Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Could Lloyd’s names capital start to look a lot like ILS capital?


Lloyd’s ‘names’ are perhaps the original incarnation of third-party capital in the insurance and reinsurance market. Largely high net worth individuals, who backed syndicates and often took on unlimited liability, the ‘names’ model is set for change and could begin to look at lot like ILS capital.

Lloyd's of London buildingAlready some of the agencies managing these ‘names’ and their capital are branching out and marshaling capital from other third-party sources into the Lloyd’s market, through funds or special purpose syndicates (SPS), ensuring that third-party capital remains at the heart of the world’s oldest insurance and reinsurance market.

But the concept of Lloyd’s ‘names’ is considered archaic by many and in need of modernisation, something that even the chairman of the market John Nelson admitted to in a recent speech, when he said that the mechanisms for accepting ‘names’ capital into the market are “frankly archaic and come from a different era.”

Nelson said in his speech to the Association of Lloyd’s Members Annual Conference on Monday of this week, that it is an “absolute necessity” that Lloyd’s modernises, in order to face up to the challenges of the market, and that this is true of how names capital is managed as well.

“Names’ capital is an element – sadly a diminishing element – of the total capital available in Lloyd’s,” Nelson explained. “When it comes to names’ capital, we have to face up to the fact the percentage share is continuing to fall.”

‘Names’ have been providing less capacity to the Lloyd’s of London insurance and reinsurance market for some years now, as corporate members and businesses operating at Lloyd’s have used their own capital or sourced it in more modern ways and from more institutional type providers.

As well as Lloyd’s, in its current form, perhaps being less attractive to investors, and the continued spectre of unlimited liability which caused massive losses for some Lloyd’s names in the past, the reduction in names capital is likely also a reflection of the modernisation of wealth management.

Private individuals now have access to a much greater choice of ways to manage and invest their capital, many of which are much simpler, and perhaps less risky, than applying to become a Lloyd’s name.

But whatever has caused the shrinking of names capital, as a percentage of overall capital at Lloyd’s, it’s clear that there are better ways to bring new capital into the market, including from high-net worth individuals.

Nelson said that in the future there is “most definitely a role for names’ capital” adding that there is a good case to be made for “high net-worth individuals to commit capital into the Lloyd’s market when looking at the higher risk/higher return end of their portfolios.”

Nelson went on to explain that the “archaic” structures and complexity of names capital, both for new names and for managing agents, “renders it “user unfriendly” at both ends of the spectrum.”

But perhaps it needn’t be so, as the tools and structures to enable wealthy private individuals to invest in Lloyd’s, attach their private capital to risk and benefit from the returns (or pay the claims due) already exist.

The insurance-linked securities (ILS) market (and in fact asset management as a whole) is a clear example of how significant sums of capital can be brought directly into the reinsurance market, to place behind policies and contracts, managed in a style that investors today are familiar and comfortable with.

The fund structure is one that could be used to help names (private backers) return to Lloyd’s in greater numbers, with funds at Lloyd’s able to manage capital for deployment into syndicates as pseudo-loans that can be used for underwriting capitalisation purposes.

That perhaps isn’t the best approach for everyone though.

Better for many private, wealthy investors, might be an investment fund that could be listed on the London Stock Exchange and managed by some recognised wealth manager, on behalf of the Corporation of Lloyd’s or a managing agent.

High net worth individuals could buy into this investment fund, as they might into such ILS funds as the CATCo and Blue Capital vehicles which are also listed in London today.

The capital accumulated could be invested pro-rata into Lloyd’s underwriting, providing a diversified spread of the return of insurance and reinsurance business underwritten at Lloyd’s. A compelling opportunity for any private investor and a sidecar-like pool of efficient capital for the Lloyd’s reinsurance market to draw on.

An alternative could be for the investment fund to be a feeder into a special purpose syndicate (SPS), which could enter into quota share or reinsurance agreements with or alongside other syndicates, enabling ‘names’ to specify or have more control over where their capital goes (as they historically were able), or simply this vehicle could make itself available as an underwriting companion, to augment the capital of Lloyd’s syndicates.

