Lloyd’s in the 21st Century

Any institution — and there aren’t many — that survives and thrives for 320 years must find ways to adapt to changing conditions. Lloyd’s of London’s transformation offers some insights as to how such a transformation can be accomplished. Founded in the age of sail, the London market now operates efficiently in the space age.

The first lesson is don’t be complacent. “We’ve won several battles, but the war continues,” said Louise Shield, Lloyd’s head of communications, in a telephone interview. She explained that, while Lloyd’s has been and continues to be a world leader in terms of its product offerings, the way it historically operated — i.e., its structure and business systems — needed to be remodeled to make those products more available at a lower cost.

Lloyd’s had ignored the need for those changes until it was almost too late. However, when claims, on 20, 30 and 40 year-old policies for asbestos and environmental damages hit the market in the 1980s, a solution had to be found. To meet the specific liabilities, Lloyd’s set up Equitas in 1996, a run-off vehicle, which eventually managed to settle most of the claims. Berkshire Hathaway took it over in 2007.

However, along with the liabilities, Lloyd’s faced claims of another sort — numerous lawsuits filed by its “Names” — the traditional individual investors, who pledged their assets to the Syndicates to cover claims in exchange for a share in profits. The combined threats nearly ended Lloyd’s. The European Edition of Time Magazine ran a 20-page cover story in February 2000 outlining all the reasons Lloyd’s would soon collapse.

The crisis forced Lloyd’s management to make a change that revolutionized the London market forever. In 1994, it admitted corporate capital to fund its Syndicates for the first time. That decision 14 years ago initiated the numerous changes Lloyd’s embarked on. The way Lloyd’s is now governed and operated bears little resemblance to the past. Even the brokers’ venerable slipcases — those bulging satchels stuffed with paper documents that are presented to underwriters — can now be reduced in size and speeded along through electronic processing.

Despite its evolution over the years, Lloyd’s remained dependent on individual Names with unlimited liability to supply capital until the end of the 20th century. Corporate capital changed that and made implementing new structures imperative. However, Lloyd’s is rather like the supertankers it insures. It doesn’t turn, stop, or change course very quickly. The structural changes came in increments, but they have accelerated in recent years. Lloyd’s learned the innate truth of the reverse “Golden Rule” — i.e. “He who has the gold makes the rules.”

The transformation has exceeded expectations and has brought about a renaissance at Lloyd’s. “The London market is now more transparent and more open in its financial transactions,” said Julian James, CEO of Lockton International in London, in an interview. He has experience on both sides of the market. James served for many years as Lloyd’s director of worldwide markets, and views Lloyd’s evolution in a positive light.

“Ten years ago Lloyd’s wasn’t rated,” James continued, “now three agencies rate Lloyd’s [‘A+’ from Standard & Poor’s and Fitch; ‘A’ from A.M. Best]. There’s been a big improvement in the chain of security, and the clients have a better understanding of the market and how it works.”

Lloyd’s dedication to making back office processing more efficient is part of that transparency. “It’s a big step forward,” James explained, “as it speeds up processing and reduces costs.” The Financial Services Authority’s (FSA) goal of ending the practice of “deal now, detail later” is rapidly becoming a reality, James said.

As the head of a core division of a major broker (Lockton is currently ranked as the 10th largest in the world by most surveys), James is concerned with preserving choices for his clients. “That’s one thing that hasn’t changed,” he said in discussing Lloyd’s. “It’s still an entrepreneurial market. Many Syndicates specialize in different products, so there’s competition and there’s choice.” That’s increasingly important in a globalized economy that faces new and emerging risks on a regular basis.

Talking to Lockton’s James and Shield of Lloyd’s, one gets the impression that, although Lloyd’s has achieved significant changes on the technical side, it has maintained the best and most important parts of its unique structure, and has integrated them with new and changing conditions. Some material makeovers include the following.

Management

In 1996, soon after corporate capital arrived, Lloyd’s named its first ever CEO, Nick Prettejohn. Significantly, he came from outside Lloyd’s, as a senior management consultant at Bain & Co. He was handed a specific mandate to continue modernizing Lloyd’s structure and procedures.

In November 2002 Lord Peter Levene of Portsoken was unanimously confirmed by the Council of Lloyd’s as its 61st chairman, the first one from outside the London market in its 314-year history. Levene’s experience included his role as head of London’s Docklands Light Railway and the city’s Canary Wharf property development project, chairman of the defense contractor United Scientific Holdings, as well as a term as Lord Mayor of the City of London and as a vice-chairman of Deutsche Bank AG.

