Following the interventions of Spitzer and Tiner [Head of the U.K.’s Financial Services Authority, which regulates the insurance industry], who can possibly doubt that we need a transparent, auditable and structured record of the process of a transaction or that we must have a proper and prompt record of an insurance contract?”

He followed that discussion, along with remarks on the necessity to disclose compensation and make it more transparent, with an examination of contract certainty, beginning with the work, done by Lloyd’s and the IUA on the LMP slip (London Market Principles), calling it the “foundation of the market’s drive to contract certainty: a critical issue for both commercial and regulatory reasons.”

“There are two fundamental points on contract certainty worth making right away, Prettejohn noted: “The first is, there is no such thing as contract certainty. Contracts don’t offer absolute certainty as any lawyer will tell you – perhaps even for free. But they offer more certainty in their existence than in their absence, and they form the basis for discussion, interpretation and dispute if necessary. The second is, the starting point for contract certainty is agreement of terms rather than delivery of documentation.”

Prettejohn’s vision of the future London market, which he indicated was a personal view, requires “changed behaviour. Behaviour that can be measured, and therefore standards and performance levels that can be enforced if necessary. The health of the brand – the Lloyd’s brand, and indeed the London brand – never mind the regulatory integrity of our market, depends on that change in behaviour being achieved.

“Then, and only then, can technology have its powerful impact. Because having worked out what behaviour we need, we can then seek to capture and enshrine the benefits of that behaviour in a four step programme:
One – simplified, harmonised business processes involving the multiple exchange of
Two – standardised data through
Three – structured electronic messages organised typically by
Four – community platforms which minimise interfacing costs and enforce discipline.”

In closing Prettejohn reiterated that the “the subscription market is a hugely valuable mechanism that delivers real benefits to policyholders, brokers and underwriters. It only really exists in London. But it can only continue to deliver those real benefits if the sharing of information is as natural as the sharing of risk.

“Data exchange is fundamental to the underwriting and broking process. But that exchange can only work truly effectively if the underlying language is shared. There is so much that differentiates London from the rest of the industry, we cannot afford the complication of a different language or languages either within London, or between London and elsewhere.

“That is why ACORD standards are such a vital continuing thread in what we are doing. Change behaviour, share a language. That way the London Market has a genuinely exciting future as the magnet for talent and business. Underwriting excellence, supported by process excellence. Then the power of the subscription market will be truly felt and felt for an enduring future.”

The full text of Nick Prettejohn’s speech can be obtained on the Lloyd’s Web site at: http://www.lloyds.com.