UK: Family Wealth Management: Renewed Fears All Eyes On The US And Europe - Autumn 2011

Last Updated: 12 September 2011
Article by Smith & Williamson

FOREWORD

It never rains...

Economic turmoil has plagued the media headlines of late, as country after country has fallen victim to stagnant growth, soaring debts and deficit problems.

There was a unanimous sigh of relief across Europe when the Greek parliament voted to accept new austerity measures. But news of sluggish second-quarter growth in the UK and growing contagion risks to Italy and Spain were quick to dampen spirits once again.

Across the pond, the US wasn't faring much better. Tense negotiations between President Obama's administration and the Republicans over the extension of the debt ceiling and deficit reduction programme went down to the wire. Extending the debt ceiling was the only possible answer – but the 11th-hour brinkmanship was to be expected.

In light of recent events, it is perhaps not surprising that this issue of Family Wealth Management focuses on the continued global economic uncertainty. As well as our regular look at the global markets in our investment outlook article, we ask if the US dollar will remain the reserve currency in the wake of the country's financial troubles. We also travel further afield to the Asian markets to find out if the Asian bubble will burst or gently deflate.

Closer to home, IHT could soon be in the spotlight. Speculation that HMRC is set to zone in on IHT liabilities could see unsuspecting executors in the frame. Concern that IHT reliefs may also be reviewed means now is a good time to get your affairs in order, alleviating the potential burden on loved ones.

Finally, high net worth individuals may be interested in our article on membership of Lloyd's as an alternative asset class, while higher earners in danger of going over the lifetime allowance for pensions should read how to avoid a substantial tax charge.

INVESTMENT OUTLOOK -SELECTED HIGHLIGHTS FROM SOME OF THE WORLD'S MARKETS.

World: hit by a double whammy

The markets rapidly rotated to an aggressive 'risk off' position in August in response to a double whammy of concerns – the display of alarmingly dysfunctional political leadership on either side of the Atlantic, together with mounting concerns over the fragility of the US economy. Consequently, global equities contracted 13% in rapid order, Gold moved from $1628 to just shy of $1900 and US and UK bond yields approached all time lows.

While it is tempting to treat the sell off as an attractive entry point we need to acknowledge that the decline in the bond yields is posing major questions over the trajectory of growth, and therefore returns, expected from equities. The connectivity between nominal bond yields and nominal gross domestic product (GDP) growth suggests we have entered the stage of the cycle when operating leverage (the impact that a shift in revenue growth has on earnings) turns negative. Consequently a health warning needs to be attached to what appear to be apparently low market valuations – 2012 EPS forecasts look set to ratchet lower.

As in 2009 and 2010, policy initiatives and macro factors, not valuations, will be the catalysts for a recovery in equities. Much attention is therefore focused on whether Federal Reserve chairman Ben Bernanke can rally the market and sentiment. Unfortunately, he is more constrained in his policy options compared to last year. Therefore a 2010 redux is unlikely. The other policy response that would have a major market impact would be a signal of co-ordinated action in the eurozone (particularly a German acceptance of a move towards fiscal union and the establishment of eurozone bonds). This feels like hope rather than expectation. Until we get clarification on the status of the US economy and the eurozone debt crisis, markets are likely to remain volatile.

UK: QE2 on the radar screen

The UK economy is losing momentum. Consumption expenditure remains extremely fragile and is unlikely to rebound sharply. It has been impacted by sustained erosion in real disposable income and a deteriorating labour market. The housing market remains moribund. Net exports have failed to accelerate and with government expenditure contracting, corporate capital expenditure is the only visible source of growth stimulus. Growth projections of 1.7% (2011) and 2.5% (2012) are now looking optimistic. The chancellor has acknowledged that the recovery will be "longer and harder" than expected. It also poses questions over the sustainability of the austerity programme. UK gilt yields have hit their lowest level since the 19th century.

The August Monetary Policy Committee (MPC) minutes reflected mounting concern over the economy – no member voted for a rate hike. There was also consideration of whether there was a case for extending quantitative easing (QE) – a clear signal that further QE is on the radar screen and will be deployed if downside risks materialise.

IS THE STATUS OF THE US DOLLAR UNDER THREAT?

