A No-Name market?: Lloyd's faces a struggle in breaking its three-century embrace with private capital. (Industry Strategies).

In the spring of 1998, Ron Sandier, then the chief executive of Lloyd's, sent shudders through the dwindling ranks of individual investors who once bankrolled the entire market, coming very close to calling for the elimination of "Names" from Lloyd's capital base. Nearly four years later, the ideas behind Sandier's warning shot might at last lead to all-out war.

Sandier at the time spoke of his hope for "a streamlined and modernized market, stripped of anachronistic historical trappings." His hit list included the annual venture, the process by which each Lloyd's syndicate must recapitalize itself every year. It's a core feature of the Names system and a chronic headache to corporate capital providers, which first entered the market in 1994 and already dominated its capital structure by the time Sandier made his provocative remarks.

Sandier left in 1999, but his vision lives on in Lloyd's radical set of proposals, unveiled in January, to overhaul the market by eliminating time-honored features that have set Lloyd's apart for much of its history. Targeted for elimination are the unlimited-liability investors who supplied all of Lloyd's capital for more than 300 years, the three-year system of accounting that has frustrated efforts to make the market's results understandable and the annual venture. All now are seen as commercial handicaps in the 21st century.

But Lloyd's plan faces hurdles, with the opposition of Names perhaps the most daunting. They supply a minority of Lloyd's capital--some [pound sterling]3 billion (about $4.3 billion) out of the total of [pound sterling]12.3 billion for 2002--but the 2,490 active Names and thousands more still on the market's rolls are a formidable voting bloc that the market would have to sway in favor of the changes. Lloyd's is hoping that proposals to let the Names continue trading under different arrangements--or sufficient compensation for giving up that right--will win favor as details emerge.

The key points of the proposal, drawn up by the Chairman's Strategy Group formed last March, are as follows:

* Lloyd's would be restructured to operate as a franchise business, with its existing regulatory and market boards and committees replaced by a single franchise board. Managing agents would operate as franchisees of Lloyd's.

* The current system of three-year accounting, under which final results are reported three years after a year of account closes, would be replaced by more conventional, annual reporting under generally accepted accounting principles.

* A new way would be created for individual Names to trade on a contractual basis after January 2005, although Lloyd's offered few details on this aspect. Lloyd's would explore ways to buy out individual members' existing rights for cash.

* No new, unlimited-liability Names would be accepted, and Lloyd's would end the annual venture under which syndicates now must line up capital providers for each year of account.

Implications of Change

The ruling Council of Lloyd's cleared the proposals for a period of informal "consultation" with participants in the market before details are made final and put to a vote of the membership later this year.

The changes would have important implications for participants at Lloyd's, which are now primarily corporate investors. Syndicates would gain far greater flexibility in managing their capital, with the ability to make longer-term investments, carry reserves from year to year and buy multiyear reinsurance coverage. They also would find their results more readily comparable to non-Lloyd's insurers, addressing long-standing complaints that the market is unintelligible to outsiders.

But managing agencies, many of which are controlled by their corporate capital providers, would face closer oversight by Lloyd's as the guardian of the franchise embodied in the market.

Andrew Beazley, active underwriter with the Beazley Furlonge Ltd. managing agency, said making the franchise structure official would simply be recognizing what Lloyd's already has become. He said the franchise has great value, allowing insurance buyers to shop among competitors in a unique environment and come away with a "security" that bundles coverage from multiple underwriters under the Lloyd's name.

"The past few years have seen that value being jeopardized and tarnished" by bad underwriting, Beazley said. "Everyone has got to accept that there is a duty to the franchise; there is not just a duty to one's own business," he said.

Beazley said it was "extremely healthy" and "quite creative" for Lloyd's to seek alternative means for individual Names to continue trading. "The message that people have to understand is, this is not a civil war between private capital providers and the market," he said.

But Beazley argued that it was unrealistic for Names to go on with unlimited liability. "Socially, it's difficult nowadays...if people have to reach for assets beyond what they have exposed up front," he said.

Not all Names trade with unlimited liability, but those who do are liable for all of their personal wealth to pay losses if the capital held at a syndicate isn't enough to pay claims. Many Names suffered that fate during some of the market's darkest days in the late 1980s and early 1990s.

A Different Point of View

The Association of Lloyd's Members disputed the market's view of traditional Names, saying the annual venture's advantages were being ignored and its costs overstated. The ALM placed the blame for losses on bad underwriting rather than on the costs associated with the annual venture, saying that private capital has earned consistently better results than "overseas insurance industry capital" in recent years.

