Lloyd's And Mr. Ponzi
most infamous fraudster in the history of the United States was Mr. Ponzi.
He was convicted of operating a massive investment scheme in which he offered
unusually high interest rates to his depositors. He paid these high returns
out of the new capital he attracted from new depositors. Eventually, of
course, his scheme collapsed when he could not atttract sufficient new deposits
to both pay interest to his old depositors and repay those of them who asked
for the return of their money.
There are interesting parallels between Lloyd's and Mr. Ponzi's scheme. A major difference, however, is that Lloyd's made and executed its plans with the knowledge and connivance of a great Department of Government, the Department of Trade and Industry.
a tangled web we weave
Sir Walter Scott
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A Names Defence Association Paper
LLOYD'S OF LONDON
"Lloyd's was, and is, an institution of vital national importance. The job to be done was daunting, but it would involve things I knew about: the unravelling of fraud and the development of accounting rules." Ian Hay Davison, Chief Executive of Lloyd's 1983-86
LLOYD'S – A DRAIN ON THE UK's DOLLAR RESERVES
Lloyd's Annual Settlements Statistics Package indicates that Lloyd's has been a large drain on the UK's dollar reserves since at least 1967. A summary of the profits and losses earned by Lloyd's from its main American business class "US $ Non-Marine, All Other" is contained in Appendix 1 to this report. It shows that Lloyd's has recorded losses in 21 of the last 25 policy years in that major class of business, with aggregate underwriting losses over those years of $4.6 billion. In addition, provision for a further worsening of the losses from the policies written during those years amounting to approx. $790 million is indicated by the most recent set of Lloyd's Settlement Statistics. This additional loss will be provided for in the 1992 year Syndicate Accounts which are now being finalized.
LLOYD'S – A LONG TERM LOSS MAKING INSTITUTION
For the Syndicate Account years from 1979 to 1991, Lloyd's Annual Global Accounts, which cover all classes of business worldwide, have recorded aggregate underwriting deficits of £5.7 billion and overall pre-tax trading losses of £4.2 billion. As shown in the Summary of Lloyd's Global Accounts in Appendix 2 to this report, those losses are equivalent to £6.2 billion and £3.4 billion in today's currency, that is after adjusting for the reduction in the purchasing power of the £. Further losses for the 1992 Year of Account, which are due to be announced in May of this year, are widely forecast at £1 to £2 billion.
FALSE PROFITS – FALSE TAXATION REVENUES FOR THE TREASURY
On 24 February 1982 the magnitude of the ultimate losses from long standing unlimited US Liability policies was officially admitted by the Lloyd's Panel of Approved Syndicate Auditors when they wrote to the Lloyd's Council for guidance. The auditors had learned that the ultimate losses from those policies, based on the US Attorneys Reports to Insurers, were so large as to be unquantifiable. Lloyd's reply simply referred the problem to the Directors of the Managing Agencies. A few weeks later almost all the 1979 year Syndicate Accounts were closed without provision for those losses, without any informatory notes about them, and without any qualifications by the auditors in their audit certificates.
In all the years since then, nobody has explained what happened during the intervening weeks to make those losses quantifiable.
As is clearly evident, full provision for the losses mentioned above should have been made in the Accounts for the syndicate years of the late 1970's and early 1980's. Alternatively, and what probably would have been the best decision, the Accounts of many afflicted syndicates should have been left open. In the event, no adequate provisions were made and one or two syndicates left their Accounts open. The same happened in most of the following years in the 1980's. As was inevitable, the losses eventually started to impact on Lloyd's Syndicates in the late 1980's and the early 1990's. Thus only recently have syndicate Accounts and Lloyd's Global Accounts started to reflect the deficits for which provision should have been made so many years ago.
The results of all those years of falsely overstated profit declarations benefited working Names in general and those Names whose syndicates were able to re-insure their risks at a sizeable undervalue to other less knowledgeable syndicates. In addition, the Inland Revenue and the Treasury benefited handsomely. Had adequate provisions been made when they properly should have been, Lloyd's as a whole would have declared substantial losses and UK taxation revenues would have been substantially lower.
The overstatement of profits continued throughout most of the 1980's. It has been estimated that over those years the Treasury collected between £500 million and £1 billion more than was truly justified as a result of those false profits being declared at Lloyd's.
More recently, however, the Inland Revenue's taxation receipts have been lowered as a result of the current losses at Lloyd's being offset against the insurance incomes of those Names who were fortunate enough to still have some. In the longer term the reduction in Inheritance Tax revenues will be substantial; the beneficiaries, of course, being many residents of the USA and the Internal Revenue Service of that country.
CONCEALMENT OF INFORMATION ABOUT UNQUANTIFIABLE US LIABILITY LOSSES
Extensive research by the Names Defence Association and other Names has revealed that a few leading Lloyd's Committee and Council members and underwriters were aware in the mid 1970's that Lloyd's was facing unquantifiably large losses resulting from its old American Liability policies. These were policies, issued over many years by Lloyd's, which were unlimited as to the number of claims which could be made by any policyholder.
No evidence has been found that Names in general were informed either directly or indirectly by the Council or by Lloyd's officials either at that time or in following years as more and more evidence of the forthcoming avalanche of asbestos related and pollution claims was collected. Throughout the 1970's and 1980's the Chairmen of Lloyd's were publicly silent on the enormity of the forthcoming losses. Other than a brief mention in the June 1985 Annual Chairman's Speech by Sir Peter Miller, to the effect that the Wellington Agreement had been drawn up to cope with the asbestos crisis, no Chairman's Annual Speech in the 1980's made any reference to the US Asbestos and Pollution Liability problems. Not until 1992 did a Chairman publicly refer to them, when Mr. David Coleridge talked of "huge uncertainties on pollution" and of the need to ". . . strengthen North American long-tail reserves".
In addition, no evidence has been found that Parliament was informed of the magnitude of the coming losses when it was considering the Lloyd's Bill in 1982.
