Ways the wealthy cash in on risk

Investing in insurance market Lloyd’s of London can yield 20pc or more in a good year, reports Richard Evans

It is one of the pillars of the City of London yet almost no private savers invest in it. We have all heard of Lloyd’s of London, established in a coffee house more than three centuries ago to insure ships and their cargoes – but fewer people realise that some of the money behind the market comes from private investors.

Most are unaware of the large returns – 20pc or more in a good year – that can be made at Lloyd’s, or of the fact that those returns are unconnected to what is happening in the stock, bond and currency markets. And that’s before we talk about the potential to avoid inheritance tax. London remains the global centre of insurance and Lloyd’s, in its iconic Richard Rogersdesigned headquarters, is at its heart.

Investing in this unique marketplace of risk effectively means profiting from the difference between premiums and claims on a huge range of insurance. But investing in Lloyd’s is not for everyone. Here we explain who should consider investing in the market, the pros and cons and how they can go about it.

Who can invest in the Lloyd’s of London market?

Lloyd’s needs capital to back up the insurance policies issued by its members and that capital can come from both institutions and individuals. However, because of the complexity and costs, only the wealthy should consider it.

“We advise clients not to invest more than 10pc of their net wealth into Lloyd’s, and because of the costs involved it doesn’t make sense to invest less than about £500,000 in the market,” says Emily Apple, of Alpha Insurance Analysts, which helps investors join the Lloyd’s market. “So you’d need to have £ 5m of net wealth or better still £8m-£10m.”

How do you go about investing in Lloyd’s?

The only way for private savers is to use a company such as Alpha, which acts as a middleman between investors and

Lloyd’s insurers. There are three such companies; the other two are Argenta Private Capital and Hampden Agencies.

How does investing in Lloyd’s work?

Insurance companies, which include some well known, listed names such as Hiscox and Beazley, organise “syndi

Lloyd’s of London, in its Richard Rogers-designed HQ, is at the global centre of insurance cates” to write insurance policies for clients. Syndicates operate one year at a time, so investors can choose to take part one year at a time, too.

It will recommend that the investor’s capital be split among a variety of syndicates. Kate Tongue, of Argenta, says: “For diversification we would advise investing in at least six syndicates.”

That capital, along with premiums received from policyholders, forms the pot of money from which claims can be paid. If the syndicate is profitable in a particular year, the investor keeps all his or her capital and receives a share of the profits. In the case of loss, he or she has to pay a share towards meeting claims.

The accounts for a particular year of operation of a syndicate are therefore not finalised for three years, which is when the investor can expect the first returns. Most investors remain in the market and invest in the syndicates each year, so before long they receive annual returns as successive years are finalised and returns paid.

When investors commit capital to a syndicate, they do so in the form of “collateral”. This means that the assets they commit, which can include cash, shares and other types, remain theirs unless they are needed to meet claims and any income generated (interest or dividends) goes to them.

Private investors cannot put money into Lloyd’s directly but must do so via either a limited company or a partnership. The agent you choose will set up and administer the company or partnership for you. Alternatively, such companies and partnerships come up for sale as existing investors want to leave the market, so you can bid for one of them.

What sort of returns could you expect?

The historic average is about 10pc a year. However, the market is cyclical and now is acknowledged to be a good moment in the cycle: Argenta Private Capital, for example, predicts returns of more than 20pc this year. These figures do not include the interest or dividends you can expect from the assets you commit to Lloyd’s as collateral.

What are the advantages and disadvantages of investing at Lloyd’s?

Aside from the obvious – the potentially very high returns – returns are “uncorrelated” to those from other assets such as shares, bonds and property. Another big plus is the scope for “double returns”: profits from the syndicates’ underwriting business plus interest or dividends from the assets you commit as collateral.

There is also tax efficiency: the limited company or partnership through which you invest in Lloyd’s is a business and qualifies for “business relief ”, which means that there is no inheritance tax liability after the first two years. Tax relief on disposal may also be available to some investors.

The disadvantages are the large amounts of capital needed and the delay before you receive your first share of underwriting profits, as well as the chance of losing some capital.

If you put money in, is it easy to get it out again?

When you want to quit the market, you can either wind up your limited company or partnership or, more likely, sell it to a new investor who wants to join the market.

Either way, investing in Lloyd’s makes sense only over the long term in view of the costs and complexities involved. Agents recommend a minimum of five years and ideally more.

What are the costs of investing in Lloyd’s?

There is a fee for setting up the limited company or partnership for a new investor, typically about £6,000. Your agent will also charge an annual fee of about 1pc. Some agents charge a performance fee too.

‘We advise clients not to invest more than 10pc of their net wealth’

Is it still possible to lose everything, as some investors did in the 1990s?

No. In the old days private investors in Lloyd’s, called “names”, shouldered unlimited liability, which meant all their assets, not just those committed to Lloyd’s, could be used to meet claims once other sources of funds were exhausted. Many “names” were ruined when unexpected sums were due in claims over systemic problems such as asbestos-related diseases.

Now new private investors in Lloyd’s can enter the market only via a corporate vehicle – a limited company or partnership – that confers limited liability. You could in principle lose all the money you commit to Lloyd’s, but not more.