Names change for the new investors

Predictions of the demise of Lloyd's Names have been considerably exaggerated, it would seem. Not so long ago it seemed only the foolhardy or the blindly optimistic would have suggested that private capital really had any future at Lloyd's.

After all, since corporate capital was introduced into the market the decline in the fortunes of Names has been fairly dramatic, with those wealthy individuals who once wholly supported the marketplace now only accounting for some 20% of total capacity.

Furthermore, in recent years the number of active Members has also reduced considerably. In 1998 there were 6, 835 individual Members at Lloyd's, yet by 2003, savaged by some of the heaviest losses ever faced, this number had dwindled to only 2,198.

Not insignificant
But hold your horses, for such a sorry tale of woe does not really tell the whole story. Granted, Names may now only account for 20% of the market's overall capacity, but given that this now stands at over £16bn, this figure of some £3.7bn does not seem so insignificant after all.

And although the number of individual Members now stands at only 1,124, this is mostly a result of the changing nature of participation at Lloyd's for private capital, which means that the old individual Member with unlimited liability has been effectively supplanted by vehicles such as NameCos, Scottish limited partnerships (SLPs) and limited liability partnerships (LLPs) – more of which later.

More interestingly still, the seemingly inexorable decline in the amount of private capital supporting Lloyd's seems finally to be have been halted. Indeed, such is the attractiveness of Lime Street at the moment that for the first time in years significant sums are being invested by new Names, keen to put their capital to good use in what is once more seen as a promising opportunity, after so long being viewed as simply a bottomless pit in which to throw money.

The amount of new money that has recently been ploughed into Lloyd's by this new breed of Names may not match the sums that the corporate sector is able to generate, but it is still significant – and some of the figures willing to support Lloyd's once again are certainly high profile.

For example, last autumn the Conservative party treasurer Lord Marland was one of a group of City grandees to join Insurance Capital Partners, a limited liability partnership originally formed by Members' Agency CBS (now part of Hampden) which commenced trading last year with £75m of capacity on 15 syndicates.

Other members of the LLP include David Ross, co-founder of Carphone Warehouse and chairman of National Express; hedge fund manager Crispin Odey; and Michael Spencer, head of interdealer broker ICAP.

And such high profile investors are being joined by other lesser known City figures.

Market optimism
Indeed, the feeling among supporters of private capital is one of unabashed optimism at the moment. According to Nigel Hanbury, chief executive of Members' agency Hampden Private Capital: "We've not seen as many new Names for 20 years.

"They seem to be approach-ing us from all sorts of different areas, though they are principally from the UK and are very sophisticated investors, many of whom work in the City and the financial world.

We are also seeing interest from the Far East and the Gulf. In the Middle East they like diversification and many of them have assets in London which they want to put to good use. So someone might have a flat overlooking Hyde Park, for example, which is a super investment but one which they can also put to work at Lloyd's."

He says the same issues of diversification also apply to potential investors from the Far East – and this is no idle talk. Hampden has opened an office in Hong Kong to service the significant levels of interest currently being shown.

And it's just this sort of wealthy individual, with valuable assets or surplus capital to spare, which is now seeing Lloyd's in a new light. And there's no doubt that much of this new found interest in private capital participation has itself been aided by the vibrant performance of the City itself, with bonuses reaching new heights.

Committed people
This point is developed by Neil Coulson, a partner at CLB Littlejohn Frazer and someone who specialises in advisc for Lloyd's Names.

"The majority of Names probably wouldn't want to do less than £500,000 of business at Lloyd's and the majority are looking at over £1m, so these are pretty committed people. And many will have been encouraged by recent City bonuses. The feeling will be 'why not chuck some of this money into Lloyd's rather than a hedge fund?' These are people with expensive second holiday homes. Again, they could obtain a letter of credit and make that asset work for them."

This ability to make capital work efficiently is regarded as one of the key advantages of investing in Lloyd's, according to Hanbury, who sings the praises of the double use of assets that being a Name can bring.

But it's far from the only benefit as he sees it: "We are in a profitable part of the cycle, and although rates are coming off in some areas, they are doing so from a profitable position. And the sort of return on capital that has been achieved recently [by Names] is excellent.

Also, the risk that investors at Lloyd's take are not common to investors elsewhere. So a stock market crash will not affect your investment at Lloyd's."

Partnership vehicles
The recent innovation of the limited liability partnership is also something that he sees as important in attracting new Members. "To be in an LLP at Lloyd's means that they get their assets 100% protected from inheritance tax and the income is pensionable."

