Competitive markets are not new to Beazley. In 2010 we delivered an improved underwriting performance against a backdrop of deteriorating market conditions.
2010 saw an exceptional performance from the company that Andrew Beazley and Nick Furlonge founded twenty five years ago, maintaining our track record of unbroken profitability with a pre-tax profit of $250.8m (2009: $158.1m) on gross premiums that fell 1% from 2009 to $1,741.6m. Excluding a one-off foreign exchange gain of $33.7m, the pre-tax profit was $217.1m and despite competition increasing across most of our lines of business, we achieved an improved combined ratio of 88% (2009: 90%).
The board is pleased to announce a second interim dividend of 5.1 pence per ordinary share (2009: 4.7 pence per ordinary share) and a special dividend of 2.5 pence per ordinary share. Together with the first interim dividend of 2.4 pence per ordinary share, these dividends give a total of 10.0 pence.
Premium rates on renewal business fell by 2% (2009: 3% increase), placing increased emphasis on the skill of our underwriters in identifying profitable underwriting opportunities. Competitive markets are not new to Beazley: through our history we have experienced multiple market cycles. The peaks and troughs vary by line of business, geography and size of risk, so the task for a diversified business such as ours is to optimise the portfolio mix to achieve healthy returns across the cycle. Our combined ratio of 88% and our return on equity of 21.4% in 2010 (2009: 16.0%) reflects our success in achieving this.
Our investments returned $37.5m or 1.0% (2009: $88.1m, 2.7%) in an environment characterised by continuing macro-economic uncertainty, weak global demand and very low interest rates. Our investment returns increased in the course of the year, but our focus remains on capital preservation given the continuing risk of severe market downturns. Accordingly, the majority of our invested assets (63.8% at year end) are cash, cash equivalents and sovereign or supranational bonds and the duration of our overall fixed income portfolio is just over one year. We seek some return above risk free rates via a portfolio of capital growth assets.
Growth opportunities for the insurance industry as a whole proved limited in 2010. At Beazley we identified and capitalised on three, two organic and one the result of a prior acquisition. Organically, our reinsurance business grew by 23% to $174.4m, supported by our new special purpose syndicate (6107), backed by third party capital. By the end of December our reinsurance team had written $16.4m for the account of this syndicate.
We also continued to see strong growth in demand for data breach insurance in the US. Publicity surrounding corporate data breaches involving the loss of personal customer information continues at a high level. Beazley Breach Response has been successfully introduced in the US market as a comprehensive solution to this growing risk.
Our third area of growth was in our life, accident and health business, following our acquisition in 2008 of Momentum Underwriting Management Limited (MUM). Premiums underwritten by this division grew by 15% to $78.1m and the business performed better than we had expected, contributing $4.7m to profits. As we had hoped, the conjunction of the skills of the team, most of whom have worked together for more than a decade, and the Beazley name has proved very attractive to brokers.
A further recent acquisition, that of the First State underwriting agency in the US, is now fully integrated into Beazley. The highly experienced team led by Judy Patterson focuses on surplus lines commercial property risks and forms the core of our excess and surplus (E&S) commercial property business in the US, which underwrote premiums of $110.0m last year (2009:$102.8m).
Demand was also strong for energy insurance in 2010, following the Deepwater Horizon disaster in the Gulf of Mexico. We expect demand for our products to remain strong in 2011 as a result of rising commodity prices, customer awareness of risk and, in some cases, regulators requiring additional financial security from oil and gas companies. Paul Dawson and his team are respected heads of this class and will look to increase their share of the market if conditions remain attractive.
Change in functional currency
In April 2010, we announced a change in our functional currency for Beazley plc and its principal operating entities from sterling to the US dollar, reflecting the growth of our dollar denominated premiums and the fact that the regulatory capital supporting the business is largely held in dollars. We believe that this change will give investors a clearer understanding of the group's performance over time. Accounting in dollars will significantly reduce the future volatility of Beazley's reported earnings due to foreign exchange movements – and in particular due to foreign exchange on non-monetary items.
In June 2009 we redomiciled our holding company to Ireland. The move has achieved all the objectives we described in last year’s annual report, affording us a strong regulatory environment and a competitive tax regime. Our effective tax rate in 2010 was 13%. We take comfort in the Irish government’s strong commitment to the existing corporate tax rate, which has proved an incentive to investment by many companies in the insurance industry, among others.
Our claims experience was positive in 2010, with a claims ratio of 52% that was an improvement on 55% in 2009, despite the impact of two major earthquakes. Our balanced underwriting portfolio gives us the ability to offset the impact of catastrophe losses with profits from other lines of business. This also improves the capital efficiency of our business.
In 2010 the US hurricane season passed without incident but there were two significant earthquakes along the Pacific “ring of fire”, the first in Chile and the second in New Zealand. Our estimate of the claims cost from the Chilean earthquake remains in the range of $55m to $75m. In the case of New Zealand we initially estimated a group loss of $15m- $30m based on a market loss of $2bn- $4bn. We have subsequently increased this to a group loss of $35m, based on the updated market view of losses to $3bn-$5bn.
The number of claims in our political risks book, which had risen in 2009 due to the impact of the global economic crisis on trade credit business, returned to long-term average levels in 2010.
Specialty lines, our largest single division, also saw a reduction in the frequency of claims for directors’ and officers’ (D&O) and employment practices liability (EPL) business, two of our more recession-exposed lines. Our approach to recession planning and cycle management in specialty lines has been rigorous, reducing our exposures in areas such as EPL, D&O and mid market architects and engineers (A&E) professional liability while increasing our underwriting areas such as data breach insurance and parts of our healthcare account.
