September 2015

Issue 72

General ReView
About this Newsletter
This issue of General Review was
written by Chris Myers, Enterprise Risk
and Capital Management Professional.
Each issue provides review and
comment on current investment and
capital management subjects impacting
the insurance industry. Chris may be
reached at chris.myers@grneam.com.
Farmington Office
General ReNew England
Asset Management, Inc.
74 Batterson Park Road, 3rd Floor
Farmington, CT 06032
+1 860 676 8722
Exploring Lloyds Syndicates
Investment Choices
Volume 2: Contrarian Outcomes Matter
Executive Summary
Low investment yields, softening insurance rates and coverage terms, regulatory
pressures and general economic uncertainties highlight the new normal that
insurance companies face on a daily basis. The Lloyds insurance marketplace is not
immune to this landscape. Although these difficulties can affect either side of an
enterprises balance sheet, Lloyds managing agencies and syndicates continue to
follow a tradition of marked conservatism in their investment strategy relative to
their insurance operations (see Exhibit 1). This would imply an elevated insurance
risk budget relative to investment risk, which perhaps is driven by expectations of
relatively higher risk-adjusted return through undertakings or could be linked to
historical traditions.1
In this second volume of Exploring Lloyds Syndicates Investment Choices, GRNEAM
will discuss the impact of balancing return and risk across the enterprise, given some
of the aforementioned challenges. In particular, we will apply an Enterprise-Based
Asset Allocation (EBAA) process for a Lloyds enterprise embedding mark-to-market
metrics not unlike those within Solvency II. The result is an optimal, yet contrarian
illustrative portfolio. It may be outside of typical ranges of a Lloyds syndicate
investment strategy, but the analysis highlights some considerations to support an
enterprise risk and capital strategy nonetheless.
Also see our first volume in this series.
Exhibit 1. Evaluation of Lloyds Historic Earnings Performance2
Lloyds 20052014 Earnings From Continuing Operations

4500 3000
Dublin Office

Component Earnings
4000 2500
GRNEAM Limited 3500 2000
Total Earnings

3000
Registered Office: 2500 1500
2000 1000
The Oval, Block 3 1500 500
Shelbourne Road 1000 0
500 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Ballsbridge, Dublin 4 Ireland 0 -500
-500 -1000
+353 1 6738 500 -1000 -1500
Investment Earnings Insurance Earnings Total Earnings
Ten-Year Earnings Statistics
London Office
Investment Insurance Total Overall, Lloyds earnings
GRNEAM Limited London Branch
000,000 Earnings Earnings Earnings from 2005 to 2014 were
6th Floor, 3 Minster Court
23.5B, with approximately
Mincing Lane Total 11,116 12,414 23,530
53% derived from insurance
London EC3R 7DD United Kingdom Yearly Average 1,112 1,241 2,353 versus 47% from investments.
+44 20 7929 2715 Insurance earnings volatility
Yearly Volatility 402 1,391 1,512
(StDev) was three times the volatility
www.grneam.com
Source: GRNEAM and Lloyds 2014 Annual Financials from investments over
the period.
Optimal Sources for Enterprise Performance
Exhibit 1 shows that investment-driven earnings performance on a simplified
risk-adjusted basis outpaced insurance-driven earnings over the past 10 years. This
includes notable stress events having an impact on both sides of the balance sheet,
such as the major property catastrophe loss years of 2005 and 2011, and the financial
crisis in 2008.
To understand this more fully, consider Exhibit 2, which compares the average
insurance and investment returns3 over the past 10 years to their underlying standard
deviations. While insurance returns have historically been close to 500 basis points
higher than investments, the unit of return per unit of risk investments has historically
doubled that of insurance.
Exhibit 2. Comparison of 20052014 Historic Investments and Insurance Returns per
Their Respective Unit of Risk

Investments Insurance
Average Return (%) 2.60% 7.49%
Volatility (StDev) 1.30% 9.14%
Return per Unit of Risk 2.00 0.82

Historic results are not necessarily indicative of future performance. Moreover, there
are multiple ways to measure return and risk beyond earnings and standard deviation.
At issue is if the sources of returns across the enterprise merit their underlying risks,
and choosing an optimal mix of those sources to enhance overall performance and
value to the enterprise. Reaching the optimal mix should consider prospective views
on how insurance lines and asset classes will evolve in the coming period, how
these sources correlate, and ultimately if the sources of risk and return fall within the
organizations risk tolerance levels.
Expected return on equity (ROE) is a logical starting point for such analysis. It is worth
revisiting the components of ROE for a typical non-life insurer that were discussed in
the first volume of this series. ROE could be decomposed into four elements following
a DuPont framework:4 insurance returns (i.e., 1 minus the combined ratio), premium
leverage (i.e., net earned premiums divided by equity capital), investment returns
(i.e., investment gains and income divided by invested assets), and investment
leverage (i.e., invested assets divided by equity capital). Exhibit 3 illustrates this
formula, which is further refined when adjusted for taxes.5
Exhibit 3. DuPont Framework for Decomposition of an Insurers ROE
Return Earnings Premium U/W Investment Investment
on = = X + X
Equity Leverage Margin Leverage Returns
Equity

