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"The world's specialist insurance market"
|Headquarters||Lloyd's building, Lime Street|
London, United Kingdom
|Key people||John Nelson (Chairman)|
Inga Beale (chief executive officer)
"The world's specialist insurance market"
|Headquarters||Lloyd's building, Lime Street|
London, United Kingdom
|Key people||John Nelson (Chairman)|
Inga Beale (chief executive officer)
Lloyd's of London (also known simply as Lloyd's) is an insurance market located in London's primary financial district, the City of London. It serves as a partially mutualised marketplace where multiple financial backers, known as underwriters, or "members", both individuals (traditionally known as "Names") and corporations, come together to pool and spread risk. Unlike most of its competitors in the industry, it is not a company but it is a corporate body governed by the Lloyd's Act of 1871 and subsequent Acts of the Parliament of the United Kingdom.
The insurance business underwritten at Lloyd's is predominantly general insurance and reinsurance, although in 2013 there were five syndicates writing term life assurance. The market has its roots in marine insurance and was founded by Edward Lloyd at his coffee house on Tower Street in the 17th century. Today, it is based at the Lloyd's building on Lime Street. Fidentia (Latin for "confidence") is the motto of Lloyd's.
In 2011, over £23.44 billion of gross premiums were transacted in the Lloyd's market and in the aggregate it made a pre-tax loss of £516 million, driven by a number of significant natural disasters which gave rise to the highest ever annual level of claims for Lloyd's. In 2012, Lloyd's made a pre-tax profit of £2.77 billion on a record £25.50 billion of gross written premiums.
The market began in Lloyd's Coffee House, opened by Edward Lloyd in around 1688 on Tower Street in the historic City of London. This establishment was a popular place for sailors, merchants, and ship owners, and Lloyd catered to them with reliable shipping news. The shipping industry community frequented the place to discuss deals among themselves, including insurance. Just after Christmas 1691, the shop relocated to Lombard Street (a blue plaque commemorates this location). This arrangement carried on until 1774, long after Lloyd's death in 1713, when the participating members of the insurance arrangement formed a committee and moved to the Royal Exchange on Cornhill as The Society of Lloyd's.
The Royal Exchange was destroyed by fire in 1838 and, although the building was rebuilt by 1844, many of Lloyd's early records were lost. 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.
It was realised that the membership of the Society, which had been largely made up of market participants, was 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, which produced the Cromer report in 1968. This report advocated the widening of membership to non-market participants, including non-British subjects and women, and to reduce the 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 issues arose which were to have significant influence on the course of the Society. The first was the tax structure in the UK: capital gains were taxed at 40% (0% on gilts), earned income was taxed in the top bracket at 83%, and investment income in the top bracket at 98%. 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 gilt or other bond 'ex dividend' and selling it 'cum dividend', creating an income loss and a tax-free capital gain. Syndicate funds were also moved offshore (which later created problems through fraud and self-dealing).
Because Lloyd's acted as a tax shelter in addition to being an insurance market, 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 the number of underwriters working in the markets. Thirdly, during the decade a number of scandals had come to light, including the collapse of the Sass syndicate, which had highlighted both the lack of regulation and the lack of legal powers of the Committee of Lloyd's (as it was then) to manage the Society.
Arising simultaneously with these developments were wider issues: firstly, in the United States, an ever-widening interpretation by the courts of insurance coverage in relation to workers' compensation for asbestos-related losses, which created a huge, and initially not recognised and then not acknowledged, 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 to the current year, 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. The main purpose of the 1982 Act was to separate the ownership of the managing agents of the Lloyd's underwriting syndicates from the ownership of the insurance broking firms (which acted as intermediaries, not as underwriters) with the objective of removing conflicts of interest.
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 British 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 to mid 1990s, Lloyd's went through perhaps 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 that were typically excluded on broad-form (wide cover) liability policies.
Also in the 1980s Lloyd's was accused of fraud by several American states and external Names (investors in underwriting syndicates). Some of the more high-profile accusations included:
The classic example of long-tail insurance risks is asbestosis/mesothelioma claims under employers' liability or workers' compensation insurances. A worker at an industrial plant may have been exposed to asbestos in the 1960s, fallen ill 20 years later, and claimed 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 back 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 written from the 1940s to the mid-1970s for companies with exposure to asbestosis claims.
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' (RITC).
