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| Active and flexible capital management has enhanced Amlin's shareholder return over recent years. Management of the balance sheet has focused on the amount of capital required, the level of debt capital employed, improved cash and investment management and the quality
of assets held. |
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Richard Hextall
Finance Director |
Another important component is the management of the insurance liability base. Due to the inherent uncertainty in our business there is a high degree of subjectivity surrounding the level of liabilities that are recorded. A consistent and robust reserving policy is critical to management of the Group's balance sheet.
Amount of capital deployed - the framework
Historically, Amlin's capital has been set using the Lloyd's risk based capital (RBC) framework.
This used market wide data to assess the capital needs by line of business, with credit given for greater diversity of underwriting across classes of business. The framework used average market data and applied the RBC ratios indiscriminately across all Lloyd's businesses. No recognition was given to historic outperformance of the market or better risk management. With a performance that has been consistently better than the average for the market, we believe that Amlin has been required to hold more capital than would otherwise have been the case.
During 2005, the introduction of a new capital regime and the start-up of Amlin Bermuda has changed our capital setting framework.
In the UK, the FSA took over regulation of Lloyd's in 2001 and has been pushing for consistency in the treatment of non-life insurance businesses. One consequence of this is that each regulated business is now expected to complete an Individual Capital Assessment (ICA) of the level of capital required to contain the risk of insolvency in any year to no greater than a probability of 0.5% - this is equivalent to a BBB insurance financial strength rating level. The Corporation of Lloyd's is responsible for managing the Society's overall solvency due to the mutuality at the centre of the Lloyd's chain of security. Amlin is therefore required to submit its ICA to Lloyd's.
| Capital deployed |
| At 31 Dec |
**2001
£m |
**2002
£m |
**2003
£m |
*2004
£m |
*2005
£m |
 |
| Equity shareholders' funds |
134.5 |
303.4 |
380.5 |
459.8 |
792.6 |
| Debt capital employed |
11.5 |
10.9 |
10.3 |
58.6 |
298.3 |
| Letters of credit |
129.6 |
150.7 |
180.3 |
130.0 |
150.0 |
|
| |
275.6 |
465.0 |
571.1 |
648.4 |
1,240.9 |
|
| (*/** see Financial Highlights for basis of preparation)
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Once Lloyd's is satisfied that all syndicates' capital requirements have been assessed to an equivalent risk based level, an uplift of 35% is applied to the ICA figure to raise the capital to a level which will support Lloyd's higher financial strength rating.
Lloyd's have used the old RBC system as a benchmark and, as a transitional measure, have limited the ICA driven capital ratio to a corridor of +/- 15% of the central RBC ratio. Thus far, Lloyd's has also continued to apply a minimum RBC ratio of 40% of capacity.
Amount of capital deployed - measurement
As set out in last year's annual report, Amlin has invested a considerable amount of resource into developing a dynamic financial analysis (DFA) model for the purpose of assessing the capital required for ICA purposes and to monitor better the total amount of economic capital required for the business. Essentially the DFA model predicts a range of possible outcomes for each class of business written by the Group based on historic and expected variability in claims. Thousands of simulations are run through the model to provide a range of likely possible outcomes.
The modelled outcomes are highly dependent on the assessment of profit margins in the business, assumptions about variability of returns and correlations of different classes of business. Similarly
the investment risk of the business is modelled using historic asset class volatility data. Finally a subjective assessment of operational risk capital is made - so all in all a highly complex process.
Our ICA for Syndicate 2001 indicates that our capital requirement should be well below the minimum 40% allowed by Lloyd's but the syndicate has had to adopt the minimum ratio. We have also used our DFA model to help assess a prudent level of capital for Amlin Bermuda. Its output proved very helpful in our discussions with rating agencies as it demonstrated that, in the short term, we are carrying capital above the level required for our assigned ratings. The actual level of capital is driven by commercial reasons - that is to be a serious business operating in the reinsurance market, for which our soundings indicated that a minimum of US$1 billion would be required to trade with our desired client base.
Capital planning and distribution policy
As the cycle turns and margins begin to erode in the future we would still expect to reduce our underwriting in line with our underwriting strategy. This should lead to surplus capital growing in the business. Subject to maintaining an adequate level of financial strength rating from the rating agencies which is required by clients and brokers, we still intend to use capital management as a tool for enhancing long term returns on equity.
However, we are again currently fully utilising the capital of the business to underwrite. Our dividend policy for 2004, 2005 and 2006, as previously announced, is to pay dividends which are the higher of 8p adjusted for inflation from 2004, or 30% of the current year earnings.
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