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Weighing The Risk: Changes To 333-Year-Old Insurance Market Could Reshape London's Real Estate Sector

On the morning of 30 November 2019, the Vietnamese cargo ship Toan Phat 68 was hit suddenly by unexpected stormy weather, and sank four nautical miles off the coast of central Vietnam, dumping its consignment of 2,950 tons of cement and 25 tonnes of oil into the sea. The 10 crew members were saved, but the captain died of a heart attack.

More than 8,000 miles away, on news of the tragic accident, a man took a quill and pot of ink, and recorded news of the loss in a leather-bound ledger kept on the trading floor of an office in London.

“Captain reportedly sent coordinates before ship lost contact,” he wrote. “All crew saved but captain found dead by rescue team.”

Lloyd's of London is the world’s oldest and largest insurance market, where £35B of insurance premiums were written in 2018, and is one of the epicentres of the global insurance industry. The way it does business is antiquated, but over the course of its 333-year history it has been hugely successful.

The Lloyds Building at 1 Lime St. in the City

As a result it has created an ecosystem of companies and offices clustered around its building at 1 Lime St. in the City of London that is unlike anything else in the world of global finance in 2020.

But Lloyd's, and the insurance industry more generally, is at a turning point. And the change it is undergoing could have a huge impact on the makeup of the City of London, and London’s economy more generally.

Driven by rising costs, increased competition and falling profit margins, the underwriters and brokers that form the backbone of the insurance industry are under pressure to modernise the way they work. Insurance in London is still a face-to-face rather than digital business, with premiums bought and sold verbally and contracts signed and settled using pen, paper and rubber stamps. The industry is trying to work out how it jumps straight from this into the world of big data and artificial intelligence.

Industry grandee Stephen Caitlin told Bisnow he thinks headcount in the London insurance sector could reduce by 25% to 50% over the next 10 years, vastly reducing its need for physical space.

Lloyd's has the option to move in the next few years and is trying to work out how its business will change, where it should be located and how much space it needs. Where it goes, both physically and in the way it operates, the rest of London insurance will follow.

Beyond hurting margins, those old working practices may be slowly strangling the London insurance market: Lloyds was last year accused of fostering a culture of sexual harassment, and it is becoming increasingly hard to attract young people to work in an unmodernised culture, at a time when the sector is facing a wave of older execs retiring.

But for some, the trust created from its unique way of working is the sector’s biggest strength, and gives the City of London a huge competitive advantage. The relationship between a network of individuals who have worked in each other’s pocket for decades provides confidence to conduct business in a sector which, above all else, is about measuring risk. Anything that fractures that confidence could see London become just one centre among many in the global insurance sector, which would have a huge impact on the City’s companies and real estate.

You Call That A Cluster? It's Good, But It's No London Insurance Cluster

The Gherkin has increasingly been crowded out by other office towers.

London is the world’s third-largest city in terms of insurance bought and sold, and No. 1 for more complex insurance in sectors like shipping. Lloyd's accounts for about half of all the insurance business done in London, £35B out of about £65B in 2018, and that means around half of all insurance bought and sold in London is done in person.

While most modern financial markets, like the New York Stock Exchange or the Chicago Board of Trade, have moved to electronic trading systems and thus have lost their loud and bustling character, business at Lloyd's is conducted face-to-face on an open-plan trading floor the size of a football pitch. (See box at end of story for how it works in practice.)

For this reason, insurance businesses cluster around it in a way that is unique in the white collar world today. People talk about tech and finance clusters, but Silicon Valley spreads over hundreds of square miles and financial firms in New York and London no longer have to be on Wall Street or in the Square Mile. In insurance, brokers Marsh & McLennan and Jardine Lloyd Thompson are considered to be at the very outer reaches of the sector. Both are an eight-minute walk from Lloyd's.

“Lloyd's remains the central focal point for insurance firms,” Knight Frank Central London Tenant Representation partner Jack Measom said. “Geographically, every search I do for an insurance firm relates to its distance from Lloyd's.”

Brookfield head of Central London leasing Martin Wallace recounts how when private equity firm KKR bought insurance broker Willis in 1998, it planned to move the company to London’s Docklands area, 25 minutes by train from Lloyd's. By 2004 the broker had leased 420K SF in a building within spitting distance of the market.

That has made the EC3 postcode the insurance sector dominates a big draw for developers, and it has rewarded them handsomely. The insurance sector has accounted for an average of 8% of City take-up annually, according to Knight Frank, or 450K SF a year. The sector accounts for 11% of all City of London office space of 10K SF or more, according to CBRE

“There is a finite supply of assets in that area,” Wallace said, and he believes permissions to build tall towers in that part of the City are likely to become more scarce. “You have the insurance sector there, there is the micro infrastructure of bars and restaurants up little alleyways where the deals in that sector get done, plus it is becoming more appealing to tenants in other sectors.”

When Landsec and British Land developed speculative towers on Leadenhall Street and Fenchurch Street near Lloyd's in the wake of the financial crisis, they were filled up mainly by insurance companies like Aon. Both companies later sold the projects for huge profits. Swiss Re built London icon the Gherkin in the shadow of Lloyd's, and Brookfield was in talks to sell a nearby site to reinsurance firm Munich Re for a 600K SF tower until late last year. 

