S&P Comments on Lloyd’s Reform Proposals

January 30, 2002

Standard & Poor’s has issued a bulletin which discusses the proposed structural reforms announced by Lloyd’s of London on January 17. While warning of numerous hurdles to be overcome before any of the radical changes are implemented, S&P’s report considers the overall nature of the changes to be in the best interests of the Lloyd’s market and its capital providers.

After discussion with Lloyd’s management S&P indicated it “considers that the proposed reforms address many of the structural weaknesses in the Lloyd’s market which, if left unresolved, would make it increasingly difficult for Lloyd’s to sustain its franchise in the global insurance market. Such reforms will, however, be challenging to implement. The proposals have no immediate impact on the single-‘A’ insurer financial strength rating on Lloyd’s, but they are in line with Standard & Poor’s expectations for radical reform.”

As other analysts have pointed out, there are advantages and disadvantages to having both corporate and private capital, but essentially “it is not efficient for both types of capital to coexist.” S&P saw a reduction in the costs associated with raising capital if the distinction, i.e. the Names unlimited liability status, was modified to harmonize with the corporate capital providers, who now contribute over 80 percent of Lloyd’s capacity. “The proposals also formalize corporate capital as Lloyd’s primary capital structure, and remove the concept of the separation of capital provision from underwriting, S&P said. “The current agency relationship would cease to exist. Explicit in the capital structure proposals, therefore, is the cessation of unlimited liability, and the need to find an efficient and equitable solution for unaligned capital providers to enable them to continue to participate in Lloyd’s,” it added.

The rating agency foresaw an increase in the “clarity to the relationship between Lloyd’s centrally and the wider Lloyd’s market,” and predicted this could reinforce business planning and the monitoring process at Lloyd’s. “As the franchisor, Lloyd’s will have an explicit interest in the profitability of the franchisees. Having the direct authority to remove ‘loss-making’ franchisees should, in the long term, improve the overall profitability, and therefore the attractiveness, of Lloyd’s for capital providers,” said S&P.

S&P also approved Lloyd’s proposed change from its admittedly archaic three-year accounting system to GAAP standards, but indicated it would be hard to achieve. It also noted that, “other proposals associated with the change in accounting could have a significant impact on the current rating on Lloyd’s. The move to annual accounting would imply an annual profit payout, and would require the solvency regime to be rewritten. Both of these factors might involve a change to the amount of capital within Lloyd’s. ”

The conclusion sounded a cautious note concerning the extent to which the various reform proposals might be changed or amended, as an increasingly large constituency sought to influence their ultimate form

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