Extensive proof that Lloyd's insiders had that knowledge in considerable detail over many years and from impeccable sources is contained in the Names Defence Association's 280 page Research Report No. 2. This factual record consists of extracts and summaries taken from many thousands of pages of source documents, from the early 1970's to the 1990's, including many yearly and half-yearly US Attorneys' Reports to Lloyd's and other insurers on asbestos related claims, official Working Party minutes, reports of Lloyd's Toplis and Harding subsidiary, US and UK Government reports, US and UK legal testimony, official Lloyd's Enquiry findings, letters, Lloyd's Committee minutes and other such papers.
BREACHING OF THE LLOYD'S ACTS
The concealment of all that material information about the magnitude of future US Liability losses was contrary to both the spirit and the letter of the Lloyd's Acts. The objects of Lloyd's are laid down in section 4 of the Lloyd's Act of 1911. They are:
"The carrying on by Members of the Society of the business of insurance of every description including guarantee business;
The advancement and protection of the interests of Members of the Society in connection with the business carried on by them as Members of the Society and in respect of shipping and cargoes and freight and other insurable property or insurable interests or otherwise;
The collection publication and diffusion of intelligence and information;
The doing of all things incidental or conducive to the fulfillment of the objects of the Society."
Particularly relevant to the allegations by some Names that Lloyd's was guilty of fraudulent concealment is that Lloyd's has had, since 1911, the statutory obligation, as stated above, for: "The collection publication and diffusion of intelligence and information".
Lloyd's properly collected material information relating to those forthcoming US Liability claims and they monitored developments carefully and conscientiously over all the years of the 1980's. It collected that information in detail and at considerable cost from the most knowledgeable professional experts. But it did not publish or diffuse that information to its Members. We now know that only a few key inside working Names were privy to it.
Some Names have now concluded that the withholding of that material information, essential for any Name and his agents to properly assess his underwriting commitments at Lloyd's, could only have been made deliberately. They believe that the failures to publish that information over so many years could only have resulted from a series of knowing and deliberate decisions. It is not credible that a series of simple oversights is the explanation. Lloyd's, they say, did not have the option of publishing or not publishing information of such importance; it had a statutory obligation to publish it.
INITIAL REASONS FOR THE CONCEALMENT
One reason for the deliberate early concealments can be deduced from other research studies of the Names Defence Association. A number of key Lloyd's insider working Names took advantage of their privileged information to re-insure their own syndicates' US Liability risks to other less knowledgeable and unsuspecting syndicates. The first examples of such insider trading took place in the mid and late 1970's. More have been identified in 1981 and early 1982 prior to closure of the1979 Syndicate Accounts and prior to the passage of the Lloyd's Bill through Parliament.
Like insider trading on the Stock Market, which is illegal, insider trading by insureds which involves the concealment of material information from the insurer is cause in law for the resulting policy to be voided. The possibility now exists for a number of critical reinsurance policies and indeed whole re-insurance programs at Lloyd's to be challenged and voided. This process may start as an unplanned side-effect of the Gooda Walker Action Group's forthcoming legal action against brokers, if that is successful. If it is not, other Names can be expected to take the initiative. The effect on the Lloyd's market might then ultimately be terminal.
Closure of the 1979 Year Accounts
The closure of the 1979 year Syndicate Accounts was effected by the setting of artificially low Reinsurance to Close (RITC) ‘premiums'. The reality was that the long term losses now known to be inevitable were so large that actuarially sound RITC ‘premiums' were incalculable. The repercussions of leaving open the Accounts of all the badly affected syndicates would have destroyed Lloyd's worldwide reputation of professional expertise and financial soundness. It would have caused many Names to resign and it would have reduced the attractions of Lloyd's to prospective new members.
Lloyd's take the view that a Re-Insurance to Close contract is a policy of insurance, under which risk is transferred at a premium. As the then Chairman of Lloyd's, Mr. Peter Miller, told Names in November 1986 "The crucial point, as far as Lloyd's is concerned, is that we view the reinsurance to close not as a reserve but as a policy of insurance transferring risk at a premium. It is a policy of insurance. We have always believed that, . . ."
Some Names now seek counsel as to whether in fact that is true for all RITC contracts which have been effected in the last twenty years. In law an insurance policy requires the payment of a "premium" to cover the possibility of unforeseen risks and liabilities. Lloyd's RITC policies involve a payment by the old year syndicate to the new year syndicate when it transfers its outstanding risks. The sums of money paid are commonly but misleadingly described as "reserves", these being calculated to cover both the reported claims and "incurred but not reported" claims (IBNR's) from policyholders. It is believed that many do not normally include an additional "premium" to cover the possibility that further as yet unknown and unforeseen liability risks might materialize in the future.
Consequently, some Names seek counsel as to whether a number of RITC policies can be set aside in law as not being contracts of insurance.
Other Names further question whether RITC policies, with ‘premiums' which were fixed by the Managing Agents at an undervalue in relation to the known risks and liabilities, amounted to contracts which were imposed on the unwitting Names of the next year syndicate under a state amounting to duress or undue influence. If so, they question whether those RITC policies might be voidable on those grounds also.
The 1982 Lloyd's Bill – Immunity from Damages
The information in Lloyd's possession about forthcoming US Liability losses was not disclosed to Parliament in 1982. Had it been disclosed the Lloyd's Bill might well not have been enacted, at any rate not in the form it ultimately took. The Bill as enacted was particularly important to Lloyd's Council members and officials in that it granted, in the absence of bad faith, the Society and themselves personal immunity from claims of damages for negligence and lack of care.
Disclosure of that information to Parliament might also have alerted hitherto unsuspecting syndicate managers that they might have underwritten policies as a result of material non-disclosure by the cedants.
If such disclosure had been made, the Bill might well not have been enacted in its final form and Lloyd's Council members would have risked being sued personally for their own past negligence. In addition, many re-insurance contracts within the market would have been able to be cancelled: Lloyd's reputation would have been severely damaged.