Traditional strategic asset allocation focuses only on optimal mixes of asset classes,
without regard to how these asset classes behave with insurance operations.
GRNEAMs EBAATM framework considers insurance operations and invested assets
jointly as the enterprise portfolio to optimize, fully embracing an investment
philosophy that recognizes both sides of the balance sheet to determine an
enterprises success (see Exhibit 4). This combined perspective provides a holistic
understanding of an organizations existing risk and return profile. It also guides
investment decision making in a more informed way, as opposed to a nave approach
of managing insurance operations and investments in independent silos.

2 GRNEAM
 Exhibit 4. Illustration of an Enterprise-Based Efficient Frontier
Enterprise Portfolio Return Efficient Frontier

B Higher Return
with Same Risk

A Firms Current
Risk/Return
C Same Return
with Lower Risk

Enterprise Portfolio Risk

Enterprise portfolio is a joint view of invested assets and insurance products.

GR-NEAMs EBAATM approach is predicated on a holistic view of the enterprise.

Investments and insurance products are viewed jointly when considering optimal
allocations. Thus, we consider the enterprise as a portfolio, not simply the invested assets.

Understanding the Enterprise Return and Risk Profile

Over time the driver for Lloyds earnings, as well as the underlying volatility of
earnings, has largely come from its insurance operations. Based on Lloyds recent
financial disclosures, statistical data and certain reasonable assumptions, we
estimate a current allocation of invested assets and insurance undertakings outlined
in Exhibit 5. Complementing these estimates are our assumptions surrounding
projected returns, volatilities and correlations. Collectively, this forms a foundational
understanding of the overall return and risk profile shown in Exhibit 6.
Exhibit 5. Estimated Current Distribution of Invested Assets and Insurance Product
Undertakings for the Lloyds Proxy Enterprise
Invested Assets Insurance Products
Total Invested Assets (M) 54,860 Total Net Earned Premiums (M) 19,575
Short Term/Cash 31.7% Reinsurance 34.1%
Corporate 30.5% Property 23.4%
Quasi/Government 24.1% Casualty 20.1%
Structured 7.5% Marine 9.0%
Equities 5.9% Energy 5.6%
Alternatives 0.3% Motor 5.5%
Total 100.0% Aviation 1.9%
Life 0.4%
Total 100.0%
Funds at Lloyd's (Proxy for Equity
15,704
Capital) (M)

Exhibit 6 shows an estimated one-year enterprise return and risk profile for the
Lloyds proxy enterprise and how this is shared between insurance and investments.
The expected return for the enterprise is 11.7%, with an underlying volatility of 18.8.
The return estimate assumes the reported year-end 2014 combined ratios by line of
business will remain the same in 2015. The volatility considers the variation of the past
five years of insurance returns as shown in Lloyds statistics.
GRNEAMs prospective view of price and income returns by asset class is reflected
within the investment returns. As expected, most enterprise earnings risk comes
from insurance operations, almost eight times more than assets, as denoted by the
insurance and investment variances within the Risk Partition table. But the expected
insurance return of 10.8% is also much higher than expected investment returns
of 0.85%.
General ReView, September 2015 3
Exhibit 6. Estimated Current Enterprise Return and Risk Profile
Enterprise Statistics Risk Partition
Total Return on Equity 11.73 Investment Variance 37.87
Earnings Risk (StDev) 18.79 Insurance Variance 297.46
99.5 VAR % of Capital 42.47 Inv. & Ins. Covariance 17.87
99.5 T-VAR % of Capital 47.35 Total Variance 353.20
Investment Return 0.85 Total Standard Deviation 18.79
Investment Leverage 3.50 Investment 99.5 T-VAR % of Capital 16.26
Insurance Return 10.78 Insurance 99.5 T-VAR % of Capital 43.62
Premium Leverage 1.25 Hedge (12.53)
Enterprise 99.5 T-VAR % of Capital 47.35
Investment Correlation 0.34
Insurance Correlation 0.28
Inv. & Ins. Correlation (0.11)

In the prior section, we discussed how premium and investment leverage influence
ROE, acting as multipliers of both returns and volatility. Moreover, the impact of
leverage on the projected risk-adjusted return, as measured by the amount of
return for a given unit of risk, is higher for insurance than for investments. These
characteristics, coupled with correlation, must be factored in as management
determines the optimal return and risk profile for the enterprise.
One of the more important factors of an insurers risk profile is the sensitivity of
its capital to extreme downside risk. T-VAR is one way to measure that tail risk
exposure. In Exhibit 6, the 99.5% T-VAR for the Lloyds proxy enterprise is 47.35%
of capital, with the insurance portion of the T-VAR accounting for 2.7 times that
of investments.

