Lancashire Holdings Ltd
LSE:LRE
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Lancashire Holdings Ltd
Earnings Call Analysis
Q2-2023 Analysis
Lancashire Holdings Ltd
The company reported significant progress in the first half of the year, continuing to grow its business according to the long-term strategy. They capitalized on the best underwriting conditions in a decade and plan to further enhance the underwriting portfolio and capitalize on favorable market conditions, expecting them to remain conducive in the foreseeable future. The focus on diversifying the product mix has resulted in a more robust underwriting portfolio, yielding higher profits efficiently against the capital base.
As part of its strategic vision, the company has announced its entry into the US underwriting market beginning in 2024. This move is driven by the current opportunities in the US A&S market and is aligned with its conservative approach toward expansion. By entering brokered product lines that complement current offerings, Lancashire US is expected to contribute to sustained growth in the world's largest insurance market.
The company celebrated 22 consecutive quarters of positive writing momentum, backed by a disciplined strategy that aligns growth with market opportunities. With a combined ratio of 79.2% and healthy risk-adjusted pricing index (RPI) figures, the portfolio demonstrates resilience against industry losses and contributes impressively to the bottom line. New classes of business entered over the past five years have reached profitable scale and are now positively impacting earnings.
A profit after tax of $159 million reflects a healthy growth in earnings per share. The company's strategy has yielded a growing insurance revenue, demonstrated by a noteworthy 33% increase compared to the previous year. Looking forward, the additional premiums written over the past few years are expected to bolster earnings further, indicating an optimistic financial trajectory for the company.
The company showed judicious financial management by reducing the outwards reinsurance spend percentage from 34% to 28% while retaining more risk. This was possible due to improved pricing and no significant losses endured in the first half of 2023, confirming their sound risk management. With an unswerving conservative reserving approach, the company maintains an 87% reserving confidence level and reports a strong investment performance with a 3.3% return and a stable AA- portfolio credit rating.
The company boasts a robust balance sheet, underscored by a solvency ratio of 312%, lending substantial capacity to support business expansion efforts. The strategic growth in business has been effectively offset by profits, showcasing a healthy financial ecosystem ready to embrace the dynamic insurance market and its opportunities.
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Hello, and welcome to the Lancashire Holdings Limited H1 2023 Earnings Call. Throughout the call, all participants will be in a listen-only mode. And afterwards, there will be a question-and-answer session. Please note this call is being recorded. Today, I'm pleased to present Alex Maloney, Group CEO; Natalie Kershaw, Group CFO; and Paul Gregory, Group CUO.
I will now hand over to Alex Maloney. Please begin your meeting.
Okay. Thank you, operator. Good morning, everyone. I will just give some brief highlights of our half year results. Then go to Paul for some underwriting and then Natalie will cover the financials, and then we'll go to Q&A.
So as I reflect on the progress our business has made during the first half of the year, I'm pleased to report that we continue to grow our business in-line with our long-term strategy at the right time in the underwriting cycle. We continue to see the best underwriting conditions in a decade for most classes of business we underwrite. Therefore it's important that we grow writings in excess of the rate change to maximize this opportunity.
Our plan for the rest of 2023 is continue to grow our business, whilst continuing our work to diversify our underwriting portfolio. We see little ill-disciplined in the marketplace on new capital entering, therefore, I expect underwriting conditions to be favorable for the foreseeable future.
As our half year results demonstrate, we are building a better and more diverse underwriting portfolio, which generates more profit against our capital base. We're using our capital more efficiently and remain in a strong capital position for future opportunity. As we entered this year’s US hurricane season, our business is in a much stronger financial position than when we entered last year's hurricane season. Our profit buffer is multiples of where we were at this point last year.
Our plan for our property cat and retro portfolios was to write a similar portfolio as we did last year. By that, I meant to deploy similar capital to that space as we did in 2022. While we are already a major writer of cat business and therefore enjoying the better than budgeted underwriting conditions for these capital constraint classes of business. So we have a much better balance of capital exposed to the hurricane season on profit, which increases the probability of much better returns.
So I'm very happy to report our business continues to deliver in line with our long-term strategy. We have a more diversified product mix where we aim to deliver lower earnings volatility which should in turn produce better returns on capital. Therefore, we are growing our underwriting at the right time, using our capital more efficiently and growing our earnings per share.