Can the US dollar maintain its position as the reserve currency given the state of the US economy?

A reserve currency is one that is commonly held in significant quantities by foreign governments and institutions as part of their accumulated foreign exchange reserves. The dominant reserve currency also tends to be the pricing currency for products traded on a global market.

History of the reserve currency

A currency may remain the de facto reserve currency for years – if not decades. But history has shown that every now and again it loses its status and is replaced with an alternative currency. For instance, in the 18th and 19th centuries, sterling was the key reserve currency. However, when the UK accumulated significant debt following both world wars, the reserve currency mantle shifted to the US dollar.

The dollar has been the primary reserve currency for the past 60 years. Most commodities are still priced in dollars and it accounts for 60% of aggregated currency reserves (the euro and sterling account for 30% and 5%, respectively). The key question though is: are we witnessing an unwinding of the dollar hegemony?

US woes

The parlous state of the US fiscal deficit, the downgrade of US debt ratings and fears that two doses of quantitative easing will debase fiat currency (money declared to be legal tender by a government, but with no intrinsic value), are understandably raising questions about the role of the dollar as a reserve currency.

China decides

Ultimately, the People's Bank of China will determine whether or not the dollar remains the key reserve currency. The Chinese have the largest global currency reserves, totalling some $3.2trn – almost three times the size of the next biggest holding. These reserves have mushroomed as a result of China maintaining the yuan peg at a low enough level to drive export growth and accumulate trade surpluses.

With almost 70% of their reserves held in dollar assets, the Chinese are keen to diversify their currency exposure. Their dilemma is that the euro – the only other practical reserve currency option – is facing significant systemic risks of its own. Consequently, while the Chinese have voiced their support for the euro and invested in peripheral European bonds, the high levels of uncertainty surrounding the sustainability of the euro means for the foreseeable future they are unlikely to shift their reserve currency exposure significantly.

Longer term, once the Chinese yuan is allowed to float freely on foreign exchange markets, there is scope for it to become a reserve currency in its own right, but this is several years away. Until then, despite losing some of its dominance, the dollar is likely to remain the global reserve currency.

Historical timeline of dominant international currencies

THE ASIAN BUBBLE?

Is there an Asian bubble and are fears that it will burst justified?

Asian markets led the recovery out of the global financial crisis. They were in a far stronger position than developed markets, which were only just beginning the painful process of deleveraging.

Strong performance

By the end of 2010, according to Bloomberg, in sterling terms the FTSE All World Asia Pacific ex Japan Index had risen 114% from the low of March 2009. It outperformed both the FTSE 100 and the S&P 500, which registered gains of 67% and 66.6%, respectively.

Governments, corporates and consumers within the region were not overleveraged; Asia had experienced its own financial crisis in the late 1990s and was therefore in a much better position to weather the storm. Current account surpluses enabled governments across Asia to increase spending. Notably, China spent billions on improving its infrastructure.

The question now being asked is whether Asia has created a bubble. This is of concern, as bubbles tend to burst rather than deflate slowly. But all the signs show that China's economy is deflating, so this shouldn't be a worry.

Chinese deflation

Inflation in China has been a major issue, as food and fuel in developing markets are a much larger proportion of the average family's shopping basket. Food prices have been responsible for approximately 70% of the increase in China's Consumer Prices Index with short-term factors, such as natural disasters and disease, being the main contributors to the rise in food prices.

The likelihood is that inflation has peaked. Much of the tightening has been directed towards the property sector, so residential price growth has slowed considerably, especially in the first-tier cities, which experienced the fastest growth. Wage growth is now outpacing property price rises and should eventually make properties more affordable. In addition the authorities have launched a low-cost housing project to build ten million homes in 2011.

Non-performing loans are on the increase but, if in the future the banks look vulnerable, the authorities are likely to step in and help the financial sector as they have done in the past.

Slowdown inevitable

It is important to remember that China is a command economy, which can quickly switch its policy stance and ease restrictions. Urbanisation will continue to be a major driver of economic growth for the foreseeable future. But, at some point, China will go through a painful contraction process – although this is unlikely to be imminent.