Lloyds On The Lookout

The ledger in which ships lost at sea are recorded.

Rumours that Lloyd's will move out of 1 Lime St. crop up semi-regularly. It has been on the site since 1925, and in 1986 moved into a futuristic-looking building designed by Richard Rogers, with the plant and machinery on the outside, alongside outward-facing glass lifts.

In 2014 Lloyd's flirted with other landlords, assessing its options of where it could move, before deciding to stay put. It is likely too late now for it to move in 2021, but its next break clause is in 2026 and it is undertaking a complete review of the way it operates that is likely to have an impact on its real estate footprint. And even if it doesn’t move location, the changes in the way it, and other insurance firms, operate is likely to have a big impact on the makeup of the City.

The review, called The Future of Lloyd's, centres on moving to a digital platform and conducting more of its business electronically. It is in the process of setting up two electronic insurance exchanges, one for simple risks, and one for more complex risks.

Lloyd's’ review process is driven by financial imperative, and is being mirrored across the insurance sector. Lloyd's made a £2.3B profit in the first half of 2019, but made a combined £3B loss in 2017 and 2018, driven by rising costs and a string of natural disasters. The return on equity of reinsurance companies, which buy existing insurance contracts, halved in the past five years, according to Willis Re.

“The costs of operating in this environment has been increasing rapidly,” one underwriter said. A typical deal his company underwrites might have two or three brokers that all take a commission, and he said the company pays to rent its box in Lloyd's as well as taking conventional office space.

And for a big slug of the day, that conventional office space isn’t even being used. Underwriters tend to be in the office until about 10am, then out doing deals at Lloyd's and, particularly for older workers, over long lunches until about 4pm, before checking back in for a couple of hours.

“Underwriters tend to make up about a third of the employee profile for insurance providers, so that is a lot of space to hold vacant and not use,” KKS Savills’ Katrina Kostic Samen said. “Underwriters tend to be the rainmakers that bring in the money, so it is very hard to persuade them to change and move to a more agile way of working rather than them having a desk where they hang their jacket.”

Fewer People, Less Property?

Convex's Stephen Catlin

Change is slow. But new companies are looking to come into the sector and shake up its working practices through technology and different ways of doing business. The way they use property is changing as well.

“The insurance sector has been a bit luddite when it comes to adopting technology,” Convex Chief Executive and Chairman Stephen Catlin said.

Catlin has 45 years in the insurance sector, sold the eponymous underwriting company he founded in the 1980s to XL for £2.8B in 2015, and last year founded Convex with $1.8B of capital, the largest-ever new capital raise in the insurance sector.

“It is hard, because in a market environment a lot of people don’t want to change,” he said. “For the big companies, adopting technology is a bit like turning round a supertanker. We’ve got no legacy processes and no legacy liabilities, so we’re starting with a blank sheet of paper.”

For Convex, that means outsourcing the entirety of its back office function to an Indian service provider, the kind of offshoring that is common in other sectors of financial services, but in insurance is a new but growing trend that could indicate a reduction of space occupied in the City.

The company hasn’t taken space in the Lloyd's building thus far, and is mulling whether to do so, although it has taken office space in the neighbouring Scalpel office tower. It is also one of many insurance outfits, including Lloyd's, looking at how it can utilise cutting-edge technology to change the way it does business.

“There is no doubt that that the ability to collect and use data using AI and algorythms will change the industry,” he said.

That will have a fundamental impact on companies and their real estate needs.

“It is a big question as to what extent people are part of the equation. A lot of the work that is being done can be replicated by machines, and that means headcount will be down 25-50% over the next five to 10 years. And when I look at all the money being put into property investment in this area [EC3], it is difficult to contemplate what the value of this property will be beyond 10 years’ time.”

Knight Frank’s Measom said one company he has just advised, RFIB, has downsized from about 28K SF in the City to about 18K SF, having moved some of its staff to cheaper locations and utilised technology to undertake some business functions.

“To be honest, there are a lot of functions in the cradle-to-grave cycle of a risk placed in Lloyd’s which can and should be done by technology,” one underwriter said. “There has been a lot of M&A activity in the sector, which has maybe led to economies of scale rather than driving technological solutions. But the business will change. We could be using AI to underwrite some types of risks, once certain parameters have been set? You will not always need a human to look at everything.”

Filling The Talent Gap

In the centre of the main floor at Lloyds is the Lutine bell, salvaged from an English shipwreck in the 18th century, which until the late half of the 20th century was rung to indicate that a ship had been lost at sea. After developing a crack, now it is only rung to mark the date of major anniversaries in Lloyds’ history, such as 9/11, which remains the largest single loss in the market’s history.

The need to change working practices is not just about cost for the insurance sector: It is also about ensuring long-term survival. According to a 2017 report by McKinsey, 25% of the insurance industry’s workforce was set to retire in 2018 and 2019, and the way the sector works in London is hindering rather than helping the recruitment of talented young replacements.

