Corporate Members Approve a Major Course Change for Lloyd’s

By Charles E. Boyle | September 30, 2002

Friday the 13th of September will henceforth be known at Lloyd’s as the day that members approved a plan that will radically alter the way the London market is conducted.

Ignoring any bad luck associated with the date, Lloyd’s announced that 79.88 percent of its members had wanted to sweep away the traditional three-year accounting system, replace Lloyd’s current organizational structures with a Franchise Board and close the market to new individual Names.

Speaking to some 350 members at the Extraordinary General Meeting recently, Lloyd’s chairman Saxon Riley urged them to support the proposed changes, promising that they would enable Lloyd’s “to maximize the wealth of its capital providers over the coming decade.” Riley’s remarks stressed that change was necessary to meet the challenges posed by the present insurance market and was part of Lloyd’s heritage. “Lloyd’s has existed for over 300 years,” Riley stated. “The history of this society is a history of change. From coffee shop, to Royal Exchange, to mutual society, to diversification, to internationalism, and on and on. That is our inheritance. And this is the inheritance I am asking you today to protect and live up to by voting for these reforms.”

While some commentators have called them the biggest changes in Lloyd’s history, they are really only the latest step in a process that began with the admission of corporate capital in 1994. That was the biggest change so far. By 1999 corporate capital already provided 75 percent of the funding for 139 active syndicates. Today there are 86 syndicates and over 80 percent of their capacity comes from corporate investment. The big insurance companies and brokers now effectively control Lloyd’s because they provide the bulk of its capital. They’re in a very strong position to impose the more sardonic version of the “Golden Rule,” i.e. “Whoever has the gold makes the rules.”

Riley, perhaps inadvertently, said much the same thing as he exhorted members to approve the changes. He stressed that their adoption would “provide a sustainable, attractive business platform for major investors who—let’s not forget—have a choice where they put their money. These are international businesses whose ongoing involvement is vital to our future.” No one needed to be reminded that Lloyd’s got less than one-tenth of the new capital that was invested in Bermuda (over $12 billion) after the Sept. 11 attacks.

The voting procedures mandated in Lloyd’s by-laws have been in effect longer than there have been corporate capital providers, but they nevertheless weighted the vote in favor of those with the biggest investments. Thus ACE Limited, currently the biggest backer of Lloyd’s syndicates, Marsh Inc., QBE, Aon and their contemporaries controlled a preponderance of the votes.

To begin with, of the 16,000 potential voters, only members with funds invested at Lloyd’s were entitled to vote. This was further weighted by how much they had invested. Lloyd’s spokesman Adrian Beeby explained that “each member is entitled to one vote for every half a million pounds [approximately $780,000] or portion of that amount, of capital invested at Lloyd’s.” Those with investment capacity from prior years, which is still at risk, were equally eligible to vote.

Lloyd’s spokesperson Sara Pittman said that of the 4,749 actual ballots cast, most of them by proxy, 1,393 formed the 80 percent majority of those in favor. Their capacity entitled them to multiple votes. Three thousand three hundred fifty-six members voted against the proposals, but they represented only around 20 percent of the votes cast relative to investment capacity.

It’s understandable why the corporate insurers and brokers who back Lloyd’s syndicates want the changes. They are for the most part public companies. One of their main concerns is their return on equity (ROE). If you have to break up a syndicate each year, wait three years to see if you made or lost money, and have no way of adequately calculating the amount of goodwill you’ve got invested, it makes ROE very difficult to calculate. Corporate accountants, institutional investors and regulatory authorities don’t appreciate that, especially in today’s scandal charged corporate environment. From Lloyd’s point of view the cumbersome procedures discourage potential capital providers from investing in the London market. Hence, both concurred on the need for reform.

The plans, prepared by management consultants Bain & Co., originally called for all unlimited liability to be phased out, but that proposal was dropped last May in the face of vigorous opposition from the “Names,” the approximately 2,400 active members who pledge unlimited liability in support of the syndicates they back.