Even though economic growth across Asia is expected to outpace the pedestrian levels forecast for the developed world, if another global financial crisis were to occur the emerging markets would not escape unscathed. Instead, a flight to liquidity (the sale of less liquid or more risky investments) is likely, as in 2009, offering investors a prime opportunity to buy Asian equities.

STAGFLATION OR DEFLATION?

We examine whether the UK is experiencing stagflation or a deflationary recession.

A stagnant economy, dysfunctional financial system and five-year government bond yields under 2% are all indicative of today's UK economy – and Japan's in the 1990s. Back then, after the great stock market crash the equity market fell by 60% in just two-and-a-half years (1989 to 1992).

Looking back at Japan

In marked contrast to Japan though, UK inflation – or at least headline inflation rates – is still relatively robust with the Retail Prices Index (RPI) and Harmonised Index of Consumer Prices growing at 5% and 4.2% year on year (y/y), respectively. It should be noted however that Japanese inflation did not turn negative y/y for nearly five years after the stock market peaked (finally turning negative in July 1994) because inflation nearly always lags behind real economic activity.

Conventional leading indicators of UK inflation, such as money supply growth (down 0.2% y/y at the end of May) and real wage growth and economic activity levels (approximately -2% y/y) suggest lower inflation rates lie ahead. Not least because most of the increase in inflation in the last two to three years has been down to either VAT increases, exchange rate weaknesses or higher commodity prices. That UK GDP levels are nearly 4% below the peak achieved before the credit bust in 2008 reinforces this. So it is hard to argue a case for monetary tightening – even for those concerned that the UK trend growth may have fallen sharply since the credit boom – particularly as inflation expectations appear stable (implied by breakevens in the gilt market).

Structural headwinds from the deleveraging of debt accumulated over the past 15 years, by both consumers and the UK Government, continue to bear down on the recovery. Also, the reluctance of the banks to mark impaired assets to market, and the willingness of regulators to accept this treatment, sometimes known as 'pretend and extend', leaves little room for new loan growth, even where there is demand. This draws clear parallels with the Japanese policy response in the 1990s and 2000s.

Risks of deflation

If the economy faces a sub-par recovery, characterised by debt deleveraging and weak demand growth, what are the risks of outright deflation of the price level?

Deflation episodes are rare in the UK. The RPI showed negative y/y inflation for nine months in 2009, but that was the first time since the 1930s. Both deflations in the 1930s and 2009 were accompanied by extreme financial dislocation, but policy responses were very different.

In 2008/09, the Bank of England moved quickly to combat deflation by printing money, allowing sterling to depreciate and buying approximately £200bn of gilts (about 14% of GDP). In contrast, in the 1930s the UK did not leave the gold standard (despite the Bank of England losing gold from July 1931) until it was forced off in September 1931 after the Invergordon Mutiny. Even after leaving the gold standard, the prevailing policy wisdom at the UK Treasury and the Bank of England in the 1930s was that the ghosts of inflation were everywhere. As such, UK monetary policy was not expansionary until 1932.

In 1936, John Maynard Keynes published The General Theory of Employment, Interest and Money arguing for aggressive fiscal expansion. There was no quantitative easing programme and the bank rate was never reduced below 3%. An increase in the money stock was largely due to capital inflows not deliberate monetary policy. UK monetary policy from 2009 onwards, a weaker sterling exchange rate and a willingness to allow a prolonged workout in the financial system reduce the risk of outright deflation in the price index, even if a prolonged period of disinflation and debt deleveraging are likely, with very low credit growth.

Lessons learnt

The important lesson learnt from the emergence of deflation in Japan is that the central bank needs to be proactive in injecting additional liquidity into the system if a highly indebted economy starts to falter. Fortunately, both the UK MPC and US Federal Reserve are well aware of these risks. Consequently, if domestic consumption fails to recover and consumers defer spending, particularly with fiscal policy being tightened, another dose of quantitative easing is likely.

Asset classes like index-linked gilts should continue to perform well in this environment, since a period of weak real economic growth alongside 3% RPI accruals is likely. Meanwhile, real yields are turning negative for much of the yield curve, as they are now for conventional gilts.

PENSION ALERT FOR HIGHER EARNERS - AVOID A CRIPPLING TAX CHARGE

Higher earners at risk of exceeding the lifetime allowance should act now before it's too late.

