Helios Underwriting — Active Lloyd’s risk management and promotion

Helios Underwriting is an AIM-quoted holding company providing investors with a limited liability direct investment into the Lloyd’s insurance market. Helios offers a unique opportunity to invest directly in a diversified portfolio of Lloyd’s syndicates, which is actively managed to reduce risk and capital requirements, delivering a track record of superior underwriting performance. It also has a proven track record of growing its portfolio through a recent upswing in pre-emptions, selective investment in syndicates and start-ups, and actively acquiring interests in syndicates and limited liability vehicles (LLVs).

We forecast that Helios will benefit from a continued upswing in the Lloyd’s underwriting cycle, with the current hard premium environment driving lower combined ratios and higher earnings. FY22 earnings faced pressure from a delay in the underwriting upswing and mark-to-market investment losses and missed our forecast by 3.7p, which represents 2.5% of starting NAV. While the company’s updated strategy for investing in growth and additional conservatism around the timing of the underwriting results upswing has led us to cut our near-term EPS forecasts, a very strong and improving capacity growth outlook has enhanced long-term prospects and strongly supports the value we see in Helios, with a forecast over-the-cycle RONAV of 15.5%.

An important store of value is Helios’s capacity fund or weighted average value (WAV), which is carried as an intangible asset on the balance sheet. WAV growth through pre-emptions and capacity accumulation results in superior RONAV and value creation for the company, supporting over-the-cycle forecasts and offering further potential upside.

Helios has been particularly successful in recent years at growing its Lloyd’s underwriting capacity through LLV acquisitions, direct syndicate investment and deploying tenancy capacity. Its tenancy or relationship capacity represents a key avenue for generating superior and diversified underwriting profits and, because it is not currently carried on its balance sheet, it provides potential for superior WAV growth (as relationships are formalised and recognised in WAV) and higher than forecast RONAV. It also allows Helios to actively support and promote syndicates, start-ups and risk categories in its drive for growth and diversification, including reducing exposure to natural catastrophe risks and increasing exposure to new and non-correlated risks.

A strategic imperative for Helios is to diversify its income stream away from underwriting profits towards fee-based income. It aims to achieve this via quota share and other reinsurance activities, receiving healthy fees in lieu of ceding capacity to third parties, while retaining upside in the form of fees earned on underwriting outperformance. Due to the lack of new entrants into the Lloyd’s market, the current environment is well suited for such arrangements, which will provide the company with a steady fee income stream.

Helios’s operational upside is well supported by Lloyd’s market dynamics and the outlook for improved return on capacity (RoC). Following declining rates since 2014, Lloyd’s has seen cumulative rate rises (premium increases), in excess of 50%, since 2017 and Helios has consistently outperformed Lloyd’s for all closed years of account (YOAs) since 2013.

Helios ended FY22 with free working capital of £10.3m, assisted by a £12.4m capital raise and £22m in new bank excess of loss (XoL) facilities. We forecast that increased syndicate underwriting results and distributions will be sufficient to fund working capital needs for capacity growth to reach 13.5% pa in the next few years. To exceed this growth rate, Helios has the option to increase its gearing as its capital base grows.

Helios benefits from diversification credits from Lloyd’s, which results in the requirement to carry less capital than the syndicates in which it invests, and puts it in a strong position when considering further LLV acquisitions and syndicate support.

Helios has experienced EPS losses over the past three years due to the residual impact of a soft underwriting environment and mark-to-market investment losses due to rising yields. This has resulted in weak RONAVs, including -3.1% (-1.1% with WAV revaluation) in FY22. We forecast a strong improvement, with EPS turning positive in FY23 and RONAV rising to 17% in FY25 (20% including WAV revaluation). Although we have cut our near-term EPS forecasts, the long-term outlook has improved markedly, with increased confidence in strong capacity growth and margin enhancement via strategic investment and portfolio diversification. Our valuation of 252p/share is unchanged, thanks to improved and well-supported long-term growth prospects captured in our terminal growth assumption of 3% pa. Our valuation is based on an over-the-cycle RONAV assumption of 15.5% and represents a 47% premium to our FY23 forecast NAV of 169p/share and a 44% premium to the current share price.