Lloyd’s described the two “key reforms” as:
Modernization of the structure—Lloyd’s existing regulatory and market boards and committees will be replaced by a single franchise board. Lloyd’s will act as a franchisor in the management of the marketplace, with the managing agents as franchisees.

—A change in the way the market reports its results— Lloyd’s current three-year accounting system will be replaced by more conventional GAAP accounting.

At the end of August, Riley wrote an open letter to Lloyd’s members, that was posted on its Web site—http://www.lloydsoflondon.com, restating the proposals, the comments received from “all constituencies” since they were first announced, and the responses from the Council of Lloyd’s.

The change to a franchise structure was generally supported by the managing general agents (MGA’s) who operate Lloyd’s underwriting syndicates. Many of them, however, expressed concern about rising costs, particularly those associated with reporting requirements. The Council’s response indicated that “the franchise is not about micro-managing individual businesses or second guessing day to day underwriting decisions.” It indicated that on adoption it would work closely on both implementing the details and the new business plan, as well as “quarterly monitoring processes.”

Plans call for combining the powers of the two existing regulatory authorities, Lloyd’s Market Board (LMB) and Lloyd’s Regulatory Board (LRB), into one entity, the Franchise Board. “This would avoid the blurring of accountability and responsibility that can occur under Lloyd’s existing governance arrangements,” said the Council.

The Council of Lloyd’s, headed by the chairman, will remain as the “statutory body responsible for the management and supervision of the market under the Lloyd’s Act 1982.” It will, however, “in order to provide an accountable, unitary structure combining risk and commercial management . . . delegate many of its functions to [the Franchise] Board, including setting the market supervision framework, in compliance with FSA [Financial Services Authority] requirements.”

To ensure that it “has sufficient oversight of the Franchise Board, the Council will set the Board a goal and principles within which the Board will operate to achieve the goal.” Not unsurprisingly, the announcement described that goal as creating and maintaining “a commercial environment at Lloyd’s in which the long term return to all capital providers is maximized.”

The response went on to explain the necessity of hiring a new staff “particularly for the new Franchise Performance function, that will command the necessary respect from the market.” It added, “The same applies for the Franchise Board.” Pittman noted that the Franchise Board will operate separately from Lloyd’s management, and will be headed and staffed by its own personnel.

The move to annual accounting is perhaps even more radical than installing a franchise system. The period dates back to the very beginning of Lloyd’s when sea voyages in sailing ships typically lasted two years or more. At first glance it would seem entirely logical to scrap such an antiquated system, but it’s not that easy. In addition to the technical problems, the system offers significant tax advantages to the Names.

Nevertheless, the Council is committed to the change. It stated that there was “very clear support from many members, external commentators and throughout the market for the introduction of annual accounting. If we are to continue to attract new capital, we have to improve our comparability and transparency. Annual accounting is fundamental to achieving both these objectives.”

There are some costly side effects. When Lloyd’s released a pro forma annual account in April for the year 2001, it posted a loss of £3.11 billion ($4.8 billion). True, as Lloyd’s CEO Nick Prettejohn observed, 2001 was “an exceptional year by any measure;” Lloyd’s WTC losses alone are now estimated at around $3 billion.

Annual accounting is a key objective of the corporate capital providers. They report earnings (losses) on an annual basis, and Lloyd’s three-year system makes it difficult to extrapolate accurate figures. The Council did indicate that under the proposed plan third-party capital providers (the Names) would be able “to continue to participate on syndicates as they do now after the move to annual accounting has been completed.”

It also assured that the plan “permits annual distribution of profits for single member corporate syndicates and, subject to further work and analysis, for aligned corporate members on spread syndicates,” and that, by and large, Lloyd’s believes “this is a fair, reasonable and sensible approach.”

