A White Paper Presented by
When Lloyd’s implemented its Reconstruction and Renewal Plan in 1996 by transferring its pre-1993 policy obligations to Equitas, it didn’t just start with a clean slate, it had already booked modest underwriting profits in its 1993, 1994, 1995 and 1996 years of accounts. It would take less than six years for Lloyd’s to become mired in underwriting losses and again struggling for survival. During the four years from 1997 through 2000, Lloyd’s underwriters lost more than $7 billion. In addition, the 2001-year of account was already deteriorating when the added weight of $2.7 billion of losses incurred on September 11 pulled Lloyd’s further under and has it gasping for breath. Lloyd’s projected losses for 2001 look to be about $4.5 billion, making their acknowledged losses in the past 5 years total more than $11.5 billion!
Significantly, Lloyd’s is not publicly talking about another Equitas-type partitioning of its old-year from its current-year liabilities. Abandoning policyholder liabilities for 1993 to 2004 years of account is, nonetheless, the hidden agenda of Lloyd’s metamorphosis from "market" to "franchise". The "Lloyd’s Chairman’s Strategy Group" plan is to divert attention away from Lloyd’s deep financial problems, by focusing on what it needs to do on a going-forward basis to compete more efficiently and cost effectively. The question is, how should U.S. regulators respond to Lloyd’s restructuring plans?
In the early to mid-1990’s, following accusations by many of Lloyd’s unlimited liability Names that they had been fraudulently induced to become members, over 22,500 withdrew. Under pressure to replace the lost capacity, in 1993 Lloyd’s opened its doors to limited liability corporate memberships. By 1997, 45% of Lloyd’s capacity was provided by corporate members. Today, there are only 2,490 individuals actively trading. Over 76% of Lloyd’s $17.4 billion of underwriting capacity is provided by 900 corporate members.
To hold existing corporate members and attract new ones, Lloyd’s proposals contemplate the abandonment of its three-year accounting system and adoption of generally accepted accounting principles. This will end the annual venture system, which requires the market to
renew its capital base each year. If the proposals are adopted as presently written, Lloyd’s will restructure its governance system and become little more than a franchiser with its corporate members as franchisees.
The foundational question is, who will benefit from the proposed changes? Lloyd’s Chairman Sax Riley has stated that the aims of the reforms are "profitability, modernity and transparency". But these lofty goals can already be achieved under Lloyd’s current governance regime. The problem Mr. Riley and his supporters within the Lloyd’s market are trying to sidestep with their restructuring plan is that newly vested capital doesn’t want to be saddled with old-year liabilities via Central Fund assessments. U.S. regulators, however, must insist that they do just that as a prerequisite for trading under Lloyd’s brand name and licenses. Otherwise, U.S. policyholders and reinsured carriers have no assurance that their claims will be paid.
Lloyd’s advertising and public relations campaigns consistently project the false image that Lloyd’s is an insurance company. Its web site www.lloydsoflondon.com presents Lloyd’s as the world’s second largest commercial insurer and the third largest reinsurer, holding approximately five percent of the world’s reinsurance. Contrary to the image Lloyd’s is attempting to project, it is a marketplace and not an insurance company. It is 3,390 individual and corporate members trading severally and not jointly, for their own account as participants in 86 separate syndicates.
Although Lloyd’s is boasting that its capacity increased in 2002, the number of individual Names actively trading dropped from 2,848 to 2,450, with the number of corporate members increasing from 895 to 900. At the same time, the number of syndicates the members participated in dropped from 108 to 86. Just ten years ago, there were over 30,000 members trading through 279 syndicates. More importantly, capacity isn’t the issue. What Lloyd’s doesn’t like to talk about is that since R&R, the market’s utilization of Lloyd’s capacity has steadily declined from 48.12% in 1996 to less than 32% in 2001.
It therefore follows that the ones who have the most to gain if Lloyd’s can stay in business, are those select few brokers who serve as middlemen between buyers and Lloyd’s underwriters.
Consequently, U.S. regulators ought to look upon the rhetoric of Lloyd’s executives and lobbyists with considerable skepticism. Whether regulators believe that Lloyd’s is insolvent, antiquated and opaque, or that the new Lloyd’s will be profitable, modern and transparent, is beside the point. Regulators must focus instead on how Lloyd’s reforms will affect existing and future U.S. policyholders and reinsureds. The real issue is, do U.S. regulators have the will to mandate that Lloyd’s-the-franchisor must bind its franchisees to fund and preserve the "chain of security" that Lloyd’s-the-market presently maintains to guarantee that the obligations of insolvent members will be paid?