Now I'd like to just pivot to Lancashire US. You would have seen the news that Lancashire will start underwriting in the US since 2024. This is an exciting opportunity for us and the next stage in the evolution of our business. We have, as always, been driven by the underwriting opportunity which currently presents itself in the US A&S market. We intend to offer product lines which suit our current appetite, but did not find a way to any of our current underwriting hubs. Our intention is to very much write business that is brokered and [underwritted] (ph) in the US marketplace.
We would adopt the same conservative approach to building our US business as we have done in other parts of our business that we have built out over the last five years. We always believe that you need to enter new product lines at the right time and with the right people, which is what we're doing in the US.
So to summarize, our long-term strategy of growing at this stage of the underwriting cycle and diversification of our underwriting portfolio is working. We continue to see underwriting opportunity for the foreseeable future and Lancashire US will provide us with continued growth in the world's largest insurance market.
I'll now hand over to Paul.
Thank you, Alex. As Alex has just mentioned, market conditions have continued to be favorable for the second quarter and we've continued to execute on our long-held strategy of growing when the market opportunity is there. We have now seen 22 consecutive quarters of positive writing momentum. The writing environment we saw in Q1 was maintained through Q2 with a very healthy RPI of 117% for the first half of the year.
More than just the headline writes, we are extremely happy with the profitability of the portfolio. The first half of the year from an industry loss perspective was far from benign as there have been numerous cat and non-cat losses. As a result, the combined ratio of 79.2% is very pleasing, but our real focus is on additional dollars of profit this produces given the larger premium base against a broadly similar level of capital.
Importantly, we continue to see the benefits of the numerous investments made over the past five years. You'll recall, I first talked about our investments in new classes back in 2018. It takes time for our investments to reach critical mass, but since then these classes we have entered have gained profitable scale and are now contributing to the bottom line. That is also a hope the investment we're looking to make in the US too. It will take a bit of time, but it will ultimately help us deliver a more resilient underwriting contribution over the longer term.
Whilst there is never a guarantee of profitability as we're in the risk business, the market conditions and our decision to build out a more diversified underwriting footprint at the correct time just enhances the probability of healthy combined ratios and ROAs. And the portfolio we put in place should be able to absorb losses, yet still deliver both less volatility and healthy levels of profitability. Most importantly, it should improve our ROA across the cycle.
In the next two slides, I'll briefly touch on the market dynamics in both our reinsurance and insurance segments. The market conditions we saw in Q1 have remained during Q2 for all of our reinsurance lines. RPI for the reinsurance segment was 123% for the first half. We continue to build out the casualty portfolio and rating was broadly flat. We are very happy with the rating adequacy, given we entered the peak of the rating environment and continue to reserve this class extremely prudently.
The specialty reinsurance portfolio also continues to grow in what is a strong market. Specific sectors such as aviation reinsurance have seen significant write improvement as the year has progressed, helped by market losses and a retraction of retro capacity. We anticipate specialty reinsurance being a core growth area for us in the coming years.
In catastrophe exposed lines such as property cat and retro, the buoyant rating environment continued. The market was far more orderly than we saw at the 1st of January, but this didn't detract from the rating conditions. It's found its level, and there were no signs of softening during Q2 renewals.
Our insurance segment continued to see strong rating momentum with an RPI of 111%. Of particular note, the property portfolio has seen continued strength in rating levels and even stronger demand. We've spoken much about the threat of inflation can pose and -- but we've also tried to highlight there is a positive to inflation. The increased demand for our products and increased demand at a time with limited supply only helps the market dynamics. The effect is clearly seen in property insurance and this has given us the opportunity to grow in one of the best property markets we've seen.
All other classes with the insurance segment continued to have positive rate momentum as the upward ratings trajectory we've seen for the past five to six years endures. Classes such as aviation, power, marine, liability and energy liability are all still seeing strong double digit RPIs.
Looking forward, we remain optimistic that market conditions will remain robust with rating adequacy in a really strong position. With new ventures, such as the US, we anticipate a good runway for growth in the coming years with a foundation of strong underlying ratings to support this, and the future underwriting contribution.
I'll now pass over to Natalie.
Thanks, Paul. Our results are presented for the first time on an IFRS-17 basis and are summarized on this slide. I'm exceptionally pleased with our underwriting performance for the first half of [2022] (ph). Our undiscounted combined ratio was a healthy 79.2% or 71.4% on a discounted basis. This translates into net insurance service result of $188.8 million, an increase of 33% compared to the same period last year, with the positive investment performance also contributing to results.