Helios reported an EPS loss of 4.9p in FY22 (£3.3m) and a total comprehensive loss of £1.3m. Syndicate underwriting profit of £0.1m was negatively affected by large mark-to-market losses on investment portfolios due to rising bond yields. Holding company P&L was affected by lower income and rising costs, while total comprehensive income benefited from a reduction in syndicate capacity revaluation. The combined ratio of 96% was weaker than the 94% in FY21 due to the impact of Ukraine reserves on the 2021 YOA and the impact of Hurricane Ian on the 2022 YOA. The COVID-affected 2020 YOA also closed less positively than expected.

We forecast a combined ratio improvement to 90% in FY23, 86.5% in FY24 and 86.8% in FY25, which includes more conservatism in the earlier years relative to our previous forecasts to allow for global uncertainty. We have further moderated our near-term forecasts to allow for Helios’s updated strategy to invest in reinsurance protection, capital efficiency measures and holding company capacity, which results in higher new business strain on a strong increase in retained capacity. This results in a 55% rise in FY23 holding company expenses, with the higher base affecting FY24 as well. This results in EPS of 15.1p in FY23, 26.6p in FY24 and 33.8p in FY25. We forecast RONAV at 9.7% in FY23, increasing to 17% in FY25 (20% allowing for capacity revaluation). The long-term outlook has been enhanced, with EPS outside our explicit forecast period expected to benefit from capacity growth of more than 10% pa and operational gearing driving EPS growth ahead of this level. We have increased our terminal growth rate assumption to 3% to reflect this.

In addition to the standard sensitivities typically tested, we include scenarios relating to capacity growth, change in combined ratio and change in interest rate.

Our valuation rises by 6.1% for every 50bp decrease in our cost of equity assumption and increasing our terminal growth rate by 50bp results in a 7.6% increase. For every 2.5% increase in annual capacity growth (via pre-emptions), our valuation increases by 12.9%. The valuation is very sensitive to the combined ratio, with a 2.5% increase resulting in a 17.8% decrease (similar to an increase in expense ratio). For every 1% increase in interest rates, our valuation increases by 3.6%, with the impact of higher investment income more meaningful than any short-term portfolio impact.

Helios is a holding company that owns capacity in more than 30 Lloyd’s syndicates/managing agents, which allows it to participate in the underwriting results of these syndicates. Its exposure is on a limited liability basis and is backed by underwriting capital that it must deposit in the funds at Lloyd’s (FAL), akin to the solvency margins that all insurance operations hold. It participates in syndicate underwriting results based on the share of capacity (which is the upper limit of gross written premiums, GWP, that may be written in an underwriting year) that it owns in the syndicate and must contribute capital in the same proportion, varying between syndicates based on underlying risk.

Helios has actively increased its participation in Lloyd’s over recent years by acquiring LLVs and the associated syndicate capacity in which they participate, by buying capacity in the Lloyd’s auctions and by subscribing to tenancy capacity. The latter only provides access to a particular YOA, does not provide guaranteed renewal for subsequent YOAs and does not attract a value, but requires Helios to provide the capital required to write business. However, it can provide the opportunity to dip in/out of underwriting certain risks when the return is forecast to be particularly attractive. Helios has used this mechanism increasingly as a promoter to new syndicates and in support of alternative and non-correlated risk classes. Tenancy capacity not only allows Helios to promote new initiatives and alternative risks, but also allows it to manage its risk profile and diversification actively. Tenancy capacity is not included on Helios’s balance sheet and hence represents a store of value that can enhance earnings and WAV growth over time (as relationships are formalised).

Helios has recently shifted more focus to actively managing its risk portfolio and solvency. It has launched a syndicate performance and evaluation team, and insourced help from the Insurance Capital Markets Research consultancy at Lloyd’s, to obtain more granular data directly from syndicates, which will help it manage current syndicates and invest in new ones.

Helios has a very light corporate structure, relying on external service providers for most of its operations. Martin Reith became Helios’s CEO in April 2023. Martin has taken on responsibility for Helios’s portfolio curation and capital management. The finance, investments and operations functions are overseen by the CFO, Arthur Manners. Both Reith and Manners have considerable Lloyd's experience, ranging from broking and underwriting to member agencies. Nigel Hanbury (Helios’s previous CEO) remains one of the biggest shareholders in the company and still has an executive role.

