Annual Report 2007

Amlin’s financial performance in 2007 was exceptional. We also made solid progress towards our goal of becoming the ìglobal reference point for qualityî in our markets. In particular, the progress made in our Enterprise Risk Management helped both Syndicate 2001 and Amlin Bermuda to receive financial security rating upgrades; our long term succession planning was strengthened through review and a detailed assessment of senior people which confirmed the strength of potential internal successors for key roles; and good performance was delivered in two key areas of client service, contract certainty and claims turnaround, each areas where Lloyd’s and the London market has been striving for improvement and where Amlin has been playing a leading role.

Both underwriting and investment markets are becoming more challenging. We nevertheless expect a further good year financially in 2008, and subject to catastrophe activity not being abnormally high, we should still be capable of delivering a return on equity above our average cross cycle target of 15%.

Financial results

We had high expectations for 2007 which were exceeded due to an exceptionally low level of claims incidence in a year where earned premiums recognised peak US catastrophe pricing and there were excellent investment returns. The record return on equity for 2007, of 37.8%, should be regarded as exceptional and unlikely to be repeated in the short term.

Gross premium written, at £1,044.7 million, was 6.2% lower than in 2006. Amlin Bermuda recorded 13.3% growth in its local currency gross premium. However the effect of a weaker US dollar, a 5% decline in renewal rates overall in 2007 and a reduction in exposure to classes where rates had become marginal more than offset this.

Profit before tax was a record £445.0 million, up 29.8% on 2006 with excellent underwriting performance across the Group. Our London operations increased their profit from underwriting by 20.1% to £238.8 million, while Amlin Bermuda’s contribution from underwriting was up 68.4% to £116.2 million, reflecting its second full year, benefiting from a healthy opening unearned premium reserve. Runoff profits from reserves were again material, totalling £109.0 million (2006: £68.9 million), and we consider our reserving strength carried forward to be just as strong as it was going into 2007.The contribution from investments increased 36.4% to £157.0 million.

Capital strategy

We have consistently articulated that our key performance metric, that which we consider is most relevant to the delivery of shareholder value, is return on equity. This means that we will actively manage our capital over the insurance cycle. We currently expect that conditions for our London market business will soften over the next two years and that with this, in line with our underwriting strategy, we will reduce exposures. We therefore believe that for our existing business, our capital requirements are likely to have peaked for the time being.

The Group’s success in generating significant levels of profit over recent years has resulted in very strong free cash flow and capital which is in excess of our requirements. Accordingly, in 2007 we started to deliver on our commitment to manage the balance sheet by paying £42.7 million in a special dividend and announcing a further £120.4 million return to shareholders by means of a B share issue which was completed in January this year.

In addition to the dividend and share buy-back referred to in the Chairman’s statement, we will continue to keep under review our capital needs with the intention of managing our capital to enhance returns on equity.

Underwriting strategy

In 2007 we continued to operate with significantly less retrocessional reinsurance than we had in 2005 and previously. The expected overall profitability of the business, given the strength of pricing in our Marine and Non-marine lines of business, meant that we were very likely to be able to cover our largest modelled catastrophe loss without impairing the balance sheet. As it turned out, our largest catastrophe event, the California bushfires, cost us only US$26 million and we again saved on outwards reinsurance relative to 2005.

In line with our focus on underwriting profit, we again flexed the business according to underwriting conditions. We were pleased to grow our reinsurance income where pricing remained attractive, however we continued to reduce exposures in our airline account, where we considered pricing to be inadequate, and for our UK Commercial account where pricing was also considered poor, we focused on retaining accounts which continued to offer reasonable margin potential.

With rates now softening in a number of our Marine and Non-marine lines, it will become more difficult to maintain the excellent balance we have had over the last two years between the downside from a major catastrophe and our expected profit. For 2008 our modelling indicates that our mean expected profit will cover each of our modelled US single zone catastrophe events. The largest of these is currently a US$119 billion Florida windstorm for which the modelled occurrence probability is approximately one in one hundred years. However, it may not cover either very significant multi zone events, such as a major windstorm affecting each of the UK, France, the Low countries and Germany, or a very major Japanese earthquake. As rates soften further, we will look to maintain an acceptable balance by purchasing more reinsurance, including retrocessional reinsurance, which we have started to do.

The increased divergence in cyclical patterns between our UK Commercial and Aviation accounts on the one hand, and our Marine and Non-marine lines on the other, which we have witnessed since the 2005 hurricane season, gives us cause for hope that by 2009 our UK Commercial classes will be experiencing better margins, helping to offset the expected loss of margin in our Marine and Non-marine divisions. With this prospect we aim to be in a position to grow our UK Commercial business and to expand in UK property insurance where to date we have had only a small account. This aim was behind our acquisition of Allied Cedar which was completed in July 2007. We are also investing in our UK marketing capability and exploring means of increasing our alignment with a number of UK brokers. We have expanded our underwriting team in Bermuda with the recruitment of two additional underwriters, doubling those with authority to commit lines. The business there now comprises of 22 people and, with the additional underwriters, Amlin Bermuda has been able to increase its marketing effort. With the AM Best rating upgrade to A which was achieved in October 2007 we are able to differentiate Amlin Bermuda from most of the other class of 2005 start ups.

We have continued to increase the granularity with which underwriting exposures can be analysed and monitored. As well as helping to ensure that we remain within our risk appetite, this helps the Group to use its balance sheet effectively. Good progress is also being made in reviewing and updating our technical pricing models. Amlin’s underwriting team has a track record of increasing its out-performance in tougher market conditions and, with all the progress achieved over the last 5 years, we are well placed to manage the next phase of this cycle successfully.

