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Lloyd's of London

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Lloyd’s Building, London (with the blue cranes). The Gherkin shaped Swiss Re Tower is in the background
Lloyd’s Building as seen from street level.

Lloyd's of London is a British insurance market. It serves as a meeting place where multiple financial backers or "members", whether individuals (traditionally known as "Names") or corporations, come together to pool and spread risk. Unlike most of its competitors in the reinsurance market, it is neither a company nor a corporation. Its peculiar status is discussed in greater detail below.

Quick facts

Annual Report and Results 2004 presents pro forma accounting results restated from a three year basis to annual accounting basis in order to provide numbers comparable with the rest of the industry. Selected data for 2004:

Income

Balance sheet

  • Balance sheet assets: £50,248 million
  • Capital, reserves, and subordinated loan notes: £12,169 million

History

The Subscription Room in the early 19th century.

The market began in Edward Lloyd's coffeehouse around 1688 in London. While Lloyd was only the proprietor of the coffeehouse, his establishment was a popular place for sailors, merchants, and shipowners and Lloyd catered to them with reliable shipping news and a variety of services. The shipping industry community frequented the place to discuss insurance deals among themselves.

This arrangement carried on long after Lloyd's death in 1713 until 1774 when the participating members of the insurance arrangement formed a committee and moved to the Royal Exchange as The Society of Lloyd's. In 1871, the first Lloyd's Act was passed in Parliament which gave the business a sound legal footing. The Lloyd's Act of 1911 set out the Society's objectives, which include the promotion of its members' interests and the collection and dissemination of information. By this time the business had become one of the pre-eminent insurers in the world.

In 1965, Hurricane Betsy caused immense damage in the Gulf of Mexico. The membership of the Society, which had been largely made up of market participants, was realised to be too small in relation to the market's capitalisation and the risks that it was underwriting. Lloyd's response was to commission a secret internal inquiry, known as the Cromer Report, which reported in 1968. This Report advocated the widening of membership to non-market participants, including non-British subjects and women, and to reduce the relatively onerous capitalisation requirements (which created a more minor investor known as a 'mini-Name'). The Report also drew attention to the danger of conflicts of interest.

During the 1970s, a number of unrelated issues arose which were to have significant influence on the course of the Society. The first was the government and tax structure in the UK: the prevailing government during this period was strongly left wing, with a top income tax rate of 83% on earned income and 98% on investment income. Lloyd's income counted as earned income, even for names who did not work at Lloyd's, and this heavily influenced the direction of underwriting: in short, it was desirable for syndicates to make a (small) underwriting loss but a (larger) investment profit. The investment profit was typically achieved by 'bond washing' or 'gilt stripping': buying the bond 'cum dividend' and selling it 'ex dividend', creating an income profit and a capital loss. Syndicate funds were also moved offshore, (which later created problems through fraud and self-dealing).

Because Lloyd's had turned itself into a tax shelter, the second issue affecting Lloyd's was an increase in its external membership, such that, by the end of the decade, the number of passive investors dwarfed market investors. Thirdly, during the decade a number of scandals had come to light, including the collapse of the Sasse syndicate and the disgrace of Moran, which had highlighted both the lack of regulation and the legal inability of the Council to manage the Society.

Simultaneously with these developments, were wider issues: firstly, in America, an ever-widening interpretation by the Courts of insurance coverage in relation to workers' compensation in relation to asbestosis losses, which had the effect of creating a huge, and initially unrecognised and then unacknowledged hole in Lloyd's reserves. Secondly, by the end of the decade, almost all of the market agreements, such as the Joint Hull Agreement, which were effectively cartels mandating minimum terms, had been abandoned under pressure of competition. Thirdly, new specialised policies had arisen which had the effect of concentrating risk: these included 'run off policies', under which the liability of previous underwriting years would be transferred, and 'Time and Distance' policies, whereby reserves would be used to buy a guarantee of future income.

In 1980, Sir Henry Fisher was commissioned by the Council of Lloyd's to produce the foundation for a new Lloyd's Act. The recommendations of his Report addressed the 'democratic deficit' and the lack of regulatory muscle.

The Lloyd's Act of 1982 further redefined the structure of the business, and was designed to give the 'external Names', introduced in response to the Cromer Report, a say in the running of the business through a new governing Council.

Immediately after the passing of the 1982 Act, evidence came to light, and internal disciplinary proceedings were commenced against, a number of individual underwriters who had siphoned sums from their businesses to their own accounts. These individuals included a Deputy Chairman of Lloyd's, Ian Posgate, and a Chairman, Sir Peter Green.

