Hiscox's group FD, Stuart Bridges

If you’ve read Aesop’s Fable number 373 ­ about the lazy
grasshopper, the industrious ants and the reversal of their fortunes when summer
turned to winter ­ then you may have a simple reference point from which to read
the financial events of the past quarter and the fallout we’ll be seeing in the
next.

You might also get a quick grasp of the strategies behind some of the
companies that are not failed, failing, or about to fail in what we’re told is
the most serious financial meltdown since the Great Depression. It is undeniably
dull: it’s prudence, so yawn-inducing even its biggest groupie, Gordon Brown,
dumped it long ago.

But what seemed so unsexy in boom time has now been transformed, in desperate
times, into a rare, much desirable asset. And one that FTSE-250 listed,
Bermuda-domiciled specialist insurer
Hiscox
seems to have made invaluable capital from, while others operating in the global
insurance sector, such as American International Group or Dutch group Aegon
(though these are life companies and Hiscox is a non-life underwriter, it would
be at pains to point out), were seduced into heavy subprime investment that
proved a very bad idea.

For group finance director Stuart Bridges, who celebrates a decade in that
role with Hiscox next autumn, the post-mortem is simple. “The key is to
understand what you are doing in your business. It doesn’t matter whether it’s a
structured investment or whether it’s a complex underwriting risk; I should be
able to understand it and if I don’t then I should go and ask and make sure I do
understand it. That for me is where things have fallen down,” he says. “Extra
yield is always going to come at extra cost unless you’re very, very lucky.

“It’s the same with underwriting: extra premium will come at extra risk and
our business is all about managing and taking risk. Key for us is constantly
being in a position to pay out claims. So a little bit of caution goes a long
way.”

Hiscox’s investment portfolio, for an example of what it does with its own
money, is at once rather traditional and a sign of the times. It is shareholder
friendly: heavily skewed to long-dated T-Bills and US AAA+ bonds, it holds no BB
or BBB-rated credits from Europe and is only punctuated by a few cheeky percent
in US sub-investment grade corporate credits. Just 1.3% of its £300m
sterling-denominated investments are high yield.

“You’ve got to be in a position where you don’t have to sell your bonds and
can hold them to maturity,” Bridges says. “We absolutely stayed away from high
yields where we saw no liquidity, enticing as they were, but if you look at the
mark-to-market valuations causing bonds to price as they are now, most will be
paid off in full.”

Up the ratings
In mid-September the group had its credit rating upgraded from A- to A by
insurance ratings agency AM Best. Bridges has refinanced the business, paying
down its entire debt load debt, extending its loan facilities to £350m and its
cash facilities to five-year terms, giving it valuable breathing space. “It is
boring and dull,” he quips. “But dull is good.”

It really is. In Hiscox’s operating business, the impact of downturn and its
swift response to changing conditions is evident. In the six months to June
2008, the company made more cash from doing less business as pre-tax profits of
£109m came from £639m of gross premiums underwritten (GPU), led by retail growth
in its UK and European markets. But by the end of September, year-on-year growth
in GPU had shrunk by 8% group-wide, pulled south by a 14.3% reduction in its UK
underwriting business ­ while its US business, less than three years old and
loss-making at the beginning of the year, grew by nearly 67% in the period from
GPU in June of just £13m. It now accounts for 40% of group business.

The changes in environment between its June results and September numbers
encouraged the company to reverse its stated intention to reduce the capacity of
its Lloyd’s of London syndicate to £550m and instead increase it to £750m. It
will also launch a second syndicate in January 2009, with £60m from its cash
haul, to write small business and technology risks for US clients.

Whereas many of the larger businesses in the insurance and reinsurance space
have recently reported seriously shrunken profits, share valuations and
dividends moving south, or emergency recapitalisations, boring old Hiscox now
looks one of the most resilient players.

What’s more interesting is what Hiscox can do with this in 2009.

For Bridges, it means going hunting: buying businesses and teams at very
tasty prices as rivals or other relevant companies go under, or look to make
quick cash in the next 12 months. Bridges isn’t naming any names, obviously.
But, so far, the company has made much capital from the nose-diving fortunes of
American International Group, having hired whole teams from the stricken
insurance giant to bolster its US business in construction, launch a Miami-based
group to serve Latin American risks, a new office in Kentucky to serve growing
director and officer liability (D&O) needs from small businesses and equine
insurance, and add senior staff to its US terrorism, media, technology and D
&O teams in Chicago and New York.

Bridges says we should expect more of the same in 2009, chiefly in Hiscox’s
key High­Net-Worth, fine art, large property, kidnap and ransom, personal
accident, errors in admissions policies, technology and media sectors. That’s a
lot of hiring and expansion ­ but, of course, he is at pains to point out that
nothing will be done with complete abandon. He is keener on teams than business
acquisitions, because he believes prices are still too high.

“We have the opportunity to buy or gain teams and we are very keen to do that
in the lines of business we know and understand; the worst thing we could do is
to believe suddenly we’re experts in lots of different business lines and branch
out into them,” he explains. “There are some businesses out there I’d like to
buy, but it would mean paying a lot of goodwill, so it’s not as valuable to us
as getting the teams.” And Hiscox is a cash buyer.

