Lloyd's sheds status quo to keep pace
with changing marketplace
By Phil Zinkewicz
"We have embarked upon this course of action ... because of problems ... that would lead to the market's decline."
-- Lloyd's Chairman Sax Riley
"This is the end of an era at Lloyd's of London, and the beginning of a new one."
That's how Lloyd's Chairman Sax Riley described the extraordinary vote that took place at Lloyd's in September. As the result of that vote, which was in favor of a total reformation of that venerable market, Lloyd's is on its way to shedding the traditional old boys, coffee shop image and cloaking itself instead in the garb of a modern corporate structure.
But the vote did not come easy. Individual "Names" at Lloyd's, under a group called the Association of Lloyd's Members (ALM), resisted the changes being called for until the very day of the vote. In the end, the ALM capitulated, recognizing that the market was indeed in need of radical alterations.
So, on that fateful Thursday in September, Lloyd's corporate members and individual Names agreed on a plan to modernize the marketplace. There were two driving forces behind the move: one, Lloyd's members believe that the market's growth has been stunted by new competition from insurance centers such as Bermuda; two, the huge losses both realized and anticipated from the World Trade Center terrorist attacks have hit some syndicates hard and the need for attracting new capital has become of paramount importance.
Part of the new plan at Lloyd's, discussed last year but finalized only in July of this year, were proposals that would have forced the Names from the marketplace, in order to concentrate on corporate capital. Names, however, put up fierce opposition and Lloyd's backed off on that. In what is a very strange situation, Names still outnumber Lloyd's corporate members, but they represent a minority of the market's capital base. Lloyd's still plans to end unlimited liability for new members and to put in place measures to encourage existing Names to convert to limited liability.
What has been left in the plan, however, is the development of a range of investment schemes, including equity and bond investments in "special purpose companies" to support Lloyd's. According to Chairman Riley, these companies would offer involvement in the market without having to become a member.
Lloyd's says that it will move to a "franchise" structure, which, it is hoped, will create a more "disciplined" marketplace of "distinct, independent businesses," and will place clear obligations on the franchisor (Lloyd's) to promote the overall profitability of the market. This will be achieved, says Lloyd's, by redefining the relationship between Lloyd's and managing agents, who are the franchisees.
Specifically, the plan calls for the following: a) a new relationship to be defined in a set of Franchise Principles, which will detail the objectives of the franchisor as well as the obligations of both the franchisees and the franchisor and bring clarity to that relationship; b) publication of guidelines addressing underwriting, risk management and standards of service; c) the setting of long-term targets for levels of profitability for the market; d) the defining of a new business planning process for syndicates; and e) the monitoring of the performance of each syndicate against the business plan. Other reform plans include the scrapping of the market's traditional three-year accounting regimen in favor of internationally used yearly accounts. This last plan will require a change in a private Act of Parliament that governs Lloyd's.
In a recent interview, Stephen Cane, chairman of the International Underwriting Association of London (IUA), an organization of non-Lloyd's companies and chairman of Alea, a relatively new reinsurance entity in London, said: "The changes taking place at Lloyd's will certainly bring more efficiency to the marketplace and enable it to compete better with other world markets. The need for these efficiencies was evident prior to September 11. At an emotional level, the tragic events of that day will never leave us. At a business level, it was a sort of clarion call. With Toulouse, Petrobras and Enron, as well as the WTC, 2001 was the worst year in insurance industry history in terms of catastrophic losses. These events have added impetus to market changes that were well underway beforehand. The industry had been aware for some time that an increasing number of serious issues were catching up on people--falling equity values, asbestos, and pollution problems, other reserve shortfalls and the very poor results of the late 1990s. All were creating long-needed momentum for change," Cane said.
Just days prior to the vote that ushered in the "new" Lloyd's, Chairman Riley made an impassioned plea to the ALM, urging the Names to put aside their concerns and to vote in favor of the changes recommended by the Lloyd's strategy group that devised the plan just a year before. "Now that we are caught up in the heady atmosphere of the hardest market for years, it can be easy to forget why we formed the group," he said. "Let me remind you: over £7 billion lost between 1997 and 2001; a market where the performance of individual businesses was anywhere between world class and bottom of the class; investors unable to compare Lloyd's with other investment opportunities and fearful of a system that would lock them into the market; and our financial security ratings being placed under increasing pressure by the rating agencies."
Chairman Riley told his audience that, by early 2001, many people in the market had realized that Lloyd's could not continue on its current course. "This was a course that led to diminution and decline. So, the Chairman's Strategy Group began to look for answers. Then, September 11. On that day, a new type of risk emerged for the world to face. And an insurer that does not evolve as risks evolve is doomed to failure," he said.
Chairman Riley then went on to address the concerns of the ALM before the vote, which, he said, fell into three key areas. The first was the concerns of Names regarding the new regulatory structure. The second was the potential for major corporate members to affect the Central Fund. The third was the potential for changes in the Lloyd's Act. He then addressed those points one by one.
The ALM had said it wanted to retain a Regulatory Board and Director of Regulation. "Why?" Riley asked. "To ensure protection for members. But we have developed a set of principles to determine exactly how the market will be managed. These principles explicitly state that we must deal with the membership openly and equitably, and we will not act in a manner unfairly prejudicial to any category of member."
Chairman Riley said that the new plan calls for a new Compliance Committee to provide Council and the membership with reassurance that the Franchise Board is living by those principles. "Indeed, we believe the Compliance Committee will have a more explicit obligation to look after all members' interests in a way that the Market Board and Regulatory Board have not."
As for the potential impact of corporate members on the Central Fund, an issue that has become known as the "risk of ruin," Chairman Riley said that Lloyd's is committed to review the concept of risk-based capital and has a project team looking at the "risk of ruin" potential. He said that recently, someone called the corporate members of Lloyd's "cuckoos in the nest," and decried that statement. "I think that's a pretty appalling statement to make about the organizations which have supported the market to the tune of £8 billion this year," said the Lloyd's chairman.
Finally, regarding the Lloyd's Act, Riley said the Chairman's Strategy Group has recommended that "we review whether changes to the Lloyd's Act are appropriate," but that it doesn't necessarily mean that the Act would be changed. "But remember, the Act was last amended in 1982," added Riley. "How many organizations continue to trade with a set of rules set in stone for over 20 years--a set of rules that predate e-commerce, new standards of good practice on governance, and a veritable revolution in the standards expected by investors?"
In the end, Chairman Riley won over his audience. The plan was accepted by the necessary margin, and now Lloyd's faces the challenge of executing it. In the next year, there will be many changes at Lloyd's. But Riley and those who strongly favored the move believe firmly that the changes are inevitable.
"We have embarked upon this course of action--these radical, yet sensible proposals--because of problems our market faces--problems," said Riley, "that would lead to the market's decline. 'Do nothing' is not an option." *