Gallagher’s pre-renewal review 2020 – Financial Commentary

Broker Gallagher has released its pre-renewal review of the P&I Club’s performance in 2019-20 and with added commentary on the year to date and the prospects for the February 2021 renewal.

It noted that 2019‑20 was characterized as “the last year of the era of the zero general increase, which had lasted, in most cases, for four years”.

Gallagher said that the declining underwriting performance had been arrested in 2019-20 albeit at a level of a $600m underwriting loss.

As in 2018, the deteriorating underwriting outcome was bailed out by investment earnings.

Gallagher said that it was hard to say which trend was more unsustainable: consecutive years of massive underwriting losses, or a year when the investment income generated double the income of the previous seven year average level.

Between 2012-13 and 2017-18 Gallagher noted that the fall and rise of the underwriting loss was mirrored by a fall and rise of investment income. However, Gallagher said that this was more coincidence than any positive correlation.

“Things started to go pear shaped in 2018-19, where investment income collapsed, and only reached positive levels in the last months of the year” The broker said that 2019-20 saw the rising trend that started in late 2018 continue unabated, and a sufficiency of investment income arose to cover the continuing underwriting loss.

Gallagher suggested that the returns of capital or premium seen in the last few years were really a return of surplus investment income rather than having anything to do with technical underwriting performance. It said that some Clubs were prepared to accept “substantial underwriting deficits on closing policy years”.

The broker accepted that, arguably, this was what mutuality meant – but it said that central to this theory was a balanced consistent use of investment income to offset premiums set at non-commercial rates.

However, as Gallagher observed, if a Club reduced its ETC year-on-year it became expected and might even be seen as an indication that the Club was charging members too much in the first place, if it was possible still to return money in even the worst of investment years.

The following table summarizes the sources of revenue generated by the Clubs in each of the past two years, and the way they have utilized these funds, either as loss absorption, distributions to members or business development and restructuring. The balance has gone to augment free reserves.

$millions 2019-20 2018-19
ETC based Underwriting Result (449.1) (277.4)
Investment Income 767.6 101.8
Foreign Exchange (14.4) (63.8)
Other Income / (Expense) (3.4) 20.4
Taxation (30.4) (0.7)
Result for the Year 270.3 (220.7)
Excess Calls 24.7 0.0
Returns of Call (72.4) (51.0)
Returns of Capital to Members (41.3) (51.9)
Returns of Capital to Other Sources* (0.0) (99.9)
Acquisition of New Businesses 0.0 18.5
Movement in Free Reserve 181.3 (404.0)
Free Reserve, start of year 5,353.9 5,757.9
Free Reserve, end of year 5,535.2 5,353.9

*UK Club amortized a subordinated loan of $100m