The reduction in the lifetime allowance from £1.8m to £1.5m from 6 April 2012 means thousands of pension investors could end up with a 55% tax charge on benefits over this amount unless they take urgent steps to register for 'fixed protection' before this date. Savers who are unsure about the size of their accumulated pension and what it may be worth when they take benefits are particularly at risk.

Will you be affected?

Under current pension rules, the value of an individual's pension arrangements must be measured against a lifetime allowance. If the value exceeds the lifetime allowance, a 55% tax charge is levied on the excess.

The lifetime allowance for the current tax year to 5 April 2012 is £1.8m, but it will reduce to £1.5m from 6 April 2012. It is quite possible that the new £1.5m threshold will be in place for a while, as the Government has not indicated when it will next be reviewed – if at all. As a result, it is expected that more and more people will gradually be drawn into the 55% tax net.

Examples of when pension funds are measured against the lifetime allowance include when taking benefits, death prior to drawing benefits, transfer to an offshore pension and at age 75, if an annuity has not been provided.

The value of money purchase (defined contribution) funds is used as a comparison with the lifetime allowance at the time of the event. For final salary (defined benefits) schemes, the annual pension amount is multiplied by 20 and any additional tax-free pension commencement lump sum is added to determine the value.

The new limit does not apply to those who elected for 'enhanced protection' before 2006. But it will potentially affect everyone else, including individuals who are already taking pension income through drawdown rather than an annuity purchase.

This is potentially a ticking time bomb for young high earners. Their pension savings may be below the £1.5m mark right now, but it is quite possible that someone in their 30s or 40s could find they've amassed savings of over £1.5m by the time they retire.

For example, if a pension fund is worth £1m today and grows at 5% per year for the next ten years, the value will exceed £1.5m. It may be a good idea for those in their 30s and 40s who have already built up a significant pension fund to elect for fixed protection now and consider other investments for building up their retirement funds.

What should you do if you might be affected?

There are three key ways to take advantage of the current higher lifetime allowance.

  1. At present, individuals can still elect for fixed protection for funds up to £1.8m and avoid the 55% tax rate. Any election must be made by 5 April 2012. From this date, individuals who take this route will have to stop pension contributions and cease to be a member of their employer's scheme. The decision as to whether or not to register for fixed protection may not be straightforward, particularly for those who are members of generous employer-sponsored pension schemes. For anyone who is already receiving a pension through drawdown, electing for fixed protection is also worth considering because of the check against the lifetime allowance at age 75.
  2. Another option for those aged 55 or more is to start drawing benefits before 6 April 2012, while the current £1.8m lifetime allowance is still in place. If pension income is taken through drawdown rather than by purchasing an annuity, it may still be worth considering fixed protection in order to keep the current lifetime allowance when the value is measured against the lifetime allowance at age 75.
  3. An alternative solution is to make extra contributions before 5 April 2012 and then take up one of the above options. Given that individuals can now get tax relief on contributions of up to £50,000 per year and, in addition, can carry forward unused contribution allowances from the previous three years, maximising contributions now and then electing for fixed protection or taking benefits may prove valuable for high earners.

What next?

Before taking any action, individuals should review their total pension investments. They will need to gather information on all their pension investments, typically built up through various providers and different employers, which can be complex and likely to take a few months as each pension provider will need to be contacted separately. So, it is essential to start the process now or risk losing out substantially.

Anyone who opts for, or wishes to retain, fixed protection will no longer be able to build up funds through their pension going forwards. Consideration will therefore need to be given to where future retirement savings should be invested.

AVOIDING A POTENTIAL IHT INVESTIGATION

Practical advice for non-professionals acting as executors of wills.

Around 12,000 estates are liable to IHT each year, with a family member or friend often acting as lay executor. What these executors may not realise is that they are personally liable for ensuring that the correct amount of IHT is paid on the deceased's estate.

The news that HMRC is expected to look more closely at IHT payments as part of its wider crackdown on tax evasion and avoidance means the need for accuracy has never been more important. Any errors could leave executors open to investigation – on this matter and in relation to their own tax affairs.

Know your role

The executor administers the deceased's estate in accordance with the will. This means identifying all assets, paying any debts and distributing what is left to the beneficiaries.

