Miles Trotter examines the recent history of investment in Lloyd's, identifies the main investors and asks whether opportunities still exist for those interested in participation in the world's oldest insurance market.

Recent years have seen rapid change in the provision of capital to the Lloyd's market. The chart below shows Lloyd's capacity split between the main types of capital provider. The market's traditional capital providers were individual unlimited liability Names. When corporate capacity first entered the market in 1994, Lloyd's rules restricted the new corporate vehicles to investment in a diversified portfolio of syndicate participations, akin to a traditional Name's portfolio.

These earliest investments in the Lloyd's market became known as spread vehicles. Twenty-five new vehicles commenced underwriting, having raised £900 million to support £1.6 billion in underwriting capacity. Initially, the entry of corporate vehicles boosted Names' confidence and in 1994 Names' capacity increased to over £9 billion. However, since 1994 the decline in Names' capacity has been swift at an average of approximately 22% a year between 1995 and 1999.The spread vehicles have also lost ground to dedicated vehicles, which participate in one or more syndicates managed by a single agency. In 1994, there was only one dedicated vehicle, Hiscox Dedicated Corporate Member Ltd, with £20.5 million in capacity.

Now, dedicated capacity is the dominant form of capital provision to Lloyd's with over £5 billion in capacity in 1999. Most of these vehicles are owned within a larger corporate structure that also includes the managing agency of the syndicates supported by the dedicated vehicle. Corporate structures of this type, incorporating both capital provision and ownership of syndicates, have become known as integrated vehicles. While these companies include a managing agency, managing underwriting for third party capital providers, they represent a transition to what will effectively be insurance companies operating in the Lloyd's market.

Last year saw the demise of the quoted spread vehicles at Lloyd's. One by one the remaining ones have merged with managing agencies and declared a new commitment to the formation of integrated vehicles. Between 1994 and 1998 growth in spread capacity was slow, and in 1999 capacity from this type of vehicle has declined sharply.

Growth has also been slow for conversion vehicles, formed to enable unlimited liability Names to convert to limited liability underwriting. Conversion capacity in 1999 is only just over £700 million in 1999, despite the considerable effort made to promote vehicles of this type.

Members' agencies and Lloyd's advisers

Until 1994, access to the Lloyd's market for unlimited Names had to be through a Lloyd's members' agent. When corporate capital was admitted in 1994, corporate members were required to appoint a Lloyd's adviser, although dispensation from this requirement could be given if adequate analytical skills existed within a corporate member. All members' agents automatically qualified for Lloyd's adviser status. In addition, new Lloyd's advisory companies were formed, some of which were entirely independent from members' agents.

From the start, many of the new corporates did not use members' agents. For example, LIMIT, the largest spread vehicle, was granted dispensation to use in-house analytical resources. Some members' agents fared better than others, successfully attracting new corporate clients in 1994 and 1995 and the new registered Lloyd's advisers were appointed by some of the vehicles. However, the move to dedicated capital provision has accentuated the break with members' agents and quickly undermined the purpose of the Lloyd's advisers. Now, most Lloyd's corporate vehicles do not employ a members' agent.

While some sections of the market may no longer need the services of a members' agent, it is unclear what will happen to the traditional agency role of capitalising new syndicates and assisting in the creation of opportunities for more able underwriters. As the corporate sector rapidly consolidates into fewer and larger trading units, there is a danger that the process of market renewal, facilitated by members' agents, may be lost.

Members' agents have also undergone a period of rapid consolidation, and it is possible that further mergers could reduce agency numbers to perhaps only three or four very large agents, controlling something around a third of Lloyd's market capacity between them. With a substantial commitment to the market as a platform, members' agents may be able to rediscover their venture capital skills, deploying Names' capacity in limited liability vehicles created to support start-up businesses in the market.