But Robert Childs, a director and partner with Hiscox plc, noted that 1989 and 1990, among the worst years in Lloyd's history, occurred in a market fully capitalized by Names. As for Names' comparative profits in recent years, Childs said they represent "a rump on the better-performing syndicates"--Names who can't be ousted from their profitable trading positions but can't claim any credit for those syndicates' success.

"That's a fair point," ALM Chairman Michael Deeny said. "It's not so much that Names make syndicates more profitable; it's that we don't make them unprofitable."

The ALM argued that the annual venture lets new capital enter the market without exposure to old losses; lets capital move with trading conditions; keeps managing agents and underwriters accountable for their performance; and fits well with the annual nature of most insurance and reinsurance contracts. Three-year accounting makes room for slow-emerging claims that can't be accounted for accurately at 12 months, the ALM said.

Deeny, a member of the Chairman's Strategy Group, hinted at the impending proposals in a letter to ALM members in December--and also suggested weapons the Names might use to defend their position if necessary. Deeny once led the Gooda Walker Action Group, which successfully sued a Lloyd's managing agency for negligent underwriting on behalf of Names, but he cautioned that Names' options for litigation generally are limited. Still, he noted in his letter that Lloyd's and the ALM both had been advised that Names' capacity on syndicates is a "property right" under the European Convention of Human Rights.

"Therefore, we have a good legal line of defense if a major attack were made on us," Deeny wrote. "Everybody should appreciate that the ALM is prepared to go to court if an attempt is made to deprive us of our fundamental rights without our consent."

Deeny also noted that the Names are able to overturn bylaws at an extraordinary general meeting, although it never has been done. "Private capital could outvote corporate capital, irrespective of capacity provided," Deeny wrote. "The ALM hopes and trusts that the Council would never put forward bylaws that would be fundamentally unjust to Names, but if this were ever to happen, the ALM would not flinch from calling an EGM [extraordinary general meeting] and urging all Names to vote to protect their interests."

Caroline Wagstaff, head of marketing and communications at Lloyd's, said the market is well aware of how much leverage the Names command. "Part of this deal will be that there will be some level of compromise," Wagstaff said. "Without that, this will not fly." She said no formal negotiations had begun, however. "So far, it's stakes in the ground," Wagstaff said.

Tax Issues

Individual Names also face a heavy tax penalty if unlimited liability ends, because they won't be able to carry forward old losses as a tax writeoff--a particularly grim prospect after the losses many members suffered from the Sept. 11 terrorist attacks on the United States, the ALM said.

"We don't think that these proposals will survive the consultation period," said ALM spokesman Robert Miller.

Stephen J.O. Catlin, chairman of Catlin Underwriting Agencies Ltd. and a participant in the drafting of the proposals, said the Names' tax issues "have been recognized and are being addressed." He noted that members would likely get the benefit of profitable years between now and 2005 to help them offset the tax losses expected with the end of unlimited liability.

Wagstaff also said that as the market developed alternative ways for Names to continue trading, it would explore ways to preserve at least some of the tax advantages they now enjoy.

Julian Avery, chairman of Wellington Underwriting plc and head of the Lloyd's Market Association, a group of corporate members, said he was hopeful that the proposals would overcome the initial opposition from Names. "I'm a great believer in commercial logic actually winning the day; the need for change is now being recognized," Avery said.

"There will be very few people who will find 100% happiness with each and every part of the proposals," he said.

Avery and others stressed the "transparency" that would result from abandoning Lloyd's arcane systems of accounting and oversight.

"Everyone is far more interested in Lloyd's today," said Joanna Parsons, an analyst with HSBC Securities in London. While three-year accounting is more accurate, it adds to the perception of an "opaque operation," Parsons said. If for no other reason, Lloyd's syndicates "have to present annual results for the market's sake," she said.

"Our aims are profitability, modernity and transparency," Lloyd's Chairman Sax Riley said in a statement. "Investors and policyholders have a choice of where they go, and we want them to be able to compare us easily, and favorably, with our competitors."

Competitive pressure and growing international scrutiny apparently have fostered a willingness among market participants to let go of unique features of Lloyd's that can't be shown to yield an advantage. "This great mysticism is probably more of a drag on our abilities," Beazley said.

Some supporters of the proposals suggested that the market's very survival hinged on pushing the changes through.

"If one hangs on to the past," Catlin said, "it's almost a death knell itself."