REASONS FOR THE CONTINUING CONCEALMENTS
Profit Sharing and Agency Commissions
The closure of the 1979 Accounts allowed Managing and Members Agencies to take profit sharing commissions based on those false and overstated profits. If the Accounts had been left open, those Agencies would not have received those particular revenues and they would have seen a further significant reduction in their future management fees, salaries and expenses as some Names resigned and as fewer Names replaced them. The revenues of agencies and the personal incomes of working Names throughout the market would have suffered.
Research findings suggest that plans were agreed by senior Lloyd's and Department of Trade and Industry officials to both encourage recruitment campaigns for new Names and increase the amount of capital to be deposited by all Names. The objectives of those plans were to provide Lloyd's with substantially larger capital funds to settle the inflow of US Liability claims due to start in size at the end of the 1980's.
As most agency fees and expenses are directly related to the number of Names and to the amount of their committed capital, which affects the amount of business which can be executed, the attractions of quietly accepting those plans were evident. An ever increasing personal income stream, at least for several years ahead, was clearly attractive to any working Name, whether he was one of those privileged few with knowledge of the US Liability problem or not. There was no obvious reason why any unsuspecting agent would wish to question the opportunities which these recruiting drives would produce.
The Selling of Lloyd's Agencies.
If the 1979 Syndicate Accounts had been left open and the recruitment campaigns for new members not been introduced, the reduction in revenues of Lloyd's Agencies would have adversely and immediately affected their profitability. The Agencies themselves would have become far less attractive to potential purchasers. Some Managing Agencies were sold to their staff as a result of the Lloyd's Act 1982 which forced the segregation of brokers from underwriting agencies. Other agencies were spruced up by their partners and shareholders for sale to major Groups or for flotation on the Stock Market. Few of these sales would have been possible at anywhere near the prices actually realised if their profits had properly reflected the true state of affairs of the syndicates for which they were responsible.
One of the most remarkable examples was the Sturge Group, the largest of the Members and Managing Agencies at Lloyd's. Sturge floated its shares on the Stock Exchange in the mid 1980's on the strength of sizeable and fast rising profits over the preceding five years, that is for those years when the concealment of US Liability losses allowed Sturge Syndicates' Accounts to be, as some Names allege, falsely closed and falsely reinsured. The published syndicate profits allowed profit sharing commissions to be paid to Sturge, and they encouraged ever rising numbers of new clients to that Group and its syndicates. Had those developments not occurred, Sturge would almost certainly not have obtained a listing on the Stock Exchange and two of its leading shareholders would not have been able to sell their own shareholdings within a few years thereafter for the estimated £40 to £50 million which they each received.
Sturge's top executives at that time included Mr. David Coleridge, who later became the Chairman of Lloyd's, and Mr. Ralph Rokeby Johnson who were both, of course, key Lloyd's insiders. Mr. Rokeby Johnson has been reported, under affidavit, as advising privately on 4th October 1973 that long term US Liability risks would eventually bankrupt Lloyd's.
"STAIR-STEPPING" – THE DTI'S INVOLVEMENT
Research findings of the Names Defence Association also show that the Department of Trade and Industry and its predecessors were also aware of Lloyd's long tail US Liability problems. The solution as to how those claims could be paid was worked out and agreed by Lloyd's and DTI officials in the early 1980's. It was twofold.
The first part of the solution was to increase the ‘reserves' at Lloyd's gradually over the coming years through a policy which they described as "stair-stepping". This term first came to the knowledge of damaged Names at meetings in 1994 between their representatives and DTI officials. In brief, stair-stepping involved the gradual increase in the Minimum Percentage Reserves laid down by Lloyd's for the setting of RITC "premiums" each year.
This policy might have been appropriate to incorporated insurance company with its own permanent fixed capital and on-going separate legal persona. But it was totally inappropriate for Lloyd's syndicates which are annual business ventures whose members vary from year to year.
As is clearly shown by Lloyd's own Annual Settlement Statistics, "stair-stepping" was implemented progressively and successfully throughout the 1980's and into the 1990's.
Some Names now seek counsel as to whether that policy of "stair-stepping" might have been a deliberate and criminal fraud on new members joining certain new syndicate years in view of the fact that those members did not receive proper financial consideration for the risks they were assuming; risks so large that, at least since 1979, they were known to be unquantifiable.
The second part of the solution was, as discussed earlier, to encourage the recruitment of ever increasing numbers of new Names at Lloyd's and to increase the total capital provided both by them and by existing Names. These objectives were also executed successfully. The number of members of Lloyd's increased from 7,710 in 1975 to 18,506 in 1980, and then to 32,433 in 1988. Increases of this magnitude were totally unjustified by the growth of the worldwide insurance market and in particular by the business likely to be introduced to Lloyd's over those years. During these same years, Lloyd's also increased the financial deposit requirements of Names, while it reduced the total wealth requirement demanded to be shown by members individually. As a result of the substantial increase in the funds and guarantees deposited directly with Lloyd's by its members, the gross underwriting capacity at Lloyd's increased from £3.42 billion in 1980 to £11.02 billion in 1988.
Although conspiracy is said to be the most difficult allegation to prove in Court, some Names now seek advice whether a conspiracy of concealment and criminal fraud may have existed at Lloyd's. They wonder if the actions of the Lloyd's Panel of Approved Syndicate Auditors do not indicate a prima facie case. They ask what caused those eminent firms of chartered accountants to issue unqualified audit certificates for the 1979 year Syndicate Accounts when only a few weeks earlier they had taken the unprecedented step of writing to Lloyd's Council for official guidance over their knowledge that future US Liability claims were so large as to be unquantifiable. The doubting Names have never received a satisfactory answer. The only conclusion that they have reached so far is that those firms of auditors might themselves have been so dependent on their large volume of Lloyd's related business that they found it relatively easy to accept whatever arguments, no matter how tenuous, that were put to them during those few brief weeks.
