While not for everyone in the wealth management space, the Lloyd's of London insurance market offers an interesting blend of investment returns for investors.

(This item, which appeared in March, is repeated here ahead of the Breakfast Briefing involving the Association of Lloyd's Members, and this publication, on 28 April in London. For more details on this event, and to register, click here.)

One of the oldest financial sectors in London, the Lloyd’s insurance market has seen its fortunes wax and wane spectacularly. After surviving near-mortal wounds in the late 1980s amid man-made and natural disasters that hit investors, the market has been reformed. In recent years results for Lloyd’s have been attractive. So attractive, in fact, that in this era of modest equity market returns and fears about quantitative easing, they look very alluring indeed. 

With a history stretching back to the 17th century, Lloyd’s is not really an insurance company so much as a subscription market backed by a layer of mutual security, taking the form of a “Central Fund” to which all members – corporate and individuals - contribute and from which policyholders may be paid if a member of Lloyd’s can’t meet its liabilities. The market has around 60 managing agents running about 100 individual syndicates which underwrite insurance and reinsurance business for policyholders. 

This market has a language all of its own

Advocates of Lloyd’s say it gives investors the opportunity to enhance returns – albeit by taking on a level of risk. So how is the market doing and why should wealth managers take a closer look? To find out more, this news service recently spoke to Anthony Young, chief executive of the Association of Lloyd’s Members (ALM), and Chandon Bleackley, an experienced figure in the market. The latter takes over from Young in May, as Young is retiring after a long career in the sector.

Young qualified as a chartered accountant with Price Waterhouse before moving to the corporate finance department of Morgan Grenfell. In 1989 he became the managing director of CI de Rougement, a managing and members’ agent at Lloyd’s. He joined the ALM as its CEO in 2000. Bleackley has worked in a number of Lloyd's members' agents since 1989, including Christie Brockbank Shipton, Alpha Insurance Analysts and Hampden Agencies. He spent over 20 years working as a syndicate analyst but, in more recent years, he has focused on marketing membership of Lloyd's to potential new members. He joined the ALM in January 2016. 

The ALM is a not for profit trade association for the individual members of Lloyd’s, commonly known as “Names”, most of whom now trade across a broad spread of Lloyd’s syndicates with limited liability, through companies or limited liability partnerships (LLP) in which they are the only investor. Names now provide only about 10 per cent of Lloyd’s capital. The rest comes from larger companies, mostly insurance companies. The ALM board is entirely constituted of people who are themselves Names at Lloyd’s.

“Names at Lloyd’s enjoy the double use of assets (ie they retain the dividend or other income from the assets which they place in trust at Lloyd’s to provide security for policyholders and they add to this the underwriting and investment results of their syndicate participations). Their underwriting results are largely uncorrelated with other investments, and they also benefit from valuable tax advantages. The Lloyd’s market today is one of the primary global hubs for reinsurance and specialty insurance business, partly due to its status as a subscription market that is backed by a mutual Central Fund, which in turn brings with it the twin advantages of greater capital efficiency and a central body which assists its component parts to consistently outperform its peer group of other insurers,” the men told this publication.

“Most people who now consider joining Lloyd’s are middle-aged professionals, generally based in the UK.  Most of them are generally employed in finance or the law, or are entrepreneurs who have built up and successfully sold their business. The main reasons that they are interested in joining as Names are because they are attracted by the fact that the market can be viewed as an alternative, largely uncorrelated asset class that has produced some good returns to its Names in the past,” the men said. “They [Names] also benefit from the double use of assets that Lloyd’s allows, and the fact that there are significant potential tax benefits associated with membership. Tax issues and estate planning are undoubtedly one of the factors for new Names wishing to join the market,” they said.

The ALM likes to cite a report on the market’s track record and potential by Professor Tim Congdon, a prominent UK economist. In a paper entitled How profitable is Lloyd’s underwriting? (June 2007), Congdon crunched the numbers for Lloyd’s over the period 1950-2005 inclusive (including two periods of heavy losses, 1989-1992 and 1998-2001) and concluded: “It follows that an equities-based investor who puts all his or her capital into Lloyd’s as FAL [funds at Lloyd’s] should eventually double the return on capital”. (NB. In fact, Names would generally be advised not to put more than a small proportion of their assets into Lloyd’s as it is still a high risk investment.)

Bleackley and Young said: “In the past, when all Names underwrote on an unlimited liability basis, there were more older, retired people as Names, and many of these were asset-rich, cash-poor people who were looking to derive an additional source of annual income from their Lloyd’s membership. A considerable number of these people had inherited wealth, often in the form of property or land, which they wished to use to derive an additional source of income by using their assets to capitalise their Lloyd’s underwriting, often via a bank guarantee secured on such assets which could be called upon by Lloyd’s to pay claims if the Name was unable to find the cash. In some cases, some of these people had over-geared themselves and therefore found it hard to pay their losses.” In contrast, the losses of Names with limited liability are limited to the assets of the companies or partnerships through which they trade. 

From 2001 to 2012 (the last year for which data is currently available under the three year accounting basis for the payment of profits at Lloyd’s), the cumulative internal rate of return for the average Name who traded throughout that period was about 16.7 per cent, and that includes the heavy losses incurred in 2001 as a result of the terrorist attacks on the World Trade Centre and the two record years for natural catastrophe claims, being 2005 and 2011. (IRR takes account of different timings of entry and exits into and out of investments.)