Managing agents

At the same time as the future began to look uncertain for members' agents, fortunes for managing agents improved. It has become apparent that the real value that managing agencies can realise is the marriage value of management and capital provision in integrated vehicles. An approach to valuing managing agencies was defined in an early issue of the Lloyd's Fund Quarterly, produced by UBS in association with SBW Insurance Research. The method values a managing agency as the sum of its net assets, the value of profit commissions on open years of account less levies and taxes (known as pipeline profit commission), and a “goodwill” element expressed as a percentage of managed capacity.

When a managing agency is sold, it is not always possible to obtain details of the terms. However, we at SBW have monitored the value placed on managing agents, using what information has been available and making assumptions as appropriate. This has included valuing managing agents when deals have been made and finding the implied value at the most recent share price. The measure of value used is always the amount paid for goodwill expressed as a percentage of managed capacity.

When Cox Insurance Holdings obtained a full listing on the London Stock Exchange in November 1995, the price paid for the issue implied a goodwill value for the agency of 1.8% to 2.2%. In January 1996, the implied goodwill value of Archer was estimated as 1.8%, Ockham was at 2.2%.

Later deals have seen increased values. Wellington paid 5.3% and the Hiscox/Hiscox Dedicated deal valued the agency goodwill at 8%. Late in 1996, LIMIT only paid between 2% to 3% for Janson Green but the deal included a commitment to sell 30% of the agency to its management at the same price. In December 1997, Finsbury Underwriting agreed terms to acquire Wren Holdings in a deal valuing the agency at 6.5%. There were further increases in 1998. Kiln was valued at 7%, Chaucer at 7.9%, SVB at 9.6% and Murray Lawrence and Atrium Cockell reached 12.6% and 13.5% respectively.

Although it is clear that prices have increased recently, the figures pale into insignificance against the implied value of managing agencies within successful integrated vehicles. The comparable goodwill per cent of capacity figures for Cox and Hiscox have both exceeded 30%, although there has been some recent downward adjustment in share price for these vehicles, particularly Cox.

It is clear that for those investing in managing agencies after the completion of Lloyd's Reconstruction and Renewal (R&R) plan in 1995, or even earlier for some more intrepid investors, the investment gains have been considerable. For those that can re- structure the business effectively, the potential gain is better still.Leading shareholders

The leading institutional investor in the UK listed Lloyd's vehicles is Fidelity, certainly in terms of the number of vehicles supported. Taken together, Fidelity group companies are major shareholders in the following public companies: LIMIT, Kiln, Benfield & Rea Investment Trust, Amlin, Goshawk Insurance Holdings, Wren, SVB Holdings, CLM Insurance Fund, and Hardy Underwriting Group.

Other companies with a spread of Lloyd's investments include the Equitable Life Assurance Society, Benfield & Rea and Brederode Insurance (a subsidiary of Brederode SA, the Belgian investment company). Some investors have taken a substantial stake in individual Lloyd's companies. Murray Johnstone companies own over 50% of Atrium Underwriting. Both Equitable Life and Benfield & Rea own over 25% of Torch Holdings, the AIM listed Lloyd's motor insurer. Warburg Pincus Ventures, the US venture capital company, own nearly 30% of Cox Insurance Holdings.

Turning to Lloyd's private companies, Bermudian insurance companies are among the leading investors. ACE has the most significant stake in Lloyd's in terms of capacity controlled, with over £400 million in aligned capacity on its own managed syndicates. Bermudian companies, Terra Nova and EXEL, also own large managing agencies at Lloyd's. Several US insurers have invested in Lloyd's, including Underwriters Reinsurance Company, Chartwell Re, UNUM Corporation, the St Paul Companies, and Western International Financial Group. Recently General Re acquired 100% of the share capital of DP Mann Holdings, the ultimate managers of syndicate 435.

Implications for the Lloyd's market

There is a clear trend away from spread investment. Share prices for the quoted spread vehicles have traded for long periods at below net asset value, while share prices of the integrated vehicles have traded at a premium. In 1998 the last spread vehicles capitulated, merging with managing agencies in order to build capacity on syndicates in-house in the same way as the integrated vehicles have done. The stark reality of a depressed share price has led to a shift in strategy towards emulation of the integrated vehicles.