In March 2006 Lloyd’s selected Richard Ward, former head of the London-based International Petroleum Exchange (IPE), as its new CEO, replacing Prettejohn. He was credited with turning the IPE from a sleepy backwater into a formidable commodity trading exchange, mainly by replacing outmoded procedures with electronic processing. He has embarked on a similar makeover at Lloyd’s.

Lloyd’s shows no ill effects from not having “insurance people” in top management posts. On the contrary, it has prospered, with net income reaching record levels — a £3.846 billion [$7.15 billion] pretax profit in 2007. Shield also noted that despite the $5.1 billion hit Lloyd’s suffered from Hurricane Katrina in 2005, its losses for the year were held to a modest $100 million.

One of the proposals contained in the United Kingdom’s consultation paper on reforming the 1982 Lloyd’s Act, released in March 2008, would recognize that senior executives may be selected from outside of Lloyd’s.

That’s been the case in North America, which accounts for around 44 percent of Lloyd’s business. When Wendy Baker, the long serving head of Lloyd’s United States and Canada operations, stepped down in April, Lloyd’s named LoriAnn Lowery to replace her. She does have lots of insurance experience — from a broker’s perspective. She most recently served as managing director and national practice leader for Risk Management and Financial Products for Wells Fargo Insurance Services, and previously held positions at MarshMac, Sedgwick and Intercontinental Brokerage.

Regulation and Franchise Structure

Even before Levene’s arrival, Lloyd’s had embarked on a radical plan to restructure the way it is governed. In January 2002 its ultimate authority, the Council of Lloyd’s, proposed replacing the existing regulatory and market boards and committees with a single franchise board. It also planned to phase out unlimited liability, replace the increasingly cumbersome three-year accounting procedures with annual accounting, and end the formality of winding up and renewing Syndicates annually.

The changeover to a franchise system was completed in 2003. Lloyd’s became the franchisor, the manager of the marketplace, with the managing general agents (MGA), who operate the Syndicates becoming franchisees.

Lloyd’s had already ceased to be a self-regulating body in 2001, when it became subject to the supervision of the newly created FSA, which also assumed regulatory authority over the entire British insurance industry in 2005. In March 2008, the U.K. government released a consultation paper, setting forth a list of proposals for updating and reforming the 1982 Lloyd’s Act (See IJ’s Web site: www.insurancejournal.com/news/international/2008/03/10/88055.htm). They would validate the changes Lloyd’s has already made, and provide for the future evolution of the market.

According to Shield, the Franchise Board, headed by Rolfe Tolle, is primarily charged with oversight, and specifically with “avoiding the insurance cycle” that has bedeviled the insurance industry from its inception. “What we need to do is concentrate on underwriting for profit,” she said. “The goal is to make money in favorable years, and to not lose too much in others.”

To accomplish this Tolle and his crew collect data from all of Lloyd’s Syndicates — their business plan, their capacity and what they want to underwrite. The Franchise Board has the power to demand changes, and/or to reject Syndicate proposals outright, and has done so.

Shield said there are currently 75 Syndicates doing business at Lloyd’s, a slight increase over the last two years. But as recently as the 1990s, there were over 300 Syndicates. The current ones are larger, better capitalized and more professionally managed, she said.

Accounting and Syndicates

Lloyd’s Syndicates began reporting their profits and losses on an annual basis in 2002. It proved costly, as Lloyd’s losses, primarily from the Sept. 11 attacks, totaled £3.11 billion ($4.5 billion at the time). Prettejohn described the changeover as “a fundamental step in our strategy of reform. It makes us more accessible and transparent, and enables us to report results that can be compared easily to those of other insurers.”

As those “other insurers” included the ones who increasingly funded Lloyd’s Syndicates, the change was unavoidable. For the most part, they are public companies that are required to report their profits and losses on an annual basis, if not quarterly. To round out the equation Lloyd’s adopted U.K. Generally Accepted Accounting Principles (GAAP) beginning Jan. 1, 2005.

By 2006 the corporate influence had grown to the point that U.K. companies with the biggest stakes in Lloyd’s — Amlin, Beazley, Catlin, Hiscox, Kiln and Wellington (now part of Catlin) — were being called the “Gang of Six” due to their influence. Lloyd’s also has a highly influential U.S./Bermuda component, featuring some heavyweights — AIG, Berkshire Hathaway, XL, ACE, Liberty Mutual and Markel among them, along with Australia’s QBE. These companies, too, have their own agenda, of which Lloyd’s is only a part.

