The acrimonious battle between Lloyd’s of London’s corporate members and its private Names threatens the insurance exchange’s character and vitality.
By Conrad de Aenlle
November 2002
Institutional Investor Magazine
When Lloyd’s of London was founded in 1771, the insurance market adopted a three-year accounting cycle rather than an annual one for a practical reason: Its most important clients -- shipowners -- kept their books open on overdue sailing ships for 36 months before concluding that the vessels had been lost at sea. The days of tall ships plying the seven seas may be long gone, but it was not until September that Lloyd’s got around to converting to annual accounts, which are now conventional for maritime insurers everywhere else.
Such is the measured pace of change at Lloyd’s, by many lights one of the more glaring anachronisms in a nation unusually partial to the past. Underscoring the exchange’s attachment to tradition, Lloyd’s Names -- the private exchange members who put up their personal wealth to back insurance policies -- have again blocked efforts by Lloyd’s corporate members to force them to relinquish their unlimited-liability status as underwriters and join corporate insurance pools, which may be less risky but also are potentially less lucrative.
So although members approved reforms in September that tighten sloppy regulatory procedures, they do nothing to resolve the fundamental impasse that has riven Lloyd’s and increasingly threatens its vitality: the split between the 11,000 Names (only 2,500 of them active in the exchange) and Lloyd’s 132 major corporate backers, which now put up four fifths of the capital but continue to have only a minority voice in its affairs thanks to the exchange’s historical one-member, one-vote system. Under Lloyd’s peculiar structure, corporate members were not allowed into underwriting syndicates until 1994, when claims setbacks forced the Names to accept insurance companies, with their timely and critical capital.
In an ominous development that raises fresh doubts about Lloyd’s long-term prospects, two of the largest corporate participants, Ace and Wellington Underwriting, recently set up ventures outside the exchange to do business that otherwise would have gone through Lloyd’s.
“Clearly, that sent all sorts of signals,” says Christopher Hodgson, CEO of Greenwich Group, a U.K.-based corporate Lloyd’s member. “Lloyd’s has got to make itself as attractive as possible to future investors. The alternative is for insurers to set up outside the market.” An American mutual fund manager with substantial holdings in property/casualty insurers worldwide points out that while Lloyd’s accounts for only 2 percent of global reinsurance, a decline in such activity on the exchange would be bound to help insurers elsewhere. “If anything happens there that takes capital out,” he says, “that’s good for whoever’s left.”
For their part, the Names believe that they have sound reasons to favor the status quo. The great appeal of being a Lloyd’s Name -- and the who’s who of members embraces rock and roll idols and football stars as well as lords and ladies -- is that one doesn’t actually have to put up any money. Names merely pledge their wealth -- down to the last penny -- to cover claims, should they arise. Thus they can simultaneously collect premiums from Lloyd’s and invest their funds in stocks or bonds or vintage Jaguars.
This is a splendid arrangement, provided of course that Lloyd’s policyholders don’t file so many claims that the underwriting syndicates can’t meet them out of the capital set aside for that purpose by their syndicates. If that happens, then Names are at risk for, in theory, everything from their bank accounts to their country estates to their silk pajamas.
Unfortunately, losses have been Lloyd’s lot for three straight years. Syndicates wound up more than £3 billion in the red in 2001, mostly because of the September 11 terrorist attacks on the World Trade Center. Lloyd’s likely net loss on 9/11-related claims alone has been estimated at £1.98 billion ($3.1 billion) on policies covering aircraft, property, liability, life, business interruption and automobiles.
A spate of disasters coupled with the ongoing terrorist threat have caused property/casualty insurance rates to surge, and, barring any calamities, Lloyd’s should return to profitability this year. Exchange officials forecast that underwriting capacity will grow from £11.5 billion in 2001 to £12.5 billion this year and to £14 billion next year.
Yet for the Names this is cheery news only if they can convert their accumulated losses into tax credits to offset the levies on future profits. This requires that they retain their unlimited-liability status at least until the losses are exhausted as de facto deductions, and losses can be carried forward three years.
“The key issue for many unlimited-liability Names is the substantial tax losses from the 1997 to 2001 underwriting years, which under current tax legislation are not allowed to be carried forward into a corporate vehicle,” explains Philip Calnan, a partner at PricewaterhouseCoopers in London. “Lloyd’s is seeking to have the legislation changed. If it is successful, then it is likely that a high proportion of Names will switch into corporate vehicles. If Lloyd’s is unsuccessful, then it may be necessary to rethink the approach.”
Meanwhile, a number of Lloyd’s corporate participants, increasingly fed up with the Names’ intransigence, are pursuing their own solutions. American insurer Markel Corp., a big presence at Lloyd’s, estimates that doing business through the exchange knocks 3 to 5 percentage points off its potential return on capital. So the Glen Allen, Virginiabased company has been writing large checks to buy out Names to purge them from its Syndicate 3000 -- a step contemplated by other corporate members.