Enhancing the Enterprise Return and Risk Profile

The previous section showed that Lloyds enterprise performance was driven by the
success of its insurance operations. We will assume that the current mix of insurance
undertakings must remain static for the coming period. Therefore risk, return and
leverage associated with insurance operations are fixed in this analysis. However,
there may be opportunities to enhance investment returns and overall ROE with some
modest adjustments to the asset allocationwithout changing the existing enterprise
risk profile shown in Exhibit 6.
Such adjustments must also consider micro-level risk factors, such as changes to
interest rate risk, credit risk and even regulatory or rating agency requirements;
for instance, certain European Union directives and recent Solvency II technical
specifications produced by the European Insurance and Occupational Pensions
Authority limit the ability of a European Union insurer (such as a Lloyds entity) to
invest in certain types of structured securities. There are potential onerous capital
charges in some cases and questions of general eligibility in others.6 As we consider
alternative portfolio structures, these restrictions will be factored into the analysis.
Exhibit 7 illustrates an efficient frontier for our Lloyds proxy enterprise. As discussed
in Exhibit 4, this curve represents optimal portfolio constructs consisting of invested
assets and insurance undertakings. Thus, it shows alternative perspectives of holistic
enterprise portfolios relative to the current portfolio.

4 GRNEAM
 Exhibit 7. An Efficient Frontier for the Lloyds Proxy Enterprise With Selected
Characteristics of a Similar Optimal T-VAR Portfolio
16 Similar
Enterprise Results Current
T-VAR
Enterprise Total ROE %

Target: Similar T-VAR

Total Return on Equity 11.7 14.2
14
Investment Returns 0.9 1.6
Insurance Returns 10.8 10.8
12 Earnings Risk (StDev) 18.8 19.5
Current
VAR (99.5%) 42.5 42.3
10 T-VAR (99.5%) 47.4 47.4
Sector Distribution %
Short Term/Cash 31.7 5.0
8
16 17 18 19 20 21 22 23 24 Quasi/Government 24.1 34.5
Enterprise Risk (Std Dev) % Corporate 30.5 49.8
Structured 7.5 0.5
Focusing on the similar 99.5% T-VAR portfolio along this frontier, we estimate
almost doubling investment return by 71bps from 0.9% to 1.6% over the Equities 5.9 9.0
coming 12-month period. Considering leverage, this translates into an increase Alternatives 0.3 1.3
in ROE to 14.2% from the current 11.7%. The earnings risk rises slightly, but Total 100.0 100.0
the enterprise risk profile as measured by T-VAR does not change. Noteworthy
Risk Assets % of Capital 22.8 52.4
is duration extension and a one notch decrease in average credit quality from
moving to this point on the frontier. Moreover, risk assets would rise to 52% of SII Asset Charges (B) 5.0 8.1
capital, elevating Solvency II asset charges from approximately 5.0B to 8.1B. Return on SII Charges (%) 9.3 10.6
However, the estimated return on these SII risk charges increases from 9.3% Average Rating AA+ AA
to 10.6%.
Below Investment Grade % 0.4 4.8
A siloed view on certain asset classes is partially informative. Even investment Duration 1.97 3.5
choices that appear to be low risk in isolation can have correlation
KeyRate < 3 % 80 28
characteristics that, when aggregated with other assets or liabilities, are less
accretive to a portfolios return and risk profile. GRNEAM feels that structured KeyRate 35 % 20 51
securities can make sense as part of a long-term fixed income strategy, but as KeyRate 57 % 0 11
regulatory restrictions for this asset class become effective under a Solvency KeyRate 710 % 0 5
II regime, that sentiment warrants new reflection. In some cases alternative
Asset/Liability Correlation (0.11) (0.09)
portfolio structures and asset class allocations will be prudent. That said, as we
consider all risk, return and correlation characteristics across eligible investment
choices, we may still find optimal portfolio constructs that enhance the overall
enterprise return and risk profile, even if an asset class such as structured securities
suddenly becomes ineligible.
GRNEAM feels that decisions to make significant changes to investment guidelines
and investment risk budgets should be done in context with other risks to which
the enterprise is exposed. Some of the portfolio changes indicated in the examples
above might present certain micro risk characteristicse.g., duration, Solvency II
capital chargesthat are too significant despite no changes in T-VAR. Corporate risk
tolerances should be understood and articulated as insurance or investment strategies
are contemplated. Otherwise, the efficacy of prudent enterprise risk management
would be challenged.

