A Brief Overview of 30 Years of Fraud at Lloyd's

Lloyd's Syndicate System
Wealthy British investors were the exclusive backers of Lloyd's of London insurance policies for nearly three hundred years. The investors came to be known as "Names" because, in the early days, their signatures were written on the face of each Lloyd's policy. Names participated in one-year venture syndicates, to insure risks, chiefly in the maritime industry. Each Name pledged his entire personal wealth to back up his share in the syndicate's policies. The syndicates accepted business for one year, then allowed two more years for claims to come in and be settled. Each syndicate closed its "year of account" and wound up its affairs after the end of the third year. The Names received their share of the profits, or paid their share of the losses, and their liability ended. If, however, all claims could not be settled by the end of the third year, the syndicate had to remain "open" and the profits or losses could not be shared among the Names until all claims were finally settled. This system was efficient and profitable in maritime business; the outcome of any given voyage was almost always known within a year, and claims settled within three.

As both commerce and insurance grew more complex, and especially as Lloyd's expanded into non-maritime business, syndicates found they could no longer truly close out their affairs after only three years. Staying open longer, however, and thus delaying the distribution of profits, would threaten their financial base: Names might well look elsewhere for more reliable investments with more rapid returns. Lloyd's solution was to have each closing syndicate-year pass its entire portfolio of policies written ("book of business"), and reserves to cover any future claims against these policies, forward to subsequent year(s) of active syndicates.

Although this novel method of closing a syndicate was not technically reinsurance as it is defined by legal precedent or insurance business practice, Lloyd's called (and still calls) this portfolio transfer "Reinsurance to Close" ("RITC"), and the reserves passed forward to the successor syndicate a "premium" paid. Since the successor syndicate assumed all the liabilities of its predecessor, RITC transactions enabled Lloyd's syndicates to continue their practice of closing and distributing profits after three years. To determine the closing syndicate's profit or loss, the syndicate manager added the total premiums collected and any gains from investment of the premium money, then subtracted the claims paid, the fees and costs of running the syndicate, and the reserves that had to be passed forward in the form of an RITC premium payment.

"Tails" of Woe
This ongoing practice of "reinsuring" one syndicate's obligations onto another made a mockery of Lloyd's portrayal of syndicates as only writing policies for one year (the "pure year"). This was and is not true, for two reasons:
The RITC transaction occurred at the end of the closing syndicate's third year, generally with its immediate successor syndicate, which was at the end of its second "open" year. The successor syndicate thus accepted a major "premium" a full year after it had supposedly stopped accepting any new business.

The successor syndicate assumed all of the closing syndicate's known and "incurred but not yet reported" ("IBNR") liabilities. Since this process was repeated annually, however, the assumed liabilities included not only those attributable to the closing syndicate's policies written during its "pure year"; it also included all the liabilities latent within a daisy-chain of RITC policies that the closing year had acquired by reinsuring to close the preceding year(s) of account.
All except sophisticated market insiders, however, were led to believe that the financial performance of each yearly syndicate was based solely on the business written in that particular syndicate's so-called "pure year", or "year of account".

There were "time bombs" hidden in the old policy obligations the syndicates inherited through the seemingly benign RITC process. Each passing year compounded the total risks accepted by the current syndicate. Again: the closing syndicate had reinsured its predecessor, who had reinsured its predecessor, and so on back to the first year of the syndicate's operation. The current syndicate was not just assuming the risks written in one calendar year by its immediate predecessor; it was assuming liability for all the latent risks on all the policies written by all of its predecessor syndicate years. In the case of a long-running syndicate, this "tail" of old liabilities might stretch back for 50 years or more. For example, Sturge agency's syndicate 210 began in 1920. At the end of 1971, by "reinsuring to close" Sturge 210 of 1969, Sturge 210 of 1970 took on liability for potential claims against policies written all the way back to 1920! These syndicate "tails" were in fact the source of most of the billions in losses suffered by Lloyd's Names in the late 1980's and early 1990's.

In Lloyd's We Trust
By necessity, the interrelationship of the Names and their agents was based on trust. The "external" Names investing in Lloyd's syndicates delegated the conduct of all their affairs at Lloyd's to their representatives at certain members' and managing agencies operating within the Lloyd's market. They were completely reliant on the active underwriters and syndicate managers to protect their interests, a reliance that applied separately to every syndicate in which a Name invested.