These facts, some of them say, are the evidence.
"From the middle of 1982 it became increasingly apparent that there was something seriously wrong . . . Fraud occurs in the City from time to time. Rarely are those who suffer the private investors, even less frequently is it true that the perpetrators of the fraud are the trustees for the investors. These were not frauds on Lloyd's; they were frauds by insiders at Lloyd's on their own members. Ian Hay Davison – Chief Executive of Lloyd's 1983-86.
Many Names suspect that the concealment of material information concerning future US Liability losses, together with the other malpractices discussed in this paper, by key insiders and by the syndicate auditors might have been fraudulent. Those persons had legal, professional and ethical reasons to publish and disclose the unquantifiable magnitude of the forthcoming losses, but none did so. They had personal financial reasons for the concealment, and many of them benefited from it. Some Names now believe that they are near to having sufficient evidence of criminal fraud to justify them presenting it to the Serious Fraud Office for the possible prosecution of leading Lloyd's personnel and others for offences under the Theft Act and other criminal statutes. One eminent London solicitor, who has been consulted by the Names Defence Association and by other members of Lloyd's, has assembled such a dossier and it is understood that he might have already presented it for informal consideration to the SFO.
LATER ABUSES AND MALPRACTICES
"Many members of the Lloyd's community in senior positions were not even vaguely aware of the legal obligations on agents to act at all times in the best interests of their principals, not to make secret profits at their principals' expense and to disclose fully all matters affecting their relationship with their principals."
Sir Patrick Neill – Regulatory Arrangements at Lloyd's, Report of the Committee of Inquiry 1987.
The LMX Spiral
The substantial increase in capital funds provided by the unsuspecting Names during the first six or seven years of the 1980's had no immediate genuine business to finance. The growth in insurance business worldwide did not match the growth in Lloyd's capital, and because the US Liability claims were not due to start reaching Lloyd's in size until the late years of the decade, a vacuum of legitimate opportunity developed. Some of the more unscrupulous underwriters, members' agents and brokers found ways to fill it. They introduced unprofessional and improper practices which had little or no valid commercial justification.
The most infamous development was the LMX Spiral. This was initiated when a few syndicates re-insured the excess risks of other better run syndicates. Those first spiral syndicates then started to re-insure those same risks with other syndicates. Syndicate A reinsured with Syndicate B. Syndicate B with Syndicate C. C with D, and then the spiral commenced as D reinsured a higher layer of the original risk with Syndicate A. And so it started again. The spiral developed in ever decreasing circles at ever higher layers of risk and ever decreasing Premiums. During the course of the spiral the syndicates writing spiral business reinsured themselves several times over. And at every turn a Lloyd's broker took 10% of the premium in commission.
A financial disaster was inevitable. It would happen with the first major catastrophe. Surprisingly no major catastrophe occurred for several years, but then the Piper Alpha oil rig blew up in late 1988. The death knell of the LMX Spiral was sounded and it collapsed within a year or two.
The business making up the spiral was not insurance. It was a series of bets that a major catastrophe would not happen within the next twelve months. It was guaranteed to end in total and overwhelming loss for the unsuspecting members of the spiral syndicates; the only question was when. The rates charged and its spiral circularity were such that no competent broker would have touched it, far less any competent or ethical underwriter. Yet Lloyd's regulators condoned it and a number of leading underwriters re-insured their worst risks with the spiral syndicates.
The Names who were placed on the LMX spiral syndicates were overwhelmingly the new Names who had been lured into Lloyd's as a result of the recruitment policies described earlier. Those new Names were, for the most part, unable to join well-run syndicates as the latter found themselves unable to attract sufficient legitimate new business to justify taking on more Names. To all this the regulators at Lloyd's turned a blind eye.
As the LMX Spiral developed in the early and mid 1980's the managing underwriters of the spiral syndicates found that their business was barely profitable, even without a major catastrophe hitting the market. To maintain the facade of profitability and to preserve their incomes and lavish life-styles, they then manufactured a record of false profits by the use of new and creative accounting practices, for example those concerning Time and Distance Policies. The latter were not, in reality, insurance policies at all. They were medium and long term investments akin to deeply discounted, long term no-coupon bonds. The false accounting device used was to credit as profits in the syndicates' Accounts the total discount value of the investment on the day that it was made. The correct practice would have apportioned the total discount in equal annual installments over the life of the ‘policy'.
Needless to say, Names on the spiral syndicates were never informed of the nature of the Time and Distance Policies nor of the accounting principles applied to them. And nor did Lloyd's regulators, approved syndicate auditors or accounting practice supervisors interfere.
Insider Trading with a Difference
Research studies have shown that Members of the Council of Lloyd's were noticeable by their absence as members of Spiral syndicates. The most knowledgeable and professionally competent of Lloyd's working Names did not themselves participate as members either; and most kept their old established clients and friends from joining them. Nevertheless, many well respected underwriters placed their own syndicates' reinsurances with the spiral syndicates. They believed that, although the spiral syndicates themselves were doomed to disaster, their own syndicates as policyholders would not suffer. Lloyd's and its Central Fund would stand behind every contract.
The widening conspiracy of silence, however, ensured that new Names were never informed. It was insider trading with a difference; insider trading at its most cynical.
Working Names Preferential Stop Loss Policies
Unknown to external Names on such syndicates as 162, 317 and 843 who underwrote the policies, a number of working Names were able to effect personal stop loss policies at very low, preferential rates and with guaranteed annual renewals at those same rates. Some of the cover provided went as high as 100% of the individual's total underwriting, making membership of Lloyd's for those favored few a one-way bet. They could not lose. Only the external Names could.
ADMINISTRATIVE ABUSES, MALPRACTICES & ILLEGALITIES
Further research has discovered that back office administration, both within the Society of Lloyd's itself and throughout many of Lloyd's agencies, is scandalously weak and inefficient. Claims, large and small, are paid without reference to the underlying policies for the simple reason that neither agencies nor Lloyd's itself have copies of these policies. Claims are commonly paid without question on the simple written application of the brokers. Instances have been discovered of claimants being paid two and three times for the same claim. Some US asbestosis patients have submitted claims through different attorneys in different cities. Yet Lloyd's paid them all.