Our overall profit after tax was $159 million, resulting in a 12.2% increase in diluted book value per share for the first -- for the half year. These results put us in an incredibly strong position going into the second half of 2023. The benefit of our growth over the last few years coming through in insurance revenue and ultimately profit. Insurance revenue is a new metric introduced by IFRS-17, and its component parts as detailed on Slide 11. Earnings will continue to come through this line from the additional premiums written in the last few years.
The rate that premiums earned through its insurance revenue will vary dependent on business mix, which impacts the period over which premiums are earned, as well as the quantum of related commission. The allocation of reinsurance premium is a similar concept to insurance revenue, but with outwards reinsurance, i.e., it comprises ceded earned premium, less outward reinstatement premium, lesser commission. The main driver is the balances of our outwards reinsurance spend, which is $331.8 million compared to $315.5 million in the first half of 2022.
Although our outwards reinsurance spend is higher in dollar terms, it has reduced as a percentage of gross premiums written compared to the same period last year from 34% to 28%. We are generally retaining more risk across the business as pricing has improved.
Our claims performance for the first half of 2023 is detailed on Slide 12. On an IFRS-17 basis, insurance service expenses and allocation of recoverable from reinsurers total for net insurance results. This incorporates expense directly attributable to underwriting, discounting and reinstatement premiums, as well as, the pure loss numbers.
Although the market loss environment was reasonably active in the first half of 2023, we did not incur any individually material catastrophe or large losses. The total undiscounted net losses, excluding reinstatement premiums from catastrophe and large loss events was $49.5 million. There is no change to our reserving approach or philosophy under IFRS-17, and we expect reserving confidence levels to remain in the 80s to 90s percentile unless there is a change to our risk appetite. IFRS-17 does provide more visibility on our conservative reserving with the new required disclosures. The reserving confidence level at 30 June is 87%, and the net risk adjustment is $217 million or 21% as net insurance contract liabilities prior to the risk adjustment.
For the current period, favorable prior year ultimate loss development totaled $46.3 million primarily due to releases on the 2022 and 2021 accident years across most lines of business. On an IFRS-17 basis, total prior year releases include the release of expense provisions as well as the impact of reinstatement premiums. These increased total releases is $72.1 million.
Turning to our investment. The investment portfolio returned 3.3% in the first half of 2023, as we started to see the benefit of higher rates on our investment income. Book yield is now 3.7% and market yield is 5.6%. The investment portfolio remains relatively conservative with an overall credit rating of AA minus. We do not intend any material changes to our investment strategy in the medium-term and we'll keep the overall portfolio duration short.
On Slide 14 we have provided two bridges to the results on an approximate IFRS-4 basis to the IFRS 17 basis. On an undiscounted basis, the combined ratio is fairly similar with a 3% reduction largely due to the differing IFRS-17 treatment for reinstatement premiums, which are netted off claim and commissions which are netted off premium. Comprehensive income on an IFRS-17 basis is $11.7 million higher than the comparable IFRS-4 basis. The discount benefit is the main driver of the increase in profits on an IFRS-17 basis.
The waterfall on Slide 15 shows the discount benefit on initial reserve was higher than the unwind of discounting from prior years, leading to an overall benefit for the period.
Moving to guidance on Slide 16. I am happy with the full year guidance previously given. As I had mentioned in the past, there is some seasonality in our underlying combined ratio which tends to be higher in H1 and for the full year. The ratio can also fluctuate due to shifts in business mix. For example, demand in the casualty business we underwrite. So it doesn't change our view for the full year.
I also want to stress that we do not manage these ratios on a quarter-by-quarter basis. Our core focus has always been on great ROA and remains there going forward. The initial guidance on an IFRS-4 basis which for the underlying combined ratio excluding catastrophe and large losses and reserve releases to be between 74% and 79%. And on undiscounted IFRS-17 basis, we would expect the equivalent guidance to be around 1 percentage point lower on both the top and bottom end of the range.
The approximate prior year ultimate loss development of $100 million to $110 million for the full year is still appropriate on an IFRS-17 basis. In addition to the ultimate loss movement, the IFRS-17 prior year development also includes reversal of prior year expense provision and the impact of reinstatement premiums. And that releases in the first half of 2023, included the reversal of recoveries on previous catastrophe events, which means the impact starts with reinstatement premiums relatively pronounced. I would not necessarily expect to see such a significant impact from reinstatement premiums going forward.
Finally, moving on to capital on Slide 17. We ended the half year with a strong balance sheet, which gives us the ability to support our fund business growth over the remainder of the year. Our regulatory capital position at June 30 is an estimated solvency ratio of 312%, which would reduce to approximately 268% following a 1 in 100 year Gulf of Mexico wind event. The increase in shareholders' equity due to profits in H1 has more than offset increased capital requirements due to business growth.