In 1986 the UK government commissioned Sir Patrick Neill to report on the standard of investor protection available at Lloyd's. His report was produced in 1987 and made a large number of recommendations but was never implemented in full.

In the late 1980s and early 1990s, Lloyd's went through the most traumatic period in its history. Unexpectedly large legal awards in US courts for punitive damages led to large claims by insureds, especially on APH (asbestos, pollution and health hazard) policies, some dating as far back as the 1940s. Many of these policies were designed to cover all liabilities not excluded on broadform liability policies.

'Recruit to dilute'

It may be wondered how the current Members of Lloyd's could be liable to pay these historical losses. This came about as a result of the Lloyd's accounting practice known as 'reinsurance-to-close'. Membership of a Lloyd's Syndicate was (and as at December 2005 still is) on an annual basis - the famous 'Lloyd's annual venture'. Each Syndicate was effectively disbanded each year and started again, often with more or less the same membership. Because claims take time to be reported and paid, the true trading result for any given Syndicate year could not be known for some time. Therefore, Lloyd's practice was to wait three years before 'closing' each Syndicate year and declaring a result.

Part of the result would include the setting-aside of reserves for future claims payments against the year. In particular, liability (or long-tail) policies tend to produce claims long after the policies are written. The reserves were paid in the form of a reinsurance premium to the next year of the Syndicate, which would in return be liable to pay any claims. This was 'reinsurance-to-close' - a reinsurance transaction that allowed the Syndicate year to be closed, and a profit or loss declared.

In this manner, liability for past losses was transferred year after year until it reached the current Syndicate. A Member joining an old Syndicate could - and often did - pick up liability for losses on policies written decades previously. So long as the reserves had been correctly estimated, and the appropriate reinsurance-to-close premium paid every year, then all would have been well. But in many cases this had not been possible. No-one could have predicted the surge in APH losses. Therefore, they were insuffuciently reserved.

(For a fuller explanation of the annual venture, and the various means of reinsuring-to-close, see below.)

As a result a great many individual Members of syndicates underwriting long term liability insurance at Lloyds's faced financial ruin by the mid 1990s.

In the early 1980s, it is alleged that some Lloyd's officials began a recruitment program to enroll new Names to help capitalise Lloyd's prior to the expected onslaught of APH claims. This allegation became known as 'recruit to dilute'; ie. recruit Names to dilute losses. When the huge extent of asbestosis losses came to light in the early 1990s, for the first time in Lloyd's history members refused or were unable to pay the claims, many alleging that they were the victims of fraud, misrepresentation, and negligence. The opaque system of accounting at Lloyds made it difficult if not impossible for many Names to realise the extent of the liability that they personally and their syndicates subscribed to.

The market was forced to restructure. In 1996 the ongoing Lloyd's was separated from its past losses. Liability for all pre-1993 business was compulsorily transfered (by reinsurance-to-close) into a special vehicle called Equitas at a cost of over $21 billion and enormous personal losses to many Names. It was subsequently discovered that a bribe, described as an 'educational briefing', had been paid by Lloyd's to the Californian Insurance Commissioner in order to prevent him obstructing the formation of Equitas [1].

The 'recruit to dilute' fraud allegations were heard at trial in 2000 in the case Sir William Jaffray & Others v. The Society of Lloyd's, and the appeal was heard in 2002. On each occasion the allegation that there had been a policy of 'recruit to dilute' was rejected: however, at first instance the judge described the Names as the innocent victims [...] of staggering incompetence and at appeal the Court found that representations that Lloyd's had a rigorous auditing system were false ([item 376 of the judgment:] [...] the answer to the question [...] whether there was in existence a rigorous system of auditing which involved the making of a reasonable estimate of outstanding liabilities, including unknown and unnoted losses, is no. Moreover, the answer would be no even if the word 'rigorous' were removed.) and strongly hinted that one of Lloyd's main witnesses, Murray Lawrence, a previous Chairman had lied in his testimony ([item 405 of the judgment:] We have serious reservations about the veracity of Mr Lawrence's evidence [...].).

Links: First Instance judgment Appeal judgment

Lloyd's then instituted some major structural changes. Corporate members with limited liability were permitted to join and underwrite insurance. No new "unlimited" Names can join (although a few thousand existing ones remain). Financial requirements for underwriting were changed, to prevent excess underwriting that was not backed by liquid assets. Market oversight has significantly increased. It has rebounded and started to thrive again after the World Trade Center attacks, but it has not regained its past importance as newly created companies in Bermuda captured a large share of the reinsurance market.

Structure

Lloyd's is not an insurance company. It is an insurance market of members. As the oldest continuously active insurance marketplace in the world, Lloyd's has retained some unusual structures and practices that differ from all other insurance providers today. Originally created as an unincorporated association of subscribing members in 1774 it was incorporated by the Lloyd's Act 1871, and is currently governed under the Lloyd's Acts of 1871 through to 1982.

