Prices at this month's capacity auctions were way below recent years. But John Francis of Hampden Agencies argues that there's never been a better time to invest. Jason Woolfe reports

On the face of it, it looks like a risky time to invest in the world's oldest insurance market.

A glance at prices achieved at the capacity auctions earlier this month shows levels way below what they reached just a few years ago.

The auctions are the main way to buy the right to a piece of the action at Lloyd's. Two more take place next month.

Low prices mean that smart investors don't fancy their chances, surely?

Not so, says John Francis. A director of Hampden Private Capital, which owns the Hampden Agencies Members' Agent that advises over a 1,000 investors at Lloyd's, he forecasts that an investor could get an underwriting return of more than 15% in the coming year.

And he produces data (see graph) showing that prices at capacity auctions behave in exactly the opposite way to what one would expect.

They are driven not by the expectation of future profit, but the availability of capital in the market, he says. Prices hit a recent high in 1998 to 1999 - precisely when losses, too, were peaking.

"This is no coincidence, as the pricing of business, just like the pricing of syndicates at auction, is linked to the availability of capital," he says.

"In 1999, members had just received four years of underwriting profits and, together with booming investment returns, there was a surfeit of capital in the industry."

This money was used at policyholder level in supporting low premiums and at auctions, by paying high prices to underwrite business the following year.

The figures from Hampden Underwriting Research show how market average prices have moved since 1995.

Prices for the top 25% syndicates (by implied market capitalisation of syndicate capacity at auction) have crashed since their 19.8p per pound of capacity peak in 1999 to 8p at the first auction this year, with the market average on a similar curve.

Francis expects prices to fall further, with the possible exception of buy-outs in which corporate members bid to increase their control of a syndicate's capacity.

Cox, Hiscox, Limit, Wellington and SVB all increased their stakes in the first capacity auction.

So if the prices are good, what are the prospects?

Target attainable
Hampden's profit target, made last September for the members it advises at Lloyd's for the current year, was 15%.

Francis says: "We're increasingly confident, subject to no severe hurricanes, that the 15% target is attainable and some bespoke members may make more."

Standard & Poor's has forecast a Lloyd's return of 11.4% for 2002, but Francis says Hampden's profit target takes account of bespoke members being on the better syndicates.

"Further rate increases for next year, particularly if marine hardens, imply that a profit of more than 15% is attainable for next year."

This compares with forecasts of further falls on the London Stock Exchange.

Analyst Bill Adlard of Hemscott Investment Analysis warned last week that "something big is starting - down". He forecast falls in the FTSE 100 to 3,364 or lower.

In contrast to the climate of fear sending stocks lower and lower, Francis believes it will drive profits higher in insurance.

"The behavioural psychology of the insurance market cannot be underestimated and this fear will, we believe, contribute to at least three years of underwriting profits starting with the 2002 account."

Hurricane Andrew, which hit the east coast of the US in 1992 was the industry's biggest loss - costing about $20bn (£12.8bn) - until the 11 September terrorist attacks.

In the aftermath of its devastation, reinsurance rates soared and Lloyd's sailed into profit of about 38% on capacity for the next three years of account.

The Lloyd's Market modernisation programme, which should make it more proactive in tackling underperforming syndicates, should also make it a better bet for investors.

So it is all the more regrettable, Francis says, that Lloyd's doesn't want any new unlimited liability investors, or Names.

Francis argues that the market benefits from investors who need the Lloyd's structure, both for the protection afforded by its central fund, which provides a safety net for policy holders, and its international licences.

If the market comes to depend too heavily on large, often overseas-based, corporations for its investment, it could find itself destabilised and vulnerable to the cyclical swings inherent in the insurance industry.

Francis says: "There's a danger that come the next down cycle - Lloyd's will find a number of overseas trade players exiting the market.

"Lloyd's is a mutual society. Therefore, it needs a significant proportion of its capital base to need Lloyd's."

On the positive side, Francis sees Lloyd's as having huge advantages over its corporate competitors.

Direct slice
Its ability to raise money swiftly through the auction system allows it to operate without the costs of rights issues needed by corporations.

Annual actuarial reviews of all the syndicates keeps reserving suitably prudent and the cash-call system of calling on members to pay out for big claims means many big losses have already been paid.

The key difference between buying shares in an insurer and investing directly in the Lloyd's Market is that the Lloyd's participant gets a direct slice of underwriting returns while retaining the flexibility to invest the capital elsewhere, making it work twice.

The underwriting prospects at Lloyd's are the brightest since

1993. It is no surprise the smart money is now taking a second look at investing in insurance at Lloyd's. n

A safer way to get a slice of the Lloyd's action
Given Lloyd's decision to discourage new unlimited liability Names, coupled with investors' understandable reluctance to expose themselves to unlimited losses, focus on Namecos is increasing.

Namecos are limited liability vehicles that participate in the market.

Hampden Agencies is the largest adviser of Namecos managed by Nomina plc, which is the market leader in the provision of Nameco services.

While both Hampden and Nomina are under common ownership, Nomina looks after the affairs of Namecos, regardless of their agents. Hampden Agencies advises the majority of the 490 Namecos currently underwriting under the umbrella of Nomina plc with a combined capacity of £285m for 2002.

The Nameco structure allows investors to build up retained profits, which are taxed at the small company tax rate of 19%.

This raises the prospect of a vehicle becoming self-financing, especially given the current hard market conditions.

Shares in Namecos have the added tax planning benefit of attracting business property relief from inheritance tax.

The annual running cost of a Nomina Nameco is a £2,250, which covers all the non-Lloyd's aspects of the Nameco, leaving the shareholder in full control of the company's underwriting programme.

Francis says several insurance brokers, active underwriters and directors of managing agents have already bought into the market using Namecos managed by Nomina.

"One of the main independent brokers approached us and said it is an effective way of investing in Lloyd's.

"Several have invested in Namecos last year and we're expecting more next year," says Francis.