Update: Lloyd's Enjoys First-Half Boost, But Warns That Positives Can Turn Negative in the Second Half

Capital is the watchword for Lloyd's as the market shows strength in its capacity-building while enjoying some benefit from trends in investments and exchange rates.

But the market sees potential trouble in some of the trends that produced positive results over the first half of the year.

Lloyd's managed to boost its first-half pretax profit 39% to 1.32 billion pounds (1.42 billion euros) as premiums and return on assets also rose from the previous year. The strengthening of the U.S. dollar was largely responsible for a 34.8% boost in gross premiums, which rose 9% in constant dollar terms.

According to Lloyd's, rate increases in casualty lines and new business brought in by both new and existing syndicates also contributed to the rise in premiums.

But the market also saw a slight decline in underwriting profit?down 3%. The combined ratio showed a small uptick this year, due?ironically?to exchange rate movements that affected the accounting treatment of non-monetary items.

Lloyd's reported a rise in claims frequency in certain casualty lines related to the global recession. Luckily, this has been offset by a calm period for catastrophe losses, with a bump in aviation losses the exception.

The first half was strong, but Lloyd's management is worried that recession-related casualty losses are "almost certain to accelerate," and the Atlantic hurricane season has a ways to go. Another "significant threat": a swine flu pandemic.

As with exchange rate movements, catastrophe loss levels are a double-edge sword for the market. Lloyd's sees "patchy improvement" in rates over the first half of the year, with "slow" price changes and pricing in casualty lines remaining "challenging."

Given that insured values "remain depressed" thanks to the recession, "absent a major catastrophic event or sharp deterioration in loss ratio, the pressure on rates and underwriting earnings will intensify," according to the Lloyd's first-half report.

Regarding investments, Lloyd's achieved a 1.6% return in the first half, compared with 0.9% a year earlier. The market reported that "extreme volatility" continued into the first quarter of 2009, but the second quarter saw promising improvements among investment classes. Most significantly, yield spreads on corporate debt securities "narrowed significantly," generating capital gains.

But Lloyd's warns that the scope for capital gains from fixed-interest securities will become "increasingly limited as yields fall and lower prevailing yield levels make it even more difficult to generate return." Thus "investment conditions will remain challenging for the rest of the year."

With tight conditions expected to continue over the second half, Lloyd's said it is looking for "areas where the market is underweight," and will pursue opportunities in Asia, Latin America and Europe. The market opened an operation in Brazil earlier this year, where it now has three managing agents. Lloyd's also gained an establishment licence in Portugal. A new business model for Lloyd?s Japan has also been worked out with regulators.

As with other multinational insurance groups, Lloyd's is looking for growth in under-served markets worldwide as underwriting and investment pressures continue to constrain growth in developed markets?a trend that appears likely to continue for the foreseeable future.