Supposedly, the underwriters carefully evaluated each risk accepted during a syndicate's existence, and every managing agent carefully calculated the RITC such that neither the old nor the new syndicate profited at the other's expense. It was extremely important that RITC be calculated fairly, because the individual Names who made up those syndicates were not necessarily the same people. Thus it is surprising that the managing agent performed this calculation without any scrutiny by an independent auditor. Setting RITC levels was entirely up to the managing agent's discretion, despite his inherent conflicts of interest.

The trust vested in the managing agent was understandable when RITC was originated, in the mid-to-late 1800's. There were less than a thousand Names altogether, and most were "working" Names, directly involved in Lloyd's day-to-day business. The "external" (non-working) Names were generally family members or other close associates of the working Names. At that time, all external Names were British nobility or upper class, and well known to one another and to the working Names, like members of an exclusive club. In such a small, tightly knit community of people, any serious errors or malfeasance by an underwriter or syndicate managing agent would be known by everyone in the market (and preferably dealt with privately, without, heaven forbid, any bad publicity).

The social pressures intrinsic to this high-class good-old-boy network, not the strictly defined duties of a fiduciary under the law of agency, were the actual basis of Lloyd's tradition of policing itself, and avoiding public scandal. Ian Hay Davison, first CEO of Lloyd's (1983-1986) hinted at this in his 1987 book, 'View of the Room', where he notes (p. 62) with classic British understatement: ". . . misunderstandings about the law of agency were widespread among the agents at Lloyd's." Nonetheless, this informal "honour system" worked reasonably well, even when Lloyd's had grown to over 6,000 such members in the 1960's.

Agents of Mis-Fortune
The apparent efficacy of Lloyd's "self-control", however, inevitably broke down when Lloyd's began seriously expanding its membership in the 1970's. The many new external Names were "outsiders", with whom the old members of the "club" had no social ties. Many of the "old guard" working Names felt little compunction about protecting their own interests, and their family and friends, at the expense of these newcomers. Ralph Hiscox expressed that attitude in the extreme in his notorious 1981 comment to John Rew about Names who lost money, that "If God had not meant for them to be sheared, he would not have made them sheep."

Lloyd's compounded the breakdown of the agents' loyalty to their Names by permitting the members and managing agencies to become limited liability corporations. This fundamental change in the structure of the Lloyd's market insulated the agents from their formerly unlimited professional liability to safeguard the interests of the Names-- a concept already little understood by the agents. As noted in the 1986 Neill Report on Lloyd's to Parliament: ". . . 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."

Mortgaging the Future
In order to carve out a share of the U.S. insurance market while a "buy American" attitude prevailed in the 1930's, 1940's and 1950's, syndicates at Lloyd's issued many low-priced, broadly worded policies, without monetary limits, insuring and reinsuring risks in the United States. The loose language of these policies gave Lloyd's a foothold in a fiercely competitive market, but these overly generous policy terms eventually came back to haunt them. By the 1960's and 1970's it was clear to a handful of highly placed working Names that claims due to asbestosis, pollution and other health hazards (so called "APH" losses) were ripening into lawsuits in the US, and increasingly large and unprecedented damages were being awarded to plaintiffs by American courts. Millions of American workers had been exposed to asbestos over the years. Tens of thousands of them were filing rightful claims against policies written 10 to 50 years earlier. American asbestos and chemical companies turned to their insurers, and their insurers turned to their reinsurers, who in very many cases were syndicates at Lloyd's.

The "Balloon" Payment Comes Due
A rising flood of claims was working its way through the courts and down the chain of reinsurance obligations toward many of Lloyd's syndicates, and that onslaught of APH claims was apparently going to continue well past the year 2000. The old policies had lain quiescent for so long that the original RITC premium/reserves had gradually been paid out as profits to closing syndicates over the years, and/or eroded away by inflation. Unlimited claims were soon to come calling on unlimited liability.

Thousands of claimants were or soon would be asking for billions of dollars, far in excess of the then-current Names' original investments in Lloyd's syndicates, and apparently in excess of their entire combined wealth besides. A handful of Lloyd's insiders knew that Britain's upper class, nobility and landed gentry were facing financial ruin, and Lloyd's ability to "pay all claims" was in jeopardy. Besides that, if word got out about the magnitude of the APH liabilities latent within numerous syndicates at Lloyd's, Names' capital investment and insurance premium income would cease. Lloyd's would go the way of the "do-do" bird.

Tapping Other People's Money
In the late 1960's the ruling Committee of Lloyd's lowered the minimum net worth requirement for Names from £75,000 to £50,000 in assets. Lloyd's then opened their membership for the first time to the British upper-middle class and foreigners, especially American, Canadian, Australian, and South African citizens-- from countries in which Lloyd's had excellent name recognition-- and began recruiting large numbers of new Names. In 1970 Lloyd's first allowed women domiciled in the UK to join, and then expanded that to include women living outside the UK in 1971.