Final Thoughts
Under the traditions of prudent enterprise risk management, insurers are tasked with
selecting an optimal mix of return opportunities given their underlying risks. That
mix is predicated on jointly satisfying the expectations of capital providers, rating
agencies and regulators. We have shown that, historically, traditional Lloyds
syndicate balance sheets have a strong bias towards insurance return and related
risk, despite certain evidence that investment returns provided a more favourable
trade off. However, if Lloyds stakeholders prefer that bias, or expect future returns
to be different, such preferences must be accounted for within any enterprise-based
asset allocation process.
General ReView, September 2015 5
As an example, GRNEAM has seen how regulatory and solvency concerns can have
an impact on investment choices. The viability of an investment strategy because
of eligibility questions or capital charges of certain asset classes might make an
otherwise efficient portfolio structure less than optimal. These aspects are critical
components as we evaluate investment strategies and risk and capital management
alternatives for clients.
Even what seems to be an optimal mix of insurance and investment must be viewed
with some scepticism. GRNEAM approaches any enterprise-based allocation process
as a guide, and one whose results should be stressed and challenged. Contrarian
views on the allocation of risk and assets provide useful insights. However, we insist
on understanding the consequences of being wrong. Collectively, this allows for
a more informed view for the investment manager, risk manager, and ultimately
the directors of the firm to make better decisions, which can lead to enhanced
performance and higher valuations.
GRNEAM will continue to evaluate other considerations in the investment
management process for Lloyds, its syndicates and its managing agencies.
Regulatory change, capital market volatility, geopolitical uncertainty and insurance
market consolidation will offer multiple choices for exploration in future discussions.
We also invite readers to suggest other topics of interest.

6 GRNEAM
Endnotes
1 This might be partially attributed to the legacy of Reinsurance to Close (RITC) transactions
used to support the typical three-year lag of closing out an underwriting year for the
operations of a syndicate account. This process added a degree of uncertainty with
measuring the ultimate risk associated with historic insurance writings. We would expect
that the impact of corporate capital backing Lloyds syndicates should reduce the influence
of RITC on investment strategy over time.
2 To isolate Lloyds investment performance from insurance operations, syndicate investment
returns are removed from the Lloyds reported technical account result and added to the
investment results captured in Lloyds non-technical returns line item. Therefore, insurance
operations are defined as the continuing operations line item from the Lloyds reported
technical account result, less syndicate investment returns.
3 Insurance returns equal annual insurance operating earnings divided by net earned
premiums. Investment returns equal investment earnings divided by financial investments
(including cash).
4 As suggested within the Lloyds annual report, we use the Funds at Lloyds balance as a
proxy for equity.
5 For this analysis, we assumed a 22% effective tax rate as calculated from the Lloyds 2013
financial statements.
6 Quick Takes, February 2015, The European Securitisation Solvency II Saga.

GRNEAMs portfolio management tools utilize deterministic scenario analysis to provide an estimated range of total
returns based on certain assumptions. These assumptions include the assignment of probabilities to each possible interest
rate and spread outcome. Projected returns do not represent actual accounts or actual trades and may not reflect the effect
of material economic and market factors. Clients could experience different results from any information shown. Results
shown are not a guarantee of actual performance returns.

General ReView, September 2015 7

 2015 General ReNew England Asset Management, Inc. All rights reserved.
This publication has been prepared solely for general informational purposes and does not constitute investment advice
or a recommendation with respect to any particular security, investment product or strategy. Nothing contained herein
constitutes an offer to provide investment or money management services, nor is it an offer to buy or sell any security or
financial instrument. While every effort has been made to ensure the accuracy of the information contained herein, neither
General ReNew England Asset Management, Inc. (GRNEAM) nor GRNEAM Limited guarantee the completeness,
accuracy or timeliness of this publication and any opinions contained herein are subject to change without notice. This
publication may not be reproduced or disseminated in any form without express written permission. GRNEAM is an SEC
registered Investment Advisor located in Farmington, CT. This designation does not imply a certain level of skill or training.
In the EU this publication is presented by GRNEAM Limited, a wholly owned subsidiary of GRNEAM with offices located
in Dublin, Ireland and London, UK. GRNEAM Limited is regulated by the Central Bank of Ireland. GRNEAM Limited is
authorised by the Central Bank of Ireland and subject to limited regulation by the Financial Conduct Authority. Details
about the extent of our regulation by the Financial Conduct Authority are available from us on request.
genrev1509-72