A step closer

27 November 2017. Published by Matthew Griffith, Partner and Neil Brown, Partner

Matthew Griffith and Neil Brown explore Lloyd's SPAs as an alternative for new market entrants to standalone syndicate formations and M&A

The use of Lloyd's special purpose syndicates, or special purpose arrangements (SPAs), to give them their up-to-date terminology, continues to evolve.

Whatever the underlying rationale - increasing underwriting capacity or taking advantage of growth opportunities mid-year - the first generation SPAs were, in many cases, an innovative way for an existing Lloyd's carrier to leverage third-party capital. Early SPAs mostly provided reinsurance capacity, while new businesses setting up in Lloyd's generally looked to establish a new standalone syndicate, often managed by an experienced managing agency or turnkey operator, or to execute an M&A deal.

But fast-forward a few years from the early days of SPAs, the achievement of broader and longer-term strategic goals - and Lloyd's market entry for new capital providers - is often at the heart of SPA transactions.

Stepping stones

Using an SPA as a stepping-stone - an interim step for a capital provider or non-Lloyd's carrier towards establishing a standalone syndicate - to gain exposure to, and experience of, the Lloyd's market has become more prevalent.

Acappella, China Re and Credit Suisse all followed this route, setting up SPAs and transitioning them to standalone syndicates, each within a relatively short period after their initial launch.

But longer-term partnering has been a theme in some of the more recent transactions. Chaucer's recent alliance with Axa has both the stepping stone and the strategic aspect, combining the global insurance giant's local distribution network with Chaucer's Lloyd's underwriting expertise for the development of African specialty business and the parties continuing to work together developing Axa's ability to establish its own Lloyd's business in the future.

But this is not always at the centre of the strategic thinking, as illustrated by Novae's recent US property excess and surplus lines SPA backed by major insurance-linked securities fund manager Securis. The deal provides significant commercial benefits to both parties with seemingly with no current intention for Securis to set up its own syndicate down the line.

Why choose SPAs?

Establishing a standalone syndicate would enable a new capital provider to underwrite its own business plan but it can be a time-consuming process, taking on average 12-18 months to pass through the application process (according to Lloyd's) and requiring significant resources to be deployed.

The process can be simplified, and significantly de-risked, by utilising the services of a turnkey managing agent, but it will rarely be advisable for a new entrant with limited experience of Lloyd's to move straight to the simultaneous formation of a syndicate and a newly authorised managing agent.

If an appropriate target were available, M&A may also be an option, though the cost of buying a Lloyd's platform, with everything already in place, can be significant, as can the risks of acquiring and integrating an existing business.

Setting up an SPA - a vehicle that writes a single quota share reinsurance contract of its host syndicate and is managed by the host's managing agent - is potentially a faster route to access Lloyd's business. The requirements that Lloyd's applies to SPA applications are less wide-ranging, so the timetable can be shorter, and the dates within it are generally more flexible.

Unlike providing capital to support an existing syndicate, where underwriting by a new capital provider can start only at the beginning of an underwriting year of account, SPAs can commence mid-year, giving significant flexibility for host syndicates and capital providers to pursue business opportunities as and when they arise.

SPAs may also be used as an alternative option in the event that plans to launch a standalone syndicate run into difficulties or delays, ensuring that capital is deployed into the market, albeit in a different way.

Supporting a syndicate directly exposes a capital provider to all classes of business underwritten. In some cases, this may take the investment outside the capital provider's risk appetite. SPAs are considerably less rigid in that they need not reinsure all of the host's business.

The underlying quota share reinsurance contract may, for example, be limited to cover only specified lines of business rather than a broad whole account quota share (again, the Novae/Securis deal is a good example of a class-specific SPA) and also to apply only to one or more defined years of account. Exposure to the host syndicate's previous underwriting years can be excluded from the reinsurance coverage.

Key legal documents

In addition to customary items required to establish a new Lloyd's-approved corporate member and certain standard Lloyd's documents, such as the managing agent's agreement with the corporate member and agreements for the provision of its underwriting capital, the key items will include business plans for the SPA and the host syndicate, the reinsurance agreement and, typically, a framework agreement between the managing agent and the corporate member - particularly in an SPA involving a longer-term strategic partnership.

The reinsurance agreement will set out clearly the business to be reinsured by the SPA. Lloyd's has helpfully developed a standard form SPA reinsurance contract that, if used as the basis of the arrangement with modifications clearly identified, will help expedite the Lloyd's review.

As to key commercial terms, Lloyd's would generally expect the host syndicate to retain a sizeable proportion of the business. Its current guidance states that this should be at least 20 percent to ensure alignment.

The framework agreement, if there is one, will supplement the standard Lloyd's managing agent's agreement and govern the parties' SPA relationship.

This may detail, for example, the business to be ceded to the SPA, budget and financial provisions for the venture, and arrangements for the cross-secondment of staff between the managing agent and the capital provider's group. It may also include exclusivity provisions to ensure that business is channelled to the host syndicate and to limit the parties' involvement in competing businesses, the use of the parties' brands and the ownership of key business assets such as customer data. And, as in most "joint venture" type agreements, the framework agreement may contain termination rights specifying when the arrangement may come to an end (for example, on a change of control).

Where it is a feature of the deal, the process and timetable for converting the SPA into a standalone syndicate should also be documented.

Assessment criteria

Lloyd's assesses the viability of the proposal and how it will add value to the market. Proposals that, for example, develop new specialist business, introduce market-leading underwriters, source business from new territories - in line with Lloyd's own Vision 2025 - or add global diversification to the market's capital base may be viewed as accretive.

The Lloyd's application process broadly comprises initial stages involving preliminary discussions and presentations leading to "in principle" approval, followed by further reviews culminating in formal approval.

The main elements Lloyd's will look at include, among other things: the nature and quality of the syndicate business plan and the rationale behind the SPA business plan; the classes of business and geographies involved; how new business or premium will be derived; and any impact on compliance with Lloyd's franchise guidelines.

Lloyd's is currently working on a new guide for setting up an SPA which, when it becomes available, will provide useful insights into its requirements and expectations and the decision-making process for SPA formations. But for now, and perhaps even more importantly pending the release of the new guidance, the first key step is to engage in early informal discussions about any new SPA with Lloyd's.

These discussions are held on a confidential basis within a dedicated group within Lloyd's and will help the parties to explore the proposal, its benefits and any potential stumbling blocks with Lloyd's before significant time and resources are incurred on the project.

The article was first published in the Insider Quarterly.

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