Lloyd's also inserted a new layer of bureaucracy, known as "members' agents", between the external Names and the syndicate managing agents. The Names' agreements with Lloyd's and their agents ensured that the Names remained passive investors, who delegated all authority to conduct business on their behalf to members' agents, who placed the Names on syndicates, and managing agents, who ran the syndicates.

Lloyd's put their recruitment drive into high gear in 1976. As a consequence, the tightly knit Lloyd's community was inundated by an influx of new, unknown members. With members' agents inserted between them, the formerly close and trusting relationship Names had with their managing agents disappeared.

Many of the aristocrats who had been Names on the threatened syndicates before 1970 also quietly "disappeared", as soon as RITC had been contracted for them, either resigning from Lloyd's altogether or moving to "safe" syndicates. Not surprisingly, none of the new Names were told of the billions in losses sliding inexorably down the chain of reinsurances toward them.

Often motivated by additional cash incentives offered by particular syndicate managers, many of the members' agents placed the new Names (and unwitting old Names) by the hundreds on what later turned out to be the most endangered syndicates. Managing agents unloaded their old syndicates' massive liabilities onto select syndicates populated largely by "new" Names, without disclosing the true extent of the old syndicates' exposure to IBNR claims. The agents compounded the problem by providing inadequate RITC premium payments to the new syndicates, distributing the resulting "profit" to the Names on the closing syndicates, and then paying themselves handsomely for their handiwork besides.

The Asbestos Dam Breaks
In August 1980, a formal study group of insiders, called the "Asbestos Working Party," was established at Lloyd's to formulate a strategy to deal with the ever-growing and ever-more-difficult to conceal problem of asbestos claims. This study group worked closely with some of Llloyd's US law firms, monitoring every asbestos-related court case filed in America.

In October 1980, the United States Court of Appeals for the Sixth Circuit announced its decision in INA v. Forty-Eight Insulations, Inc. The court held that every exposure of a person to asbestos fibers was a separate harm, and that every insurer along the way during the entire period of exposure, which might be twenty years or more for a given employee, had a duty to defend and indemnify. The court stated:

"When a manufacturer of asbestos products is insured by different insurance companies the allocation of liability should be based on the "exposure" theory. Liability should be allocated among all the insurance companies that were on risk during the years that a worker was inhaling asbestos dust." (633 F.2d 1212, U.S. Circuit Court of Appeals, 6th Circuit Michigan, October 21, 1980)

This decision directly impacted the comprehensive general liability reinsurance policies Lloyd's syndicates had been writing with no limits from the 1930's through the 1950's.

Lloyd's inner circle continued to conceal their knowledge of the massive impending losses, and kicked the recruitment campaign into overdrive, signing up more and more external Names in what became known internally as the "recruit to dilute" campaign. There were 6,001 Names in 1970. By 1988, the number of active Names had risen to 32,433. Over 30,000 new Names had actually been recruited, but two thirds (over four thousand) of the "old" Names had quietly gotten out of harm's way.

The recruitment drive was conducted by members' and managing agencies, whose employees and middle managers for the most part did not know Lloyd's very survival was at stake. Lloyd's characterized the membership drive as part of a "modernization" of the business, designed to increase Lloyd's capacity and enable them to compete more effectively in the world insurance marketplace. Senior executives at Lloyd's largest syndicates continued to under-reserve and/or inadequately reinsure for incurred but not reported losses, effectively hiding the coming losses from employees within Lloyd's market as well as Names, while maintaining an illusion of profitability.

Immunity and Self-Regulation
In 1982, Lloyd's persuaded Parliament to pass a Private Act, the Lloyd's Act of 1982, granting Lloyd's immunity from most lawsuits. The Lloyd's Act of 1982 also gave the Council of Lloyd's the power to unilaterally and even retroactively change Lloyd's by-laws, that formerly could only be amended by majority vote of the Names at a General Meeting. The extent and implications of Lloyd's (effectively complete) legal immunity, and the Council's byelaw changing powers did not become known to the external Names for at least another nine years, until 1991 (the year that losses for the 1988 year of account first became public knowledge).

In late 1986, for the upcoming 1987 year of account, Lloyd's required all Names to sign a new General Undertaking, that included "choice of forum" and "choice of law" clauses in which the Names unwittingly agreed that any legal disputes with Lloyd's would be brought in English courts under English law. Lloyd's passed off the new Undertaking as a procedural technicality. They did not disclose to the Names that the Society of Lloyd's and its Council were by fiat of Parliament effectively immune from suit in England.

