Lloyd’s Chairman Lord Levene will tonight outline a four-point plan to restore confidence in the insurance industry. Speaking to business leaders in Philadelphia at the Risk and Insurance Management Society conference, Levene will call for the insurance industry to eliminate conflicts of interest and increase transparency; work with regulators to develop and require adoption of ethical principles of behavior; communicate more effectively how the industry works – to those outside the industry and work with boards of directors, CEOs, CFOs, and not just risk managers – to demonstrate that managing risk seriously is a critical element of good corporate governance
“If we are to retain the confidence of the key player in all of this – the customer – we need full disclosure and complete transparency about who is doing what exactly, for whom, on what terms and at precisely what cost,” said Levene.
“Becoming more transparent also means doing a better job at communicating how we work to those outside our industry. And this is a truth which applies not just to the insurance industry, but to all 21st century businesses.”
Lord Levene noted that in the insurance industry, the world’s largest brokers have now taken decisive action and abandoned the practice of contingent commissions to avoid any potential conflicts of interest.
Lloyd’s is taking a collaborative approach to working with its U.K. regulator, the Financial Services Authority, to help deliver efficient business processes in the London insurance market.
“We need to move away from a strictly rule-book mentality, avoiding the creation of yet more paperwork and bureaucracy. And in its place, we can work with our regulators to develop and require adoption of ethical principles of behaviour,” he said.
“After three investigations in almost as many years, into the investment banking, mutual fund, and insurance industries, the financial services sector is certainly learning lessons. It has been left with a tarnished image in the minds of consumers, regulators and commentators. As a sector, the very business of financial services is based on trust, and we can no longer be in doubt that governance and proper conduct must take their place at the top of the agenda,” he concluded.
He will point out that managing corporate reputation is becoming more important then ever, and that the recent issues have tarnished the entire sector, not just “the few bad apples in the barrel.”
The U.S. is Lloyd’s largest market, accounting for over a third of its worldwide business. Lloyd’s writes more than $8 billion of direct and reinsurance business in the US.
A full text of the speech can be found below.
“RESTORING CONFIDENCE IN THE INSURANCE INDUSTRY”
Speech to the Philadelphia Club
Lord Levene, Chairman of Lloyd’s
April 18, 2005
Good evening. I am delighted to be here and see you all.
Lloyd’s, as you may know, is unique amongst the world’s major financial institutions. 317 years old, it is the oldest insurance market. With a capacity to accept insurance premia of 27 billion dollars, it is certainly one of the largest. And through its operations in over 200 countries and territories around the world, it is undoubtedly one of the most international. But despite this, the United States is, by a considerable margin, our largest market, accounting for over a third of our worldwide business. In 2004, Lloyd’s underwrote over 8 billion dollars of direct and reinsurance business here. The security of Lloyd’s runs like a thread through the American economy, underlined by the fact that some 93 per cent of companies listed on the Dow Jones are Lloyd’s policyholders.
Our relationship with you in Philadelphia is a microcosm of that whole. In 2004, the Lloyd’s market underwrote over 120 million dollars of surplus lines business in Pennsylvania.
This relationship spans the whole gamut of specialist risk. As you might expect, we insure many of your major companies for property, casualty and other specialist risks. Of the four Pennsylvania companies appearing on the Fortune 500 list, all have a policy at Lloyd’s. And our underwriting expertise manifests itself in less obvious ways too. The Lloyd’s market has often provided fine art insurance for the great exhibitions staged in your city over the years; and we currently provide excess property cover for the Philadelphia Port Authority.
But it is not Lloyd’s itself which I want to discuss with you tonight. Instead, six months since the New York Attorney General began his investigation into the insurance market, I want to look briefly at how our industry is responding and ask what remains to be done.
I heard William Donaldson, head of the SEC, say at last year’s World Economic Forum meeting in Davos: “Corporate governance was talked about in the early 1990s out of political correctness, but it is now deadly serious”.
After three investigations in almost as many years, into the investment banking, mutual fund, and insurance industries, the financial services sector is certainly learning lessons the hard way. It has been left with a tarnished image in the minds of consumers, regulators and commentators. But as a sector, our very business is based on trust, and we can no longer be in doubt that governance and proper conduct must take their place at the top of the agenda.
As business leaders in a wide range of industries, there is much that we can all learn from all these recent developments, and I want to explore these critical lessons this evening by looking briefly at three interesting parallels between the three recent investigations.
Eliminate conflicts of interest and increase transparency through strong boards
First, I’m sure it hasn’t gone unnoticed that each of the three financial investigations centre around potential conflicts of interest.
In the case of the insurance investigation, it’s the issue of the broker receiving payment from both the client and the insurance carrier. In the banking sector, it was the analyst giving false stock information to investors in order to get access to lucrative investment banking business.
Suddenly the question of who is working for whom is blurred and confusing. But if we are to retain the confidence of the key player in all of this – the customer – we need full disclosure and complete transparency about who is doing what exactly, for whom, on what terms and at precisely what cost. Indeed, without it, you simply do not have the economics on which to base accurate, efficient management decisions. And greater efficiency is once again to the benefit of customers.
In the insurance industry, the world’s largest brokers have now taken decisive action and abandoned the practice of contingent commissions. They have done this, not because contingent commissions are illegal, but because they cloud things and create a situation where conflict of interest can occur – after all, the broker is an agent of the policyholder, not of the insurance company. In turn, insurance company executives too have been forced to resign and their organisations made to commit to new business practices, as a result of abuses made possible by this lack of clarity.