Helios will continue to meaningfully increase its investment in both operational capacity and through reinsurance and capital efficiency initiatives in support of its new strategy. These initiatives carry a near-term cost, which is forecast to increase operational and reinsurance expenses by 55% in FY23, with growth in line with capacity thereafter. On the flipside, the enhancement to solvency will help Helios benefit from a higher interest rate environment and we forecast that income from reinsurance fees will rise from c £0.6m in FY22 to more than £2.0m in FY25.

Helios has outperformed Lloyd’s in terms of combined ratio and RoC since 2013, thanks to careful portfolio selection, with the latest midpoint RoC forecasts for 2021 (3.9%) being largely in line with Lloyd’s (4.2%), although we forecast this will rise to 8.1% once the year is closed out. We forecast that this outperformance will continue and we expect a continued positive trend from RoC in the 2022 and 2023 YOAs. We forecast a rise from 8.1% for the 2021 YOA to 11.2% and 13.4% for the 2022 and 2023 YOAs, respectively, which will emerge in FY24 and FY25.

Helios curates its portfolio on a year-to-year basis, with tactical management considering likely market conditions for the coming year and rebalancing needed as newly acquired tenancy capacity and LLVs are added. Its newly formed syndicate performance and evaluation team will further add to this capability by assessing new and diversified risk pools and optimising capital efficiency.

In the same way as a trading member of Lloyd’s, Helios was offered pre-emptions that amounted to £36.6m in 2023, a record-high due to the hard Lloyd’s underwriting environment and limited new entrants into the market. The company is optimistic that pre-emptions could add 10–15% to capacity and we forecast a conservative level of 10% pa. Helios buys and sells capacity in the Lloyd’s auctions to optimise its portfolio each year and in FY22 disposed of £31.6m in capacity, which boosted its working capital. We forecast further disposals of 2.5–5.0% of capacity over the next few years as Helios rebalances its portfolio and generates working capital for new investments.

During 2022, Helios diversified its portfolio even further by reducing exposure to natural catastrophe (natcat) heavy syndicates like Tokio Marine and Lancashire, while increasing exposure to Atrium and Managing Agency Partners, among others.

Helios has taken an active decision to moderate its natcat exposure, both through the rebalancing of its freehold capacity portfolio and through growing its tenancy exposure to speciality, non-aggregating lines and business not gravitating to the London market.

During the course of 2022, Helios increased its tenancy capacity to £149m, with £49m investment in new syndicates. Its tenancy capacity is spread between more than 10 syndicates, with the top five exposures to Dale Partners (Asta), Blenheim, Beazley, Flux Acrisure and Click for Cover.

Tenancy capacity allows Helios to improve its portfolio diversification and invest in new and growing risk classes not typically available through traditional syndicates. Click for Cover specialises in cyber cover for small and medium enterprises and attracts business that would not normally come to Lloyd’s. It has a strong cyber underwriting track record with low loss ratios. Flux is a new syndicate that uses Acrisure’s tech-driven retail distribution systems to attract new buyers to the Lloyd’s market. MIC Global (included in Other above) offers companies highly relevant, affordable insurance products, which can easily be embedded into their existing digital processes. This will accelerate the delivery of micro insurance products (including in India) when and where customers need them, allowing them to gain access to cover that is not readily available through traditional insurance methods.

From the beginning of 2021 to the beginning of 2023, Helios actively reduced its property and reinsurance risk class exposure to limit the impact of natcat claims in the near term, while its casualty exposure (in particular relating to US dollar non-marine liability) increased meaningfully and its exposure to other classes (particularly through the use of tenancy capacity) grew steadily.

With meaningful growth in capacity delivered by Helios in FY21, its risk exposure has shifted somewhat from property and reinsurance to casualty (reflecting focus by the syndicates on specialist liability risks).

Helios offers investors the opportunity to participate in the Lloyd’s market through a listed vehicle, providing much greater liquidity and requiring a smaller capital commitment than direct investment. Investors benefit from Helios’s specialist skills and relationships within the Lloyd’s market, as they relate to syndicate selection and promotion, risk monitoring and diversification, capital management and solvency, reinsurance utilisation, working capital management and growth through organic means and through acquisition (LLVs).