Distribution

A number of trends relevant to the distribution of our products gathered momentum in 2007. First, in the UK, companies such as Towergate have been seeking to aggregate increasing volumes of business by consolidating the UK broking sector, and major companies such as Axa and Groupama have been actively buying UK regional brokers. Second, affecting our global specialty products, regional insurance hubs, such as Singapore, have continued to gain strength which is likely to result in some business, which has historically been underwritten in London, ceasing to come here. Thirdly, we have seen increased convergence between capital markets and the traditional reinsurance markets as evidenced by continued growth in catastrophe bond issuance.

In the UK, the emergence of Towergate and other similar companies is unlikely to have a meaningful impact on flows of business to Amlin in the short term. Our increased focus on marketing and interest in increasing our alignment with UK brokers is intended to help address the threat that further consolidation could have in the longer term.

The growth of regional insurance hubs, such as Singapore, is happening in areas of the world where there is strong economic growth. In 2007 we opened an office in Singapore to give us access to the opportunities of a fast growing economy as well as protection from the risk that the local market will reduce flows of business to London. Lloyd’s have also applied for admitted reinsurance status in Brazil, recognising the growing strength of the Brazilian economy, and is exploring options for the establishment of a platform in the Middle East. We welcome these initiatives as an appropriately structured Lloyd’s platform provides an extremely efficient means of widening our access to specialist business where we can use our expertise.

We are following developments in the insurance linked securities market closely in the belief that there will be opportunities for Amlin to either use the capital markets to lay off risk or to use its expertise to package risk for others.

We continue to hone the service we provide to both clients and insureds, in particular through the use of more effective systems and software. Our investment in work-flow systems is paying off as the delivery of contract certainty at the time of placement has become an everyday reality, and with the use of electronic claims files we are reducing claims turnaround times. We have made a point of staying in close touch with our top 20 London market brokers so that we can work with them to enhance service to the end customer as well as provide means of eliminating unnecessary expense from the placement and claims settlement processes.

Risk management

Expertise and sound risk management processes are critical to the success of the Group. It is also becoming increasingly important to be able to demonstrate the assessment and quantification of risk to both rating agencies and regulators, and with the advent of Solvency II, a new risk based capital standard that is expected to become mandatory Europe wide in 2012, this will be crucial.

Having appointed a Chief Risk Officer in 2006, good progress was made in 2007 in reviewing and enhancing our internal definitions of risk and improving our dynamic financial analysis model which now provides us with the ability to examine potential economic performance of the business and to consider the range and probability of outcomes around a mean expected return. This helps us assess the amount of catastrophe risk which we are prepared to accept.

During 2008, as well as implementing a new risk management and reporting system, we aim to improve our articulation of risk to stakeholders. As shareholders become comfortable with this, it should help lower our cost of capital.

People

We believe there is a strong correlation between effective people practices and shareholder value. We aim for strong alignment between the Group’s vision and goals, and those of our employees, and between shareholders and employees. With the first award of shares under the Share Incentive Plan made in March 2007, 73% of employees now have an equity interest in Amlin.

Retention levels have remained within our annual target, although voluntary turnover has been closer to our target maxima than in recent years. Overall and senior underwriter voluntary turnover in 2007 was 14.4% and 8.3%, compared to target maxima of 15% and 10% respectively.

Two important pieces of work were completed in 2007 aimed at sustaining the long term success of the Group. First our values were rolled out across the Group with a healthy degree of positive employee engagement. These are now being embedded through incorporation into employee induction and appraisal processes and are aimed at promoting those aspects of the Group’s culture which have contributed to its success. Secondly, with the help of outside consultants, 39 senior / high potential employees participated in a detailed personal assessment which was designed to test both management and technical potential. This helped us improve our succession plans and confirmed to us that we have internal candidates with considerable strengths who should be able, with tailored development, to fill most senior executive posts in the Group. Relevant employees are embarking on personally tailored development plans during 2008.

We are grateful to our employees for what they and their hard work has achieved in 2007.

Outlook for 2008

The underwriting environment in 2008 is softening as expected but good margins remain for selective underwriters. Rates remain adequate across our reinsurance, property and marine classes, with prices coming off historic peaks through 2007. The UK commercial market has been under strong competitive pressure for a number of years now. It is possible that later in 2008 we will witness improved trading conditions here, and if this occurs, it will help sustain good returns for longer.

With our stable team of high quality underwriters, who have a strong track record of out-performance in softer market conditions, and a significantly improved risk management capability since the last soft market, we are confident in our ability to trade successfully through more challenging times when they come. Our underwriting philosophy means that we will reduce exposures and be prepared to forego premium income if margins become unacceptable. If this happens, we will focus on retaining good margin business where we can, and we will continue to actively manage our balance sheet with a focus on delivering shareholder returns.

The investment markets remain very volatile with continuing concerns over the extent of damage that sub-prime lending will impart to the balance sheets of financial services companies. While we have limited exposure to sub-prime loans, and believe that most of the exposures we do have remain among the best credit quality, we are cautious about the outlook for returns this year. We have therefore adopted a conservative stance by reducing equities to 8.8% of our investments and have protected 25% of these against a diminution of year end value of more than 4.6%. We are also holding 28.8% of investments in short term liquid funds. However, there will come a point at which the upside for equities will outweigh the downside and we will be prepared, at that point to increase our equity exposure, especially given the lower return expectations that exist for bonds.

With this approach we expect to deliver acceptable returns on equity for the next few years although not at the levels seen in the last two. For 2008, we expect, subject to the level of catastrophe activity not being abnormally high, to deliver a return on equity of at least our 15% average cross cycle target.

Charles Philipps
Chief Executive

 Print

© Copyright Amlin 2007