While the measures were approved, thanks to the backing of the big investors, Lloyd’s management compromised on a number of points involving the individual Names, most of whom were, and still are, opposed to the changes. The original proposal would have seen them phased out, or forced to turn into corporations, over the next three to five years. This was dropped, partly to assure passage of the rest of the program, which was really more important to the insurance companies and brokers anyway. It was also hoped that the move would persuade at least some Names to vote for the reforms, and would dissuade them from attempts to block their implementation.

Last February David Haggie, head of London-based consultants Haggie Financial, explained why the problem persists. “Essentially the private capital providers don’t have the same agenda as the corporate ones; they’re playing on a different field.” The structure is inefficient, and “it doesn’t work well to split your capital providers. This results in spending a great deal of money on controlling the structure of the market, rather than on building the Lloyd’s brand.”

As Lloyd’s spokespeople from Riley on down have often stressed, the change to annual accounting is an integral part of their efforts to modernize Lloyd’s and make its operations more transparent; and by doing so to make sure that the corporate capital providers have enough of a stake in its brand name and its continued existence to keep supporting it with their money. “It’s been a long time coming,” Haggie said.

While the existing Names can continue in their present capacity, the reform proposals clearly state that there will be no new unlimited liability members. The Council reaffirmed that “existing unlimited liability members are free to continue as such. This proposal only applies to prospective members of Lloyd’s.” While noting that “members’ agents have not actively recruited new unlimited liability members in recent years,” the response also stressed that Lloyd’s still wanted to “attract a strong capital base from a wide range of sources.”

Lloyd’s also agreed to take measures, long sought by the Names, to close the number of run-off years of account—those “years of account that are left open after 36 months rather than being reinsured to close in the normal way.”

“We have appointed a leading firm of reinsurance brokers as consultants to assist in the closure of 13 run-off years of account, most of which relate to the oldest underwriting years, from 1993 to 1997. If successful, this will allow 3,600 members who have only run-off years to be released from Lloyd’s once they have met any remaining liabilities. A further 4,700 members’ exposure to at least one run-off year will have been addressed,” said the bulletin. It also affirmed that the “first phase,” finding reinsurers willing to reinsure those years at an affordable rate, has been accomplished.

Lloyd’s won’t set a date for implementing the changes, but it certainly intends to move as quickly as possible to accommodate its corporate investors, and move to the system they’ve chosen to embrace.

It still may face significant opposition from the Names. On Sept. 2 the Association of Lloyd’s Members (ALM), representing the Names, issued a statement opposing the changes. The reason given by Chairman Michael Deeny indicated that, as the measures would require parliamentary approval, their adoption would divert Lloyd’s financial efforts. According to a BBC report Deeny stated that “For Lloyd’s to get involved in parliamentary procedures at this time is very unwise, since Lloyd’s should instead be concentrating on profitability.”

Lloyd’s does not agree with the ALM that changes in the Lloyd’s Act, which would have to be approved by a straight 75 percent majority vote and then receive parliamentary approval, are necessary to implement the plan. “These are different issues,” said Beeby. “While we’ve recommended that there be a review of the 1982 Lloyd’s Act, it would be up to the members to adopt any changes.”

When Lloyd’s first admitted corporate capital in 1994 many commentators, and quite a few Lloyd’s members, likened the decision to a “Faustian bargain” or a “Trojan Horse” that would ultimately destroy the traditional Lloyd’s. It took only 8 years to prove them right.

But, had Lloyd’s not decided to allow the world’s biggest insurers and brokers to provide the capital for its syndicates, it might not be here today in any form. Could it have survived all the disasters in between, including 9/11, without them? Could the Names alone have provided this year’s $18 billion capacity?

It was inevitable that the corporations would require Lloyd’s to change and operate more in accord with the way they do business. Those who can adapt survive; those who can’t perish. After 314 years Lloyd’s has proved once again that it’s a survivor.

From This Issue

Insurance Journal West September 30, 2002
September 30, 2002
Insurance Journal West Magazine

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