With that, I'll now hand back to Alex, please.
Okay. Thank you, Natalie. So just to summarize, we see lots of opportunity for our business, remain very well capitalized, and we are doing -- we are sticking to our strategy of growth at this point in the underwriting cycle which I just believe is essential. So I think we are completely on track. I'm excited about our half year and we'll see what the rest of the year brings for us.
So happy to go to questions now.
Thank you. [Operator Instructions] Our first question today comes from Will Hardcastle from UBS. Please go ahead.
Hey, afternoon, everyone. I hope you're well. First question, just thinking about the PMLs haven't moved too much from the full year to June 30, US particularly. Just remind me, does this include the July renewal impact at this point? Anything you can say on that?
And then just thinking about the shape of the book underneath the 1 in 100, obviously, you've put on a lot of growth. It sounds like the vast majority of that in cat-exposed is price, but is there sort of any one in X type area that we should be expecting a bit more exposure year-on-year?
Second one, just about, I guess, just thinking about the BSCR development. With more business written in 1H, is the business growth consumption sort of front-half loaded or isn't that how it works? I guess, I'm just trying to understand if we got a bigger pick-up to come more or less equal in 2H. Thanks.
Hi, Will. I'll take your first two questions. So on the first one. No, the PMLs that we released are June 30. So all business written up to and including June 30. So any business -- any cat business written on July 1 or after isn't incorporated into those numbers. We publish a revised -- the full year. But in terms of what we have communicated on kind of net cat appetite at the beginning of the year was broadly similar net cat footprint which -- as you can see, thus far that's pretty much what we've done and there's no change on that.
In terms of the shape of the cat book, I think what we've seen and we spoke about this a bit, the last update, what you've certainly seen particularly in the property catastrophe market and to a similar degree the retro market which was the big drivers of our cat footprint, you've seen the whole market try and move up level. Obviously, some of that, inflation has helped but also the number of kind of smaller to mid-size losses that have impacted the reinsurance market over the past five years have driven this.
So I think we'd be very similar to others in the -- your cat book is further away from those kind of losses. Mainly you can't get them of course. But the book has moved up level for us, if you think about where we write off, particular our property cat portfolio, it's more evidence in our syndicate portfolio which is traditionally lower down the curve, and you've seen more level come into that book which is something we were aiming to do, but the markets obviously allowed us to do it.
And then if you look at our Bermuda portfolio, that tended to be further out in the curve. So you've seen less change in level there. But hopefully, that answers those two questions for you.
Hi, Will, I'll take the third question, on the, BSCR. I mean you're right, because we write most of the business in the first half of the year, you do get most of the impact from the cat book already in H1 and the impact from P&L. What you will see coming through though in H2 is an increases in reserves or increases in premium, not a significant, but there will be. You would expect some increase in H2 in capital requirements, just from the growth that we're putting on.
That's great. Thanks, guys.
We are now going over to our next question. And the next question comes from Freya Kong from Bank of America. Please go ahead.
Hi, good afternoon. Thanks for taking my questions. Firstly, I was wondering if you could give any comments on the Bermuda tax consultation or Pillar 2 in the UK. Is there an effective tax rate we should be looking for 2024?
And then secondly, just on, I guess, thinking about growth and capital intensity and how the portfolio has evolved over the last three years, how should we think about capital intensity going forward in terms of premium written to capital requirement? Thank you.
Hi, Freya, it's Natalie. On the global tax rate, obviously, Bermuda came out with its consultation only two days ago. So we're still working through the detail on that. We're pleased that Bermuda has said they want to remain competitive and looking at offsetting deductions such as payroll tax. We shouldn't see any impact many this in 2024, though the UK regime doesn't impact us at least until 2025.
And we'll just continue to look at the most efficient corporate structure for our business and where we can make the best returns for our shareholders as we always do.
I'll take the second question, Freya. I think, as we always say, the real driver of capital for us is any of those lines of business that have catastrophe exposure. So some of the property insurance lines, obviously property cat and retro, not to say other lines of business are complete -- capital free, what I call, call capital-light. So we've been quite clear this year I think about maintaining on net cat footprint, which you can see from the PMLs. That's pretty much what we've done.
The remainder of the year is kind of non-cat lines such as aviation that obviously have much less of a capital requirement. And then look, what we'll do, we'll get towards the end of the year, get [indiscernible] and see what the market conditions are, and then give you some more guidance about future years at that point. But it's always going to be, obviously, driven by the market opportunity and not deviating from the strategy we've been employing over the past few years.