Lloyd's itself does not underwrite insurance business, leaving that to its members (see below). Instead the Society operates effectively as a market regulator, setting rules under which members operate and offering centralised administrative services to those members.

Structurally Lloyd's is governed by the Council of Lloyd's, an 18 member body roughly equivalent to the board of directors of a company. The Council's administers the Corporation of Lloyd's which runs the various services and administrative operations of Lloyd's. Finally, the Council delegates many of its day to day oversight roles, particularly relating to ensuring the market operates successfully, to the Franchise Board.

Lloyd's building

Businesses at Lloyd's

There are two classes of people and firms active at Lloyd's. The first are members or providers of capital, the second are agents, brokers, and other professionals who support the members, underwrite the risks, and represent outside customers.

Members

For most of Lloyd's history, rich individuals ("Names") backed policies written at Lloyd's with all of their personal wealth (unlimited liability). Since 1994, Lloyd's has allowed corporate members into the market, with limited liability. The losses in the early 1990s devastated the finances of many Names (Upwards of 1,500 out of 34,000 Names declared bankruptcy) and scared away others. Today, Names provide only 20% of capacity at Lloyd's, with corporations accounting for the rest. No new Names with unlimited liability are admitted, and the importance of individual Names will continue to decline as they slowly withdraw or pass away.

Syndicates

Members do not write insurance policies directly, but through syndicates. There are currently 62 syndicates competing against each other for business. Some syndicates specialize in niche insurance areas (such as aviation, marine hull, etc.) while others are generalists. Syndicates employ underwriters who decide which policies and at what prices the syndicate should write. A syndicate is similar to, but not, a partnership, differing in that each participant typically underwrites, and is therefore on risk for, differing amounts.

Managing agents

Managing agents sponsor and manage syndicates. They canvas members for commitments of capacity, create the syndicate, hire underwriters, and oversee all of the syndicate's activities. Managing agents may run more than one syndicate.

Lloyd's brokers

Outsiders, whether individuals or other insurance companies, cannot do business directly with Lloyd's syndicates. They must hire Lloyd's brokers, who are the only customer-facing companies at Lloyd's. Lloyd's brokers shop customers' policies among the syndicates, trying to obtain the best prices and terms.

Integrated Lloyd's vehicles (ILVs)

When corporations became admitted as Lloyd's members, they did not like the traditional structure. Insurance companies did not want to rely on the underwriting skills of syndicates they did not control, so they started their own. An integrated Lloyd's vehicle is a company that combines a corporate member, a managing agent, and a syndicate under one ownership. Some ILVs allow minority contributions from other members, but most now try to operate on an exclusive basis.

Current market structure

As of January 31, 2006, Lloyd's of London had the following structure: [2]

  • Capital providers
    • 55 corporate members
    • 1,497 individual Names with unlimited liability
    • 468 individual members with limited liability
  • Market participants
    • 44 managing agents
    • 62 syndicates
    • 164 Lloyd's brokers

Underwriting ventures

Lloyd's syndicates work on the basis of a three year accounting cycle (triennial accounting). Each calendar year a Lloyd’s syndicate starts a new insurance venture with a clean book containing no assets or liabilities. In first year of account, the venture accepts premiums from customers to insure risks for one year (the annual venture). At the end of the year, the venture stops writing business, but continues to exist to pay claims for the next two years of account. After three years (one year of writing and two years of paying claims) the venture is closed. Its books are balanced, any profits left over after paying out claims and reinsurance-to-close are paid out to members. Each year's venture stands on its own with regard to paying claims and collecting premiums.

Unlike most businesses, accountancy at Lloyd's does not assume the "Going concern" basis" because it is expected that each venture will last for three years and then end. The origin of this accounting cycle was in the shipping business. Syndicates would insure a ship before the start of its voyage, and the three-year period was considered to be the amount of time that it took a ship to sail around the world.

Since the 1930s, many Lloyd's syndicates branched out to underwriting policies providing coverage for general liability, and excess liability beyond that covered by other insurance policies, as well as providing upper layers of reinsurance. Comprehensive unrestricted general liability policies were very popular in the US market from the late 1940s to mid 1970s. These types of policies involve time spans longer than finite three years of a Lloyd's venture.Insurance policies that cover liabilities that that may extend for many years are called long-tail policies because the "tail" of the liability can extend out for many years into the future.

