Will Lloyds Reforms Damage Its Spirit?

"For a very long time, London underwriters, especially at Lloyds, prided themselves on their ability to react quickly and to be entrepreneurial," said Jeremy D. Cooke, president of Markel International, a Lloyds managing agency in London. "Markel really believes that underwriters should be given the authority to underwrite, but they also need a clear set of operating rules of engagement," he said.

"From our standpoint, the reforms need to aim at establishing a more disciplined marketplace," he said. "Markel cant succeed if there isnt a viable trading platform at Lloyds."

"Theres nothing entrepreneurial about losing money in marine hull for seven years out of eight," agreed Bronek Masojada, deputy chairman of Lloyds and chief executive of Hiscox plc, a Lloyds managing agency.

Underwriters sometimes think that anybody who would make moves to stop this from happening "is stifling their entrepreneurial behavior," he said.

Earlier this year, Tony Markel, the president of Markel Corp., the Richmond, Va.-based parent of Markel International, had criticized the Lloyds market for some of its practices in a hard-hitting speech in London. However, Mr. Cooke said he and Mr. Markel are now encouraged by the number of substantive reforms in the pipeline, which will "strengthen the Lloyds franchise and, hopefully, will allow it to regain its premier position."

If the reforms dont happen, "businesses like ours will find another way to write that same business," he said, emphasizing that Lloyds is a fantastic global franchise that needs to be protected via the reforms. Regardless of reforms about accounting, capital and structure, the paramount, immediate need is to create a disciplined trading platform, "where all underwriters operate under the expectation of making a gross underwriting profit," he said.

Lloyds is moving to adopt an annual GAAP accounting system from its current three-year accounting system. It also intends to create a franchise board with Lloyds acting as a franchisor to manage the marketplace, providing approval for business plans and controlling underwriting proactively, rather than as a disciplinary force after the fact.

Initial plans to convert unlimited liability members to limited liability by 2005 have been scrapped in favor of allowing unlimited liability Names to continue in the marketplace, but preventing new unlimited liability members from joining as of 2003.

Mr. Masojada agreed that underwriting guidelines are important, but he thinks the most critical thing to focus on now is getting the right team in place to run the franchise board. "To me, the most important thing is finding the right person to join as the underwriting performance director because the issues that are important now may change over time," he said, noting that Lloyds is currently searching for a person to head the franchise board.

According to market sources, some of the proposals for underwriting guidelines that are being considered include:

No syndicate will write long-term policies, i.e., in excess of 18 months, without matching reinsurance.

"The driver behind this is the need to protect the overall security of the Lloyds market and the Central Fund," said Mr. Cooke. He noted that the events of Sept. 11 clearly brought home the problems of inadequate reinsurance. "If you were writing property cover that went past your reinsurance renewal date, you found that all reinsurers were excluding terrorism," he said. "So you had policies out there with no exclusions, but your reinsurance excluded it."

"That had a very, very significant economic effect on risk management and created major potential gaps in reinsurance recoveries," he said.

A syndicate should have a reasonable expectation of making a gross underwriting profit in each line of business.

No individual syndicate should have a single gross exposure on any individual risk greater than 10 percent of the stamp.

"That means that if you have $200 million stamp capacity on a syndicate, you shouldnt be writing more than $20 million on any individual risk, even before reinsurance," Mr. Cooke explained.

He noted that this amount was exceeded in the old days. "Theyd make a huge bet and sometimes win and sometimes theyd lose," he said.

No franchisee should pursue an aggressive arbitrage strategy.

"I think that some syndicates at Lloyds have been guilty of pursuing very aggressive arbitrage strategies, buying lots of cheap reinsurance," Mr. Cooke said. "If any lesson was learned from the events of Sept. 11, it was that credit risk had never been adequately considered, let alone charged for, and that cash flow and collectibility of reinsurance had never before been anticipated on this scale from one single loss," he said.

"Its not so much an issue of solvency. Its an issue of cash flow. Weve got to pay the claim and then wait for the reinsurance to come back," Mr. Cooke said.

Each syndicate should model and manage its catastrophe exposure to a minimum return period established by the franchisor, i.e., Lloyds.

"Its simply not fair for one franchisee to write catastrophe business on a very conservative basis, spending a lot of money to buy reinsurance to protect both the syndicate and the Central Fund, if hes competing in the same marketplace with another franchisee, who has decided to risk it all and hope there wont be an earthquake in Santa Monica in the next 12 months," he emphasized.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 15, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.