The diversification benefits that Helios experiences are quantifiable and have consistently emerged in an RoC that has outperformed the Lloyd’s market as a whole in all closed underwriting years since 2013. Strategically, Helios aims to improve its diversification by implementing more active monitoring and influencing syndicate exposure, and backing and supporting new ventures, with a particular focus on non-correlated risks.

Underwriting capacity is the lifeblood of Lloyd’s syndicates and of Helios as an aggregator of syndicate exposure. The capacity owned by syndicates or by Helios through its exposure to syndicates determines the level of premiums that the syndicate can write in a given year and, as a result, underwriting profit potential.

Since FY17, Helios increased its capacity from £41.0m to £232.8 in FY21. During this period, LLV acquisitions added £69m in capacity, while investment in tenancy capacity amounted to £87.9m. Pre-emptions added another £22.4m to capacity. Over the past year, pre-emptions became more instrumental and contributed £36m of the increase from £232.8m to £296.6m at the start of 2023, while further investment in new syndicate tenancy capacity added £49.4m. LLV acquisitions only contributed £5.7m over the last year. Since FY17, Helios has increased its retained capacity from £16.1m to £238.4m to 80% (from 31%) through the reduced utilisation of quota share reinsurance (QS), meaningfully increasing its participation in the harder Lloyd’s underwriting market.

Much of the capacity growth over recent years was funded through a capital raise of £79m, as well as debt financing (£15m in FY22) and the increased use of XoL reinsurance (£25m over the period), offset by the reduced utilisation of QS. Capacity growth was further enabled by a meaningful increase in capital efficiency through the increased diversification credits reducing the FAL from Lloyd’s. The marked forecast turnaround in underwriting profits, together with a very strong outlook for pre-emptions, is forecast to drive organic capacity growth of up to 15% pa over the coming years. This could be enhanced through additional gearing and capital raising.

Because of its historical acquisition strategy, Helios’s working capital was quickly eroded by the addition of capacity, with replenishment delayed until underwriting conditions improved. With the current improved outlook, both from an underwriting and investment income point of view, the company is facing an inflection point where a strong turnaround in profits is set to provide increasing working capital to fund growth. This growth is expected to be less dependent on LLV acquisitions, with pre-emptions becoming more significant and providing capacity growth potential of 10–15%.

In addition, Helios’s current Lloyd’s syndicates are market leading and market shaping, and there have been no new entrants so far in 2023. This allows Helios to focus on shifting capital around in different syndicate exposures, enhancing underwriting upside, while using its tenancy capacity to pursue growth opportunities in new and non-correlated risks.

During FY22, working capital utilisation came mainly from increases to FAL to support investment in tenancy capacity and following pre-emption capacity. With limited profit contribution in the year, largely due to the effects of the investment market, residual underwriting pressure and investment in reinsurance and operating capacity, the company utilised its capital raise and additional gearing to fund this FAL increase. We expect FAL contributions (largely from following pre-emptions) to be funded by enhanced operating profits and capital efficiencies.

We expect the capital needs for further LLV acquisitions to be largely self-funded due to the FAL unlock that Helios’s Lloyd’s solvency diversification credits should provide. The amount of working capital available to fund the cost of LLV acquisitions will be dependent on enhanced profit generation, the ability to continue acquiring LLVs at discounts and the extent to which LLV acquisitions can be funded by share issuance.

Our forecast working capital profile above does not allow for increases in gearing or further capital raising. Such steps could increase the available working capital to fund LLV acquisitions in particular. In addition, Helios’s investment in implementing more active monitoring and influencing syndicate exposure, and backing and supporting new ventures with a particular focus on non-correlated risks, could result in more meaningful profit upside than we have allowed for in our current forecasts.

Helios reported an EPS loss of 4.9p in FY22 (net loss of £3.3m) and a total comprehensive loss of £1.3m. Syndicate underwriting operating profit of £0.1m was negatively affected by weaker than forecast underwriting results as well as mark-to-market losses on investment portfolios due to rising bond yields. The combined ratio of 96% was weaker than the 94% in FY21 due to the impact of Ukraine reserves on the 2021 YOA and the impact of Hurricane Ian on the 2022 YOA. The COVID-affected 2020 YOA also closed less positively than expected. The net impact was a £3.6m miss on syndicate underwriting operating result in FY22 relative to our forecast.

