Arbitration on Central Fund Goes Against Lloyd’s; S&P, Best Comment

January 26, 2005

When six insurers,* led by Swiss Re, agreed to back Lloyd’s Central Fund with £500 million, with a maximum for any one year of £350 million (around $500 million at the time – $650 million currently) it seemed unlikely that the cover would ever be used.

That was before Sept. 11 and ever-expanding asbestos claims. Lloyd’s has had to tap the Central Fund, its reserve used to pay claims if individual Lloyd’s members cannot do so, on several occasions since then. But when it sought reimbursement under the terms of the policy, Swiss Re and the others refused to pay and the dispute went to arbitration in April 2003.

In a decision handed down last Friday, Jan. 21, the arbitrator ruled that although the policy was valid, Swiss Re could refuse to pay the claims, as it had not properly understood the terms of the agreement and its consequences. A Lloyd’s bulletin said: “This finding is still subject to the panel further considering Lloyd’s argument that Swiss Re had affirmed the policy, and is therefore bound by its terms. The tribunal has deferred reaching any conclusions on this issue until after completion of the evidence in relation to the other insurers. The hearing with respect to the other five insurers is due to begin on 21 February.”

Lloyd’s also indicated: “If, in the worst case, the insurance policy were avoided in respect of all of the insurers, Lloyd’s central resources would reduce from £1.9 billion to £1.6 billion [$3.51 billion to $3.15 billion]. It would result in a current estimated solvency ratio for the Society of 247 percent, still stronger than the 227 percent solvency ratio as at 31 December, 2003. The estimated impact on the Central Fund as at 31 October, 2004 (as previously disclosed) would be to reduce its net assets from £801 million to £525 million [$1.48 billion to $971 million]. ”

Standard & Poor’s Ratings Services released a statement indicating that its rating and outlook on the Lloyd’s Market (A/Stable) and its ‘BBB+’ rating on the subordinated debt issued by The Society of Lloyd’s would be unaffected by the ruling.

SP noted: “The worst-case scenario, where the arbitration panel would find in favor of Swiss Re and the other five insurers with a consequent revocation of the policy, would result in the net assets of the Central Fund being reduced by an estimated £276 million ($515 million). The potential reduction of the Central Fund is not sufficient to affect the ratings on Lloyd’s Market or The Society of Lloyd’s, due to Lloyd’s current profitability, the continued commitment of the members, and the significant pool of mutual assets available to meet claims of more than £1.6 billion, including the callable layer and subordinated debt issue.”

A.M. Best Co. issued a similar bulletin saying that its rating of “A” (Excellent) and the issuer credit rating of “a” on Lloyd’s “remain unaffected following Lloyd’s publication today of an update on the arbitration hearing relating to the Central Fund insurance contract.” Best said that even if a shortfall were to occur it didn’t expect it “to be material.”

Best also commented that the current speculation relating to the proposed Fairness in Asbestos Injury Resolution Act, which is due to be presented to the U.S. Senate this week, has no impact on the ratings. The effect of any new legislative change leading to early crystallisation of Equitas’ losses will be assessed at the time the change is implemented.”

*The five other companies are: General Electric; Hannover Re; St Paul Travelers; Chubb Corp. and XL Capital Ltd. Under the terms of the policy, the insurers would pay out if calls for cash to Lloyd’s from unpaid policyholders went above £100 million ($185 million) in one year, up to the £350 million maximum. The maximum payment over the life of the policy is £500 million.

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