If the estate – that is the value of the individual's entire assets including cash, possessions, property and any investments minus any debts – exceeds the 'nil-rate band', the executor is responsible for submitting a full IHT return to HMRC. Where no IHT is due, the estate is usually referred to as an 'excepted estate' and a simpler form can be submitted to the tax authorities. But, in some cases, depending on what is in the estate and the amount of past gifts, a full IHT return may be needed even where there is no IHT liability.

Establish what's in the estate

The first step is to go through the deceased's files to find key items such as the will and bank statements. If you can't find a will, it's worth contacting the deceased's solicitor or bank. Banks routinely keep wills in safe custody for clients. If the deceased did not make regular use of a solicitor, then the next port of call should be the law firm that advised the deceased on the purchase or sale of a home or perhaps a divorce.

Bank statements are invaluable as they reveal standing orders, direct debits and sources of income, which may indicate life insurance policies or similar. These will need to be traced in order to determine their value. A copy of a previous tax return, if prepared, will also be helpful, as it should highlight all income-producing assets and any interest in trusts. Any shared interest in a property will count towards the value of the estate.

Value the estate accurately

HMRC looks at valuations carefully, so make sure you can justify your figures. It is always best to obtain independent professional valuations for residential and commercial property, unquoted shares and more esoteric investments like jewellery, antiques and classic cars.

Certainly any assets thought to be worth more than £500 must be properly valued, which typically means sourcing professional, written valuations.

A local surveyor who is a member of the Royal Institution of Chartered Surveyors should carry out any property valuations. For furniture and general possessions, speak to a local auctioneer and ask for an itemised assessment. For equities, bonds and other investments, contact the investment manager for valuations at date of death (referred to as quarter-up values). Similarly, request statements for bank accounts showing balances at the date of death and ask the bank to calculate the accrued interest.

Add up any unpaid utility bills, credit card accounts, outstanding mortgages and so on, without forgetting local newsagents, carers and similar. If you, as the executor, settle any of these outstanding bills before receiving Grant of Probate, make sure you get a signed receipt.

Liabilities outstanding at the date of death and funeral expenses can be claimed against the value of the assets, subsequently reducing the IHT liability.

Take account of gifts

Any gifts made in the seven years prior to death also need to be taken into account and must be itemised on the tax return. Remember though, individuals can make £3,000 worth of gifts per year plus £250 to any number of individuals, which all fall outside the IHT net. There are also other allowances, such as gifts in contemplation of marriage.

Ideally, the deceased or a close family member will have kept a record of such gifts. In any case, you will need to verify details, so check bank statements and cheque stubs to see what gifts appear to have been made in the last seven years. If the deceased had an accountant or a solicitor, they may have helpful information on gifts made during the deceased's lifetime.

Best practice

It is good practice for executors to prepare a statement showing the assets of the estate minus liabilities, and how the balance has been distributed. In fact, it may be worthwhile getting IHT clearance from HMRC before distributing the estate. If you are appointed executor of an estate, consider taking professional advice.

To make it easier for your own executors, let them know where your will is located, maintain a list of gifts that they will need to take into account, and keep your papers and other relevant details in an orderly manner.

REVIEWING YOUR WILL

Recent developments highlight the importance of keeping your will up to date.

In this year's Budget the Government announced plans to promote charitable legacies by lowering the rate of IHT from 40% to 36% where at least 10% of the net estate after reliefs, exemptions and the nil-rate band passes to charity.

A recent consultation document sets out this proposal in greater detail. Ultimately, its success will depend on the extent to which individuals feel they have made adequate provision for their dependants prior to making any charitable gifts – and whether HMRC can resist the urge to over-complicate the proposed relief.

In any case, its introduction will lead many to review their wills – although this is something that should be done on a regular basis while the individual remains able.

The recent case of RSPCA v Sharp [2010] EWCA Civ 1474 demonstrated how drafting an imprecise will can throw up difficulties when trying to decide how an estate should be distributed.

The case hinged on the interpretation of a nil-rate band clause which, had the RSPCA been successful, would have resulted in the deceased's family receiving considerably smaller bequests than they thought they were entitled to. Such clauses need to be reviewed anyway following the introduction of the transferable nil-rate band in October 2007.