The overcoming of these administrative problems is the subject of much present concern at Lloyd's but it is understood that little real progress is being made. One of the side benefits of Equitas, should it ever be founded, might be the centralised tackling of this enormous backlog of administrative chaos. But the problems may be insurmountable.
Evidence of Lloyd's administrative inefficiencies can soon be discovered by any Name who asks for an accounting of his interests in the US Dollar Trust Fund or in the Canadian Dollar Trust Fund. Some Names have asked for such an accounting but none has so far been produced. It appears that the Society of Lloyd's itself, which has the ultimate responsibility for those funds, and members agencies have been unable to produce any statements of the accounts of individual Names in either of those Trust Funds. Yet Names alone are the direct owners of those Trust Funds.
Other evidence is believed to have been uncovered by an Association of US Names that, contrary to the Trust Deed of the American Dollar Trust Fund, monies have regularly been loaned and borrowed from within it. Lloyd's itself alluded to these malpractices in its 1994 proposals for the establishment of a centrally promoted $500 million to $1 billion line of credit for the use of illiquid syndicates.
THE REWARDING OF ILLEGAL AND UNLAWFUL ACTIVITIES
The Sasse and Savonita affairs are well-documented in literature about Lloyd's. In brief, Lloyd's paid the policyholders' claims in full even though it had evidence which proved beyond any reasonable doubt that the claims were fraudulent and that organized crime was heavily involved. Also well documented is Lloyd's lethargy in processing legal papers for the enforced return of Mr. Peter Cameron Webb and Mr. Peter Dixon to the UK to stand trial for theft and fraud at Lloyd's. In addition there are a number of other well recorded instances where Lloyd's failed to take appropriate action for the investigation or prosecution of criminal activities.
More recently, evidence has been accumulating that Lloyd's may not have been able to pay out on the Piper Alpha policy. Some Names claim that evidence exists which indicates that Lloyd's and a number of leading underwriters knew that the Piper Alpha rig did not satisfy the Government's minimum approved safety standards. That failure would have been sufficient reason to void the policies. Other Names question whether the quantum paid out by Lloyd's for loss of production properly reflected the discounted cash flow shortfall, alleging that Lloyd's paid out the full value of the immediate loss in oil revenues without making allowance for the fact that the oil itself remained in the ground and would be extracted in later years.
Lloyd's has also regularly paid penalty and punitive damage awards levied by US Courts on corporations for industrial pollution and other anti-social offences. Some Names question whether these should rightly have been paid. Consequently they further question Lloyd's bona fides, at least as regards its own members' interests, in rewarding the perpetrators of those illegal, unlawful and anti-social activities.
Senior underwriters have often justified those payments as being in the best long term interests of Lloyd's as a whole as the goodwill of brokers and policyholders must be retained in order to protect future business. But if a Name leaves a syndicate which has made such payments, he has done so for the benefit of Names in succeeding years, not for his own future benefit and he receives no reimbursement or compensation from his successors. This practice makes a mockery of the Lloyd's Acts which state that a Name underwrites for his own account only and for no other person's.
Thus, the practice of paying out such sums may be seen to reward illegal, unlawful and anti-social activities. It may also indicate that Lloyd's acts, at times, with mala fides in regard to its own members' best interests.
NEW AND PROSPECTIVE ABUSES
At the 1994Lloyd's Annual Meeting the Chairman of the Names Defence Association drew the attention of the Chairman and the Chief Executive of Lloyd's to the massive conflicts of interest and the high administrative costs of Run-Off Managers. Although Lloyd's issued new byelaws in early 1995 concerning the appointment and regulation of managers of syndicates in run-off, it has not addressed the underlying problems and present ongoing abuses which may, even now, be worse than ever.
Members of syndicates in run-off are the victims of outrageous practices which Lloyd's regulators ignore and which some advisers suspect may be contrary to agency contracts and to Lloyd's byelaws. A recent study commissioned by the Names Defence Association has identified ten firms of run-off managers who, at 31 December 1993, had charged their client syndicates a total of £81.36 million for their future administration and future claims handling fees and expenses. Other Run-Off Managers made no such charges.
Further abuses resulting from these charges for future services involve the draw-down of deposits and guarantees and compulsory withdrawals from the Central Fund. Under Lloyd's byelaws, Names are liable to pay only for costs and expenses which have been made or incurred. They are not liable for costs and expenses which are "to be incurred". It is possible therefore that Names' deposits have been drawn-down and Central Fund withdrawals have been ordered by those Run-Off Managers and by Members Agencies for sums for which there was no lawful justification.
These huge provisions for future expenses may have provided opportunity for still further abuses. It is possible that, early in 1994, the Run-Off Managers paid themselves those monies out of syndicate funds. The subsequent interest earned by them on such massive sums would have further supplemented their own revenues at the expense of their syndicates' Names. Certain members of the Names Defence Association and their personal advisers have been endeavouring to exercise their rights of inspection of the syndicate books and records to ascertain whether such further abuses have in fact occurred. So far no such rights of inspection have been honoured by the Agencies concerned.
This same study has highlighted the concentration of the management of run-off syndicates into the hands of a tiny number of run-off agencies and service companies. According to the records studied, for example, 57 syndicates with 157 open years have either their accounting, administration or claims handling functions provided by one-particular firm of Run-Off Agents. Such a concentration is completely contrary to the intent of the Lloyd's Act of 1982 which sought to diversify the management control of syndicates.
Some Names now seek advice as to whether they have cause for legal redress against Lloyd's and against those run-off agencies.