Opening to Brokers, Expansion

In 2001, London brokers lost their exclusive rights to deal with Lloyd’s underwriters, when Lloyd’s opened the gates to applications from qualified brokers worldwide. Prettejohn explained: “With the increasing globalization of business, it is important to streamline the administrative processes associated with the placing and servicing of business. This is what the market reforms being proposed under LMP [London Market Principles], the new accreditation standards, are about. They are intended to secure a more open and efficient environment in which customer service is improved, money moves rapidly, procedures are simplified, and costs reduced. In short, everyone wins — clients, brokers and underwriters.”

Since then a number of non-U.K. brokers have been accredited to do business at Lloyd’s. Partly as a result the market has prospered. “People come to London to place business because they get the capacity [and the underwriting expertise] that they can’t get anywhere else,” said James.

It also works both ways, as James’ frequent flyer miles would no doubt confirm. Lloyd’s has opened a number of branch offices, where local brokers can access the Lloyd’s market — face to face — without going to London. In addition to a number of U.S. sites, most recently in Los Angeles, Lloyd’s has branches in Singapore, Hong Kong, China and, very soon, in Brazil, as well as branches in most European Union countries.

Shield explained that somewhat paradoxically that the more globalization accelerates, the more clients and brokers seem to want to do business locally. As examples, she cited Lloyd’s office in Brazil, which will be headed by Brazilian Marco Costa. Lloyd’s reinsurance subsidiary in Shanghai has a predominately Chinese staff. “We’re also looking at a Middle East Office in Dubai, Qatar or Bahrain,” Shield said.

The brokers’ door is set to open wider. One of the key proposals to reform the Lloyd’s Act includes making it easier to do business at Lloyd’s by opening access to managing general agents, rather than restricting it to certified Lloyd’s brokers. Section 7 of the consultation would: “Remove the restriction that requires managing agents generally to accept business only from a Lloyd’s broker, while retaining the class of ‘Lloyd’s broker’ for brokers that want to bear the title.” Shield said there’s a very good chance it will be adopted, thus furthering local access.

Electronic Processing

The proliferation of “foreign offices,” such as Shanghai, has been made possible by modern communications technology. They are more fully electronic than Lloyd’s. The elusive goal of implementing electronic processing into its procedures has bedeviled Lloyd’s for years. Its “one size fits all” attempt — first as “Blue Mountain” and then as “Kinnect” — proved unworkable. Management finally shut down the $200 million plus project in 2006.

Despite numerous pledges of support and substantial financial backing, a majority of Lloyd’s brokers and underwriters remained reluctant to adopt the system.

However, the momentum towards electronic processing could not be halted. Outside service providers such as RI3K and Xchanging developed platforms, in reinsurance and back office processing respectively, that worked. The FSA and Lloyd’s own management, led by Levene and Ward, demanded their use. Two key systems emerged: the Electronic Claims File (ECF) and the Accounting and Settlement repository (A&S).

The first makes claims instantly accessible electronically to anyone involved in the settlement process. The second calculates and processes premium payments.

In July 2007, Ward warned that the adoption of these systems was taking too long, and threatened to turn the Franchise Board loose on the problem. His message got through.

“As far as the ECF is concerned, it now handles over 90 percent of all claims,” said Shield. “A&S levels are between 80 and 90 percent” (up from 17 percent, when Ward issued his warning).

The brokers’ and underwriters’ worst fears — that face-to-face meetings would be replaced by robotic computer terminals — has proven largely unfounded. “Face-to-face discussions are still considered highly valuable,” said James, “and this should not change. What’s changed is the processing.”

The new systems have decreased costs and reduced long-standing complaints that doing business in London is too expensive. As electronic processing has become more accepted, some Syndicates have placed underwriters and representatives in local offices, increasing access and further reducing costs.

Lloyd’s China reinsurer proves it can work. Alex Letts, chief executive of RI3K, who attended the opening, said he found Shanghai “very exciting and very innovative; it’s a model for the future.” He characterized the use of “state-of-the-art technology” in China as “the new Lloyd’s,” adding that it could be put in place immediately if there were “no legacy issues.” Letts is confident that those can be overcome. “In one bound Lloyd’s is showing that the industry’s most important market is also hell bent on becoming the most modern,” he said.

Time has yet to print a correction to its 2000 article, but, to paraphrase Mark Twain, the “news of Lloyd’s death seems to have been greatly exaggerated.”