Early Reaction To Lloyds Reforms Cautious

The proposals were contained in a 56-page consultation document, which begins a consultation period that will end on Aug. 16. On Sept. 12, the market will hold an extraordinary general meeting to vote on the proposals as a whole.

Market practitioners interviewed agreed that it is the franchise proposals that will have the most immediate effect on their operations and underwriting.

"The main objective of the franchise is to create and maintain a commercial environment at Lloyds in which the long-term return to all capital providers is maximized," said the consultation document. "This can best be achieved by creating a disciplined marketplace of well-managed businesses."

Although the role of Lloyds, as franchisor, is "intended to be primarily facilitative, the franchisor will be prescriptive and require change when a franchisee does not respond to the facilitative approach or where a franchisees underperformance threatens the security and profitability of the Lloyds market," the document said.

"Each franchisee will be free to decide which types of business it wishes to write. However, the franchisor will expect each franchisee to plan forward its business mix, resources, activities and financial results," it continued.

As a result, the document includes a proposal that each syndicate submit an annual business plan to the franchisor, "supported by robust statistical analysis with actuarial input where relevant."

The document also includes a section on dealings with brokers, stating that the "financial implications of dealing with brokers are vital to the future profitability of Lloyds."

"Franchisees should be constantly aware of the financial impact of both commissions paid and premium income receivables arising out of their brokers relationships," the document said. As a result, the document proposes that "all broker commissions and chargesbe included in the profit and loss account submitted to the franchisor."

A Franchise Board will be established later this year and key personnel will be recruited for the franchisor organization, including a performance director.

David Shipley, active underwriter at MAP, a Lloyds managing agency, was concerned that the proposals allow maximum flexibility to the incoming franchise director. He said he was concerned that the franchise management process may be concerned too much with managing reporting structures and "not enough about crash testing peoples business plans."

"Until you get to a point where youve got a franchise board and franchise director that understand underwriting issues and are ruthless, then all the process and reporting and analysis wont take that risk away," he said.

"Theyre about to bring in a whole raft of additional regulation, which may well be needed. But they also need to conduct a ground-up review of existing regulation to see whether some rules may no longer be required, rather than simply adding another layer of bureaucracy," said John Hamblin, active underwriter at Cathedral Underwriting, a Lloyds managing agency.

One of the most important things being proposed is a limit on the amount of reinsurance leverage a syndicate can use. This reduces an individual syndicates exposure to the credit risk of failed reinsurers and reduces U.S. gross funding requirements, Mr. Hamblin said.

Also, to calculate gross cat exposure, "every syndicate is currently given a set of prescribed events, such as a $50 billion Northeast storm or an earthquake of a certain magnitude," as a realistic disaster scenario used to set capital requirements, he said. Currently, the syndicates produce the results of disaster scenario testing for Lloyds regulators.

"Under the franchise system, the franchisorwill have a view of whether the calculation of that figure is acceptable or not and load capital requirements accordingly," he said. "It is my understanding that they will now collect raw data from us, rather than simply the result. They will run the numbers themselves and see who is light on their estimate on what could happen in the event of a major catastrophe," he said.

"The franchisor will prescribe the amount that the syndicate can expose itself to both gross and net for the first time," he added.

Mr. Hamblin and Mr. Shipley both emphasized that they hadnt yet seen the consultation document.

"I think on the whole the document should receive warm applause from everybody," said Bronek Masojada, deputy chairman of Lloyds and chief executive of Hiscox plc, a Lloyds managing agency. Although there may be sections that cause people to complain, taken as a whole, most people will regard it as a big step forward for the market, he said.

Regarding the Lloyds capital structure, Lloyds said it plans that the main market reporting regime will be on an annual accounting basis from Jan. 1, 2005, subject to an amendment to the EU Accounts Directive.

The document said that the Chairmans Strategy Group, which devised the proposals, has concluded "it is no longer appropriate for members to put all their personal wealth at risk given the risk profile of the global specialty insurance and reinsurance business."

No new unlimited liability members will be admitted to the market after Jan. 1, 2003. However, original proposals that would have required unlimited liability members to convert to limited liability after Jan. 1, 2005 have been scrapped. Lloyds is attempting to remove tax obstacles, which act to inhibit voluntary conversion to limited liability status.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 22, 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.