Jeremy Cooke, who heads the British subsidiary of Markel, contends that an underwriting syndicate operating on corporate terms without any Names “definitely can run more efficiently.” Explains Cooke: “It requires fewer procedures and enables us to use our capital perhaps more effectively because the managing agency and capital are 100 percent aligned. If you don’t have 100 percent-aligned capital, then for certain transactions or changes in your business plan, it requires you to go through hoops to protect minority Names.”
Why put up with Lloyd’s at all when the club dues for corporate members appear to be so stiff? Much about the exchange still holds immense appeal for underwriters: a venerable brand; licenses that allow members to operate anywhere in the world; a regulatory framework that, for all its flaws, keeps Lloyd’s creditworthy at the same time that it permits flexibility; a wealth of brokering talent that continues to make Lloyd’s a wellspring of innovation and flair in an otherwise unimaginative industry; the ineffable draw of three centuries of tradition; and the indisputable fact that Lloyd’s remains a global force in marine insurance in particular.
“As we are a predominantly speciality insurer,” says Markel’s Cooke, “it makes a great deal of sense for Markel to be a participant in the world’s foremost speciality insurance market. By becoming involved in Lloyd’s, Markel was able to become a participant in international business.”
Still, several corporate insurers may be edging out Lloyd’s back door. London-based Wellington Underwriting, whose 46 percent share of Syndicate 2020 represents £290 million of underwriting capacity, decided in May to set up a reinsurance venture outside Lloyd’s. Wellington Re was capitalized at £448 million in a European private equity offering; among the backers are venture capital and alternative-investment firms, including Blackstone Group, Candover Partners and CSFB Private Equity. The firm has begun underwriting reinsurance, chiefly for p/c and U.K. commercial lines. This is business that might have been handled by Syndicate 2020.
Wellington gave the Names in Syndicate 2020 a chance to participate in Wellington Re -- but only as ordinary shareholders, not as Lloyd’s-style unlimited-liability syndicate members. Most took the firm up on its offer.
“It is important, however, that you understand that Wellington remains totally committed to the Lloyd’s market,” insists Charles Armitstead, a spokesman for Wellington Underwriting. “This firm has repeatedly stated its intention to remain one of the leading forces within the market and grow its business around Syndicate 2020 for the benefit of its Names.”
Wellington Re’s backers do not profess such public loyalty to Lloyd’s. The head of one of the private equity firms that ponied up funds for the venture says bluntly: “We and other people were worried about Lloyd’s, and there was a feeling that there was a bunch of business at Lloyd’s that will move outside. A lot of investors were wary at the time of investing in a Lloyd’s vehicle. The fact that this was outside Lloyd’s was more than helpful. It’s part of the reason we did it.”
An even more devastating blow to Lloyd’s was the August announcement by its largest underwriter, Ace, that it would reduce capacity at Lloyd’s from £900 million to £652 million in 2003. “The dynamics of the market have changed,” says the Bermuda-based insurer’s vice chairman, Donald Kramer. “The corporate players can survive outside Lloyd’s. As for the Names, Lloyd’s is the only place for them. We’re not shy and retiring in making our views known on what we think is right. The time for unlimited liability is over.”
Not all of Lloyd’s corporate members have become disenchanted. Several syndicates are increasing their underwriting capacity this year, in line with the recovery in the p/c market. XL Capital’s syndicate is going from £340 million to £440 million, and its fellow Bermudian, St. Paul’s, is upping capacity from £402 million to £529 million, Lloyd’s figures show. The U.S.'s Berkshire Hathaway, which participates in several syndicates, upped its overall capacity from £406 million to £497 million early this year and then increased it again in April through a £338 million credit facility to Wellington’s Syndicate 2020.
But this seeming show of support for Lloyd’s is deceptive, for it is wide but not deep. Global insurance giants typically have only a token presence on the exchange amounting to less than 1 percent of their total capacity. Munich Reinsurance Co.'s wholly owned Lloyd’s syndicate has a capacity of just £164 million, and the activities of Swiss Reinsurance Co. and American International Group are on an even smaller scale. The big firms are at Lloyd’s strictly to pick up stray bits of business and reinsure the reinsurers -- take excess risk off the hands of other market members.
“Their involvement at Lloyd’s is tiny, compared with their market capitalizations,” notes a London insurance analyst. “These are $30 billion to $40 billion companies, and their capacity at Lloyd’s runs into the hundreds of millions. It’s something they never got excited about. They want to be there because there are certain lines where Lloyd’s is where the expertise is, and maybe also for competitive reasons. But it’s not where Swiss Re and Munich Re conduct their business.”
The latest procedural reforms aren’t apt to change that. Although welcome enough, they’re less than earth-shattering. The most important establishes a “franchise” board to govern the often fractious relations between Lloyd’s and managing agents, the underwriters who control syndicates of investors.
Lloyd’s-appointed regulators will be empowered to impose more rigorous standards of risk control on members and intervene more swiftly when problems arise for syndicates. The regulator, on behalf of the franchiser -- that is, Lloyd’s -- will set capital and reporting requirements for the franchisees -- that is, the managing agents.