The $500 Million Line of Credit
If Lloyd's succeeds in establishing a centrally organized $500 million to $1 billion line of credit for the use of illiquid syndicates, damaged Names on syndicates which make use of those facilities may be placed in a very much worse situation. At present, many damaged Names refuse to pay their alleged losses because they believe those losses are invalid or illegal. If, however, a major bank sues them for repayment of a loan which was taken out by a syndicate manager in their name, they may have scant redress. It is one thing to argue over the legitimacy of insurance underwriting losses; it is quite another to dispute a simple bank loan.
Damaged Names may in due course be faced with having to defend themselves in the Courts against major banks who seek recovery of their loans. When that happens Lloyd's will, in one quick and cynical move, have succeeded in distancing itself from its problems of collecting money from its recalcitrant members.
MORE INSIDER TRADING – BABY SYNDICATES: PREFERRED SYNDICATES: DEDICATED SYNDICATES
"Parliament's concern had begun in April 1985. These concerns were aggravated in August and September by revelations about the extent to which parallel underwriting syndicates continued to be used by insiders at Lloyd's to benefit themselves at the expense of the innocent outside member." Ian Hay Davison – Chief Executive of Lloyd's 1983-86
Baby syndicates were banned in the latter part of the 1980's. Some of those syndicates contained only one member; others contained as few as two, three or four. Only influential and favored Names appeared on the lists of the babies, for example the wives and family members of some syndicate auditors.
In 1979, 54% of all the 360 syndicates were operating "in parallel", that is a major syndicate had a closely associated baby or preferred syndicate alongside. This high ratio reduced gradually year by year until 1986 when 30% of syndicates operated in parallel. And only then were baby syndicates banned.
Research findings of the Names Defence Association indicate that abuses were rife. Baby syndicates opened up to accept the high layer excess of risk re-insurance policies on a claims made basis; and were closed down within two or three years before any claims could be expected. Baby syndicates re-insured their outstanding risks to their ‘parent' syndicates at an undervalue before closing down. Delays in processing paperwork allowed some baby syndicates to accept very short-term risks when there was no risk, for example kidnapping after the expedition had been completed and the risk had terminated. And so on.
Some Names now seek counsel as to whether the underwriters involved in forms of insider trading such as those might have been guilty of illegal or unlawful acts.
External Names on Sturge syndicate 206 for the years 1979 to 1983, for example, did not fare as well as the favoured insiders on Sturge syndicate 207. During those five years, syndicate 206 had an average of 1,510 members, while syndicate 207 averaged 35 members. The net profitability per £10,000 line, however, was vastly different. Syndicate 206 averaged net profits of 6.13% over those years, while syndicate 207 averaged 33.35%.
The members for the time being of the Committee and Council of Lloyd's were well aware of the above abuses and there is evidence that some of them participated in them. One former Chairman of Lloyd's has publicly admitted that he was a member of a baby syndicate together with certain other former Chairmen of Lloyd's. Since baby and preferred syndicates could only have been tolerated because they enriched the insiders who participated in them, including those members of the Committee and Council who did, at the expense of the generality of external Names who did not participate, some of the external Names impoverished by these baby and preferred syndicates consider that they may have been the victims of malfeasance or abuse of power on the part of Lloyd's.
After baby syndicates were banned the rather larger Preferred Syndicates were permitted, and they continue today. It is believed that further abuses may still be practised in preferred syndicates through reciprocal understandings among some of the less ethical underwriters, their brokers and favoured clients.
Another manifestation of insider trading may emerge with the introduction of Dedicated Syndicates, where one corporate investor provides all the capital, which run alongside non-dedicated syndicates managed by the same agency. The scope for substantial abuse remains.
REGULATION OF LLOYD'S – FAILURE OF THE DTI'S RESPONSIBILITIES
Monitoring of Risk and Asset Diversification
Research findings indicate that neither the DTI nor Lloyd's regulators adequately monitored the spread and magnitude of underwriting risks in individual syndicates on any regular or systematic basis. Nor did they properly monitor the spread and diversification of the financial assets of individual syndicates.
Financial reporting procedures which cover such obvious matters are fundamental in the regulation of financial institutions throughout the developed world. They are particularly applied to insurance companies and money market funds, the types of organisations most akin to Lloyd's syndicates.
The most basic of regulatory procedures were either lacking or non-existent when it came to the regulation of Lloyd's syndicates.
The Solvency of Lloyd's
Research undertaken by the Names Defence Association indicates that the DTI has in the past years considered only claims paid and claims incurred and accounted for as specific liabilities by Lloyd's syndicates when making its annual solvency examinations. It has not taken into account any provisions for the long term US Liability losses known to be facing the Lloyd's market, even though it had detailed knowledge that those would be massive, unquantifiable, and unavoidable.
Lloyd's syndicates in run-off are akin to insolvent and bankrupt businesses. Financial businesses elsewhere seldom become insolvent or bankrupt when they are overseen by competent regulators. When they do, like Barlow Clowes, BCCI, Johnson Mathey Bank and Barings, they are exceptional; they make headline news.
In 1994, there were 478 Lloyd's syndicates in run-off.
The DTI has the ultimate responsibility for regulating the solvency and financial well-being of Lloyd's. It has clearly failed.
Names as Policyholders
The DTI also has a staturory responsibility to protect the interests of insurance policyholders, whether of Lloyd's policies or of other British insurers. Names at Lloyd's, because of their status as RITC, excess of loss re-insurance, E&O insurance, or personal stop-loss policyhokders, must represent numerically the largest group of policyholders at Lloyd's. As was evident at recent hearings of the Treasury Select Committee, the DTI has so far not considered the interests of Names as policyholders.
TRADING WHEN INSOLVENT OR BANKRUPT
The actions of Lloyd's and DTI officials in assessing solvency might be likened to those of directors and auditors of a company who ignore its long term debt when considering its financial strength and ability to continue trading. If company directors allow their company to continue trading when they know that it will in due course be unable to pay all its creditors in full, those directors are guilty of a criminal offence. Lloyd's syndicates have certainly been solvent in recent years, that is using solvency in its common layman's business meaning of being able to pay creditors as they present their bills. But bankruptcy is a different phenomenon. Bankruptcy means that the debtor will be unable to pay in full all his known creditors when eventually those debts fall due. The DTI and key Lloyd's insiders have for many years had material information which clearly indicated that many of Lloyd's syndicates have been in the bankruptcy category.