The influence of Names and their agents is diminishing. As third party capital providers, Names do not provide the form of support that the majority of underwriters now seek. The period of decline in Names' influence has seen a variety of corporate structures enter the Lloyd's market, of which integrated vehicles have proved the most effective means of drawing out the full value of Lloyd's businesses.

Unfortunately, the development of alternative underwriting arrangements for Names has been slow and, despite several attempts, a vehicle has not been found that is attractive to most Names and provides underwriters with the type of capital support most want for the future. However, unlimited liability Names and Names underwriting in conversion vehicles provide nearly 35% of the market's capacity, and an opportunity still remains to marshal this financial commitment in a different form that can meet the objectives of both sides.

For those investors that have bought managing agencies in Lloyd's the rewards can be considerable. While it is difficult to obtain definitive information, it is certain that the value of managing agents has increased considerably over the past two to three years, possibly as much as fivefold. Investors that have benefited from these increases include a number of Bermudian and US insurance company investors and several of the specialist listed Lloyd's companies.Whether investment opportunities are still readily available at Lloyd's now is less certain. Almost all managing agencies, formerly privately held companies, have sold to investors committed to providing capital to support underwriting on in-house syndicates. In the absence of any existing agencies available for sale, the other option of starting a new agency requires extensive insurance and Lloyd's expertise.

However, for some investors it is apparent that Lloyd's will continue to have its attractions. CGU recently announced its plans to move all its marine underwriting into the Lloyd's market through the formation of a new syndicate to be managed by its managing agency subsidiary, Marlborough Underwriting Agency.Commenting on the move, CGU managing director Cees Schrauwers stated that the company wanted to transfer all marine underwriting to Lloyd's because Lloyd's has consistently outperformed the company market: “. . . We are trying to create shareholder value, and we want to be in the best place possible, and we believe the best place is Lloyd's.” It appears likely that many insurance investors will continue to beat a path to Lloyd's.

Miles Trotter is a director of SBW Insurance Research Ltd, a member of the Amlin group, a leading managing agent and service provider in the Lloyd's market. Tel: +44 (0) 171 860 8226; fax: +44 (0) 171 860 8773; e-mail: research@sbwir.demon.co.uk.

Glossary

aligned member: a corporate member of a syndicate under common control with the managing agent of that syndicate.
conversion: the means by which an individual unlimited liability member of Lloyd's transfers his underwriting business to a limited liability member.corporate member: a company incorporated with limited or unlimited liability admitted to membership of Lloyd's.
corporate vehicle: corporate member subsidiaries of a single holding company, and the holding company itself and other companies in the group.
dedicated vehicle: a corporate vehicle that participates exclusively in the syndicates of a single managing agent or managing agent group.
individual member: an individual underwriting with unlimited liability.
integrated vehicle: a company that owns a controlling interest in a managing agency and a dedicated vehicle supporting the managing agency's syndicates.
Lloyd's adviser: an adviser registered under the Lloyd's Advisers Byelaw (No. 19 of 1993) retained by a corporate member principally for syndicate analysis and negotiation of syndicate participations.
managing agent: an underwriting agent responsible for managing a syndicate and, among other things, employing the active underwriter.
members' agent: an underwriting agent responsible for advising members on syndicate selection and administering members' Lloyd's affairs.
member: except where the context otherwise requires, an underwriting member of Lloyd's, whether corporate or individual.
Name: an individual member of Lloyd's.
spread vehicle: a corporate member or a group of corporate members writing alongside individual members on a spread of syndicates across the market.
syndicate: a member or a group of members for whose account a managing agent accepts insurance business at Lloyd's.
syndicate participation: that part of a member's underwriting which is allocated to a syndicate for the relevant year of account.