Holding company income faced modest pressure in FY22 due to lower investment income from a high base in FY21 (including one-offs) and a zero contribution from goodwill on bargain purchases (LLV acquisition at a discount to fair value). Fees from reinsurers, which is a combination of fees on ceded QS capacity and QS profit share, moderated due to the higher syndicate combined ratio.

Holding company expenses for FY22 were slightly better than forecasts (£6.5m versus £6.9m), with stop-loss costs lower than forecast (due to GAAP accounting allowing costs to be spread over two years), while operating costs were ahead of our forecast (holding company costs were £3.6m, with transaction costs of £0.7m and finance costs of £0.9m).

The FY22 headline loss of £3.3m included a tax rebate of £1.9m and resulted in a £2.4m miss relative to our forecast. The net impact was for an EPS loss of 4.9p relative to our forecast loss of 1.2p for FY22.

We forecast a combined ratio improvement to 90% in FY23, from a weaker base in FY22, but still reflecting a bottom-of-the-cycle hangover, with the claims ratio for the 2022 YOA still under pressure and the 2021 YOA reflecting Ukraine conservatism. We forecast RoC for the closed 2021 YOA to rise to 8.1%, which is lower than our previous forecast. Despite Helios’s reduced natcat exposure, it still faces the risk of an expensive hurricane season and we have opted to take a more conservative approach to FY23 than our previous forecast. As a result, we have reduced our FY23 underwriting operating result forecast by £6.7m to £21.2m, which is still a meaningful £20.1m increase on the FY22 level.

We forecast that holding company income in FY23 will benefit from a sharp increase in investment income, offset by a slower than previously forecast increase in reinsurance income. After only earning c 1% on holding company assets in FY22, Helios has changed its investment strategy (using an investment manager to manage FAL in a higher-yielding portfolio), which will result in a yield closer to 4%. This results in a meaningful increase in investment income to £3.6m, much higher than our previous FY23 forecast of £0.6m (which included an allowance for finance costs – now included in our operating cost forecast). We have also taken a more conservative view on reinsurance income until there is more certainty about an expected marked uptick in QS profit share as underwriting results improve.

We forecast a 55% increase in holding company expenses in FY23 to allow for Helios’s strategy to invest in its new syndicate performance and evaluation team, the impact of its increased financing costs and its increased use of XoL and other reinsurance. Holding company expenses are a combination of pre-acquisition costs (allowing for timing differences on syndicate capacity growth), stop-loss costs and operating costs. We forecast a marked increase in stop-loss costs from £1.3m in FY22 to £4.2m in FY23, which is higher than our previous forecast of £3.3m.

Stop-loss costs can be more accurately described as reinsurance costs as they include both the cost of stop-loss insurance (which provides a 10% indemnity band for any YOA loss over 36 months exceeding 107.5% of capacity) and the cost of reinsurance XoL protection. XoL costs are paid at a percentage of cover, which amounted to c £0.5m in FY22 and will increase to £2m in FY23 on the back of increased cover (from £5m to £25m). We forecast stop-loss protection of £3.9m in FY23, which rises with growth in capacity. GAAP accounting allows for reinsurance costs to be spread over two years, which moderates the forecast FY23 cost impact to £4.2m (versus the £5.9m sum of the above two items).

Helios’s investment in its syndicate performance and evaluation team is forecast to increase holding company costs by 15% to £4.2m in FY23. We forecast that bank XoL finance costs will grow to £1.2m and remain flat thereafter. Allowing for c £0.5m in transaction costs results in an increase in FY23 operating costs to £5.9m, well ahead of our previous forecast of £3.5m (note that we have now correctly included finance costs within this item as opposed to offsetting from investment income).

The net impact of our lower underwriting operating result forecast and the 55% increase in holding company expenses, offset by much higher investment income, is for a large increase in our forecast headline earnings from a loss of £3.3m in FY22 to a profit of £11.6m (£5.1m lower than our previous forecast). This results in a 31% cut in our FY23 EPS forecast to 15.1p (due to meaningful investment in the business and more conservatism applied to near-term underwriting profit improvement). We forecast RONAV of 9.7% (13.1% with pre-emption-driven revaluations) in FY23.