No time to speculate
Bridges doesn’t come across as a show-off. He will concede that he has “achieved
a lot in a very short space of time”. But his chairman Robert Hiscox hasn’t been
shy about what he thinks the business can do in 2009, commenting in Hiscox’s
interim results this August that “there is no reason why the second half [of
2008] should not be good, barring the extraordinary” and lambasting the banks
for doing “unparalleled harm to the world economy”, while the insurance industry
“has not been seduced by the culture of leverage.”

Well, not the ones that stuck to behaving like insurers and resisted playing
speculators. Bridges grinningly admits that has meant “a few boring years” ­
grinningly because that, he says, “has put us in a position where life is going
to be anything but in the next few years.”

Boring, however, has not meant static. In the decade Bridges has done this
job, he has become more deeply involved in group strategy and has presided over
the group expanding from one office in the City of London to a business spa
nning 13 countries. He has kept costs reined in by plumping for joint ventures
with smaller, expert rivals in various geographical locations, to expand its
reach.

He led the 2005 redomicile of the firm to Bermuda, the UK’s first listed
company to do so, taking advantage of the island’s offshore tax haven status and
its growing reputation as a centre for the lucrative reinsurance market due to
its geographical proximity to the US.

That move marked its expansion into international business and now that its
US business is its growth engine, this decision looks especially fortuitous.

An engineering graduate, Bridges has worked at senior and board level across
both major listed firms and privately-owned companies ­ prior to joining Hiscox,
he spent one year as chief executive at Lowri Beck, the energy metering services
company.

He came to the insurance world with zero knowledge of that market, but a CV
packed with two decades in corporate finance. He ran financial markets groups
for Arthur Andersen in London and Chicago in the 1980s, before moving onto
structuring mergers and mezzanine debt for property firm Richard Ellis and three
years in the mid-1990s at Henderson Investment Management. There, he had his
first crack at the FD role, where he “effectively” did that job while serving as
a director of a quoted property investment trust.

Outside the company, Bridges has been an active member of his peer group. He
sat on the
Financial
Reporting Council’s review group on the Turnbull Guidance on
Internal Control and is seven months into a chairmanship of the ICAEW’s
Business Advisory Board, the Institute’s lobbying force. He is currently helping
the Association of British Insurers’ financial regulation and tax committee
straighten up the UK version of Insolvency II rules, the capital adequacy and
governance guidelines for insurers in Europe, for use by their British
counterparts.

“It’s fascinating being on the
ICAEW
business advisory board because you learn so much,” Bridges says. “I think the
Institute does a fantastic job on the lobbying work it does, especially on
technical issues ­ but I think almost nobody can see it. To make that more
effective and more visible I think would be a good thing.”

Stand against regulation
He has been vociferous in the past about the impact the increasing weight of
financial regulation, such as IFRSs, and the lack of cohesive supervision of the
different guidelines, rules and regulations across borders, has on FDs being
able to focus on running their businesses. “IFRS did become massively
time-consuming [for FDs] in terms of implementation and now with Solvency II
coming through, the key is to not get too involved or dragged down into the
details,” Bridges says. “As an FD involved in broad strategy, you can’t just
say, ‘this is finance, this is media, this is operations and this is me’. I
think the FD role is a very broad one across the group, really trying to make
the company run better wherever you can.”

That said, he acknowledges the technical element of his role has been an
opportunity, too, since the rest of the board has had to learn about these
issues and Stuart has been the first point of contact. “Actually, I think the
various board roles [chairman, chief executive and FD] are merging to a certain
extent. I know a lot of my colleagues refer to the fact that when they make
presentations to the board, it’s very much what a CEO would have presented a few
years ago,” he says.

So where are the blackspots for Stuart and for Hiscox? Not surprisingly, it’s
the weather; Hiscox employs a large team of PhDs using über-complex models to
predict when the next storm will be, where it will go and how strong it will be.
On that, Stuart and his team figure out the potential cost to them in claims.
But even with all that science behind it, it is the one subject that gives the
FD sleepless nights. Perhaps it is the element of unbridled risk. “Having been
through the credit crisis, you have a large investment portfolio, you’ve got
lots of deposits with banks and you need to protect that money. But the main
thing that concerns me is the big event, and wondering, have we taken too much
risk on it?” he explains.

That aside, 2009 could be Bridges’s year. Analysts rate the stock a ‘hold’ ­
rare right now and a satisfying mark of quality ­ following its half-year 2008
results. The company was lauded for having one of the most diversified business
models in its field, as well as one of the least leveraged balance sheets. Numis
Securities says it expects to revise its full-year 2008 EPS forecast upwards by
around 10%, while UBS analysts say they are comforted that Hiscox is unlikely to
be forced into a bond sale since it has secured its funding position into at le
ast 2013.

We know now that the leading western economies are in recession, but Hiscox
is ready to profit from disaster. “We are in a great position because we kept
our powder dry on the capital and we were very sensible on that. We’ve built a
very good, well-diversified business with a mix of retail and corporate business
that a lot of people really quite like the model of now,” he muses.

“We’ve suddenly got an opportunity in front of us, with the dislocation in
our market, to go forward. At the minute the future really does look quite
exceptional.”