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Sure Thing

By Spear's

George Leigh looks at the remarkable comeback of the world’s most venerable – and vulnerable – insurance firm

If you lit up a large cigar in White’s or Boodles fifteen years ago and said that by 2007 Lloyd’s would once again be a fashionable investment opportunity for Britain’s monied classes, chances are that you’d have been laughed out of the door.

But then, disaster is the stock in trade of the insurance industry, and 300 years of history doesn’t simply disappear in a single puff of ill-advised smoke. Lloyd’s had been hit by several Titanic-like disasters before: fire rased the Royal Exchange – where Lloyd’s was once housed – to the ground in 1838, destroying the majority of Lloyd’s early records.

Yet, the Exchange was rebuilt, and the market which Edward Lloyd set up in a coffee house in 1688 on Tower Street was reconvened. Today, the Richard Rogers-designed Lloyd’s building on Lime Street is one of the architectural centrepieces of modern London.

Moreover, amongst serious high-net-worth (HNW) private investors in the UK who are looking at ways of diversifying their investment portfolio in a way not linked to property prices or stockmarket, the opportunities offered by becoming a ‘name’ today at Lloyd’s – either through limited companies (‘Namecos’) with limited liability or as one of the new limited liability partnerships (LLPs) – means that a new breed of Lloyd’s member are able to sleep at night in their Holland Park houses, Sussex mansions or racing yachts moored in Valencia.

The much-needed revolution at Lloyd’s has meant wealthy and savvy HNWs with considerable assets are once again making up to 52 per cent returns on capital in some years on their assets pledged to various Lloyd’s syndicates.

These syndicates write different classes of insurance and reinsurance business, in areas such as marine, non-marine, aviation and UK motor. Names usually invest in a number of sundicates, in a spread portfolio, thereby ensuring that they have a good spread of insurance risk.

So what went wrong? Nigel Hanbury, chief executive of the Hampden Agencies (whose firm is the largest advisor to private names at Lloyd’s) and a member of Lloyd’s Council, may look the part of the charming gentleman-insurance broker, but he does not make any excuses for the Lloyd’s debacle of the 1980s or early ’90s.

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Almost everyone knows someone who was caught up in this recurring Lloyd’s nightmare and many ‘names’ were seriously hurt by it, being forced to sell their estates, houses, pictures, yachts, jewellery, family silver – in some cases everything – in order to pay their underwriting losses.

‘Someone once said to me that an aeroplane never crashes by itself,’ says Hanbury. ‘It crashes because the engine fell off, the pilot fell asleep or when he pulls the lever, he pulls the wrong one. Lloyd’s was the same thing. There was an awful lot of stuff which went wrong.

‘In a phrase, the problem was “unlimited liability”. People make money and lose money in investments all the time and when you have unlimited liability you have no negotiating position. Large swathes of England were pledged on the back of Lloyd’s.’

There wasn’t just one reason for the Lloyd’s fiasco. The system was outdated and ineffective when it came up against the poisonous concoction of asbestosis claims and the litigious nature of the US courts. The Lloyd’s of the 1980s was a very different place to the Lloyd’s of today.

Perhaps the biggest change has been that while the previous generation of Lloyd’s names were signed up in a state of relative ignorance, often feeling flattered to be asked – like joining a private club – today’s agents and brokers go to serious lengths to make sure that all new ‘names’ know exactly what they are getting themselves into.

A good example of a Lloyd’s name who toughed out the dark days of unlimited liability and remains a name today is Aubrey Adams, managing director of estate agents Savills, who first became a member in 1986.

‘I think I had one year when there was a profit and then we started hitting the troubles,’ he recalls. ‘The worst of it was just not knowing what you could be in for. But when I became a member one of my sponsors did warn me that I had to think hard about some of the potential claims coming out of the US.’

Aubrey has no bitterness about the way he was first introduced into the market: ‘It was not a hard sell. My tax adviser told me that I should take a look at Lloyd’s. I went into Lloyd’s with my eyes pretty wide open but just slightly unaware of what the potential downside could be’.

Although Aubrey had the assets and alternative private means to weather the bad years, many others – who possibly went into Lloyd’s for all the wrong reasons – were not so fortunate.