Okay, thanks. So is it fair to say then about the 20 points of deployment year-to-date has mostly just been in property insurance?
Sorry, sorry, Freya you broke up there on the question, could you repeat that, please?
Is it fair to say then that the around 20 points of deployments, you saw year-to-date was mostly in property insurance?
Freya, it Jelena. We wouldn't ordinarily comment on exactly what percentage of the BSCR ratio relates to sort of anything. As you know we are ultimately driven by the AM Best ratings and that's what we focus on, what we do have substantial headroom and that will be our focus. We wouldn't ordinarily sort of look at individual lines of business because naturally, you will have some offsets in that overall number from diversification and so on. So it's a little bit more complex than just looking at the headline number.
Okay, thank you.
And we're taking our next question. This question comes from Kamran Hossain from J. P. Morgan. Please go ahead, sir.
Hey. Two questions and maybe just one follow-up. The first one is just on the US setup. There were some implications of doing as I assume that if you're going to be writing business there, you are probably going to access [indiscernible] has some minimum size, et cetera. Just wondering kind of -- if you can maybe set out what you think those requirements might be or how much capital you might have to decided to do that.
The second question is on the, I guess the casualty book where you've helpfully said where you are being very prudent. Can you show how claims experience so far on kind of what you've seen on that book? And at what point do you really release kind of conservatism? So I know you guys are certainly going for few years, it wouldn't maximize anything yet, but just interested in when that might start to come through.
And then the third question is somewhat from the global minimum tax in Bermuda. If I try to think about the size of your operations, you just simply fall below that kind of threshold. I think it's $750 million for units of businesses in Bermuda, so just interested whether you are still there. We know it's very early days. Thanks.
So, okay, Kamran. So I'll start with the US question. So I think that we are clearly going to need some capital to expand into the US. That will be driven by the product mix, but if you look at the capital position we're currently in, we're more than comfortable that we can setup in the US, come out with a business plan based on the opportunity, based on who we hire in some of those roles and fund our expansion.
So yeah, we would definitely need some capital to apply In the US, that will be driven by the business plan. We finally settled one when we start underwriting next year, but -- and again, just one other thing on that, we were at nice point well. We've got lots of opportunity across the group. So we will just deploy capital in the best place for our shareholders whether that's in our London book, our Bermuda book, our US book, we're back to that point where the business is competing for capital.
So -- but the ultimate point is, we have plenty of cash, we have plenty of headroom to fund the growth opportunity in the US.
On your casualty question, Kamran. I think obviously the first point is, we started writing casualty reinsurance at the beginning of 2021. So we're only just over two years into that and I think it's too early to really comment on any loss trends.
But what I would say, there's nothing there that gives us any cause for concern particularly given how prudently we are reserved in that portfolio, which we think is obviously wholly appropriate.
I think in terms of when will we start to review that prudence, I think we've said before, when we enter short tail classes of business, we tend to kind of have a look about three years in an on casualty, and we've -- again, we've said this before, kind of, I think the kind of minimum time period would be looking at is, five years, and that's also something we have seen in the meantime that would mean we need to look at it again. But I think that should hopefully give you some kind of timeline.
Hi, Kamran. On the tax question, that particular exemption you mentioned, wouldn't apply to us. There are other exemptions in the regulation that we're currently working through and hopefully, we'll have some more information on the next call.
Okay, thank you.
We are going over to our next question. And this question comes from [Darryl] (ph) Gold from RBC. Please go ahead.
Hi, good afternoon, everyone. I can hope you can hear me, okay. Just two questions, please. So first one is just on the US platform. I appreciate it's very early days, but can you maybe expand a bit about -- into the lines that you're expanding into the potential deification effects, as well and maybe also a rough kind of topline number that you're targeting at the moment.
And the second one, just going back to capital. So it's 310% at the moment, and it sounds, that's going to be much stronger built-in in second half. Now assuming that we have a normal hurricane season, and I know that you've got it US expansion as well. Is it fair to say that you'll be rolling out the potential for any excess capital returns for this year already? Thank you.
So I'll take the first one, and I'll ask Natalie to ask the second one. I think, our view is that, what we're looking to achieve in the US is product lines that we're very comfortable with, so similar to some of the products that we currently sell. So let's just pick property as an example, I think that dependent on the size of the opportunity, drives the ultimate product mix which will just drive the opportunity.