Short-term liquidity is one thing. A state of secret bankruptcy is another.
This issue is particularly relevant in view of the one year nature of Lloyd's syndicates. A one year syndicate with significant exposure to US Liability risks would have had little chance of making sufficient profits in that one year to cover the totality of its ultimate liabilities. If, as was generally the case, that syndicate did not receive a sufficiently large opening RITC ‘premium' from the preceding year's syndicate, it would have traded for the rest of its year in a state of secret bankruptcy. It would have been unable to pay all its current creditors and in addition pay an actuarially sound and proper RITC ‘premium' to the succeeding year syndicate. Many long-tail syndicates were able to trade and then to close out their Accounts only because they in turn managed to pay out improper and fraudulently low RITC ‘premiums' to their successors.
It is now evident that during the 1980's many syndicates were in the above situation. Some Names seek counsel whether Lloyd's officials, DTI officials and some Agency directors and managers might have been criminally guilty of allowing those syndicates to trade while knowing that they would be unable to satisfy all their contractually committed liabilities in full.
Eventually, of course, the long tail US Liability problem manifested itself in such magnitude that syndicates found themselves unable to even go through the motions of setting up RITC ‘premiums'. Those syndicates now make up the mass of syndicates in run-off.
SOLVENCY AND THE SOCIETY OF LLOYD'S
Damaged Names May Have Little to Fear
Contrary to much current speculation, there may be little chance that the Society of Lloyd's itself is at risk of being declared insolvent. The Society may not in fact be a party to Lloyd's policies and it may have no ultimate financial liability to policyholders. Although it has increasingly used the monies held in the Central Fund to finance the payment of claims and Managing Agents' expenses, it does so only on the advice of its Council where, in its opinion, it is expedient for the advancement and protection of the interest of the members of the Society in connection with the business carried on by them as members. The Council might be quite able to refuse to give similar advice in the future. The Society of Lloyd's itself may therefore not be at risk of insolvency.
If and when the Central Fund's assets are exhausted many syndicates will face almost certain eventual insolvency; particularly those whose members will not or cannot pay their alleged debts. External policyholders will then be forced to sue Names through the English courts if they wish to have their claims settled. Detailed and exhaustive legal advice has, however, been given to some American Names which states clearly and unambiguously that the practical obstacles and the technical difficulties of doing this would make such a course of action quite uneconomic and unrealistic.
In addition, the likelihood of Lloyd's syndicates suing other Lloyd's syndicates for non-performance raises the spectre of an institution in the madhouse. It is simply not a realistic scenario where defaulting Names find that they are on two syndicates, one of which is suing the other. Not only would they find themselves suing other defaulting Names, they would find themselves suing themselves. Although this may in fact already have started to happen as litigating Names sue for E & O awards or damaged Names to sue for stop loss reimbursements, the likelihood of a mass of syndicates suing each other is remote. An uncontrollable chain reaction which would clog the Courts and arbitration offices for years ahead could not be tolerated, much though it would please many damaged and aggrieved Names.
It therefore seems probable that damaged Names may have little to fear, and perhaps much to gain, if the Central Fund is exhausted or ceases to be used to pay the alleged debts of the so-called defaulters.
DTI Annual Solvency Tests
It is also clear that the annual tests of solvency set by the DTI for Lloyd's are theoretical and inappropriate for the situation in 1995 where syndicates in run-off outnumber syndicates still trading by a factor of perhaps three.
A strong argument can be made that syndicates in run-off should be segregated by Lloyd's from syndicates still trading in all matters, and that they should be treated as the bankrupt business organisations which they essentially are and placed under the control of official receivers for a speedy winding up, leaving the policyholders to sue underwriting Names individually thereafter.
There may be little likelihood that many syndicates are at risk of becoming insolvent in the near future at least not as far as having their cheques bounce. At 31 December 1993 Lloyd's syndicates held in their totality cash funds and reserves of more than £12.75 billion. On a speedy winding-up of syndicates in run-off some damaged Names might even recover some money.
LLOYD'S STATUTORY DUTIES AND ITS POLICYHOLDERS
Nowhere in the Lloyd's Acts is it stated that the Society of Lloyd's has a duty to its policyholders. Such duty as Lloyd's has to its policyholders is incidental and secondary to its obligations to Names. It has a duty to policyholders only in the same way that any business undertaking has a duty to honour the contracts it makes with its customers. It is a truism that it is much easier to obtain repeat business from a satisfied customer than it is to find a new customer.
It is unfortunate that many persons, including some learned judges and many senior Lloyd's personnel, appear to be under a wrong impression of what the Lloyd's Acts actually state.
LLOYD'S – ITS DUTIES OF CARE AND UTMOST GOOD FAITH
Power without Responsibility
During the years 1992 to 1994 the High Courts and Court of Appeal decided that Lloyd's has no duty of care to its members. The Courts decided that, under its Acts, Lloyd's has powers over its members, but it has no duties or responsibilities to them.
Some Names were confused when, in spite of the Court of Appeal's decision that Lloyd's has no duty of care, they read what the Master of Rolls said about the Lloyd's Council in that judgement. He wrote, "The decision makers were representative of Lloyd's Names, mostly elected by them. There was no obligation on the decision makers to make their decisions independently on the basis of considerations relating to the public interest. They were obliged to act in pursuance of the objects of Lloyd's. . . as set out in section 10 of the 1871 Act. . ."
