5 January 1998

Superintendent Levin

New York Insurance Commissioners

New York State Insurance Department

160 West Broadway, 18th Floor

New York 10013

USA

By fax to: 001 212 602 0437

Dear Superintendent Levin

I was interested to read in the Press Release you issued on 3 December that the New York Insurance Commissioners had decided to reduce the deposit requirements in respect of Lloyd's of London surplus lines business. In that Press Release you said: "Lloyd's, Equitas and the DTI have pledged complete access for Insurance Department staff to key financial, claims paying and reinsurance recoverables going forward, so that the Department can continue to closely monitor the financial health of both Lloyd's and Equitas.". I am concerned to know how you think you are going to be able to do this.

As I understand it, when Equitas was formed the Commissioners were only concerned to examine the adequacy of the premium being paid to Equitas in the aggregate; they made no attempt to determine what the appropriate split was between the individual syndicates. As you know, the division between the syndicates has proved to be a contentious exercise and Lloyd's has had great difficulty in justifying the calculations of the figures. It failed to persuade the English Courts that it was able to claim the sums it was demanding from non-paying Names on the basis of the evidence it was putting before the courts. It has now been given until 12 January to produce more adequate evidence. Since, as you know, the premium was calculated in the aggregate only, it is extremely difficult for Lloyd's to provide full proof and justification at syndicate and Name level. This is because of the arbitrary allocations that were made between individual syndicates and the adjustments that were made in the process of "negotiation". If Lloyd's fails to satisfy the Court in January, then its debt collection process against Names will basically collapse. Presumably, its inability to collect the hundreds of millions it had previously said it was trying to collect from Names will produce some sort of shortfall in its ongoing solvency position.

That, however, is not the end of the story for Lloyd's. As you know, a number of Names have now issued pro-active fraud writs against Lloyd's. In addition, hundreds of Names have counterclaims against Lloyd's based on fraud. At the heart of those fraud allegations is the substantial body of evidence assembled by Names that Lloyd's failed to reserve for known liabilities in respect of Asbestos Bodily Injury in the late 1970s and early 1980s. The scale of that deficiency was very substantial and, on the evidence available to us, it would appear that Lloyd's has been trading while it is insolvent since at least 1983 - on one view the date should be as early as 1977. The assembled evidence appears to suggest that Equitas is still substantially under-reserved for Asbestos Bodily Injury liabilities. The real threat, however, comes from a fraud trial. If the Names succeed in demonstrating in that fraud trial that the evidence they have assembled shows that Lloyd's did fail to reserve adequately in the early 1980s and therefore fraudulently misrepresented its profitability throughout the 1980s, then that evidence will become available to Lloyd's reinsurers. It would be adequate grounds for the reinsurers to repudiate contracts of reinsurance purchased by Lloyd's syndicates throughout the 1980s. Such repudiation would be on a far more widespread scale than the limited repudiation by IntAP companies and would undoubtedly pose a threat to the solvency of Equitas and thereby trigger both proportional insolvency clauses and the requirements for the ongoing market to indemnify the Joint American Trust Fund. We are profoundly sceptical about the willingness and ability of the ongoing market to meet the resulting obligations. In summary, we find it very difficult to see what justification there is for the Commissioners to conclude that Lloyd's "has demonstrated increasing financial strength through its R&R (Equitas) program."

Our scepticism is clearly shared by the professionals in the Lloyd's market. For over two years both the Treasury Select Committee and Names' organisations (including the corporate capital providers) have been pressing for the re-instatement of proper Errors & Omissions insurance. I am sure you will recall that Peter Miller told Parliament in 1982 that this was the most important single protection that capital providers had. Since 1991, there has been no such protection available at Lloyd's and the reason has simply been that the professional standards of Lloyd's underwriters have been so low as to be uninsurable. For over a year, Lloyd's has been struggling to put together some E&O insurance on a syndicate by syndicate basis. While limited (and worthless) cover is available for clerical error, no syndicates at Lloyd's nor companies in the London market are prepared to provide E&O insurance of the type available throughout the 1980s. This, in spite of the fact that there is gross over capacity within the insurance industry in general. We have spoken to brokers on the subject at length and are told that no underwriters are prepared to write it - even at very high premiums - because they do not have the confidence in the professional abilities of Lloyd's underwriters to be able to adequately assess the risks that the policies would pose. This peer group review opinion seems to run completely contrary to the Commissioners opinion that "new internal controls and enhanced periodic financial reporting" ... "actuarial opinions on a syndicate by syndicate basis" ... "better computer systems" are improving Lloyd's financial strength. If the professionals within the market do not believe that and hence are unable to provide E&O cover, on what basis do the Commissioners feel it is possible to make a proper assessment?

We are sure you have seen Equitas's auditors' opinions with their view that it is impossible to tell whether or not Equitas is adequately reserved due to the inadequate data and incomplete records. That same deficiency has made it impossible to assess the liabilities of Names at syndicate level. If a base data is unquantifiable it is extremely difficult to see how the regulator or anybody else can conclude that the current data is adequate or that the reserving strength is adequate. You, however, have clearly concluded that there are methods open to you which appear to ellude Coopers & Lybrand and at the moment appear to ellude other professionals in the Lloyd's market or Lloyd's itself. Please would you be kind enough to explain to us how you feel you can establish Lloyd's syndicates' figures with sufficient accuracy to be able to be confident about the protection available to policyholders that I know is your sole concern?

I look forward to hearing from you.

Yours sincerely

Christopher D. Stockwell

Chairman

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