Aon/Berkshire Deal Roils Lloyd’s Waters

Aon and Warren Buffett’s Berkshire Hathaway announced in March that they had negotiated the establishment of a “sidecar” facility to operate at Lloyd’s. The deal, which had been in the works for some time, benefits both parties. There are questions being raised, however, as to whether it benefits Lloyd’s.

Under the agreement, Aon, which originates around 23 percent of all Lloyd’s business, will cede 7.5 percent of the premiums it receives on Lloyd’s business to Berkshire, which in turn will assume that portion of the insured risk. Berkshire will also pay Aon a commission, the amount of which hasn’t been disclosed.

The two parties are well matched. Aon is one of the largest insurance intermediaries in the world. In addition to traditional brokerage services, it operates captives and runs several advisory subsidiaries.

Berkshire is one of the biggest and richest global conglomerates. Under Buffett’s leadership it has collected shares in companies ranging from Coca-Cola, the Burlington Northern & Santa Fe railroad and General Re as well as GEICO, National Indemnity and other insurers.

It also sits on a pile of cash – more than $30 billion.

Both Aon and Berkshire are heavyweights that overwhelmingly deal with reputable, solvent enterprises. Their downside risk in this deal is minimal.

Lloyd’s adheres to the same high standards and has the added capabilities, honed over 300 years, of specializing in complex risks. As its former U.S. president Wendy Baker once remarked: “If you want to insure Joe’s Garage, you go down the street; if you want to insure the [members of the] State Garage Owners Association, you go to Lloyd’s.”

David P. Prosperi, Aon’s vice president of global public relations, says the arrangement with Berkshire represents an initiative to “serve our clients.” It “provides additional capacity and gives [Aon’s] clients an opportunity to take advantage of that.”

Aon sees the deal with Berkshire as a “win, win, win” initiative – for the company, for its clients and for Lloyd’s.

It is potentially “a big and important part of the market,” Prosperi says. “It will strengthen the [Lloyd’s] market and will help it achieve the goals set for 2025.” He also notes that 75 percent to 90 percent of Aon’s clients – polled at a Risk and Insurance Management Society conference in Los Angeles in April – view the Berkshire tie-up favorably, especially as the additional capacity would facilitate further growth.

He stresses that agreeing to cede 7.5 percent of a placement to Berkshire isn’t mandatory. It remains a decision to be made by Aon’s clients.

Peter Hughes, managing partner of London-based consultants Litmus Analytics, wrote: “It seems to me that this is an arrangement between three parties involving something that none of them owns – the right to choose where the contract is placed. Surely that decision rests with the buyer alone? If the buyer decides that Berkshire can have the 7.5 percent, or that it should be placed in Lloyd’s, or that it’s up to Aon, it’s their decision.”

Despite the seeming advantages the deal promises, Lloyd’s is concerned about how it will ultimately affect the market.

Lloyd’s finance director, Luke Savage, speaking at a conference organized by Insurance Insider, as reported by the Financial Times, cited several concerns.

He pointed out that Berkshire won’t actually be doing any underwriting. It relies on the placements Aon makes with lead and following syndicates, thereby avoiding underwriting costs. With increasing scrutiny from regulators, the Financial Times article also questions whether risk oversight of the transactions is adequate.

While these are legitimate concerns, they shouldn’t cause major problems. As far as oversight is concerned, very few people question the ability of Tom Bolt, performance director of the Lloyd’s Franchise Board, and his team to analyze the syndicate business plans and to enforce strict control.

In some respects Berkshire is stepping into the shoes of Lloyd’s Names, which also didn’t participate in underwriting. The difference being that Berkshire’s agreement with Aon covers the entire market. That agreement, however, no doubt spells out the types of risk by line of business that are included or excluded.

Another point Savage made expresses an existential concern.

Since 1994, when Lloyd’s admitted corporate capital to fund the syndicates, it has undergone profound changes, most notably consolidation of the market from more than 300 syndicates to around 80.

Lloyd’s changed its accounting system from three years to annual. Its syndicates now answer to the Franchise Board. It appointed its first CEO, Nick Prettejohn, in 1999 and is slowly increasing the use of digital technology.

This has created larger, better capitalized brokers – Aon, Marsh, Willis and JLT – that have increased their market shares at the expense of smaller operations. Savage justifiably sees the deal with Berkshire leading to similar arrangements, which will accelerate this trend.

In addition, as Baker recognized, Lloyd’s strength comes from the ability of its underwriters and brokers to structure and price complex risks. More use of “big data” and number crunching turned out by computers means less need for the expertise that sustained Lloyd’s for over 300 years.

Hughes also said “there is a danger that the increasing power of the Big Three looks worrisome to Lloyd’s.” Including JLT, the four largest brokers produced 58 percent of Lloyd’s primary insurance premium (more with reinsurance).

When so much of one’s business comes from only four sources, it’s enough to worry anybody.

With consolidation, Lloyd’s now faces the prospect of “commoditization.” There is a “possibility that the market is shifting to a more commoditized product, which could be a further fear,” Hughes said.

“The more standardized modeling and pricing become, the more homogenized the systems and rules that are put in place, the more possible it is to commoditize the product,” Hughes said. As a result, he said, there’s “perhaps less value Lloyd’s can add.”

For Lloyd’s that is indeed cause for concern.

Topics Excess Surplus Lloyd's Aon