Argo expands use of third-party capital in its Lloyd’s Syndicate 1200

International specialty insurance and reinsurance firm Argo Group is deepening its relationship with third-party capital investors by expanding the use of investor money, alongside its own, in its Lloyd’s of London Syndicate 1200.

Argo is no stranger to third-party capital and letting capital market investors work alongside its to share in the returns of its underwriting.

Argo’s fully collateralized reinsurance sidecar, Harambee Re, was renewed for the 2015 underwriting year, as a reinsurance only vehicle as the re/insurer looked to continue to work alongside investors in its reinsurance book.

Previously, Argo has also sponsored catastrophe bonds, in order to leverage third-party capital for its own reinsurance and retrocession needs. Argo’s recent cat bond issues are the $100m Loma Reinsurance Ltd. (Series 2011-1), the $100m Loma Reinsurance Ltd. (Series 2011-2) and the $172m Loma Reinsurance (Bermuda) Ltd. (Series 2013-1).

The Loma Re cat bond series has secured Argo over $370m of reinsurance protection from third-party investors over recent years, another example of its ongoing relationship with the capital markets and insurance-linked securities (ILS).

Now Argo is further deepening its relationship with third-party sources of reinsurance capital, by bringing additional investor-backed money into its Syndicate 1200 at Lloyd’s.

The syndicate underwrites worldwide specialty property, alongside other lines and has a particular focus on sort-tail property catastrophe and man-made disaster risks, the type of risks that third-party investors enjoy backing.

During the firm’s latest earnings call, CEO of Argo Group Mark Watson discussed the syndicates progress, saying that while the results from the syndicate have been solid, “Pricing and competition remain intense across the Lloyd’s market.”

Watson explained that the syndicate’s results may look a little different at mid-year 2015, than analysts were used to, as the retained risks are lower due to Argo’s “increased use of third-party capital at the syndicate.”

“We believe having strong partners participating in the results gives us the flexibility to expand the business, when the opportunity presents itself, and also gives us an attractive source of fee based income,” Watson explained.

Of course the use of third-party capital in the syndicate at this time of lower underwriting returns and higher competition could also be a good way to boost Syndicate 1200’s competitiveness within the Lloyd’s market.

By adding lower-cost third-party sourced capital into the underwriting mix at the syndicate, Argo can perhaps better manage and optimise the returns generated while also building deeper relationships with investors for the future.

Of course as the third-party capital mix is increased at the syndicate, making up an increasing proportion of its capacity, the results are affected.

CFO Jay Bullock explained; “Over the last couple of years we have increased the use of that third-party capital. So it’s having an effect on the variance in growth rate, between gross which includes much of that third-party capital, and that which does not.”

Watson said that he expects the results will continue to reflect this shift towards underwriting with more third-party capital over the course of the next year as well, as Argo continues to adjust the mix of capital sources as it builds capacity at Syndicate 1200.

And Watson believes that the way Argo is working with the third-party investors is not cannibalising its underwriting profits from the syndicate.

“Whatever lost underwriting income we have we’ll make up for with fee income. It may not be dollar for dollar, or in this case pound for pound, but it’s pretty close to that,” Watson explained.

As well as the fee income earned Argo is also benefiting from the ability to modify its capital base, thanks to the flexible way it can bring additional third-party capital into its underwriting at the syndicate.

“Of course it frees up capital,” Watson continued. “So our return on capital invested in the syndicate, on a percentage basis, is actually better.”

So leveraging third-party capital is a win-win for Argo then.

Argo benefits from additional underwriting capacity. It can reduce the cost of its underwriting capital through the addition of lower-cost third-party money, which could enable it to remain more competitive. It can earn fees on the capital it takes from investors. And overall this strategy improves the return on its own capital that is invested in Syndicate 1200.

A very positive use-case for third-party capital within the Lloyd’s of London market. It’s no surprise that a number of smaller Lloyd’s syndicates are increasingly looking to bring investors into their businesses as capital partners, while larger Lloyd’s players look to the special purpose syndicate or sidecar type structures to leverage third-party funding alongside their own.

With the fund’s at Lloyd’s business also set to expand, when the opportunity allows as investors look to back established syndicates, there seems ample opportunities for the insurers and reinsurers who operate in the market to bring third-party capital into their businesses.