As for Lloyd’s, our view is that we must have full, mandatory disclosure of commissions, not just at Lloyd’s but globally, because this is a global business. And the wider lesson is one which applies across all industry sectors. Conflicts of interest will always occur but we need to ensure that company management acts in the best interest of shareholders.
What’s the solution? One of the cornerstones of good corporate governance is a proper mix of directors including a genuinely independent board. That often means a stronger role for independent non-executive directors and greater oversight by independent professionals. Today, however, many companies are found to be wanting in terms of the training they provide to directors on their duties and liabilities.
Certainly at Lloyd’s, we have radically changed our governance structure over recent years. Where before we had multiple boards and committees overseeing the market, we now have one Franchise Board, with a strong mix of Lloyd’s market and genuinely independent directors, delivering a much simpler, cohesive governance structure. In doing so, I believe that we have made Lloyd’s a stronger market for the insurance industry professionals and buyers to work with, and that same logic must also apply to other companies too.
Do a better job of communicating with those outside our industry
Second, the financial investigations tackled not just isolated, criminal behaviour within some pockets of the industry, but also highlighted widespread, longstanding and legal, but nonetheless questionable, business practices.
The mutual fund investigation exposed illegal late trading of funds after market closing – but it also focused on what is a legal and tolerated industry practice – market timing. Likewise the insurance industry investigation exposed isolated examples of the illegal practice of bid-rigging – but it also drew attention to industry-wide practices on contingent commissions.
These legal practices have been described by one commentator as “open secrets” within their sectors. As one put it, referring to the practice of market timing, “the industry had that one coming to it for a while.”
The financial services sector has perhaps grown complacent. It had perhaps failed to understand the importance of transparency of the whole business process. The investigations highlight practices and processes which the outside world did not understand.
Becoming more transparent means doing a better job of communicating how we work to those outside the industry. And this is a truth which, once again, applies to all 21st century businesses.
Whatever our industry, we need to understand that, when something goes wrong, the reputation of the entire sector is tarnished, not just the few bad apples in the barrel. Society at large does not – usually – differentiate between one organisation and another. We must recognise too that governments often cannot resist the call to intervene wherever they see market failure.
The lesson is that by communicating better in the first place – and where appropriate working collectively with our peers where we have common interest – we lessen the need to spend lurching from crisis to crisis. In other words, more time communicating and building relationships with consumers, politicians and economic leaders in the first place means less time fire-fighting later down the line.
Work with regulators to develop ethical principles of behaviour
Third, let’s look at the impact of this new breed of investigations we are experiencing. The tendency is for it all to lead to new and greater regulation.
The investment banking and mutual fund investigations were swiftly followed by regulatory crackdowns by the SEC. And testifying to the Senate in November on the insurance investigation, Spitzer said “There are too many gaps in regulation across the 50 states and many state regulators have not been sufficiently aggressive in terms of supervising this industry.”
But those of us in highly regulated industries will hardly welcome yet more regulation. Indeed, in a new survey published by the London insurance broker Miller, some 29 per cent of US risk managers said that corporate governance and regulatory risks are the biggest concerns their boards face. As a result, more than 50 per cent say that liability cover for their directors and officers is their biggest insurance priority.
So what is the appropriate policy response to these investigations? Well, back in the UK, we are working closely with our regulator the Financial Services Authority, to help drive through change in the London insurance market’s business process.
In the end, this kind of collaborative approach may be more helpful than an onslaught of new rules. Rules generate loopholes, and loopholes lead to malfeasance. But if introducing more rules won’t work, developing principles of behaviour just might, especially if backed by clear guidance to minimise compliance costs.
Ethics has finally become sexy, but you cannot legislate good ethics. We need to move away from a strictly rule-book mentality, avoiding the creation of yet more paperwork and bureaucracy. And in its place, we can work with our regulators to develop and require adoption of ethical principles of behaviour.
Take reputational risk seriously as part of good corporate governance
In conclusion, managing corporate reputation is becoming more important than ever.
Some argue that we are witnessing is part of a widespread breakdown in trust between all organisations and their consumers, investors and regulators. Whether or not you believe that, loss of reputation is now perceived as the second biggest threat to organisations after business interruption – not surprising when today’s brands are worth billions.
Where reputation was in the past seen as intangible and difficult to price, few leaders today would argue about its financial importance – just ask shareholders of Enron or Andersen. Fortune magazine has been publishing its “most admired companies” in US for 20 years. It calculates that a one-point change on its scale makes an average difference of 107 million dollars to the company’s market value.
At Lloyd’s, we know about the value of our brand and reputation. It’s our most cherished asset – or to use a very British analogy – our Crown Jewels.
So it’s not surprising that last year’s survey at Davos showed that 92% of business leaders see reputation as being important to their corporate strategy. In fact, when asked to identify the most important measure of success for their business, more CEOs opted for corporate reputation than profitability!
Stronger corporate boards eliminating conflicts of interest; greater communication with those outside our industries; working with regulators to develop sound principles of behaviour; and taking reputational risk seriously as part of our corporate governance. These are some of the lessons which we can take away from the recent investigations and apply to all of our own businesses.
As for the insurance sector, it’s been an interesting six months, and I’m sure there are at least another interesting six to come. As an insurance industry, we sell a promise to pay when things go wrong, and that requires faith and trust. We certainly need to work right now to regain that faith and trust, but I think we are moving in the right direction.
For Lloyd’s part, I can assure you that our promise to pay remains as good as it ever was, after 9/11, after the San Francisco Earthquake, or when we started over 300 years ago. I can assure you too that our relationship with you, the business leaders of the United States has never been more important and we look forward to continuing to work with you and to help you manage the risks which you face.
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