Making proper provision for your dependants was the subject of Ilott v Mitson [2011] EWCA Civ 346. This was an action brought under the Inheritance (Provision for Family and Dependants) Act 1964 by an estranged daughter (Ilott) whose mother had left her estate to three animal charities and made no provision for her.

Ilott was able to establish that despite having been financially independent of her mother for many years, she was still entitled to reasonable provision from the estate, and that special circumstances or moral obligation were not pre-conditions for a successful claim.

Some commentators have interpreted this judgment as an attack on the principle of testamentary freedom. But, whatever your views, it does underline the need to give due consideration to the needs of family and dependants.

If all else fails and there is goodwill between the legatees, variation can be carried out within two years of death by a deed of family arrangement.

PRINCIPAL IHT RELIEFS

Make the most of IHT reliefs while they're still available.

Following its recent review of tax reliefs the Office of Tax Simplification recommended a full-scale review of IHT rather than a piecemeal review of individual IHT reliefs.

The Government's response indicated that no further changes to IHT are planned for the foreseeable future, although this subject may be revisited at some point later on. It is important then that you make use of IHT reliefs while they're still available. Use the following checklist to help you.

  1. Write a will and review it regularly

    Without a will, all your assets will pass to surviving relatives (or, in certain circumstances, the Crown), in accordance with fixed rules which may not coincide with your wishes nor give a tax-efficient result. If you have made a will, it is crucial that you review it regularly and keep it up to date.
  2. Make potentially exempt transfers

    A potentially exempt transfer can include cash, property or any other asset. There is no upper limit on the value and it can go to family or friends. You must live for seven years after making the gift for it to be fully exempt for IHT purposes, although after three years the IHT liability on amounts over the nil-rate band starts to reduce. You cannot retain any benefit in the gift and capital gains tax may be charged on any gifts other than cash.
  3. Give away annual gifts

    You can give away £3,000 a year of capital. If you miss one year, you can give away £6,000 the following year. You can also make small annual gifts of £250 a year to an unlimited number of people, provided these payments do not form part of a larger gift.
  4. Celebrate in style

    An allowance is available for a wedding gift of up to £5,000 from parent to child, while up to £2,500 can be given by a grandparent or great-grandparent to his or her grandchild or great-grandchild. Wedding gifts of up to £1,000 can be made to anyone else who is getting married.
  5. Make gifts of normal expenditure

    Regular gifts from income can be made for an unlimited amount, as long as it can be proven that gifts are made regularly and are from surplus income. You do not have to live for seven years after making the gift for it to be exempt from IHT. This exemption is ideal for grandparents willing to pay their grandchildren's school fees.
  6. Consider charitable legacies

    The Government is to introduce a lower rate of IHT on deaths on or after 6 April 2012 where people leave a charitable legacy of 10% or more of their net estate (after deducting reliefs, exemptions and the nil-rate band).

Other IHT reliefs include business property relief and agricultural property relief. These valuable reliefs are available on certain business assets and agricultural property and, in these cases, care should be taken to ensure that the stringent tests are met.

MEMBERSHIP OF LLOYD'S - A VIABLE ALTERNATIVE ASSET CLASS?

Recent strong profits, despite some spectacular insured losses, have wealthy investors asking what Lloyd's membership is all about. Jeremy Evans and Chandon Bleackley of Lloyd's agent Hampden explain.

Membership of Lloyd's is now viewed by an increasing number of sophisticated, high net worth investors, who understand the inherent risks involved, as an alternative asset class. Over the past decade, Lloyd's has produced some outstanding results – in stark contrast to the recent performance of some other asset classes. As well as the potential to produce good profits (and losses) and perhaps capital gains, membership also has tax and estate-planning benefits.

How does Lloyd's work?

Lloyd's operates as a marketplace and as a society. Individual and corporate members form syndicates annually to underwrite insurance risks, providing capital to support this. Members also purchase the right to participate on syndicates by acquiring syndicate 'capacity' in an annual auction process and accept profits or losses accordingly.

Members are advised by a members' agent, of which there are currently three – Alpha, Argenta and Hampden. Members' agents guide interested parties through the process of application for membership. Their key role is then to analyse the trends in the market and the individual syndicates and to advise members about their underwriting portfolio and how large a limit to underwrite in each year of account, which will have a direct impact on the returns or losses that each individual investor may receive. Syndicates trade on an annual basis, but operate a three-year system of accounting, normally closing a year of account after 36 months. At this point, profits and losses are finalised and paid out to members.