But I think it's going to be things like property. It's going to be marine business. It's going to be energy casualty, the classes of business that we currently underwrite. So I just see the US as a natural extension for us. Product lines are very comfortable with, someone internally that already works for us, has got a lot of experience. He is going to run the operation and an access in a pool of risks that currently don't come to London.
So that will require some capital. It will depend on who ultimately we hire. We are hiring people already, and any guidance on the size of the opportunity will be given at the end of the year when we give you our guidance for '24.
We probably won't start underwriting until April '24. But that depends on how quickly we can get sets up but we'll give you all the guidance when we give you our yearly guidance for '24.
Hi, Natalie. We're not -- there's no change to our approach to capital management this year. So we'll get to the end of the year post-wind season, looking to next year, including the US to determine how much capital we need. But we're certainly not ruling out a special dividend at this point. It's far too early to say that.
Hello, this is the operator. Do you have any more questions?
No, that's all from my side. Thank you.
Thank you very much. We are now going over to our next question. And the next question comes from Andreas van Embden from Peel Hunt LLP. Please go ahead, sir.
Hello, good afternoon. Just a question around your property cat book. You mentioned that in your introductory remarks, you said, there was an increased probability of much better returns this year. Is there any way you could sort of talk about those returns on the property cat reinsurance book? What is the IRR you will be able to generate on that portfolio in 2023 and how does that compare to 2022?
And with the changes in the attachment points and the rate increases you push through, could you maybe just talk around the breakeven point whether -- at what percentile on the curve you would be breaking even and how does that compare with last year. Thank you.
Hi, Andreas. So first, just a point of clarity. My comments around overall profitability was obviously around the overall portfolio, and we're not necessarily specific to the property cat book, albeit with the market conditions we've seen, obviously the same kind of logic applies.
I'm going to -- now I'm going to frustrate you with this answer, but we don't give out those kind of metrics on particular lines of business. So I won't be doing that here now. But look, what I can say is, obviously on the property cat portfolio, the whole market, including ourselves have increased level of attachment point which pushes you further away from some of those smaller to mid-size losses. There is clearly more premium coming through the system. We've increased rates and all that does is, put you into a position where your overall cat footprint is just in a much better spot.
So directionally we're going in exactly the right direction. We're really happy with what we've seen on all areas of our cat book, not just the property cat book, in terms of the market dynamics, and we're really happy with the portfolio we've ended up with. As we always say, there is always events out that can come in and create us -- and the market problems. But we just -- overall, we're in a much better spot. And apologies, I'm not going to give you the answer that you want.
All right. Okay, thanks. Thanks for clarifying a little bit. May I have one follow-up then. Just thinking about your US business. You mentioned you're writing this on company paper in the UK. Does this means this is going to be written outside of Lloyd's? And if, so what drives our decision not to sort of just have a -- bind a contract between your syndicates at Lloyd's and your new US operation? Thanks.
Yes, it will be written outside of Lloyd's on asset of London company paper and we just feel at this point, that's the most efficient way for us to access the US market. But that may change over time. We might utilize the syndicate paper. We have multiple options, but we just feel at this point in time, this gives us the best and quickest access to market that we want.
So it's a moment-in-time thing. It may change as you know, Andreas, we're not too fussed about where we write business or what platform we write business on, we're just trying to maximize the opportunity.
Okay. And what's the cost advantage of setting up the US platform versus just writing it out of Lloyd's, aside from accessing the business, it doesn't come to Lloyd's. Is there any major cost advantage?
No, no. It's not about cost, it's about accessing business that doesn't come to Lloyd's. So there would be absolutely no point in us going to the US to write business that comes to Lloyd's or our Lancashire platform. This is solely about writing business that stays in the US.
So let's just go back to property. The more complex, large risks for the property market tend to find their way to the London market and in the US, you probably write more vanilla property business. It just doesn't need to lead the US. So our approach is very much setting up onshore US to write business that doesn't come to London.
Okay. So it is not going to cannibalize your syndicates at Lloyd's?
That would be insane, I mean, there is nothing -- there would be no -- I mean, yeah, I've seen that happen before. But we're not setting on to compete with ourselves.
All right. Okay, thank you very much.
And we're taking our next question. The next question comes from Faizan Lakhani from HSBC. Please go ahead, sir.
Hi, thank you very much for taking my questions. The first is just coming back to the point on the insurance revenue, I understand different lines of business have different earning patterns. How should we think about the shape of the earn-through, especially as that business mix changes?