‘I was slightly amused back in the old days when some people saw membership of Lloyd’s as membership of a social club. Like a badge of honour. And it was probably those people who were very badly hit and couldn’t afford it. To my mind it is a business venture like anything else.

‘It is really for people who are serious investors. You need to do it on a reasonable scale, you need to have other assets, and then it becomes a proper business venture. I don’t think anybody should be in Lloyd’s if they are looking at it as their main source of income’.

Talk to any of the top leading underwriters today and although they will privately concede that some of the prospective opportunities today at Lloyd’s are not as great as they were around 2002/3, and some may say that the ending of unlimited liability (although some ‘names’ do still choose this option) and the reduction in the total number of syndicates (in particular, those accepting private, third-party capital) have combined to improve the risk:reward ratio for participants across the cycle.

As Lloyd’s underwriter David Shipley, of Managing Agency Partners, puts it: ‘While nobody should be fooled into believing that the insurance industry as a whole is well run or that cycles have been consigned to history, the Lloyd’s market has shown that it can generate excellent profits in good years, and the syndicates accepting private capital have generally outperformed the market average, probably because many of them have a sharper underwriting focus than one would find in a more corporate environment’.

Nigel Hanbury is certainly one of the sharpest and more seasoned Lloyd’s advisers in today’s insurance market. Hampden provides advice on different classes of (re)-insurance business, which are matched with HNW clients’ appetite for risk and reward to create bespoke syndicate portfolios.

His firm’s clients currently provide £1.5 billion of capacity to Lloyd’s, making up 9.5 per cent of the total Lloyd’s capacity of £16.1 billion. They can either invest via a unit trust type of participation, which pools clients’ syndicate participations into one fund known as a MAPA; or else as individual ‘names’ who pledge their assets on an unlimited liability basis (few who wish to sleep at night choose this option today), through limited companies or English LLPs. Following the introduction in 2007 of LLP partnerships, 185 of their clients swiftly converted into LLPs for the 2007 account.

Hanbury has had family associations with Lloyd’s for many years. As a young man back in the 1970s, when he was working outside of insurance but his family were Lloyd’s names and investors, he couldn’t but help notice the sizeable and seemingly endless stream of cheques cascading through his family letterbox.

Knowing that ‘there’s no such thing as a free lunch’, Nigel took a closer look at how Lloyd’s worked in order to understand the income source of the cheques. He liked the model so much that he joined Lloyd’s as a broker and then switched to the members agency side in 1986 when ‘the troubles’ weren’t very far away.

Hanbury lost money himself when the business went down, but decided to stick it out as both a name and as a career. ‘The weaker companies were going to the wall and the casualty rate was like the Somme. But I was in a firm that was not damaged that badly and I felt Lloyd’s was still a good business, lots of time and money had gone into it… I thought it would have been a pity to abandon ship.’

When Lloyd’s hit trouble two decades ago there were 420 syndicates and now there are just 66. From a standing army of 220 member’s agents, only two now survive. ‘So there has been this enormous culling,’ says Hanbury. ‘Combined with the move into the electronic age, Lloyd’s is just unrecognizable today.’

Gone are the days when Lloyd’s operated like a secret private club with a laissez-faire attitude that included CEOs giving their secretaries memberships at Lloyd’s as a retiring present. ‘That sort of thing was inexcusable,’ says Hanbury.

The ideal potential Lloyd’s name today is a HNW with more than £5 million in assets, although many have less. Of the £5 million, they might pledge perhaps a million to Lloyd’s, so if disaster struck they would still have several rooves over their head and be able to pay the school fees. They should ideally have a portfolio of stock, maybe some bonds, probably some hedge funds and some private equity.

‘They should be a reasonably sophisticated investor, simply wanting to add Lloyd’s on as an additional asset class alongside existing asset classes,’ advises Hanbury. ‘I don’t feel comfortable with clients wanting to pledge over half their net worth. Ten per cent is what I would usually advise.’

In the old days such cautionary advice was often not forthcoming, especially in the days of ‘Recruit to Dilute’ – by which some less scrupulous members proposed their friends or acquaintances to minimise their own exposure. Back then Lloyd’s Central had no real authority over the conduct of business in the market. That has all changed.

