For whom the Lutine tolls: Warren Buffett's big gamble on cleaning up at Lloyd's

As the Sage of Omaha backs a £125m venture geared to buying small companies on the London insurance market, Simon Hildrey asks if the master investor's money might get shipwrecked
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The Independent Online

Where Warren Buffett treads, investors are invariably keen to follow. But sceptics wonder whether a plan backed by the Sage of Omaha to consolidate the Lloyd's of London insurance market will succeed.

Where Warren Buffett treads, investors are invariably keen to follow. But sceptics wonder whether a plan backed by the Sage of Omaha to consolidate the Lloyd's of London insurance market will succeed.

The master investor is to take a 25 per cent stake in Capital Insurance Holdings (CIH), which has been established to buy small quoted companies at Lloyd's. The driver behind CIH is Michael Wade, who is also chief executive of Rostrum Group.

This is not the first time Wade has attempted to consolidate the sector. He set up Rostrum three years ago to raise money from pension funds and institutions to try to buy the four largest quoted companies.

Since then, Rostrum has been building stakes in Lloyd's companies, he says, but the owners of the largest have not been interested in selling. "This is because of the vested interests in retaining control of the companies."

This time, he intends to raise £125m for CIH, which would then acquire Euclidian, an unquoted insurer to which Buffett's Berkshire Hathaway provides re-insurance. Buffett is to exchange a £77m letter of credit for a 25 per cent stake in CIH, which some analysts interpret as a reduction in his exposure to the sector as it will leave him with a £31m holding. Wade, however, says Berkshire Hathaway will also provide £30m of re-insurance to Euclidian, "so it is not reducing its commitment".

Wade is optimistic he will be able to raise the £125m from institutions over the next 10 days. He has long argued that most Lloyd's firms are too small to attract the attention of big investors.

"Institutional investors are fed up with lots of small companies in Lloyd's. None of them are 'must have' stocks because they do not have scale and do not come within the FTSE 100. We want to create one with a capitalisation above £2bn through consolidation."

Wade says both the earnings and share prices of Lloyd's companies will be boosted by a number of elements of consolidation. These include "complementary underwriting skills, future pipeline profits, a lower risk based capital requirement, improved re-insurance purchasing power, management cost savings and less proportionate exposure to any one risk or class".

He is optimistic CIH will be able to persuade the companies to consolidate. "We have realised that, to succeed, we need a holding vehicle instead of a shareholder like Rostrum. Capital Insurance Holdings will have an independent board and we need a holding company to effect discussions. The other advantage this time is that we are offering a paper-for-paper transaction in Capital Insurance Holdings. The underwriting entities will preserve their own identity as we feel the role of the underwriting villages is attractive."

But Geoff Miller, an analyst at Bridgewell Securities, does not believe Wade will be more successful with CIH than he was with Rostrom. "I am sceptical about whether there will be meaningful consolidation. Shareholders and companies would gain little and the smaller stocks do not appear to suffer overly as a result of their size. There would be few central cost savings.

"Consolidation requires two conflicting objectives to be met. Underwriters would need to be tied into the new vehicle but, at the same time, capital would need to be re-allocated as rates change. These cultural issues have been tackled by the larger players but would be

a stumbling block to a consolidator. "The danger for any consolidator is that it pays a premium, then the people walk. Generous packages to ensure this doesn't happen will not be to the benefit of shareholders."

Miller says that putting together the nine smallest vehicles would only create a business of £1.4bn, including the £125m of CIH. "This is unlikely to attract a different set of investors to those already invested in companies like Brit or Amlin."

Fourteen companies and 66 syndicates are listed in the Lloyd's market. Miller says the five largest listed companies - Brit Insurance, Amlin, Catlin, Hiscox and Wellington - each have market capitalisations of more than £400m and a total worth of nearly £3bn.

Nick Johnson, an analyst at Numis, is also sceptical about Wade's chances. "Lloyd's is successful because it is a collection of individual businesses and cultures. One of the key risks is underwriters leaving and setting up new firms. Lloyd's offers a great grazing ground for headhunters."

That Wade has dropped his earlier suggestion of integration, he says, in favour of positioning companies under one umbrella suggests he has accepted defeat on this issue.

But Johnson admits there would be some economies of scale, particularly in terms of buying power and the diversification of re-insurance. The plan would also focus investor attention on the Lloyd's sector, in which he argues many companies are undervalued following three years of premium rises after 11 September 2001.

Alex Foster, manager of the Hiscox Insurance Portfolio, which has invested more than a fifth of its assets in five Lloyd's firms, is in favour of consolidation among the smaller players.

"The small size of Lloyd's companies means they are not a realistic proposition for institutional investors, even though there are some good underwriting companies. They do not need more capital, but from a shareholder's point of view there needs to be more liquidity."

Foster, however, is not convinced that anyone will be in a hurry to take up any offers. "You cannot make the management of these companies sell if they do not want to."

A chief executive of a Lloyd's company who did not wish to be named says consolidation has been blocked in the past by "the egos" of individuals, even though one single "big and powerful block" would benefit investors. But, he adds, the current economic environment may be conducive to consolidation.

"The Lloyd's market has enjoyed three cracking years," says the chief executive. "Hopefully 2005 will be good as well, and there is a good pipeline of profit for Lloyd's companies which will not be fully paid out until mid-2009. A lot of underwriters are in their mid-50s so that takes them up to 60 and near retirement. There may not be a better time for them to accept takeover offers, especially if the owners are allowed to retain control."

The chief executive of another company says consolidation appears to be a logical development, but he agrees that it has been thwarted in the past by personalities.

"Integration would not necessarily mean an increase in the amount of business written. Brokers like to spread the business around underwriters. Two times two does not automatically make four.

"The companies are run very differently. We get on well if we are not made to do things the same way. But if we were forced to integrate, we would squabble like hell and it is easy for underwriters to leave. The only cost savings would be in the salaries of chief executives and finance directors."

He adds that if the companies are put under the same umbrella group but not integrated under Wade's model, there are potential problems. "What if we turn down business we think is bad and a sister company accepts it?"

Lloyd's has historically been a graveyard for the unwary speculator. Will it prove different for the world's most lauded investor?

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