Membership of a Lloyd's syndicate was not like owning shares in a company. An individual "joined" for one calendar year only – known as the 'Lloyd's annual venture'. At the end of the year, the syndicate as an ongoing trading entity was effectively disbanded.
However, usually the syndicate re-formed for the next calendar year with more or less the same membership and the same identifying number. In this way, a syndicate could have a continuous existence going back (in some cases) 50 years or more, but each year was accounted for separately. There would have been 50 separate incarnations of the syndicate, each one a separate trading entity that underwrote insurance for one calendar year only.
Since claims take time to be reported and paid, the profit or loss for each syndicate took time to become apparent. The practice at Lloyd's was to wait three years (that is, 36 months from the beginning of the year in which the business was written) before "closing" the year for accounting purposes and declaring a result.
For example, a 2003 syndicate would ordinarily declare its results following the end of December 2005. The syndicate's members would be paid any underwriting (and investment) profit during the 2006 calendar year, in proportion to their participation in the syndicate; conversely, they would have to reimburse the syndicate during 2006 for their share of any loss.
To arrive at the profit or loss, reserves were set aside for future claims payments, that is, both reserves for claims that had been notified but not yet paid, and also estimated amounts required for claims that had been incurred but not reported (IBNR). The estimation process is difficult and can be inaccurate; in particular, liability (or long-tail) policies tend to produce claims long after the policies are written.
The reserve for future claims liabilities was set aside in an unusual way. The syndicate bought a reinsurance policy to pay any future claims; the premium was equal to the amount of the reserve. In other words, rather than putting the reserve into a bank to earn interest, the syndicate transferred its (strictly, its members') liability to pay future claims to a reinsurer. This was RITC – a transaction that allowed the syndicate to be closed, and a profit or loss declared.
The reinsurer was always another Lloyd's syndicate(s), often the succeeding year of the same syndicate. The members of Syndicate X in 2004 reinsured the future claims liabilities for members of Syndicate X in 2003. The membership might be the same, or it might have changed.
In this manner, liability for past losses could be transferred year after year until it reached the current syndicate. A member joining a syndicate with a long history of such transactions 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 RITC 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, the amounts of money transferred from earlier years by successive RITC premiums to cover these losses were insufficient, and the current members had to pay the shortfall.
(By contrast, within a stock company, an initial reserve for future claims liabilities is set aside immediately, in year 1. Any deterioration in that initial reserve in subsequent years will result in a reduced profit in the later years, and a consequently reduced dividend and/or share price for shareholders in those later years, whether or not those shareholders in the later year are the same as the shareholders in year 1. Arguably, Lloyd's practice of using reserves in year 3 to establish the RITC premiums should have resulted in a more equitable handling of long-tail losses such as APH than would the stock company approach. Nevertheless, the difficulties in correctly estimating losses such as APH overwhelmed even Lloyd's extended process.)
As a result a great many individual members of syndicates underwriting long-tail liability insurance at Lloyd's faced financial loss by the mid-1990s.
It is alleged that, in the early 1980s, some Lloyd's officials began a recruitment programme to enrol new Names to help capitalise Lloyd's prior to the expected onslaught of APH claims. This allegation became known as 'recruit to dilute': in other words, 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 large numbers of 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 Lloyd's made it difficult, if not impossible, for many Names to understand 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 transferred (by RITC) into a special vehicle called Equitas at a cost of over $21 billion and enormous personal losses for many Names.
The 'recruit to dilute' fraud allegations were heard in court in 2000 in the case Sir William Jaffray & Ors v. The Society of Lloyd's (see first instance judgment) 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 (see appeal judgment) 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 [...].).
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 hundred existing ones remained). Financial requirements for underwriting were changed, to prevent excess underwriting that was not backed by liquid assets. Market oversight has significantly increased. Lloyd's rebounded and started to thrive again after the September 11 attacks, but it has faced increased competition from newly created companies in Bermuda and other markets.
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 a non-incorporated association of subscribing members, 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. Instead, the Society operates effectively as a market regulator, setting rules under which members operate and offering centralised administrative services to those members.
The Lloyd's Act 1982 defines the management structure and rules under which Lloyd's operates. Under the Act, the Council of Lloyd's is responsible for the management and supervision of the market. It is regulated by the Prudential Regulation Authority and the Financial Conduct Authority.
The Council normally has six working, six external and six nominated members. The appointment of nominated members, including that of the chief executive officer, is confirmed by the Governor of the Bank of England. The working and external members are elected by Lloyd's members. The chairman and deputy chairmen are elected annually by the Council from among the working members of the Council. All members are approved by the regulating bodies.
