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OPERATING AND FINANCIAL REVIEW / THE COMPANY / DELIVERING VALUE /
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| CHANGES TO THE DISTRIBUTION REGIME |
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Currently Lloyd’s operates a three year
distribution system and a restrictive capital
regime. Consequently, Amlin, to date, has not
had free funds available from the successful
underwriting years from 2002 onwards.
However, the 2002 profits are released from
trust funds in June 2005 and 2003 profits are
released in June 2006. The chart illustrates
the amount of cash which we anticipate will
be released into Amlin free funds over the next
few years, based on our current syndicate year
of account forecasts.
From 1 January 2005, Lloyd’s has moved the
syndicate accounting requirements onto an
annual accounted basis. As a consequence,
cash distribution from the syndicate will also
switch to that basis. This means cash
distribution should accelerate as illustrated
below when compared with the previous chart.
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| CHANGES TO THE CAPITAL REGIME |
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Positively, the Lloyd’s capital framework is
also about to change. The FSA took over
regulation of Lloyd’s in December 2001
and, as a policy, has been pushing for greater
consistency in the regulation of all non-life
insurance underwriters in the UK, including
Lloyd’s. Three important changes are being
made to the regulatory capital framework.
First, annual accounted profits will be allowable
as solvency capital and will be available to
support underwriting from 1 January 2006.
Given the scale of the disallowance for Amlin
this is a welcome change for the Group.
Cumulative financing costs would have been
reduced by £6 million over the last three years
if this regime had operated throughout.
Second, each regulated firm is expected to
complete an Individual Capital Assessment
(“ICA”). Essentially this means that we will
have to assess and maintain a level of capital
so that the risk of insolvency in any year is no
greater than a probability of 0.5%. In the past
our capital has been set using the Lloyd’s risk
based capital framework, which uses market
wide data to assess capital needs. Given that
our performance has been consistently better
than the market we would expect that over
time, as Lloyd’s moves towards accepting ICA
submissions rather than its risk based capital
figure, our relative capital requirement will fall.
Third, the type of capital that can be utilised is
now more closely defined. Equity capital
is admissible and is unlimited. For the time
being this also applies to LOCs. Other debt
capital will be restricted. For example
unsecured, subordinated term debt will
be restricted to 25% of the total capital
employed and the terms of the debt are
very closely defined by the FSA.
With this Lloyd’s is changing its capital release
tests. Under current rules, as capacity at
Lloyd’s is reduced, there is a delay in the
release of capital. This is changing from
June 2005 with capital requirements simply
matching the risk based capital assessed. We
expect that this will lead to a further release
of £50 million into free funds in 2005.
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| PREPARING FOR THE NEW CAPITAL REGIME |
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A considerable amount of effort has been made
at Amlin to develop our ICA model and we
submitted our assessment to Lloyd’s in the first
tranche of agents in October 2004.
Amlin issued US$50 million of FSA compliant
subordinated debt in November 2004. This is
callable by Amlin after ten years. In addition to
enhancing our ability to meet the new capital
tests, this long term debt issue increases
Amlin’s available capital to be deployed for
underwriting purposes, particularly in periods of
growth, at lower cost than the subordinated
LOCs that it replaced.
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| CAPITAL PLANNING |
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As capacity reduces in line with our underwriting
strategy, we expect that surplus capital will
grow within the business. Our financial focus
remains on meeting our long term return on
equity targets. Given this aim, we intend to
carefully assess the need to retain this capital
in the business.
It is important for long term value creation that
we plan the level of capital required to support
the business as we enter the next upswing, and
the potential source of this capital. We will also
need to assess the level of capital required to
meet our strategic goal of setting up a non-Lloyd’s operation.
However, this should still
leave room for good dividends over this next
phase of the cycle.
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