In 1986, Lloyd's also required that all Names sign a new Members Agency Agreement. In stark contrast to the minimal disclosures Lloyd's made concerning the General Undertaking, extensive, detailed explanations of the implications of the new agency agreement were given to Names well in advance of the deadline to sign it.

Soaking Up Excess Capacity
Lloyd's premium capacity increased dramatically as a result of the exponential growth in the number of Names. Lloyd's brokers and managing agents were not generating that much new business, but they needed to keep all of the Names' capital "in play". Beginning in about 1984, the syndicate managers accomplished this objective by absorbing the excess capacity in a "reinsurance spiral". Syndicates unnecessarily reinsured other syndicates against excessive loss during their year of account (as opposed to reinsuring to close prior years of account). They then obtained reinsurance on that reinsurance (properly, "retrocessional" insurance) from other syndicates, who then did the same with still others, in what became known as the "LMX" spiral. ("LMX" is an acronym for "London excess of loss market". In hindsight it would be more accurate to call it the "London excess of capacity market".)

The limited information in the Names' financial statements made it appear that their investments were doing well. Although few Names received substantial "dividends" in hand, most were heartened to see their personal reserves at Lloyd's increase at a respectable pace. In reality, since each Name's risk was spread across multiple syndicates, the twists and turns of the spiral tended to re-focus the risks back onto the same Names. [This was not a neat geometric "spiral"; it was in truth more like a plate of spaghetti.] Some of the largest brokers at Lloyd's, in concert with certain managing agents on various syndicates, had in fact put many of the Names in the position of repeatedly reinsuring themselves, i.e. concentrating instead of spreading a Name's vulnerability to enormous losses. Lloyd's brokers took fees and commissions "off the top"-- and managing agents took "profits" and fees "off the bottom"-- each step of the way. The spiral enabled Lloyd's to perpetuate the illusion of being a sound investment for several more years.

Lloyd's syndicates merrily wrote these incestuous and unnecessary reinsurance policies with other Lloyd's syndicates along with their usual "book" of legitimate ("outside") business; but the appearance of "profitability" could only last as long as all was relatively calm. When (not "if") major catastrophic losses occurred, the affected syndicates and their Names were doomed. The commissions and fees taken off the top and bottom by the brokers and agents who "churned" the market into a spiral of redundant reinsurance transactions had eaten away much of the premium reserves available to pay claims. The remaining reserves were dangerously low-- as low as 35% of premium in many instances. That is one reason why "typical" disasters such as hurricanes and oil rig fires resulted in "atypical" and exponential losses to the Names underwriting in the late 1980's and early 1990's.

The Days of Reckoning
The unwitting new Names, who believed they were investing in one of the world's oldest and safest institutions, were left to bear the losses when they hit, with a vengeance, in 1991. That year, Lloyd's announced losses of 500 million pounds ($800 million) on the 1988 year of account, which at the time was the largest single-year loss in its history. By 1995, the cumulative losses on the 1988 through 1992 years of account had grown to $14 billion (£8 billion), even according to Lloyd's unaudited, and undoubtedly minimized, accounting figures.

Lloyd's first paid claims out premium reserves, and then began sending cash calls to Names on the affected syndicates. Lloyd's portrayed the huge "calls" on Names' capital as the result of "short-tail" claims such as hurricanes and oil rig fires. The magnitude of the cash-calls, however, indicate that the payment of, and amassing reserves for, "long-tail" APH liabilities had finally begun in earnest. These "acts of God" merely triggered a chain reaction of claims that provided a smoke screen that hid the true nature of the LMX spiral and the asbestos crisis.

From 1991 to 1995, the premium reserves of hundreds of the 1988 to1992 syndicate-years were seriously depleted or exhausted by the end of their three-year accounting cycle. The syndicates could not close, and the Names bore unlimited personal liability for all the future claims. Those future claims are still unquantifiable.

LMX spiral "short-tail" claims are expected to be completely "run off" by approximately 2003. Asbestos-Pollution-Health claims, however, are expected to continue to flow into Lloyd's until the year 2030 and possibly beyond. It is now generally agreed that any Names on a syndicate reinsuring APH risks were financially ruined the day they were placed on it by their agents. Many Names were hit hard by both the LMX spiral and APH claims.

Since 1991, thousands of Names have been bankrupted, and more than 30 have committed suicide. Lloyd's continues to make cash calls, and English courts have continued to issue rulings in Lloyd's favor, making it easier for Lloyd's to collect more and more money from the remaining Names and/or their estates.

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