We forecast a very strong 76% increase in FY24 EPS to 26.6p, driven by robust top-line growth and a healthy reduction in combined ratio from 90% to 86.5% as the Lloyd’s underwriting cycle continues its upswing. Our forecast underwriting operating result of £34.9m is slightly lower than our previous forecast of £36.6m as we continue to exercise caution with regard to Ukraine and natcat claims. Our RoC forecast for the closed 2022 YOA increases to 11.2%. It is important to note that our FY24 forecasts do not allow for the potential benefits from Helios’s investment in its syndicate performance and evaluation team and hence provide additional potential upside on concrete delivery. Despite the strong forecast growth in FY24 EPS, it represents a 15% cut relative to our previous forecast of 31.3p.

We forecast 27% growth in FY25 EPS to 33.8p on the back of 13.5% capacity growth, rising RoC and operational gearing as underwriting operating growth outpaces growth in holding company expenses. RoC for the closed 2023 YOA is forecast to rise to 13.4%, which is in line with long-term pricing targets and compares to 3.6% for the 2020 YOA (disclosed in FY22). While we forecast 21% growth in the underwriting operating result, we forecast that holding company expenses will grow at only 9%, which results in improved operational gearing.

We expect strong levels of capacity growth to continue after FY25 and operational gearing to help deliver superior earnings growth outside of our explicit forecast period. This strongly supports the inclusion of terminal growth of 3% in our valuation. We forecast that RONAV will increase from 9.7% in FY23 to 17% in FY25 (almost 20% including revaluations) and remain at superior levels thereafter. We employ a 15.5% over-the-cycle RONAV in our valuation.

Our base case valuation of 252p/share uses a 15.5% over-the-cycle RONAV, derived as the average return (excluding revaluations) forecast from FY23 to FY25 of 14% plus a conservative allowance of 1.5% pa for revaluations (on the back of our forecast of 10% pa pre-emptions and the company’s guided range of 10–15%). It is important to note that our forecasts make no allowance for the potential uplift to WAV and NAV from converting the current tenancy capacity of £149m (not valued in WAV or NAV) to freehold capacity. Such uplifts could provide healthy NAV uplifts over the long term.

We have lifted our cost of equity from 9.8% to 10.7%, based on a risk-free rate of 4.2%, a risk premium of 6.5% and a beta of 1x. On the back of the potential upside from tenancy capacity NAV uplifts, improved visibility on underwriting outlook and the company’s investment in its new strategy, we have made an important change to our valuation methodology by introducing a terminal growth rate of 3% (versus zero previously). Our valuation without this change would be 225p/share, 11% lower than our base case.

Our valuation of 252p/share is unchanged and is well supported by Helios’s operating outlook and our EPS forecasts, despite the downgrades that we have employed in the near term, as well as a higher discount rate.

Our fair value for Helios is at a 1.47x multiple of its FY23 forecast NAV of 169p/share and at a 44% premium to the current share price. The valuation is very well supported by FY24 and FY25 EPS forecasts, with forward earnings multiples implied by our valuation of 9.5x and 7.5x, respectively. Similarly, the dividend yield becomes attractive from FY24.

Helios has underperformed its peer group over the last two years, with Beazley and Hiscox performing particularly well. Helios’s underperformance can be explained partly by its aggressive capacity growth, funded by share issuance. This leaves the company in a very strong position for delivering healthy EPS growth and RONAV pick-up in coming years, which could help to narrow the underperformance discount.

While our valuation for Helios indicates relative value on an implied forward earnings and NAV multiple basis, the company undershoots the peer group on dividend yield. This is because Helios chooses to retain most of its earnings to fund capacity growth.

In addition to the standard sensitivities we typically test, including discount rate, terminal growth and combined ratio, we have conducted scenarios on the impact of higher growth from pre-emptions and higher interest rates.

Our valuation increases by 6.9% and decreases by 6.1% for every 50bp decrease or increase in discount rate assumption, while increasing our terminal growth rate by 0.5% results in a 7.6% increase. For every 2.5% increase in annual capacity growth (via pre-emptions), our valuation increases by 12.9%. The valuation is very sensitive to the combined ratio, with a 2.5% increase resulting in a 17.8% decrease (similar for an increase expense ratio). For every 1% increase in interest rates, our valuation increases by 3.6%, with the impact of higher investment income more meaningful than any short-term portfolio impact.