The Intelligent Quarterly from the publishers of The Insurance Insider

Summer 2013

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Atrium, Kiln, Heritage, Brit, Chaucer, Hardy and Omega: the roll-call of London Stock Exchange-listed Lloyd's businesses that have been bought out has been growing in the past few years and the process has accelerated appreciably during the last 12 months.

At root, Lloyd's-listed businesses have sold recently because Lloyd's is a remarkably attractive proposition to someone looking to acquire in the insurance sector.

A senior Lime Street source puts it like this: "If you are a domestic insurer in the US, China or India you can take a bite-size chunk and immediately give yourself access to business all over the world overnight through licences that would have taken you 25 years to get otherwise."

James Britton, a financial adviser at PeelHunt, has a similar view. He says that in a soft market disciplined insurers are laying down capital that they do not want to deploy in underwriting. One possible use for this money is acquisition, with an international strategy the most obvious play for an insurer concentrated in one market. Britton points out that CEOs of big insurance groups don't tend to like overseas acquisitions where they have to spend much more than 10 percent of their market cap, because it is tantamount to betting their careers.

"It's very difficult to get a decent business if you apply that 10 percent mechanism - unless you come to Lloyd's. Because with Lloyd's you're buying a mutual with licences and you're getting a readymade international investment vehicle at a stroke," he comments. "It's about being able to do it sensibly without betting the store."

Demand has also been stoked by the draconian attitude that the Franchise Board has taken to would-be entrants in recent years. As one head of a financial advisory business says: "A lot of people have wanted a Lloyd's platform since 2005, then in 2008/09 Lloyd's effectively brought the shutter down on 'willy-nilly' start-ups. Everyone wants a Lloyd's platform. You can't start up, so how do you get in? You have to buy something."

And with the majority of Lloyd's businesses now part of multi-platform corporate insurers and unequivocally not for sale, the quarry available for M&A hunters has thinned out. Buyers have the choice of a private equity-backed business where the owners feel that they haven't made enough money yet (Ark, Cathedral, Antares, Barbican), the failed Lloyd's experiments of an overseas insurer (Equity, Marketform, Sagicor) or the smaller-cap listed insurers.

Turn the clock back two years to the time of the Brit approach and the universe had already fallen from its height of more than a dozen listed Lloyd's vehicles. In mid-2010 we had Chaucer, Omega, Hardy and Novae in the small cap bracket. It is soon likely to contain just Novae, with no prospect of the stocks being replenished any time soon.

Reflecting on recent M&A activity, Canopius executive chairman Michael Watson says that "an increasing scarcity value" is one of the drivers of deals - or "buy now while stocks last", as one banking source quipped.

The small caps have been among the most attractive targets because they have been affordable and digestible, without being the hollowed-out husk platform buys (Jubilee, Broadgate, TSM) seen elsewhere. "Amlin, Catlin and Hiscox are quite a big bite for anyone who isn't China Re. More people feel comfortable having a go at the small caps," our Lime Street doyen observes.

Unforgiving businesses
The Lloyd's small caps have been attractive buys for strategic bidders like The Hanover, CNA and Canopius. But although they are attractive as a small part of a bigger group, they can be unforgiving businesses to run on an independent basis.

Our Lime Street veteran again: "These are very volatile bits of kit, quite high risk - you've got gearing everywhere: investment gearing, underwriting gearing, reinsurance gearing... and that's a very difficult thing to keep stable."

"As a CEO of one of those businesses you're spinning lots of plates and if one of them drops you're in trouble."

The senior executive stresses that, although being part of Lloyd's creates the illusion of scale, the capital markets continue to assess these insurers in isolation.

"The P&C world is a big boy's game and it takes a lot to get it right, quarter after quarter and not to spook the capital," he says.

The volatility of these companies, which do not have a large parental balance sheet to shelter under, explains why some have looked for sales.

Click to enlarge It's also worth noting that sales have been more attractive to investors because on the sell-side they are reaping the benefits of the embargo that Lloyd's has placed on new entrants. Financial advisers across the sector agree that there is currently a Lloyd's entrance premium that all sellers can expect to enjoy.

Our unnamed financial advisory MD puts the goodwill paid as the cost of entry to Lloyd's in the region of £10mn-£20mn and says "that goodwill makes it attractive to shareholders". The platform price, of course, also stretches further with a small business like Hardy than it does with a big one like Catlin.

Extinction or resurrection
If the Lloyd's stage were to shrink further - and there are many in the industry who have been talking for the last year about the small caps being picked off inexorably - then one must ask whether these (re)insurers are truly extinct or whether they will be resurrected in the future.

Our unnamed banking source noted the importance of reaching a certain scale to allow management costs and expenses to be kept down; while the financial advisory MD - a professional proponent of companies buying companies - speaks at length about the advantages of scale.

"There are a number of reasons why big is better", he says. "A decent risk department becomes relatively more costly for smaller companies. And insurers can lever their size and gain better market position as a leader. A bigger, more diversified insurer will also have a better capital position and more efficient reinsurance buying."

The Lime Street executive tells IQ that scale is "fundamental". Many of the problems of small cap players trying to deliver Amlin-equalling returns to investors would fade away if these businesses were looking Amlin in the eye rather than the shin, he says.

In short, it doesn't look good for the small cap Lloyd's insurer. The days of the traditional bantamweight start-up seem to be behind us now thanks in part to the risk management demands of Solvency II, and therefore the market is increasingly dominated by corporatised businesses of scale that slot into broader global corporations.

In such a landscape - with risk-free investment returns almost non-existent, casualty rates unattractive and strong pricing confined to volatile property cat business - it is hard to see how £200mn-£300mn Lloyd's businesses can compete for investors' capital with the titans of the sector. Novae may well be the last of a dying breed.

If you want to invest in Lloyd's long term you can buy Amlin, Catlin, Hiscox or Beazley on the London Stock Exchange. Otherwise, the individual investor has no other option these days than to contact the members' agent - a relic of a bygone period that seems to be holding up surprisingly well.