The Lloyd's market has benefited from three key structural changes in recent years.

  1. The foundation of the Performance Management Directorate, which Lloyd's established in 2003 to oversee syndicate underwriting, has led to much-improved underwriting standards.
  2. All of Lloyd's pre-1993 liability exposures have been reinsured into Equitas, which has since been acquired by Berkshire Hathaway.
  3. Since 2003, all new members have joined with limited liability, trading through limited liability vehicles (LLVs) established for that purpose.

Who joins Lloyd's and why?

Members of Lloyd's are high net worth individuals who have a risk profile that is commensurate with such a high-risk investment, usually investing 5% to 10% of their overall wealth as one part of a diverse and sophisticated investment portfolio. They join for the following reasons.

Potential for significant profits over the insurance cycle

Members trade on a portfolio of syndicates, which underwrite insurance and reinsurance business. Members deposit funds at Lloyd's (FAL) to support their underwriting on these syndicates. FAL are usually a minimum of 40% of the maximum amount that may be underwritten in a given year, known as the premium income limit (PIL). The Lloyd's market has produced some very good returns since 2001, although it must be appreciated that past performance is not necessarily a guide to future potential profitability.

Double use of assets

Members pledge an asset that they already own to Lloyd's as FAL to support their underwriting PIL. FAL can include cash, bank guarantees, shares and letters of credit. The member retains ownership of the original asset, and the beneficial interest in the FAL, profiting from any growth or return on the underlying asset. Lloyd's requires new members to show a minimum FAL of £350,000 in order to support their underwriting.

Low correlation with other asset classes

The insurance cycle has had a low correlation with other financial market cycles. The Lloyd's market has made money despite the recent financial crisis because Lloyd's business is writing insurance – and even in tough economic times, businesses need insurance.

Opportunities for financial planning

Trading as a limited liability member of Lloyd's – either in a Nameco or an English limited liability partnership (LLP) – offers tax and estate-planning benefits. An individual or a family group can participate in either vehicle. The LLVs, and not the people within them, are the members of Lloyd's. This means that the LLVs carry on trading after the death of an individual(s) within them.

A Nameco is a UK-registered company and is taxed as such. Its underwriting profits are subject to corporation tax and its directors set its dividend policy.

An LLP is a tax-transparent vehicle that pays out underwriting profits (subject to income tax) to its partners each year. However, earnings from an LLP are deemed to be earned income for pension purposes. Deciding whether to trade through a Nameco or LLP is a key decision, as it has to suit the individual members' financial circumstances and longer-term goals.

Risk and reward?

Lloyd's syndicates are in the business of writing insurance and reinsurance risks. The two largest categories of business being written at Lloyd's in 2011 are property insurance and reinsurance. As such, the market is exposed to natural catastrophe losses, such as earthquakes and windstorms, as well as man-made losses. Lloyd's also underwrites smaller amounts of energy, aviation, marine, UK motor and liability business.

The past decade has seen some dramatic insured losses including the World Trade Centre in 2001, hurricane Katrina in 2005, and hurricanes Gustav and Ike in 2008. Members of Lloyd's made a loss in 2001, but managed to make an overall profit in both 2005 and 2008, largely down to improvements made in risk management. Despite these improvements, prospective members should be aware that Lloyd's is still a very high-risk investment.

Large losses usually lead to an upward correction in rating levels, which tends to enhance profitability. As a result, good profits were made for Lloyd's members in 2002, 2003, 2004, 2006 and 2007. While Lloyd's generally made profits in these years, some individual syndicates still made losses and therefore the returns for individual investors would be reflective of the performance of the specific syndicates within their underwriting portfolio.

Becoming a member of Lloyd's should be seen as a medium to long-term investment. The insurance market is exposed to all types of loss scenarios and individual investors have to understand that whilst Lloyd's has the capability of producing high returns, they could lose money at some point. Lloyd's is a high-risk, highreturn business that is not suitable for all and it is important that appropriate advice should be taken before committing to join the market.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.