Review
Financial management
Adjusting the type of capital deployed
The second key stage in effective balance sheet management is determining the mix of debt and equity required to meet medium and long term business needs. Our approach to financial leverage is clear. When underwriting margins are strong, debt capital will form a greater proportion of the overall capital deployed. When margins reduce, the level of debt capital deployed to support our underwriting will be reduced.
The approach is driven by the amount of underwriting risk to which we believe the balance sheet is exposed. If margins increase we will want to expand our business, particularly in attritional classes. In such circumstances, while the level of underwriting risk increases, the expected underwriting margin grows too and the income statement is better placed to absorb volatility from catastrophic events. The risk of financial loss is lower and we would use debt to fund the business expansion.
In line with this philosophy, in recent years, our debt to total capital ratio has fluctuated. For example, in 2005 debt increased in order to allow us to open Amlin Bermuda and increase our catastrophe underwriting risk. Margins were very strong and we believed that funding growth through debt was appropriate. During 2006 and 2007 the debt ratio reduced as profits increased net assets. At the end of 2008 the net debt to total capital ratio stands at nil (2007: nil). With stronger (re)insurance markets anticipated in 2009 and beyond, we will once more consider the use of debt capital, where appropriate, to support growth in our business.
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We use subordinated debt as part of our capital management strategy. The subordinated debt is regulatory compliant, longer term, unsecured and contains no financial covenants that could lead to early forced repayment. Additionally, the debt is recognised as capital by a number of the ratings agencies.
We have also recently renegotiated existing banking facilities which provides further flexibility. On 3 September 2008 Amlin plc entered into an amended five year debt facility with its banks. The new facility provides an unsecured £250 million multicurrency revolving credit facility available by way of cash advances or letter of credit (LOC). At the same time, Amlin Bermuda cancelled its existing unsecured revolving credit facility for US$100 million.
The completion of the Group’s first special purpose syndicate (SPS), Syndicate 6106, announced in December 2008, is another example of how we adjust the type of capital that supports the business in line with market development. The SPS was established to write a 15% quota share contract of the excess of loss reinsurance account of Syndicate 2001. The transaction provides external members capital to support 2009 underwriting, enabling Syndicate 2001 to take advantage of strong opportunities in peak zones in the US, Japan and Europe, despite the risk appetite constraints of the Group.
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