Lloyd’s of London Chief Financial Officer (CFO) Burkhard Keese has explained that the primary motivation behind the £650 million reinsurance cover that Lloyd’s has purchased for its Central Fund is to facilitate the rapid pace of growth that the market has achieved recently, and is continuing to target.
In a press briefing this morning, the Lloyd’s executive explained that in order for the market to grow, the size of the Central Fund needs to grow in parallel with the size of the Funds at Lloyd’s.
However, growing the Central Fund is quite expensive to the members, as they need to pay tax on contributions and Lloyd’s itself needs to pay income tax.
So by putting this reinsurance structure in place, Lloyd’s will be able to grow more efficiently, Keese says, and at a cost that is almost three times cheaper than by having to increase the funds in the Central Fund or Funds at Lloyd’s.
“By reducing the risk for the Central Fund with this cover, we give the market a lot of leeway,” he told members of the press. “Now, if it’s profitable, they can grow without being stopped by having to put much more money into the Central Fund.”
The Central Fund cover has been designed to protect Lloyd’s and its members against major industry loss events, such as another global pandemic or future global financial crisis, and provides aggregate reinsurance protection from an attachment point of £600 million, up to £1.25 billion.
It’s thought that Lloyd’s could write 30% to 40% more in overall premiums thanks to the coverage, which has a five-year term and is effective from January 2021.
“We grew last year by nearly 10% in terms of exposure and price,” Keese said in regard to the new coverage. “And we are planning to do so again this next year and the year after. With this very strong growth, which was driven by good rates in the market, the Central Fund would have become relatively smaller and weaker, compared to the size of the business.”
“The Central Fund couldn’t have grown that much, because we only collect 36 basis points of the revenues of each member. So if you grow 10% it takes quite a long time until you have reached the old strengths again. And of course, the very low interest rate environment produces very low investment returns. And that’s the reason why we decided to use that cover, because then we can allow the market to grow without weakening the Central Fund.”
The first £450 million of the Lloyd’s Central Fund cover is fully collateralised and has been provided using a newly established cell company and financed by investment bank JP Morgan.
The remaining £200 million is backed by eight major global re/insurers, of which Berkshire Hathaway and Munich Re are rumoured to have the largest participation.
Steve Jule, Chief Accountant at Lloyd’s, confirmed that the reinsurance layers do have reinstatements, which will allow Lloyd’s to replenish the cover if it is fully-eroded.
He added that the cover is also expected to provide “a significant impact in terms of capital efficiency,” as well as “material benefits in terms of solvency cover.”
Keese further remarked that the implementation of the cover shows that the financial services industry “has regained its trust in Lloyd’s,” and in particular its ability “to reshape our future and return to profitability.”
“It comes at a nice time and gives clearly the right signal, that the financial services industry believes in us and trusts our business model,” he said.”
“We won’t ask for as much growth funding from the members as we did before,” Keese stipulated, “but there will be always some growth funding we require so that we maintain this super strong balance sheet position and solvency position.”
The Central Fund at Lloyd’s is a roughly £3 billion backstop funded by its underwriting members, protecting the market in times of stress.