A long-standing criticism of Lloyd’s is that the quality of the underwriting is uneven, forcing the more conservative and creditworthy syndicates to bail out the reckless ones when they get into trouble. Lloyd’s is held together by the Central Fund, essentially an insurance policy for the insurers, which all exchange participants contribute to and which is used to pay claims on behalf of insolvent members.
The franchise plan has won wide support, but skeptics wonder how it will be implemented. “The proposal is a good idea in principle,” says Michael Carpenter, CEO of Talbot Underwriting, a small insurer owned by American and Bermudian interests. “We’re a market that operates on the same capital base ultimately, and we need to ensure that no one member blows up the society and the capital base. The huge difficulty is putting that into practice. How does a central organization like Lloyd’s control adequately the separate businesses that operate in the market? Management has not been good at foreseeing losses, and neither have capital providers. Who is to say a central band of policemen is going to be any better?”
Others worry that the new regulatory regime will stifle the underwriting creativity for which Lloyd’s is renowned. From the days of insuring chorines’ calves, Lloyd’s has gone on to preeminence in lines like political risk insurance. Several African nations recently bought coverage to protect foreign companies in their territories against losses because of war or other calamities.
“There is a risk that the franchiser’s new role might threaten the level of underwriter innovation, for which Lloyd’s has always been widely recognized,” cautions a January report by Standard & Poor’s. “The challenge will therefore be to strike the right balance between underwriting freedom and regulation of the franchisees.” The U.S. rating agency does, however, effectively endorse the new regulatory arrangement by declaring, “Having the direct authority to remove loss-making franchisees should, in the long term, improve the overall profitability, and therefore the attractiveness, of Lloyd’s for capital providers.”
Even before debate on the reforms got under way in earnest, Lloyd’s had made significant improvements in its operating procedures. Bronek Masojada, CEO of London-based Lloyd’s member Hiscox and chairman of the Lloyd’s Underwriting Agents Association, gives high marks to Lloyd’s CEO Nicholas Prettejohn for outsourcing many administrative functions and simplifying settlement procedures.
Prettejohn is not as popular with the Names as he is with corporate members like Masojada. “Many Names believe that Prettejohn finds Names a nuisance and that he thinks they should be ejected from Lloyd’s,” says one Name. “It is also thought that he is not evenhanded in his approach between private and corporate capital.” Nearly 70 percent of Names voted against the franchise regulatory system and annual reporting, thereby delivering a slap in the face to Prettejohn. The measures passed anyway because corporate members’ votes were capital-weighted under a deal struck with the Names to keep unlimited liability off the agenda.
Lloyd’s official Adrian Beeby contends that “the reforms will allow corporates to do business in the most efficient way and not have to follow procedures for the benefit of private capital” -- that is, the Names. As he very optimistically sees it, unlimited liability is a dead issue. And as for Prettejohn’s ignoring Names’ interests, Beeby has this to say: “Surely the fact that the original set of proposals published in January were changed markedly shows that Lloyd’s did indeed listen very closely to the views of all its members.”
Nonetheless, the Names are unlikely to yield on unlimited liability without absolute assurance that they can carry losses forward.
Their mood is not accommodative. Robert Miller, an official of the Association of Lloyd’s Members, which represents the Names, maintains that Lloyd’s problem isn’t Names’ losses but the losses of the corporate members that insinuated themselves into their market.
“Why is Lloyd’s in trouble?” he asks. “Because there are a whole lot of Bermudian and international corporates who have been racking up losses. Something needs to be done to stop the corporates, in most cases, from damaging the business of everyone else. Private capital knows more about the insurance business than the insurance business seems to.”
Miller insists that from 1998 through 2000, the latest period for which figures are available, the losses of Lloyd’s private capital providers came to a smaller percentage of their underwriting capacity than did those of “the internationals” -- meaning German, Japanese and Swiss insurers. Bermudian and U.S. insurers were in between, he says. The corporate insurers, Miller contends, “have backed a number of completely dud managing agents who have produced awful losses for them.”
Hiscox’s Masojada finds Miller’s argument unconvincing. He points out that the corporate insurers had to buy their way into Lloyd’s by acquiring the only businesses that were up for sale: the bad ones, not the healthy ones. Thus the corporations’ early results may have looked exaggeratedly grim.
If the Names regard the corporates as carpetbaggers with more money than sense, then the corporates view the Names as amateurs with little money and even less sense. Says the CEO of one of Lloyd’s corporate insurers with barely concealed condescension: “I’m not anti-Names as such. They’re all wonderful people who live in rectories in England.”
Ultimately, Lloyd’s may change without a bloody revolution. “You have to look at the macrotrends,” says Masojada. “Eighty percent of the capital at Lloyd’s is from limited-liability corporates; eight years ago it was zero. A few years from now, individual Names will have left, and the market will comprise 100 percent corporate investors.”
That may well make for a more modern, efficient and professional insurance market. But without characters like the aging actress who was played by Dame Judith Dench in the David Hare play Amy’s View -- she supported herself as a Lloyd’s Name -- the exchange won’t be nearly as colorful.