RELATED ARTICLE: Toe to Toe

Before Lloyd's revealed its radical blueprint for reinventing itself, the debate over the market's future already was coming into focus. Anthony E Markel, president and chief executive officer of Markel Corp., took the rhetoric of tradition vs. modernization to a new level in a speech delivered to the Insurance Institute of London on Jan. 8. Markel Corp. participates in the Lloyd's market through its Syndicate 3000, the entity formed when it recently consolidated six syndicates.

Markel's speech was notable enough by itself, pulling no punches in its call for Lloyd's to shed many of the trappings of its history. But it resonated more loudly when on Jan. 17, Lloyd's delivered a proposal for change--parts of which could have been written by Markel himself. That same day, however, David Shipley, active underwriter of Managing Agency Partners Ltd., fired back at Markel in an article published in Insurance Day. Following are some excerpts from Markel's speech and Shipley's reply

Markel: "Let's start with a fundamental precept: In order to change, you've got to recognize the need for change, be willing to accept change and aggressively pursue change. After two years of close observation, I'm not sure that's an accurate representation of the current mood here in London. As a matter of fact, I feel there is still a pervasive 'institutional arrogance' that belies logic and, frankly, is totally unsupported by results."

Shipley: "At the heart of the confusion in Tony's speech is a very old fallacy. It runs like this: 1) Something is wrong; therefore, 2) We need a change; and 3) Here is a change; so, 4) We need this change. It is how management consultants wreck businesses all over the world. If anyone hasn't worked out the flaws, they are: 1) We haven't identified what's wrong, so 2) We can't know how to fix it, and 3) We could make different changes."

Markel: "What are you--or I should say we, now--so proud of? Underwriting results are awful. Based on the latest estimates I've seen, Lloyd's will have lost almost [pounds sterling]6.5 billion (about $9.3 billion) for the five-year period from 1997 through 2001. Lawsuits and allegations of mismanagement have been rampant, costs continue to be of grave concern, and client service is awful. Hell, you got a 'clean slate' in 1992 with the formation of Equitas, and it took you less than a decade to totally screw it up again."

Shipley: "No, Tony, it took your peers less than three years to totally screw it up again. That, put simply, is the effect of American corporate capital, or, more accurately, overseas insurance capital as owners, on the Lloyd's market, and I have the figures to prove it. What happened was that, between 1996 and 1998, Lloyd's imported the worst features of the industry's herd behavior--dissipation of underwriting talent, demand for top-line growth, acquisition mania--and forgot what it was good at: rapid response from empowered underwriters, bespoke solutions rather than products, alignment of strategy and interest between capital providers, management and street-level underwriters."

Markel: "The annual joint venture needs to be eliminated. The total reconstitution of syndicate support creates an unproductive diversion of time and resources, in addition to emphasizing and supporting a short-term focus and mentality at the expense of a solid, businesslike long-term perspective and resulting discipline."

Shipley: "And why does Tony who owns his own business, feel so sorry for people like us with our onerous 12-month joint venture that he seeks to abolish for us? If you have a fully owned syndicate, all you have to do to reconstitute the capital each year is to renew a letter of credit and sign a few forms. Beats a rights issue."

Markel: "Some would say that this would signal the end of Names at Lloyd's. I have no problem with any form of investment in Lloyd's, as long as it is long-term capital! As a result, if the Names want to commit capital to the market on a long-term basis, I am totally in favor of it."

Shipley: "I'm sick of the endless debate about capital structures, and I'm heartily sorry for joining it again. You do what works for You, Tony, and let us do what works for us. Capital will generally be robust if it is making a profit, and vulnerable if it is losing money, just like anywhere else."

Market "We need to go to GAAP accounting. I think a recent quote from Morgan Stanley says it all: 'Lloyd's accounting is nontransparent, lacks real-time information and does not conform to international standards. Excellent financial information (GAAP) is important in retaining longterm, quality capital providers!"

Shipley: "Yet who really thinks GAAP accounting is transparent? Not the shareholders of any of the many companies who report excellent results quarter after quarter, and then take billion-dollar charges against adverse loss development (read, institutional under-reserving and overstated earnings). If a reinsurance cedant came to me with GAAP quarterly numbers, rather than triangulated underwriting-year statistics with case-incurred losses and IBNR [incurred, but not reported] losses clearly separated, I would laugh at him. Why do these investment gurus think they can make sense of GAAP numbers, when all the key detail is blurred? The syndicate quarterly returns are as good as it gets anywhere, and I recommend everyone in the industry reports on the same basis. That would separate the true analysts from the tea-leaf readers and momentum traders."