These new partnership vehicles are also welcomed by Coulson. "You now have this LLP structure in place, which has caused a hiatus while it was getting sorted out, but is probably the most attractive option nowadays because you can't go in as an individual," he says.

"You do have to jump through hoops to join an LLP, but you get taxed in the same way as an individual so you can offset your losses against income, and it's easier to work through things to make sure you get inheritance tax relief on your funds at Lloyd's."

And there's little doubt that this structure is being embraced by private capital. For despite the fact that Lloyd's saw a 25% fall in unlimited liability Names during 2006, the number of limited liability names soared by 42%. And according to John Maudslay, director of Hampden Private Capital, there have been 294 LLPs established for 2007.

The advantage of LLPs is also highlighted by Anthony Young, chief executive of the Association of Lloyd's Members.

He says that LLPs replicate almost every tax advantage of the old unlimited liability underwriting regime, with added monetary advantages. For example, a typical Name underwriting £1m of capacity for the 2003 account will have made some £200,000 of profits in the 2006/07 tax year, all of which can be contributed to their pension scheme with tax relief up to a limit of £215,000. Moreover, income from the assets within the pension fund then accrues free of all UK tax.

Yet Young makes a salient point about participation at Lloyd's: "As with all invest-ments the key to success is the profitability of the underlying investment, not the tax advantages. This is why it is Rolf Tolle, and not Gordon Brown, who is the key figure for Names."

Burgeoning market
And who would argue with such a point? For to be brutally honest, there is no doubt that the key reason that Lloyd's is once again being seen in a favourable light by private capital is because it's making money, and plenty of it.

Despite rates declining, with a benign claims environment last year, the market made an extremely healthy £3.7bn profit.

And the market has been generally performing considerably better in recent years than it did for much of the 1980s and 1990s, when extreme volatility seemed to be its defining feature with thousands of Names facing bankruptcy.

Of course, the extent to which Lloyd's is really able to demonstrate an improved level of performance over the coming years will really define whether or not more private capital can be attracted to the market.

During the good times in the 1970s and early 1980s, prior to the near collapse precipitated by long-tail liabilities kicking in and the disastrous excess of loss spirals, results were so inviting that investors couldn't wait to join the club and become one of the select few to be a Name.

Yet what many of them didn't count on, or that they simply chose to ignore, was that the unlimited liability status, advantageous from an tax standpoint, was one which would bring many to ruin once the profits started to turn to losses.

With the establishment of the Franchise Performance Board and stricter regulatory regime now in place, Lloyd's is hoping that it has turned the corner and that the bad old days of record losses and massive volatility are firmly behind it.

And if private capital is to have any chance of a long-term future in Lime Street, then the recent improved performance needs to be replicated for some time to come. And this is where many people are understandably nervous.

As Coulson observes: "The market has had good results recently, but on the more cautious side, we're coming off the top of the cycle now, so in many ways the best thing that could happen in 2007 is for another hurricane to occur. So it will be interesting to see whether there is more discipline at Lloyd's."

He is also cautious about lauding the long-term prospects for private capital because of other concerns. "There is decline in the number of syndicates that Names can participate in, and there are still a few that would like to get rid of their remaining Names," he explains.

"There have been some start-ups where they have Names on board, but still the selection of syndicates is dwindling and it's a slow trend. Unless you get more start-ups that offer access to Names, there could be a problem."

But such difficulties won't be resolved overnight. And besides, as has been pointed out, there have been a number of new syndicates in recent months which have been ready and willing to accept the capital support offered by individuals.

Among these have been syndicates 6101, 6102 and 6103, all of which are part of Lloyd's attempts to support unaligned capital and are special purpose quota share reinsurance syndicates.

Significant change
Hanbury is enthusiastic about Lloyd's decision to create these new syndicates. "This change in Lloyd's participation is the most significant change for a very long time," he comments.

"Names can use what has been termed 'just in time capital' at a cheap cost to the managing agent. For example, David Shipley at MAP wanted £48m to support his syndicate and we were able to produce £42m within three weeks.

Now, had the Florida changes been worse he could have closed it down with no loss of face and no loss of money, unlike the Bermuda sidecars."

So on balance it would seem that, after so many years in the doldrums, the prospects for Names don't seem so bad after all.

And to make matters even better, last year's deal that Lloyd's struck with Berkshire Hathaway, to reinsure the liabilities of Equitas, has meant that many of the threats and worries that were hanging around in the background, threatening to once more swallow up the capital of Names, have now disappeared.

And Hanbury is confident enough to predict that within a few years, Names' participation at Lloyd's will rise from the current 20% level to 30% of total capacity. Would you bet against him? IT