Here is a chart to illustrate:

Prices are now high because very little new capacity is becoming available (ie supply is tight), and also because Names are not selling much existing capacity. The most likely cause of a future drop in prices would be if substantial new capacity were made available, probably largely by pre-emptions on existing syndicates if conditions in insurance markets were to improve so that the managing agent wishes to expand the syndicate. By and large the price is determined by Names buying and selling, although sometimes the managing agent might also try to buy capacity on its own syndicate.

Why recruit more Names?
Names’ capacity amounts to about 10 per cent of the overall market capacity. If that capacity drops below 10 per cent then the number of external Names elected onto the Council of Lloyd’s will be chopped from two to just one, probably in 2019. More Names will mean these investors will have more influence on the market, and will also allow more Names’ syndicates to be formed, thus providing Names with greater choice. (“Capacity” means the amount of premium income a syndicate or Name can underwrite.)

There are more than 180 firms of insurance and reinsurance brokers working at Lloyd’s, many of whom specialise in particular classes of business, but about half of it is brought in by the "Big Three" of Aon, Marsh and Willis. To be accredited, each Lloyd’s broker must show that it understands the market. 

Since the early 1990s reforms, Lloyd’s is now capitalised by large dedicated corporate members, only underwriting on their own managed syndicates and by third party members, mostly spread across a wide spread of syndicates. The vast majority of the latter are the Names. Corporate members were first introduced into Lloyd’s in 1994. Prior to that time, Lloyd’s was exclusively capitalised by third-party, unlimited liability members. In the late 1980s, the number of these unlimited liability members of Lloyd’s peaked at about 34,000.  (No new unlimited liability members have been permitted to enter the market since 2003.) 

As a normal rule, profits (or losses) are only paid out (or collected) after three years. So for example, the profits of business underwritten in 2016 are only calculated as at 31 December 2018 and are paid out in May 2019. However, cash calls may be required earlier than this following abnormally high claims activity. And yes, there are tax breaks, including the possibility of getting 100 per cent Business Property Relief against inheritance tax.

A Name trades on a portfolio of syndicates that are chosen in conjunction with his members’ agent. After 36 months, the syndicates calculate their individual profits and losses, and the Name’s shares of these are aggregated together to produce his annual result, which is normally expressed as a percentage of his capacity. Thus, a typical Name, with £1 million of capacity, who achieves a profit of £100,000 in a given year of account, is said to have achieved a profit of 10 per cent of capacity.

Other details

There are some other terms and pointers for wannabe Names to bear in mind. Each Name’s members’ agent charges an annual fee and may also charge a profit commission for its services. Also, each syndicate at Lloyd’s is an annual venture, normally renewable at the end of each year, at the option of the Name. Each year of account runs for 36 months.  Each Name essentially “puts up” or lodges capital each year, known as funds at Lloyd’s, which provides part of the necessary policyholder’s security to enable syndicates to underwrite insurance and reinsurance risks.

The required investment to become a Name at Lloyd’s is very largely made up of the cost of acquiring capacity on syndicates (ie the right to a particular premium limit on those syndicates) plus the funds at Lloyd’s (FAL) requirement. Capacity may generally only be acquired in the capacity auctions, which take place in October each year and which are normally highly illiquid, so that prices can sometimes be very volatile. The more highly regarded syndicates tended to cost about 60 pence to 70 pence per £1 of capacity in the latest auction season, but the less well regarded syndicates cost as little as 0.1 pence per £1 of capacity, and capacity on new syndicates, or on those syndicates on which there is no security of tenure for longer than one year, tend to cost nothing at all. Including such syndicates, the average value of a well-spread portfolio of syndicates in the most recent auction season was in the region of 40 pence per £1 of capacity. 

The size of each Names’ FAL requirement is largely calculated as a percentage of “capacity”. The capacity of a syndicate or a Name is the limit to the gross premium income, excluding brokerage, which it may underwrite in the given year. This percentage will be higher or lower depending on the risk profile of the planned business, but for a Name with a spread across many syndicates it will normally be about 50 per cent of capacity. 

An alternative, and perhaps easier, way to become a Name is to buy an existing company (known as a “Nameco”) or LLP from a Name who wishes to sell. Each members’ agent publishes on its website details of all such vehicles which are available for sale at any one time, and each members’ agent is normally prepared to advise potential Names in connection with the acquisition of such an entity.

The FAL can be in cash, bonds and/or shares, and/or letters of credit or a bank guarantee, either of which can be backed by an asset that the bank will accept as security although it should not be backed by the Name’s principal private residence.  

Syndicates underwrite insurance business in several different currencies. Typically, about 60 per cent of the business underwritten in Lloyd’s is underwritten in US dollars. This means that there is an exchange rate risk.  

They earn an annual investment return, including capital gains (or losses), on the premiums that they receive and on the reserves put by to cover losses not yet paid. The investment strategy pursued by most syndicates is very conservative and usually involves a portfolio built around cash and high grade short duration bonds (mostly US and UK).  

In summary, this is a complex market and with a language and approach that is very different from, say, playing in mainstream equities, or even venture capital and fixed income. However, at a time when the search for tax-advantaged, and hopefully, lowly-correlated returns has been boosted by the woes of the stock market this year, the Lloyd’s market might find a new wave of interest.

Click here for details on an upcoming event hosted by this publication on the opportunities and challenges of the Lloyd’s insurance market in relation to wealth managers.