The second is on the operating expense growth. If I look -- if I'm calculating correctly, it seems to be up 30% given that you plan to grow in the US and through various portfolios. Should we assume that the absolute growth level should be similar in the outer years as well?
And finally, I just wanted to understand the combined ratio guidance. You mentioned there is some seasonality half-on-half. How much is that roughly in a normalized year? And if you could just sort of provide a qualitative update on how much the combined ratios benefited from stronger rates versus business mix shift? Thank you.
Hi Faizan, I'll take those questions. On the earnings-through, into the revenue, you should really think about that in the same way that you would have previously talked about, Western coming through into the net premiums earned. I think we used to say 12 to 18 months with the additional casualty, or probably looking at slightly longer than that. So it's important to know, I think that we're still seeing the benefit of the increase in premium to grow last year and even the year before that, that's still coming through.
On operating expense growth, that's really all payroll related. So it's headcount to support the growth in that business as well as inflation. As far as inflation last year, obviously, inflationary impacts last year were pretty high. We wouldn't necessarily expect to see that going forward, but we do expect a certain amount of headcount growth, especially with the US business.
I guess, all backs to the lower group. Yeah.
Yeah. I mean, the expense in dollar terms will continue to increase. But as a percentage of revenue, it will decrease, which is the main point. It is still profitable.
And then on the seasonality point. I mean we always give guidance for the full year and we generally finished the year with a lower underlying core than H1. This is like, there is a couple of factors. One is that we tend to release conservatism and the loss ratio through the year. So will start off the year with a higher level of margin than we finished the year with.
And the other factor is, as we're growing, you're getting higher earnings coming through in H2 which all sides to reduce your expense ratio. So these two things are going on that as well as business mix with things like casualty, which tend to impact the ratio as well. if you want, as an indication of an impact, if you could potentially look at last year, and the difference between the underlying H1 last year on the full year.
Okay. And in terms of the benefit on the combined ratio from rates versus from shift in business mix in H1, any indication on how that sort of played his part?
I think the main indication that we've given is the 5% hit from casualty. So if you take that off, you'll be -- next to the rest, it will be coming down to the impacts of rate.
Perfect. Thank you very much.
[Operator Instructions] We're going over now to next question. This question comes from James Pearse from Jefferies. Please go ahead.
Hi, thanks for taking my questions. Hope you're all well. Have you been surprised by the absence of meaningful new capital in the traditional reinsurance market so far this year and do you expect that to change if 2023 proves to be another elevated cat loss year and property reinsurance continues to harden?
And maybe just as a follow-up to that, when and under what circumstances do you expect meaningful capital returns to the ILS market? And then I just had another question on your AM Best capital model. Is there any impact from IFRS 17 on your capital model, i.e. IFRS metrics now feeding into AM Best models or is there no change? Thank you.
I'll just start the new entrants and capital and I think PG will talk about ILS. I think if you went back in time, in our marketplace times such as this when the underwriting opportunity seems strong, you'd historically get start-ups, particularly in Bermuda. So I am somewhat surprised you haven't seen any size up companies, but I think it's a bit more complex than maybe prior cycles.
I think the -- so great climate debate is obviously, -- climate is an opportunity which -- or a threat. And I think that's a big debate for some people. I think just a change in cost of capital and other opportunities for investors make the sort of -- the current underwriting opportunity difficult. And I just think, just the old fashion basic, the industry hasn't made any real money for five years.
So I just don't think there's enough evidence of much better market for people that are not currently in our world. So clearly, we think it's an opportunity. Clearly we can see the forward is a great cat market, is a great overall market, but I think investors want to see a bit more evidence before capital flows into the system.
I don't -- even I don't think that happens after one year either. So I don't think that if the current hurricane seasons benign, I don't think you get a massive influx of capital into the system after one cat year -- one clean cat year or benign cat year.
But over time if the industry can prove that returns are there which are meaningful when looking at the margin over the risk-free, I think you should expect more capital to come in, but I think you need -- the industry needs to prove that sustainable returns are there that are far and excess of risk free, which is quite generous for not doing much.
Yeah. To be honest, just, it's kind of going echo the same points re-ILS. I think whatever form of capital is that's just grappling with the same issues, i.e, a number of years with the industry where performance hasn't been good. I agree with Alex that one good year is not going to be enough to suddenly realize the capital to flood into the market. The market probably needs to prove itself more and the same applies in ILS.
