New name of the game: Lloyd's aims to turn the corner with corporate capital, writes Paul Durman

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The Independent Online
TO THE casual observer, the spectacle of the City raising hundreds of millions to invest in the Lloyd's insurance market must look the height of foolhardiness. Lloyd's, after all, has become almost a byword for mismanagement and incompetence, if not worse.

In the past couple of months more than 20 of the new Lloyd's investment companies have announced plans to raise perhaps pounds 2bn. Although the final total may be nearer half that, it is still an enormous amount for a market that has lost pounds 5.5bn in the latest three years for which results are available.

This inflow is driven by hope of profits, not eccentricity. Market professionals believe the insurance cycle has embarked on a powerful upswing into profitability.

For 300 years the Lloyd's names, the members of the society whose money supports insurance underwriting, have borne unlimited liability for their losses. The theoretical possibility of the names losing everything, down to the shirts on their backs, has given the unravelling disaster much of its drama.

Names have left by the thousand. Earlier this year Lloyd's believed it faced a potentially devastating loss of underwriting capacity. And so the decision was taken to admit corporate capital through investment companies operating with limited liability.

As it turned out, the traditional members of Lloyd's proved surprisingly resilient. They are now expected to provide about pounds 8bn or more of underwriting capacity next year, at worst a modest fall on the 1993 total.

After a long period of scepticism, enthusiasm for corporate capital took the City by storm until, a month ago, it seemed that every London merchant bank was polishing up plans for a Lloyd's investment company. But many investors remain unconvinced.

Several Lloyd's companies with big names behind them have fallen a long way short of fund-raising targets. Last week even the mighty Cazenove and Lazard Brothers had to admit defeat, abandoning plans for a pounds 60m investment trust because of lack of investor interest.

Anyone investing in Lloyd's will want to be assured that future standards of professionalism will be much higher than in the late 1980s, particularly in the absence of a guarantee that they will not have to pick up part of the bill for past losses. Lloyd's has responded to the crisis by reforming its system of regulation, introducing tougher training and professional requirements.

The catastrophic losses of recent years have driven the worst-run firms out of business. Lloyd's was not universally incompetent. Even in the trough year of 1990, when the market lost pounds 2.9bn, more than 100 of Lloyd's 388 syndicates managed to make a profit.

The introduction of corporate capital should reinforce better standards. Listed Lloyd's investment companies will expect earlier and fuller disclosure of trading news from syndicates than individual names have traditionally been given.

Investors who do not like what they hear will, for the first time, be able to reduce their exposure by selling their holdings of Lloyd's investment companies in the stock market. Theoretically this should allow investors to cap their losses at any time by selling out.

Lloyd's stated aim of achieving a 10 per cent return on premiums has allowed the investment companies to produce projections showing pleasantly rising profits and dividends. The only thing certain about these forecasts is that they will turn out to be wrong.

How should investors choose between the numerous Lloyd's vehicles? An investment in Lloyd's is first and foremost an investment in insurance. The skill of the adviser responsible for syndicate selection is consequently of paramount importance. Most companies have opted for a conservative investment policy aimed at capital preservation or tracking a stock market index.

Investors should consider carefully whether they want to back a company with a more adventurous investment strategy, thus compounding the insurance risk.

About half of the Lloyd's companies have chosen traditional members' agents as their advisers on syndicates. Many of the others are using specially created firms that draw on the expertise of insurers, brokers or insurance research companies.

The case against members' agents is that these firms are associated with the failures of the past. However, the agents advising the Lloyd's companies are typically the firms that have delivered substantially better results than the market as a whole, such as Wren, Roberts & Hiscox and Murray Lawrence. Although these firms have been unable to avoid the losses of recent years, at least they have a demonstrable track record.

The argument for agents is that they have long-standing relationships with syndicate underwriters and are more likely to be able to secure the good-quality capacity that everyone wants. They are also more likely to know which underwriters are not to be trusted.

These advantages will diminish over time. They did not prevent the London Insurance Market Investment Trust (Limit), the pounds 280m fund from Samuel Montagu, from securing legally binding commitments for pounds 480m of capacity. Limit's syndicate selection is in the hands of Allan Nichols, until recently a leading insurance analyst with James Capel, the stockbrokers.

Agents are mostly working with smaller funds. Wren is among those that say this is because of a shortage of good capacity. This raises concerns about Limit and the other large funds from SG Warburg and Barclays de Zoete Wedd. These leading institutions would not have been so enthusiastic about a modest pounds 30m investment trust.

The Lloyd's investment companies vary in the degree to which they spread risk between syndicates. Limit is backing nearly 100 syndicates, or more than half of those operating next year. This will make it virtually a tracker fund for Lloyd's. If the consensus view on the outlook for profits proves to be correct, Limit is assured of sharing in the benefits. But Limit will find it correspondingly difficult to avoid any subsequent swing into losses.

Warburg's New London Capital is taking the opposite approach and plans to back about 20 syndicates next year. This selective approach makes it more important that Warburg gets it right.

Costs also vary considerably. Investment management fees range from 0.08 per cent of funds managed (for an index- tracking manager) to 0.75 per cent. More important, there are big differences in the profit commissions paid to the Lloyd's advisers.

Reflecting its in-house research, Limit qualifies for a profit commission of only 1 per cent. Commissions of 5 or 6 per cent are more common. CLM Advisers, the Sedgwick subsidiary that is adviser to BZW's CLM Insurance fund, will be paid 7.5 per cent.

It is difficult to see the tide turning against corporate capital. There can be few individual names for whom it does not make sense to limit their liability.

(Photograph omitted)

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