Lloyd’s Emerges (Again) as a Center of Special-Purpose Activity

Lloyd's Emerges (Again) as a Center of Special-Purpose Activity Robert O'Connor

Lloyd's has emerged as a center of the special-purpose underwriting activity that has developed on a piecemeal basis since the aftermath of the great hurricanes of 2005.

Such high-profile Lloyd's insurers as Beazley Group plc and Amlin plc recently have been linked to interest in the special-purpose vehicles sector within Lloyd's. Beazley (LSE: BEZ) has been in discussions about setting up a special-purpose syndicate. And Amlin (LSE: AML) has made the decision to establish one.

"We've seen a modest reappearance in 2009 of sidecars," said Catherine Thomas, managing senior financial analyst at A.M. Best Co. in London. "That's really in line with the general increase in the availability of alternative vehicles for risk transfer following the trough that we had in the second half of 2008."

Thomas defines a sidecar as a "limited-life special-purpose entity" that is designed to provide quota share reinsurance to its sponsor, which is normally a reinsurance company or an insurer.

"They're opportunistic investments that can be terminated very quickly, so they usually have a term of about one to three years," Thomas said.

Sidecars, she noted, allow investors to benefit from strong property/catastrophe rates without being exposed to risks growing out of an insurer's legacy or its wider portfolio.

"When rates are high, we're more likely to see investors attracted to the market and see more of these types of structures," Thomas said.

The sidecar market boomed in early 2006 in the wake of Hurricane Katrina, Thomas said. This, she added, was followed by a drop in activity in 2007 and 2008. Not only did catastrophe premiums fall in 2008, Thomas said, but the international financial crisis cut into the supply of capital.

Des Potter, managing director of Aon Benfield Securities Ltd. in London, said the favorable reinsurance market conditions after the 2005 hurricanes attracted hedge fund and private equity capital.

Potter agreed the international financial crisis led to a fall in sidecar market activity in 2008 and 2009. "Although rates were relatively attractive, the availability of capital was scarce," he said.

Lloyd's has been cushioned against the retrenchment in the sidecar market, Potter said. Names, those traditional providers of Lloyd's capital, have been able to use assets in support of syndicates that they know and respect, he explained.

Lloyd's itself welcomes special-purpose syndicates. Such a vehicle, said Luke Savage, Lloyd's finance director, would allow a managing agent to establish a framework for a limited time that would let Names spread capital and participate in the insurer's portfolio.

"We've seen a number of those special-purpose syndicates over the past year or so," Savage said. "It's benefited both parties."

Capital providers got access to a wider range of risks, Savage said, while managing agents got to tap into new sources of funds, either from their own capital providers or via the reinsurance market. "A special-purpose syndicate is pretty similar to a sidecar," Savage said.

Lloyd's, Savage said, is very protective of its standing in the market and would not welcome in outsiders who would establish vehicles that would "take all of the qualities of Lloyd's -- our brand, our credit rating, our license network -- and milk it for the benefit of third parties."

Savage believes the influx of new capacity into the insurance sector after the terrorist attacks on the United States on Sept. 11, 2001 "was probably to the advantage of Bermuda and to the disadvantage of Lloyd's."

Caution has paid off for Lloyd's, Savage said. The creation of the Lloyd's Franchise Performance Directorate has meant that Lloyd's has suffered no big failures since 2003, he said.

Lloyd's reputation as a well-disciplined market, Savage said, has meant that participants in the market are no longer so concerned that their peers will get into trouble and create problems for the Central Fund.

Potter agrees that Lloyd's careful approach has served it well. "I think the franchise board will continue to be cautious and be very selective in terms of any syndicate putting a growth plan in front of them in the current market conditions," he said.

Prospects for the sidecar market in 2009, Thomas suggested, are likely to be affected by the continuing difficulty reinsurers have in obtaining capital. She expects these constraints to continue into the January 2010 renewals. But an expected rebound in the capital markets next year, she added, should boost the sidecar sector.

Sidecars, Thomas said, can serve as an alternative to retrocessional insurance. In 2006, she recalled, stirrings in the capital markets made more money available to the retrocession market and helped limit premium increases.

Another uncertainty, Thomas said, is the outlook for the catastrophe market over the rest of 2009. Higher levels of catastrophe activity, she explained, could be expected to boost premiums and encourage the use of sidecars.

Lloyd's has a current Best's Financial Strength Rating of A (Excellent).

(By Robert O'Connor, London editor: [email protected])

(c) 2009 A.M. Best Company, Inc. Lloyd's has emerged as a center of the special-purpose underwriting activity that has developed on a piecemeal basis since the aftermath of the great hurricanes of 2005.