‘Now Lloyd’s understands that it is a franchise. One person behaving badly affects everyone else. Hanbury likens it to McDonalds selling a cold hamburger in Beijing, and it affecting the market in the UK. ‘It ruins the franchise throughout the world’.

Why become a Lloyd’s name today? ‘The more uncertain the world you’re in, the more valuable insurance is,’ says Hanbury. ‘That’s why.’

Events like costly terrorism attacks and hurricanes can be both good and bad for Lloyd’s members. The important point to realise is that members are paid out in three-year cycles. The year 2001 was a bad year for the insurance market as a result of the World Trade Centre loss.

Lloyd’s recorded a loss of 28 per cent on capital. However, in an age of global terrorism, people are now prepared to pay higher rates to protect against such eventualities, and rates increased by a substantial margin.

Thus Hanbury’s HNW clients recorded a profit of 34 per cent on their assets pledged in 2002, a whopping 52 per cent in 2003 and 22 per cent in 2004. In 2005 the firm managed to just about break even, despite the hurricanes Rita, Katrina and Wilma. ‘It gives you a great chance to make meaningful money.

‘From 2001 to 2006, our investors have made over 100 per cent in their capital pledged. 2005 was an appalling year, but 2006 is another winner with around 40 per cent returns on capital.’

An investment in Lloyd’s is purely aligned to what people are prepared to pay (rates, terms and conditions) and what is paid out (claims). Before the World Trade Centre loss (which was hugely costly for names), insurance companies often didn’t charge separately for terrorism.

‘We threw it in for free with property insurance. People didn’t appreciate the risk. After 9/11, we started charging separately for terrorism. And everybody takes it, from fish farmers in Norway to grain storage facilities in Idaho. Boards of directors insist on it. So now, that market is profitable and good to be in.’

Profit is inevitably aligned to the trends in the market – in the lexicon of the hedge fund, this is not an ‘absolute return’ – but Lloyd’s consistently outperforms its competitors. It’s the world’s leading insurance market, and this is unsurprising when you consider that those who insure with Lloyd’s include: 93 per cent of Dow Jones Industrial Average companies, 94 per cent of FTSE 100 companies, 85 per cent of Fortune 500 US Companies and the top 20 global banks – to name but a few.

As investment in Lloyd’s does, in part, correlate to a variety of unpredictable variables, it might be seen as taking a punt on the state of the world. True, there’s a ‘fender-bender’ – as Americans call light road accidents – everyday in every town in every country, but nowhere near as many as there are cars insured.

Another reason for looking at Lloyd’s as an investment opportunity is that the risks taken by Lloyd’s aren’t affected by the portfolio risks a HNW individual has elsewhere. ‘Property market or stock market – up or down,’ says Hanbury. ‘It makes no difference. People with a lot of money are now thinking London property is a bit toppy. The equity can be used at Lloyd’s and it doesn’t make any difference to us what other asset classes do.’

Another reason Lloyd’s can be attractive to HNWs is that it allows a double use of assets for a relatively low cost (to get into Lloyd’s will cost you a one-off joining fee of £10,000 and being a member incurs an annual ‘running fee’ of £5000). On top of that you have to spend money to get into your chosen syndicates, although that money is like buying into a debenture at Wimbledon in that you get the money out if you want to leave the syndicate.

‘In the old days, you sometimes had to wait for years to get into certain syndicates,’ says Hanbury. ‘Now you simply buy in. We don’t actually want the investors to give us their cash. We want them to just pledge it, usually through a letter of credit. So you might have an investor with a buy-to-let portfolio of twenty houses in Wolverhampton that has doubled in value. That means his yield has probably gone down quite significantly.

‘Now it is looking like a big pot of money with lots of equity getting you a two per cent yield. Well, you can get an additional return by simply pledging the value to Lloyd’s through a letter of credit and, because of ‘limited liability’, the exposure is limited to an amount of credit, so you get to use it for a second time to get a second yield on those assets.’

While making money out of disaster, Lloyd’s takes pride in the good works that it does, and much of the redevelopment of New Orleans is being constructed on funds made available by Lloyd’s and other insurance firms.

Do you need to have a gambler’s appetite to be a Lloyd’s name today? ‘I think there is a huge difference between joining Lloyd’s and gambling,’ says Hanbury. ‘It is not gambling – as the names own the casino. Over time we always hope to make money’.

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