Lloyd's may lure outside investors as legacy problems begin to fade

LONDON—The resolution of concerns over Lloyd's of London's potential exposure to the legacy policies reinsured by Equitas Ltd. is expected to prompt more investors to consider entering the market and could spark more consolidation activity.

Recent weeks have seen several deals involving Lloyd's business, including the proposed acquisition of Wellington Underwriting P.L.C. by Bermuda-based Catlin Group Ltd., which has a large operation at Lloyd's; the purchase of Creechurch Underwriting Ltd. by Guernsey-based Lloyd's company Canopius Group Ltd.; and the sale of Cathedral Capital P.L.C. to Alchemy Partners L.L.P., which marked the first venture into the Lloyd's market by the buyout specialist.

And some observers predict that strategic changes at Lloyd's, as well as the resolution of the Equitas concerns, could prove to be a catalyst for more deals, including greater outside investment.

Last month, Equitas--the runoff reinsurer for the pre-1993 long-tail liabilities of Lloyd's syndicates--announced a deal with Berkshire Hathaway Inc. under which the U.S. giant will reinsure, and eventually assume, Equitas' liabilities (BI, Oct. 23).

The existence of Equitas had been a drag on the Lloyd's market's financial strength rating, according to analysts, and it gave potential investors pause. In particular, there were concerns Lloyd's companies might be tapped to pay Equitas' liabilities should the runoff reinsurer fail.

In the wake of the announcement of the Berkshire-Equitas deal, Standard & Poor's Corp. revised its outlook on the Lloyd's market's A rating to positive from stable and indicated that the deal is likely to "remove any realistic potential for reserve inadequacy at Lloyd's to undermine confidence in Lloyd's."

The competitive position of the market probably will improve as a result of the Equitas deal and as the market's "optimal platform strategy" plan takes hold, said S&P analyst Marcus Rivaldi in London.

That plan, unveiled at the start of the year, is a three-year program aimed at helping the market retain corporate investors and maintain a strong competitive position by improving the efficiency of market processes, among other things.

If overseas companies are looking to expand in Europe, Mr. Rivaldi said, "Lloyd's could be a domicile of choice," and if they wish to diversify their portfolios, they may now be more willing to buy into Lloyd's, Mr. Rivaldi said.

Companies that currently operate at Lloyd's may become less concerned about any perceived need to diversify out of the market, he said, and so may, instead, seek to merge with other Lloyd's companies.

Mr. Rivaldi said he expects to see all of those scenarios take place.

The Catlin-Wellington deal likely was not predicated on the resolution of the Equitas question, Mr. Rivaldi noted, but future mergers or acquisitions may well progress as a result of the removal of the uncertainty regarding Equitas.

There are several factors that are likely to prompt investor interest in Lloyd's, noted Andrew Holderness, head of insurance at London-based law firm Clyde & Co.

For one, the market suffered a manageable loss from the storms that hit the United States in 2005, whereas 10 years ago, events of such magnitude likely would have caused a far bigger marketwide loss, he said. That change demonstrates the robustness of the market in the face of a large event, he said.

Secondly, the Equitas deal potentially will remove uncertainty about the market and "can only be a positive," he said.

And thirdly, outside investors often like to know that there is an exit route, so the ability for them to set up mechanisms such as sidecars at Lloyd's or enter into quota-share reinsurance arrangements is likely to be viewed positively and shows a responsiveness of the market, he noted.

Increase in activity

While there is unlikely to be further M&A activity this year--companies are likely to concentrate more on their business plans ahead of the renewals--Mr. Holderness said he would not be surprised if after the end of year break, "the slide rule gets dusted off" and there is more activity.

The £113 million ($241.6 million) sale of Cathedral to Alchemy demonstrates the increasing attractiveness of Lloyd's to the investment community, said Tim Matthews, a corporate finance partner at Clyde & Co., who was involved in the deal.

While the sale marks Alchemy's entry into the Lloyd's market, the deal is likely to be the first of many, he noted, as there are other investors who want to enter the market while insurance and reinsurance rates are high, and there are several small to midsize Lloyd's companies that are looking to increase their capital to better compete.

"There are a number of businesses I have heard of that are looking to diversify, and there are a number that are looking perhaps to set up at Lloyd's for the first time," added one market source.