The end of 2010 and the start of 2011 have been marked by heavy rains and flooding in Queensland, Australia as well as a significant tropical storm, Yasi. We do not expect the cost to Beazley of the insured losses occuring in 2010 from these events to be material. Whilst it is too early to be able to make any definitive statement concerning the events that have occurred so far during 2011 due to the uncertainty, we believe they will be contained within our first half 2011 catastrophe budget.
Delivery against strategic priorities
Our strategy focuses on three areas: prudent capital allocation to achieve sustainable profitability across the group; nurturing and enhancing our skills base; and scaling our operations so that, as growth opportunities arise, we can continue to provide the high level of service that our clients and brokers have the right to expect.
In the second half of 2010 we made an approach to acquire Hardy Underwriting Bermuda Limited (Hardy), a small complementary and high quality specialty insurer. Whilst our indicative offer represented a significant premium to Hardy’s net tangible assets, we would have been able to achieve our target rate of return. However, Hardy’s board were of the view that our proposals did not fully value the company and so we withdrew. Seeking to acquire teams of underwriters, underwriting agents or small or medium sized insurance companies in our target markets and product sets remains one of our key priorities.
We have never been reluctant to return capital to shareholders in circumstances where we are not confident that we can allocate it to meet or exceed our pretax cross-cycle return on equity target rate of 18%. During the course of 2010 Beazley plc acquired 16.8m of its own shares to be held in treasury at an average price of 112.1p.
Our markets are becoming more competitive but in 2010 we planted the seeds for a number of growth opportunities that we expect to bear fruit in 2011 and future years. John McNally, one of the most experienced underwriters of M&A-related transaction liability insurance in London, joined our management liability team at Lloyd’s. The team has since encountered a strong appetite from private equity investors looking to reduce some of the risks to which merger and acquisitions (M&A) transactions are exposed. We are fast becoming a leading market in London for these specialist types of insurance, which are increasingly appealing to clients in Europe and Asia, as well as to the traditional buyers in the US.
In the US, our newly formed environmental liability team led by John Beauchamp unveiled three new products in the course of the year. Environmental risks threaten a wide variety of commercial organisations, including owners of property; industrial and commercial operations; general and specialty contractors; and the environmental services industry. The claims can be complex and benefit from strong risk management and claims support. They play to the strengths of Beazley and of Lloyd’s – and we will begin underwriting environmental risks from the Beazley box at Lloyd’s in 2011.
A third area in which we see considerable growth potential for Beazley is the specialist accident and health market in the US. In January 2010, we were delighted to welcome Paul Gulstrand, who joined us from UnitedHealth Group to develop our accident and health insurance business in the US. In the course of 2011, Paul and his team will begin to offer a range of simple and streamlined insurance products to US employers that wish to offer “gap protection” to their employees in an affordable manner, providing cover not normally afforded under company health care plans.
All of our product lines, old and new, rely on the skills of seasoned underwriting and claims professionals, working closely together, to deliver profitable growth over time. Beazley is not a hierarchical or bureaucratic company: over our 25 years we have found that the greatest success comes from taking highly motivated and experienced individuals and giving them the entrepreneurial freedom to develop their business. This is the approach that has governed the growth of our Lloyd’s business and we have found it holds particular appeal in the US where our marketing tag line is "straight answers".
A consequence of this approach is that we make hiring decisions very carefully. Entrepreneurial freedom is not to everyone’s taste and some underwriters lack the experience to exercise it with confidence and success. But the payback for investing time in identifying these individuals is high: good people tend to stay with Beazley for many years.
Growth of locally underwritten US business
In March, we celebrated our fifth anniversary as a local US insurer. In our first year, 2005, we underwrote $15m through our US operations; last year we underwrote $393.6m, 23% of total group premiums, up from $370.7m in 2009.
Our local US business focuses on smaller scale risks in lines of business with which we were already very familiar through our Lloyd’s syndicates. Our position at Lloyd’s in large risk business has proved a powerful source of credibility for our US underwriters in targeting smaller clients.
Board and executive changes
We made a series of additions to the Beazley board in 2010. In November Ken Sroka joined the board as a non-executive director. He was formerly head of product development at Zurich Financial Services, where he created and directed Zurich's financial lines business in North America and more recently focused on the development of specialist products.
Rolf Tolle and Adrian Cox were appointed to the board in December. Rolf had joined the board of Beazley Furlonge Ltd, the Lloyd’s managing agency which forms part of the Beazley Group, in June. He retired as franchise performance director at Lloyd’s in December 2009 after seven years in the role. Adrian has headed our largest division, Specialty Lines, since 2008.
We also made two appointments to the Beazley executive committee in 2010. Strong broker relationships are the lifeblood of Beazley and we were delighted to welcome Dan Jones as a member of the senior management team in June. In his new role, Dan – who stood down as a non-executive director on the Beazley plc board – is focusing on deepening relationships with key business producers around the world. Dan brings extensive knowledge of the insurance broking sector on both sides of the Atlantic. Between 1997 and 2005, he served as a senior executive at Marsh, Inc.
Andrew Pryde has also joined the executive committee as chief risk officer. As group actuary, Andrew has been leading our efforts to ensure compliance with Solvency II, which are well advanced.
Andrew Beazley, who co-founded the company with Nick Furlonge and led it successfully for 22 years, died on 13 October. Andrew was a powerful source of inspiration to us and, through his career, to hundreds of people at Beazley and in the broader insurance market. We will miss him deeply as a colleague and as a friend.
Andrew co-founded and led a company that has achieved a 25-year record of unbroken profitability and steady growth through often turbulent market conditions, built on mutual trust, openness, respect and a strong sense of fun. It is a legacy we cherish.
Jonathan Agnew Andrew Horton
Chairman Chief executive
8 February 2011