Those recent major Court decisions make little sense to many Names who have read the Lloyd's Act, 1911 which lists the current objectives of Lloyd's and which replaced those in the 1871 Act to which the Master of Rolls erroneously referred. Those Names argue that, if Lloyd's does not have a duty to act at all times to achieve its statutory objects, there is no reason to have those objects enshrined in an Act of Parliament at all. They do not understand why the Courts have interpreted the "objects" of Lloyd's as meaning "powers" as they have been unable to find any dictionary which even remotely assigns it such a meaning. They speculate that if Parliament had wished Lloyd's to have only "powers" it would have used that word in its enactments; it would not have used the word "objects". They, who are not trained in the arcane language and interpretations of the law, believe that when Parliament specified that Lloyd's has "objects" which are clear, unambiguous and unqualified by any provisos, Parliament inferred a distinct duty and obligation on Lloyd's to endeavour to implement and achieve those objects.
In addition, in the light of those judgements, they wonder why Section 14 of the Lloyd's Act, 1982 should exist at all. That section gives Lloyd's immunity from being sued for damages by Names for negligence or anything else in the absence of bad faith. They argue that such an exemption is only needed if Lloyd's does indeed have a duty to its members. Without such a duty, there is no need for immunity.
To the consternation of some Names, the Courts also decided in 1994 that the Crown Prosecution Service and the Coastguard Service have no duty to act with care when they go about their daily tasks of prosecuting suspected felons or of saving lives on the high seas. The Courts of England have thus found that the Society of Lloyd's and other great national institutions have powers but no responsibilities. Some Names find that a frightening prospect. They liken such a state of affairs to a corrupt third world dictatorship where private citizens have no status or rights. They believe that these decisions of the English Courts are fundamentally flawed and should be challenged at the first major opportunity. They realise, therefore, that their task of obtaining justice as regards their grievances at Lloyd's may be unusually difficult in England.
Indeed, a number of them now believe that they will be forced in due course to look to the Laws of the European Community and the United States of America. Already the Writs Response Group is sponsoring the defence of Mr. John Clementson against a solvency writ from Lloyd's, his defence being based on alleged illegalities and infringements of European law by Lloyd's concerning inter alia its operation of the Central Fund.
Misrepresentation – Good Faith
It is unlikely that any person ever joined Lloyd's except on the understanding that Lloyd's would act in good faith and with care and diligence in all circumstances to all people, including themselves. Many Names now believe that they were fraudulently encouraged to join Lloyd's by the Society itself through the false promises of its brochures, its records of false profitability as shown in its Annual Global Accounts, its false reputation as a major dollar earner, and particularly by its carefully developed but false reputation for its probity, a reputation built up over centuries. In brief, they believe that they were totally misled by Lloyd's. In fact, they now believe, it was not an honourable and profitable body.
Had those Names been told that the Society of Lloyd's and its Managing and Members Agencies believed that they had no duty to act with care and diligence as regards the members' and clients' interests, they would not have joined. Had they been told that the Society of Lloyd's itself, together with its leading Agencies, would put forward those pleas in the High Courts and Court of Appeal, they even more certainly would not have joined. But that is just what Lloyd's and its leading Agencies did plead in several recent cases. Why, those Names wonder, was no Name ever told of those beliefs and attitudes at a Rota meeting, or on any other occasion.
For those and other reasons, some members of the Lloyd's Action Group for Restitution and Deposit Defence are now planning Court action to have their memberships of Lloyd's set aside.
LITIGANTS IN PERSON
Some damaged Names are increasingly determined to take a hard line regarding their alleged losses at Lloyd's. Because legal costs are so high as to be unaffordable to all but the seriously rich, a number of them have indicated that if necessary they will be prepared to defend themselves by acting as litigants in person if they are sued by Lloyd's. The Names Defence Association will endeavour to assist them in this course of action particularly if it becomes apparent that damaged Names will not or cannot subscribe the very substantial funds which will be required to proceed through a trial in a more conventional manner.
It is foreseen that several hundred Names might then be able to supplement the basic NDA master Defence with uniquely different and personal arguments when they represent themselves in Court. The volume of evidential information already assembled by the NDA, together with the products of the individualised programmes of evidence gathering by each of those Names, would ensure that when any of them comes to Court for trial, his case will not be quickly completed.
The possibility exists that the High Courts could be tied up for years by aggrieved Names, each determined to have his own particular say, and at length.
THE DISSEMINATION OF LOSSES THROUGHOUT LLOYD'S
Many Names who are so far relatively little hurt by the losses at Lloyd's will find that they too do not remain unscathed. The spreading of the E & O awards over other syndicates and the impact of personal stop loss claims will hurt many. The voiding of re-insurance policies on the grounds of material non-disclosure will hurt still more. The failure of more Names to meet their commitments will place further demands on those who wish to continue.
As time goes by the number of complacent Names will diminish; and the number of those who believe they have been deluded and defrauded will increase. Lloyd's is Britain's biggest financial scandal since the South Seas bubble; and it will only get worse. The formation of Equitas, should it happen, will provide a little breathing space but ultimately Government action and new legislation, whether in the UK or the USA, may be needed before the problems of Lloyd's and the US insurance industry are fully resolved.
The tragedy is that if the Cromer Report had not been concealed from the Names for fifteen years, and if its recommendations had been implemented by Lloyd's during the 1970's, the damage inflicted by long-tail US Liabilities would have been quickly confined and isolated to only a few, and Lloyd's would not now be in its present perilous state. The responsibility for that rests firmly with successive Lloyd's Councils and with the DTI.
(Asterisks ( * ) see note 2 below)
Notes: 1. The above figures are calculated from Lloyd's Settlement Statistics Package at 31 Dec. 1993.
(Data sources: Lloyd's; Barclays de Zoete Wedd Securities)
Note: The pre-tax profit or loss to Names is arrived at after adding investment income to the underwriting surplus or deficit, and then deducting management, agency and Lloyd's expenses and agents' ‘profit-sharing' commissions.
Note: It is probable that the inflation adjusted figures would show materially worse overall losses if the (much lower) US and Canadian cost of living inflation factors had been applied to US$ and Cdn$ underwriting profits and losses
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