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Lloyd's syndicates balloon as buyers seek bigger partners

Merger trend may put squeeze on midsize rivals

Lloyd's syndicates balloon as buyers seek bigger partners

The recent uptick in mergers and acquisitions of Lloyd's of London business is resulting in syndicates that are very large by the market's historical standards.

But a perceived need for greater size in order to stay competitive is one factor driving that M&A activity, experts say.

For example, the $4.3 billion merger of XL Group P.L.C. and Catlin Group Ltd., which is slated to be finalized in the coming weeks, will result in a multiline syndicate that will write as much as 10% of the business that goes through Lloyd's.

But there still is a place for smaller specialist players offering coverage such as fine art and specie, experts say.

It is midsize syndicates that are neither large nor niche that may find themselves struggling to compete, they say.

To an extent, scale has always been significant for syndicates at Lloyd's, but current trends may be adding to their desire to grow, said Mark Nicholson, credit analyst at Standard & Poor's Corp. in London.

One trend is that many cedents now buy less reinsurance and want smaller panels of reinsurers, meaning they wish to deal with larger counterparties, Mr. Nicholson said.

In addition, the cost of complying with the Solvency II risk-based capital regime, which goes into effect in Europe next year, may feel disproportionately severe to smaller entities and drive the desire for greater scale, he said.

Still, “if you have a strong reputation in specialists business, you are probably seeing the same business that you would have” previously, he said.

Lloyd's is known for its entrepreneurial culture and “by definition, some of that (business) is small stuff,” said Eamonn Flanagan, head of the Liverpool, England, office of Shore Capital Group Ltd.

“If all the focus is on size and scale, then you risk losing some of that entrepreneurial spirit” — something that Lloyd's is keen to guard against, he said.

“On the other hand, some of the losses are starting to look supersized,” he said, pointing to the combined estimated insured losses from hurricanes Katrina, Rita and Wilma in 2005 of about $65 billion, and the Japanese earthquake and tsunami in 2011, which caused insured losses of about $35 billion, as examples.

When large losses do occur, syndicates need to be sure they can pay their share and still underwrite the following day, so size becomes a concern, he said.

For “larger-ticket business,” such as property catastrophe, brokers often prefer syndicates that can offer larger line sizes, allowing them to place more business with fewer syndicates, said Anna Bender, associate director at Fitch Ratings Ltd. in London.

In addition, size and reputation matter when it comes to being the lead underwriter, since larger syndicates typically lead more slips, apart from very specialized areas, she said.

Under Solvency II, a larger and more diversified book of business results in less onerous capital requirements, Ms. Bender said.

Investors also may influence size, Mr. Flanagan said. Large corporate investors may be more keen to support scale, while individual investors, known as names, might be more aligned with smaller niche syndicates, he said.

The recent adoption by brokerages such as Aon P.L.C. and Willis Group Holdings P.L.C. of market facilities to place certain lines of business, has “pertinence to the size of a syndicate” to quickly tap large lines of capital to take part in such facilities, Mr. Flanagan said.

But smaller syndicates have reacted to this development by forming consortia for certain lines of business to offer sizable lines on slips, he said.

“The main drivers towards consolidation are costs, capital ratios and broker efficiency,” said Robert Smith, director at Syndicate Research Ltd. in London.

“A syndicate writing a general book of business will have to be a certain scale in order to operate efficiently, achieve a diversified book with a lower capital ratio and be meaningful to brokers,” he said.

But smaller, more focused syndicates also can operate efficiently, he said.

If they are supported by a diversified spread of investors, syndicates' capital ratios likely will be lower, he said.

While having a number of very large syndicates may be seen as a threat to the relevance of the Lloyd's model of a syndicated marketplace, great advantages remain and these businesses wish to remain at Lloyd's, Mr. Flanagan said.

“These are not altruistic, sentimental” reasons, he said, pointing out that many of the CEOs of the largest Lloyd's businesses — such as Charles Philipps at Amlin P.L.C., Bronek Masojada at Hiscox Ltd. and Andrew Horton at Beazley Group P.L.C. — “are capital markets people” by background “who take decisions devoid of sentimentality.”

Access to global licenses that Lloyd's offers is one huge advantage of operating there, which allows immediate underwriting based on those licenses rather than having to go through a time-consuming and costly application process, he said.

There are also capital advantages for syndicates, in part because the market is backed by central capital resources, which might allow business to release capital to shareholders or use capital elsewhere, he said.