The Council can discharge some of its functions directly by making decisions and issuing resolutions, requirements, rules and byelaws. The Council delegates most of its daily oversight roles, particularly relating to ensuring the market operates successfully, to the Franchise Board.
The Franchise Board lays down guidelines for all syndicates and operates a business planning and monitoring process to safeguard high standards of underwriting and risk management, thereby improving sustainable profitability and enhancing the financial strength of the market.
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 (for example, individuals and companies seeking insurance or insurance companies seeking reinsurance).
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 (4.4%) Names were declared bankrupt) and scared away others. Today, individual Names provide only 14% of capacity at Lloyd's, with UK-listed and other corporate members providing 31% and the remainder via the international insurance industry. No new Names with unlimited liability are admitted, and the importance of individual Names will continue to decline as they slowly withdraw, convert (generally, now, into Limited Liability Partnerships) or die.
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.
Members' agents co-ordinate the members' underwriting and act as a buffer between Lloyd's, the managing agents and the members. They were introduced in the mid-1970s and grew in number until many went bust; many of the businesses merged, and there are now only four left (Argenta, Hampden, Alpha and LMAS, which has no active Names). It is mandatory that unlimited Names write through a members' agent, and many limited liability members choose to do so.
Recent results have benefited from tougher underwriting standards imposed by the Franchise Board and improved terms and conditions following widespread underwriting losses during the period 1998 to 2001, the September 11 attacks, and large hurricane-related property and energy claims in both 2004 and 2005.
Coverholders are an important source of business for Lloyd's. Their numbers have increased steadily in recent years, and there are now about 2,500 Lloyd's coverholders producing around 30% of Lloyd's premium income each year. The balance of Lloyd's business is distributed around the world through a network of brokers. Coverholders allow Lloyd's syndicates to operate in a region or country as if they were a local insurer. This is achieved by Lloyd's syndicates delegating their underwriting authority to coverholders. A coverholder can have full or limited authority to underwrite on behalf of a Lloyd's syndicate. It will usually issue the insurance documentation and will often handle claims. The document setting out the terms of the coverholder's delegated authority is known as a binding authority.
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. They are therefore often referred to as intermediaries. Lloyd's brokers shop customers' policies among the syndicates, trying to obtain the best prices and terms.
When corporations became admitted as Lloyd's members, they often disliked 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 (ILV) is a group of companies that combines a corporate member, a managing agent, and a syndicate under common ownership. Some ILVs allow minority contributions from other members, but most now try to operate on an exclusive basis.
Lloyd's capital structure, often referred to as the Chain of Security, provides financial security to policyholders and capital efficiency to members. The Corporation is responsible for setting both member and central capital levels to achieve a level of capitalisation that is robust and allows members the potential to earn superior returns.
There are three 'links' in the chain: the funds in the first and second links are held in trust, primarily for the benefit of policyholders whose contracts are underwritten by the relevant member. Members underwrite for their own account and are not liable for other members' losses.
The third link — the Central Fund — contains mutual assets held by the Corporation which are available, subject to Council approval, to meet any member's insurance liabilities.
Lloyd's syndicates write a diverse range of policies, both direct insurance and reinsurance, covering casualty, property, marine, energy, motor, aviation and many other types of risk. Lloyd's has a unique niche in unusual, specialist business such as kidnap and ransom, fine art, aviation, marine, satellite, bloodstock and other insurances.
The general public knows Lloyd's for some unusual or notable policies it has written. For example, Lloyd's has insured:
The present Lloyd's building, at 1 Lime Street, was designed by architect Richard Rogers and was completed in 1986. It stands on the site of the old Roman Forum. The 1925 facade still survives, appearing strangely stranded with the modern building visible through the gates on the northern side on Leadenhall Street. In 2011 it was listed as a Grade I building by heritage minister John Penrose.
In the great Underwriting Room of Lloyd's stands the Lutine Bell, which was struck when the fate of a ship "overdue" at its destination port became known. If the ship was 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), or for the annual Remembrance Day service and anniversaries of major world events (one ring).
Lloyd's was named Business Insurance Readers Choice winner 2007 for Best Reinsurance Company.
Lloyd's is also the main plotline in English author Penny Vincenzi's novel An Absolute Scandal (2007), which centres around the scandals during the 1980s and 1990s told via a large ensemble cast.