Sexual harassment is common in Lloyd's and the insurance sector that surrounds it, Bloomberg Businessweek wrote last year. And a culture where people are expected to be in one place from 9am to 6pm most days is increasingly out of sync with the modern workplace.

“For an industry that is not embracing tech and is male-dominated, it is hard to attract younger workers,” KKS Savills Senior Workplace Strategist Yetta Reardon Smith said. “It is struggling to fill that gap. Data scientists can go and work anywhere.”

As a greater proportion of insurance is bought and sold online, the people and companies within the sector will also have a challenge to redefine what they do and keep themselves in a job, Reardon Smith said.

“The law sector saw that technology would change and commoditise its business, and unskilled itself pretty quickly,” she said. “For insurance I think that will be more of a challenge.”

The Power Of Good Faith

The Lloyds Building from afar

But for some in the industry, it is important not to throw the baby out with the bathwater, particularly when it comes to technology, and to try to preserve the characteristics that have made the London insurance market so successful for the past 333 years.

“Lloyd's is based on trust, and trust is the most efficient element of any business transaction,” another underwriter said. “The reason Lloyds and London have been so successful for more than 300 years is the extra trust and efficiency that is created by sitting in front of someone and looking them in the eye. A broker can come and sit with an underwriter and because they trust each other, they can summarise risks and complete multiple transactions in a short space of time. If all information is presented electronically, underwriters may find themselves on the receiving end of a “data dump”, eroding the potential efficiencies which electronic placement could offer." 

For some in the industry, there is an inevitability to some of the functions in the insurance business being automated: the back office processes and the handling of small and midsized claims for instance. But digitising the buying and selling of more complex insurance of the sort that is undertaken at Lloyd's could have a hugely detrimental impact on the sector in London, the industry that operates there and the space it occupies, and the City of London itself.

“We have this huge amount of trust and efficiency, and if you move to a more digital environment, we have to make sure we don’t lose the magic of this unique environment,” the underwriter said. “This London market ecosystem could unwind if the trust goes, including how you use buildings, how well all [of] it works together. We don’t want the community to disperse.”

Once more is done electronically, the need to be in London and pay London rent is no longer there for companies, he said, which would be a blow for the UK capital.

“We are trying to adopt the best bits of the old system and get rid of the bad parts,” Convex’s Catlin said. “Lloyd's and the insurance market are a hugely important part of the City’s institutional life. It is 25% of the City’s GDP, so it is hugely consequential for UK plc. There is a lot to lose as well as a lot to gain. The situation where you can see the whites of someone’s eyes and transact in real time is a huge competitive advantage for London. There have been exchanges elsewhere but they have never succeeded, and there has never been a market as cohesive as Lloyd's and as London.”

There is a feeling among those in the property sector that Lloyds will stay, if not in exactly the same building, then in the same area.

“That area will remain the core of the insurance industry,” Brookfield’s Wallace said. “The amount of knowledge and expertise in that small area is unrivalled.”

The sector as a whole knows it must change, but will have to fight harder than most to enact that change successfully. Tradition is what has made Lloyd's, and insurance in London, so successful. It is what allowed it to survive disasters that could have wiped out the sector, like the sinking of the Titanic or 9/11. But it is also holding it back. It needs to adapt to the fourth industrial revolution, while maintaining elements that predate the first. The implications will be seismic for the insurance sector, and for London more generally.

The boxes of the main underwriting room at Lloyds, where insurance is bought and sold face-to-face.

Here's how Lloyd's of London works. If you are a company that wants a ship or a building insured, or a wealthy individual that wants to insure a Picasso, you ask an insurance broker to find you some insurance. In London, there is a better than even chance that broker then walks from his or her office into the Lloyd's Building and queues up at the desk of one of the insurance syndicates of underwriters that operate in Lloyd's, of which there are about 80.

The desks are called boxes, and the design is based on the design of the benches in the original coffee house of Edward Lloyd in nearby Tower Street that gave birth to the Lloyd's market. Some of the syndicates are made up of wealthy individuals, but that is increasingly rare: today they are more likely to be large global corporate insurance companies like Amlin or Hiscox.

The broker will chat to the underwriter, talk through the deal and agree a price. The underwriter might agree to insure 100% of the risk, or just a portion, in which case the broker will go round different syndicates until he or she has covered all of the risk. Because a big proportion of the contracts are still written on paper and rubber stamped, the thousands of people working on the trading floor and the four smaller but similar floors above this all wander round with chunky folders of paper under their arms. The demographic is overwhelmingly male, and the dress code formal — until a few years ago ties were mandatory.

Even if Lloyd's stays put and doesn’t move, the way it operates is likely to change. Like all modern workplaces, it is looking at how to foster more collaboration and innovation, and has installed an insurance technology incubator in its building. But KKS Savills Senior Workplace Strategist Yetta Reardon Smith said the fixed infrastructure of the boxes and trading floor make flexible, collaborative working more difficult.

“If you go back to its roots, it’s a coffee house that has been built on personal interaction,” she said. “As they introduce more technology, that will have to be reflected in the physical environment.”