This would have more of an underwriting overhead than a straightforward Lloyd’s sidecar-like investment fund, but a managing agent could ensure guidelines were followed on the arrangements entered into, underwriters could be hired if needed and the vehicle could provide investors with access to a diversified book of risk from across the Lloyd’s market, or indeed the more concentrated risk investment others might seek.

Another option that might tie in well with the work being undertaken by the London Market Group (LMG) might be for London to have a segregate cell vehicle, which would allow the ultra high net worth investors of the world to have their own segregated accounts, which syndicate underwriters could perhaps apply to for capital.

In such a segregated account style investment vehicle, ‘names’ could elect to back the syndicates and underwriters they wanted to work with, while having their own underwriting pool to generate returns from.

Issues of run-off, being reinsured to close and the like would all still exist. But the Lloyd’s market could certainly deal with those, perhaps even offering some way for investors in whatever type of structure was chosen as a future vehicle for ‘names’ to have liquidity opportunities in order to recover and redeploy capital.

Of course other investors would likely want to take on the risks in run-off anyway and specialist run-off players and ILS capital could help to provide ‘names’ with opportunities for liquidity in this way.

Nelson said that Lloyd’s has been urging members agents “to develop models for names’ capital fit for the 21st century” for a number of years, with the aim of finding ways to make names capital a “simpler, more orthodox, more user-friendly” source of capital, both for Lloyd’s and the investors themselves.

However, Nelson lamented that there has been “a notable lack of progress on this.”

Of course Lloyd’s could go a whole lot further, embracing technology to become a leading insurtech market, with an electronic system that made it simple for ‘names’ or other third-party investors to allocate capital to the market and even to select portfolio variables, such as lines of business and risk appetite.

That would be truly groundbreaking, provide the Lloyd’s ‘names’ of the future with control over where their capital is deployed, to a degree, be incredibly efficient and also position the Lloyd’s market as a world-leader in insurance technology (insurtech) and insurance-linked investing.

With a diversified pool of risk as large and varied as Lloyd’s commands, if the routes to deploy capital into the market could be made simpler and more efficient, the amount of private names capital that it could use for its insurance and reinsurance underwriting would surely grow.

But that’s a far-off vision of where the Lloyd’s market could get to in years to come, if it truly wants to embrace outside investor capital. In the nearer term it is more likely that Lloyd’s could launch something fund-like and a more modern structure for the ‘names’ who want more control over their capital deployment.

Nelson continued; “If this names’ capital is to survive, and if we at Lloyd’s are to continue to support it, it does need to evolve significantly. New private capital needs to be attractive and it needs to be in a form that is more attractive to managing agents.”

What’s needed is a change in mind-set, from the concept of a Lloyd’s ‘name’ as a member, to one where Lloyd’s has ‘investors’ into a variety of capacity vehicles, with differing levels of active/passive approach to underwriting, offering a range of risk adjusted returns (perhaps selectable), but all serving a basic need, to make it easier and more efficient for private capital to enter the market.

“Names’ capital needs to engage to be part of the modernisation of Lloyd’s if it is to continue,” Nelson said.

And Lloyd’s needs to engage with global investment markets and investors, taking a lead from the modernisation of those markets, if it is to be able to capture some of the wealth and capital that would like to access the returns of its risks.

The same, of course, goes for capital from institutional investors such as pension funds, ILS funds, sovereign wealth funds, endowments and other major investors, engagement here is key and Lloyd’s has begun this in more earnest lately.

For Lloyd’s, as its Vision 2020 deadline looms ever closer, perhaps an approach can be followed which creates new structures and fund-like mechanisms for capital to participate in the Lloyd’s market, that would be suitable for private and institutional capital alike.

If that was the case then Lloyd’s names capital would, to all extents and purposes, look just like insurance-linked investor or ILS capital, and a standardised structure or platform for welcoming third-party capital providers into the Lloyd’s market would be a more efficient model for Lloyd’s as a corporation and a market to adopt and enhance the returns investors could expect to benefit from.

Also read:

Alternative capital to continue disruption of reinsurance: Nelson, Lloyd’s.

Efficient ILS structure will help secure London’s future: Beale, Lloyd’s.

Lloyd’s continues to loosen up to alternative capital & ILS.

For a detailed look at how Lloyd’s has shifted increasingly towards embracing ILS and alternative capital read our article from December.

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