Although U.S. regulators white-list syndicates as approved non-admitted carriers based upon the sum of capital pledged by their participants, the only mutualization that really binds the members together is a Central Fund established and administered by Lloyd’s. The purpose of the Central Fund is twofold. The fund is used to pay the losses of those members that become insolvent or have reached the maximum of their limited liability status. At present, it is estimated that the Central Fund has $400 million in assets, funded by assessments levied on Lloyd’s members based upon their allocated overall premium limit.
Currently, the minimum capital ratio for members writing at least 85% of their business in the U.K. motor market is 35% of premium income. All others are subject to a 40% ratio. The 40% ratio allows Names to write $2.50 of net premiums for each $1 held or deposited in their Funds At Lloyd’s ("FAL"). Based upon $17.4 billion of capacity, simple arithmetic indicates that the members’ FAL accounts total approximately $6.96 billion.
Since September 11, 2001 Lloyd’s has made two cash calls totaling $1.9 billion. Obviously, the Premiums Trust Funds ("PTF") funds have been materially depleted, and the infusion of cash was needed to pay policyholder claims and meet U.S. trust fund deposit requirements. Members have the option of using funds in their FAL accounts or drawing from their other resources to satisfy cash calls. Faced with approximately $11.5 billion of accumulated losses and less than $7 billion of FAL available, it’s only a matter of time until the FAL accounts of a significant number of individual Names and limited liability corporate members are exhausted. After they are depleted, the Central Fund will be expected to make up any shortfall.
While Lloyd’s touts the virtues of the Central Fund, its existence increases the underwriters’ cost of doing business. For the past several years, Lloyd’s has assessed its members up to 2% of their allocated overall premium limit. Lloyd’s can also make a proportionate call of $426 million upon the members’ PTF’s without their consent. Further amounts can be called with their prior consent. This process worked efficiently before limited liability corporations became dominant suppliers of capacity and underwriters were in the black.
Because each underwriting year stands on its own, those members that are actively trading at the end of a calendar year must decide whether they want to reestablish their trading capacity for the succeeding year or withdraw. If they withdraw, voluntarily or otherwise, they remain responsible for their policy obligations until syndicate managers close open years of account by purchasing reinsurance-to-close contracts after two additional years have passed, or all policy liabilities have been settled, or, if they are limited liability members, they have depleted their pledged capital. Given the proposed reforms and approximately $11.5 billion of accumulated underwriting losses, it seems illogical that any individual member would want to continue to trade at Lloyd’s.
Once all the individuals are gone, the burden of replenishing the Central Fund will have to be borne entirely by limited liability members. It is difficult to imagine why any company would trade forward at Lloyd’s knowing that its financial resources may be confiscated to satisfy the obligations of insolvent members. Why would any underwriter accept this exposure when it can be avoided by moving to Bermuda or another more favorable trading venue?
If Lloyd’s wants to establish a new image as a franchiser and remove the tarnish from its trade name, it needs to find a way to assure payment of its members’ existing obligations. Any Equitas-like solution will be a hard sell. Too many Names, policyholders and claimants have been soured by their dealings with Equitas. There are also troubling indications that Equitas will not be able to fully pay all outstanding claims. Although the reinsured Names were led to believe that Equitas would provide finality to their policy obligations, they are now facing the prospect that they will be called upon to make up any shortfall.
It is the American Names Association’s position that Lloyd’s optimism about the future must be tempered by the realities of its past performance. Lloyd’s has been wrapped in turmoil of its own making for over two decades and has again reached the precipice of collapse.
If regulators allow Lloyd’s to trade forward without complete assurance that Lloyd’s members will meet their past and present obligations, they will be jeopardizing U.S. companies and consumers who already purchased Lloyd’s coverage, and put a new generation of policyholders at risk. The issue regulators must address is, what should they do to protect the interests of American policyholders in the current situation?
ANA believes the evidence that Lloyd’s is in financial jeopardy is sufficiently persuasive to warrant that regulators issue a cease and desist order preventing Lloyd’s members from underwriting any new or renewal policies covering risks located in the United States commencing no later than January 1, 2003. The order should include provisions for case-by-case exemptions when it can be clearly demonstrated that the national interest will be jeopardized when an applicant engaged in an enterprise critical to the national interest cannot procure insurance from an alternative source.
Even if the regulators determine that the perpetuation of Lloyd’s presence in the U.S. market is needed, withdrawal of the cease and desist order should be conditioned upon the following:
To provide transparency to the past,
To provide a clear image of Lloyd’s vision of the future,
In this way, regulators will have fulfilled their obligations to American policyholders and ceding companies.