And I think also what's happening, it's not just what happens inside our industry, but what is happening elsewhere. And I think in the ILS market, you've seen some investors with what they perceive to be other opportunities elsewhere that are more compelling and perceive to have less volatility. So I think what our industry does is one factor and what else is happening on around the world and in the global economy, is another. And it just seems similar trends.
Hi, James. On the IFRS 17 and AM Best question, currently, there is no change to the model as a result of IFRS 17. I do believe that AM Best is going to come out with some guidance on that in the next few months. But we don't expect to have a significant impact on our capital requirements.
Got it. Thanks, guys.
We are now taking our next question. The next question comes from Abid Hussain from Panmure Gordon. Please go ahead, sir.
Hi, thanks for taking my questions. Two questions. One, coming back on the tax question in Bermuda. So just, I guess, asking the same question a different way. If your effective tax rate doesn't become 15%, would you still choose to operate out of Bermuda? So I guess I'm asking, are there any advantages, other than tax for being in Bermuda? So for example, is there any capital benefit for remaining in Bermuda? So that's the first question.
And my second question is really a follow on to the previous one on rates. Just trying to get more color on how long do you think these favorable conditions can endure in the market. At some point, capital does need to come into the sector. Is this a multi-year story still from this point? So just any more color you can give to that, talk to that point, please. Thank you.
I'll take the second question, then we'll come back to tax and Bermuda question. So look, for me, it's not about putting how many years is the [indiscernible] market got, it's how much aggregate return you make. So I think that if you have -- if the industry has to absolutely stand out years, obviously, the market softens quicker. If the industry has two years, which are fine but not stand out, then it lasts longer. I think it's as simple as that.
I think investors are going to want proof of good returns. If you look at, -- well, good return today is very different to what it was two years ago. So I think the bar has been set a lot higher and these businesses need to make a lot more money. And I think until the industry can prove that -- those bigger returns, then the market is not going to soften.
So I think it's all about quantum of return. And let's be realistic, we are the biggest believers of the cycle and the cycle is driven by great returns or bad returns. So I think the market will soften at some point but no one has actually made any real money yet. So I think it's way too early. And as I said, if people don't make enough money, the market will hold longer and if there's two standout years, the market would soften sooner. I don't think it's anything more communicated than that.
Can I [Multiple Speakers] just before you move on, can I just -- is a standout year sort of 20% plus return on ROE or is it sort of 30%. Just so I can contextualize what a stand-out year might look like.
Look, I think it depends on what company you are -- what products you're selling. It could to be very different for us to what an ILS would refund but if risk free is 5%, a stand-out year is not 15%, is it? So it's going to be more than that. So yes, I think it's north of 20%. It is a great return but it's not -- I just think the bowls move so much in the last 18 months that I just don't think that's factored for the system here.
Okay. So I'll start on the answer to your second point on Bermuda [indiscernible] plans on the tax side. But what we need to raise, it's a fantastic marketplace for a lot of reinsurance products that we sell. There's really good talent on the island that is a proper market. So there is definite value -- have been here and having our underwriting team here to access those opportunities, whether that be casualty reinsurance, specialty reinsurance, and that cat reinsurance.
A lot -- almost all of the reinsurance business or the vast majority of the reinsurance portfolio that we underwrite is in Bermuda and the reason it's in Bermuda is, this is where the talent is and this is where the market is. So there is a definite advantages being here on island.
And also to add to that, the Bermuda regulatory regime on the BSCR capital model is specifically designed for reinsurers and that actually really help us as well.
Okay, thank you.
We are now taking our next question. And our next question is from Tryfonas Spyrou from Berenberg. Please go ahead.
Hi, just a final question on growth. I guess, is it fair to expect that given everything you said on particularly the US and platform there, that the $2.1 billion that consensus sort of expect for next year. I think it's around 7% growth year-on-year. Is it fair to say that looks relatively demanding and growth again next year should be well into the double digits also? Thank you.
A - Jelena Bjelanovic
Tryfonas, it's Jelena. I'm going to take this for the team. As you will know, it's a little bit too early for us to talk about premium number for 2024. We've always said we're fully driven by the market opportunity and as both Alex, Paul, and Natalie have -- all three of them have already said, we'll give you proper guidance early next year once we have reported our full-year numbers. There's obviously still a good half year to go in terms of the renewal still to come and business opportunities to look at. So, we will give you a bit more detail early next year.
Okay, all right, thank you.
At this moment in time, we have no further questions. I would now like to hand the call back to Alex Maloney for the closing remarks.
Okay, thank you very much for your questions today. We'll wrap up there.
Thank you all for attending. You may now disconnect.