Performance
Outlook for 2008
Managing the next down cycle
A number of factors lead us to believe that both the market and Amlin are better placed to manage the next down cycle than in the period 1997-2000.
Positive developments since last down cycle
Market
There is an increased divergence in cyclical position between classes.
Rating agencies are scrutinising the industry more closely.
Lloyd’s Franchise Performance regime should ensure the Lloyd’s market as a whole is more disciplined.
The risk based capital regime in the UK will penalise underwriters writing for income and not margin.
Amlin
We have applied a consistent and well understood underwriting philosophy since our reorganisation in 2000. Previously, there were several philosophies and some underwriters had grown their portfolios into a softening market.
Our underwriting team is stable and has gained more experience than it had in the last soft market. We have proportionately larger catastrophe exposures following the start up of Amlin Bermuda.
We have largely exited from poorly performing classes, such as private motor.
Amlin’s financial strength ratings are positively differentiated, strengthening our marketing capability.
We have significantly enhanced the quality, timeliness and availability of management information and have developed a stronger risk management function. This, should enable Amlin to manage the business better and spot issues earlier.
Our capital management strategy is aligned to the cycle and intended to optimise return on equity.
We are well reserved.
We have strong investment gearing, providing greater flexibility to our financial management.
Business development
Amlin Bermuda made a significant contribution to profit in 2007 in its second year of trading. Whilst written premium levels were below the level anticipated, overall profitability was strong. The diversity of the book is good.
The business is well placed for some further growth in 2008. During the year, two additional underwriters were hired who will help broaden Amlin Bermuda’s marketing capability. Additionally, in October Amlin Bermuda was upgraded from A- to A by AM Best and our expectation is that this will contribute to generating greater premium income through higher shares of clients’ programmes.
We will consider acquisitions where strategically they will help build the diversity of the portfolio so that we can maintain a good balance of risk. In July we purchased the Allied Cedar Group in the UK, which whilst modest, will provide us with greater access to the UK property market, an area where we are keen to grow when conditions improve. In November, we opened Amlin Singapore to develop access to regional Asian business which typically is not seen in the London market. We anticipate building this business through 2008 and hope that in time it will make an important contribution to the Group.
Healthy unearned premium reserves
At 31 December 2007, net unearned premium reserves totalled £474.3 million. While 6.6% less than in the prior year (2006: £507.8 million) they contain a significant proportion of reinsurance and other income which was written at strong rates. This provides a sound base for 2008 earnings.
Continued prudently reserved balance sheet
Our policy of reserving above the level of actuarial best estimate has resulted in material run off profits from reserves in recent years. Assuming claims development which is no worse than normal expectations, this policy should deliver further run-off profits in 2008.
Catastrophe risks
The greatest risk to our performance in 2008 is a year with major catastrophe activity. With the purchase of more reinsurance cover in 2008, the Group’s potential for major event losses has been reduced.
Our largest modelled event at 1 January 2008, being a European windstorm affecting both the UK and several continental countries, was a potential aggregate claim of £316 million, equivalent to 32% of net tangible assets at 31 December 2007. This compares with our largest modelled loss at 1 January 2007 of £364 million for the same scenario, which represented 42% of net tangible assets at 31 December 2006. It should be recognised that these are extreme events. All single zone events which we model are expected to incur losses materially less than these, in the most cases below £240 million.
Investment outlook
Markets continue to be volatile, reflecting the uncertainty created by events in the United States. As always we will monitor markets closely and adjust asset allocations to reflect potential returns and perceived risk.
January 2008 has proven to be a difficult month for investment markets with sharp falls in equity markets and further price falls for credit related bonds. The diversity of our asset allocation again proved helpful with the losses on equity and credit offset by good returns on government bonds and interest earned on cash. With the gain in value of the equity option, overall January 2008’s returns were 0.4%.
Expenses
In line with the general market softening over the next twelve months we expect to see a reduction in our variable expense base.
Business acquisition costs are expected to fall in proportion to gross premium. If profit levels reduce, staff incentive payments will also reduce.
Summary
With an average level of catastrophe activity we are targeting a return on equity in excess of 15% for 2008, which is still ahead of our cross cycle target of 15%.
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