Before an insurance venture can be closed at the end of three years, its liabilities must be balanced by paying out all outstanding claims which have not been paid, and making provision (setting aside a reserve) to pay any incurred but not reported losses (IBNRs) which may occur in the future. An example of an example an IBNR loss is lawsuit filed in the future seeking damages for business activities that occurred in the insured time period.

Inside the Lloyd's system, potential incurred-but-not-reported losses are reserved for and transferred (reinsured) at the time of closing by estimating the potential total future liability, and then paying a one time premium for a reinsurance-to-close policy(s) (RITCs) which transfers the risk. Typically, the reinsurer is the following underwriting year of the same syndicate, but it may be with another syndicate(s). The transfer of residual capital as RITC premiums from year to year and venture to venture ensures solvency for future liabilities.

Long-tail policies are thus rolled over from year to year and in theory there is always capital available from accumulated RITC premiums to pay claims. It also means that the largest insurance risk typically underwritten by a syndicate are its own reinsurance liabilities for previous years. If the premiums paid for reinsuring previous years were too low, then the syndicate may become undercapitalised thereby forcing it to rely on the unlimited liability of the names. This follows from Lloyd's practice of policyholders always being paid in full irrespective of any financial difficulties individual names might have.

The structure of triennial accounting and RITCs is considered by some to be ill-suited to modern business. The root of the problem is the difficulty of forecasting the results of risks which have a long duration (or 'tail'). The system of RITC can convey enormous amounts of latent liability onto the shoulders of latter year investors. If the full nature of the liability liabilities is not understood and cannot be quantified, then it is impossible to properly reserve for it. This can result in highly

The classic example is asbestosis claims. A worker at an industrial plant may have been exposed to asbestos in the 1960s, fallen ill 20 years later, and collected compensation from his former employer in the 1990s. The employer would report a claim to the insurance company that wrote the policy in the 1960s. However because the insurer did not understand the full nature of the future risk in the 1960s, it and its reinsurers would not have properly reserved for it. In the case of Lloyd's this resulted in the bankruptcy of thousands of individual investors who indemnified (via RITC) general liability insurance writen from 1940s to the mid 1970s for companies with exposure to asbestosis claims.

Capital backing

Several different pools of capital back the ability of Lloyd's to pay claims. These pools together are called "Lloyd's chain of security."

  1. Premium trust funds. Premiums collected from customers are deposited in a trust fund which members cannot access until the dissolution of the annual venture. This trust fund is the first source of payment. If there is money left in the fund at the end of the venture's three year life, it is distributed to members as profit. At the end of 2004, total amount of premium trust funds equaled almost £22 billion.
  2. Funds at Lloyd's. Members have to deposit additional funds at Lloyd's in case that premiums do not cover claims and the venture ends up in a loss. At the end of 2004, total funds at Lloyd's equaled £9.6 billion.
  3. Personal wealth. Individual members (names) pledge all of their personal wealth to pay claims. As of the end of 2004, this category of personal wealth totaled less than £220 million, due to declining number of names.
  4. Central fund. Lloyd's levies a premium on all policies written and deposits the proceeds in a central fund that will pay claims if the members backing a policy go bankrupt and cannot meet their obligations. As of the end of 2004, central fund assets exceeded £550 million.

Lloyd's claim paying ability is rated A by A.M. Best and A by Standard & Poor's.

Types of policies

Lloyd's syndicates write a diverse range of policies, both direct insurance and reinsurance, covering property, liability, catastrophe and many other risks. Lloyd's has a unique niche in unusual, specialist business such as kidnap and ransom insurance, fine art insurance, aviation insurance, marine, etc.

The general public knows Lloyd's for some unusual policies it has written in the past. Lloyd's has insured:

Miscellaneous

The present Lloyd's building was designed by architect Richard Rogers and was completed in 1986. It stands on the site of the old Roman Forum.

In the great Underwriting Room of Lloyd's stands the Lutine Bell, which used to be struck when the fate of a ship "overdue" at its destination port became known. If the ship were safe, the bell would be rung twice: if it had sunk, the bell would be rung once. (This had the practical purpose of immediately stopping the sale or purchase of "overdue" reinsurance on that vessel.) Now it is only rung for ceremonial purposes, such as the visit of a distinguished guest (two rings); and for major world catastrophes, such as 9/11, the Asian Tsunami Disaster, and the 2005 London transport explosions (one ring).

The Pink Floyd bootleg album "The Floyd's of London" is a recording of a September 30, 1971 concert at London's Paris Cinema. [3]

Each Year on the last Friday before Remembrance Sunday a memorial service is held involving representatives from each of the three armed services and a unit from the Army Cadet Force; 26 Troop The Life Guards Household Cavalry Regiment. The ACF Sector flag is carried by the most senior cadet in the unit.

See also

Data

Criticism

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