End of a tradition: Lloyd's plan to move to U.K. GAAP and then to International Accounting Standards promises to bring transparency to a traditional market that is now dominated by corporate interests.

On Jan. 1, 2005, Lloyd's of London will end a tradition of more than 300 years by adopting U.K. Generally Accepted Accounting Principles and moving from three-year reporting to annual reporting. Outsiders, who have long been puzzled about the arcane ways of Lloyd's, could be excused for seeing the change as a step from the unknown to the known.

Lloyd's believes that the switch, which eventually will be followed by the adoption of International Accounting Standards, will increase transparency and make it easier for outsiders to understand the workings of the market.

The change has been largely driven by the corporate capital that has come into Lloyd's over the past decade. This restructuring followed the huge losses, many resulting from U.S. asbestos exposures, that hit Lloyd's in the early 1990s.

These losses were a particular blow for many of the Lloyd's "Names," private investors who had accepted unlimited liability in exchange for the chance to participate in the market. Names had traditionally been drawn from the wealthiest strata of British society. Such investors, whose fortunes had grown along with the British Empire, were financially and psychologically prepared for a market that was capable of producing dramatic ups and downs.

In the years before Lloyd's ran into trouble, the roster of Names expanded to include people who were merely well-off rather than very rich. This group was largely made up of professional people attracted by the seemingly easy pickings, the relative low capital requirements and the social cachet of being a Name. But, as events were to demonstrate, the main drawback with unlimited liability is that it is unlimited. When the enormous claims began to roll in, many of these Names could not withstand the losses. Some complained that they had been steered onto syndicates that were likely to be hit hard.

In seeking corporate capital, Lloyd's began a long cultural transformation. The red-coated doormen are still at their entryway posts, important news of the day, such as the sinking of a ship, is carefully entered into a ledger in large, flowing handwriting that would not have been out of place in Queen Victoria's day. And the Lutine Bell, salvaged from the British warship Lutine, which went down in 1799, still stands over the proceedings, ready to signal major events, both good and bad.

But corporations live on information and the good opinion of their shareholders. Any reporting system that runs three years late is not likely to meet these needs. The corporate entities that now dominate Lloyd's have long been attuned to annual accounting.

"The change to annual accounting was very much brought on by the fact that all the major plcs in the U.K. report currently on an annual accounting basis," said Ted Noble, group finance director of Chaucer Holdings plc, which embodies the new corporate style of Lloyd's. "Plcs think on that basis. It's a more current basis of accounting than the Lloyd's basis."

Richard Hextall, finance director of Amlin plc, another corporate participant, welcomed the move toward U.K. GAAP as something that will increase transparency. "Good communications," he said, "help us to get across our message to clients, rating agencies and finance capital providers in a way that they can understand. The greater consistency that we have with normal accounting practice, the better."

Hextall said that Lloyd's reputation for complexity is another reason to make the reporting more understandable. He suggested that the old-style regime might create "a fear that you're hiding something and not giving a full picture."

Hextall is confident that the new reporting regime will produce information that will be more valuable to capital providers--particularly as these entities grow in significance within Lloyd's. "You have got a more powerful stakeholder from an analyst perspective, from a shareholder perspective," Hextall said." And if that power is collected into larger groups of capital, then it will drive change."

Kenneth Curtis, finance director of Chaucer Syndicates Ltd., the main operating subsidiary of Chaucer Holdings, agreed that the change to U.K. GAAP at Lloyd's fits in with a demand from stakeholders for greater transparency. And he sees an important advantage for the corporate interests within Lloyd's. "I think anything that makes Lloyd's results more transparent--and this will make the results more transparent;' Curtis said, "will be a plus in terms of attracting capital."

IAS Looms Large

The Lloyd's move to U.K. GAAP is not the only deadline on the horizon. As of Jan. 1, 2005, U.K. listed corporations will he required by the European Union to report their results under International Accounting Standards. Lloyd's itself has not said when it plans to move from U.K. GAAP to IAS.

Katherine Letsinger, group finance director for Wellington Underwriting plc and its managing agency, noted one barrier to the adoption of IAS by Lloyd's. She said that no decision has been made on how IAS will treat insurance contracts. She believes that the resolution of that issue might come in 2007. Letsinger regards the adoption of U.K. GAAP by Lloyd's as a cautious first step toward [AS.

Noble said that the three-year reporting regime has made it difficult to compare Lloyd's to the wider insurance market. "Annual accounting is a more current form of accounting," he said. "So Lloyd's highlighted results were always a couple of years old, whereas everybody else was always talking about what was going on now."

And there is the matter of continuing negative echoes. Lloyd's, for instance, is currently closing its 2001 underwriting year, evoking unavoidable memories of the terrorist attack on the World Trade Center. "One of the advantages of annual accounting," said David V. Draining, group Finance director for Lloyd's underwriter Creechurch Group, "is that it does bring what's happening at the moment to people's attention."

Curtis recalled that corporate money began coming into Lloyd's as far back as 1993-94. "So Lloyd's has muddled along for nine years or so without it [annual accounting]," he said. "But the major plcs have been reporting results [within Lloyd's] on an annual accounting basis for four or five years now."

Dunning said that the three-year accounting period is a product of history. Lloyd's traces its beginnings to the coffeehouse opened by Edward Lloyd on Lombard Street in 1691. There the London insurance industry of the day gathered to do business.

In the early days, Dunning said, the loss of a ship in a far corner of the world would not be immediately known to the people who had insured it. He added that an extended reporting period was also well suited to syndicates that could have different capital providers in each of the three years of account. "Lloyd's," Dunning said, "developed this system whereby they would wait three years for an account to close, therefore allowing either profits or losses to be crystallized for those Names on that particular year."

Years of Preparation

Lloyd's, with the inherent caution of an insurance market, has prepared painstakingly for the changes. Through its Chairman's Strategy Group, it has, over the past two years, elicited the views of market participants through seminars and questionnaires. Lloyd's approach and its argument seem to have been well received. "I think there is a genuine feeling that it is best to bring about consistency," Dunning said.

Patricia Hakong, head of accounting policy at Lloyd's, endorses the gradual strategy. "This isn't a sort of 'big bang' approach," she said.

Hakong believes that the move toward U.K. GAAP will suit the corporate members very well. "There is discipline with these entities," she said, "which means that the separate corporate members will have discipline on the managing agents that are writing the business."

Dunning said that, while the change will be welcomed, it will bring about a great deal of work in such areas as systems and routines. But he sees solid long-term savings in the eventual adoption of IAS through smoother processes and greater transparency. Dunning added that the switch from the relatively leisurely three-year reporting period to one year will create some information technology challenges. Dunning said that Creechurch, which outsources its IT, has developed its own annual accounting system to get a faster handle on its results. He said that Lloyd's has been working with the managing agencies to encourage the faster collection of data. "You have to get a pretty good understanding of what's currently happening and what your exposures are," he said.

Letsinger, a member of the strategy group, said that Lloyd's has done a good job of assembling representatives of various interests. She said that the committee includes people from agencies that represent spread vehicles, or syndicates that include both corporate capital and traditional Names. There are also agencies which deal only with corporate capital. And there is an agency whose corporate capital reports to its parent on a U.S. GAAP basis. Letsinger said that the people from the Lloyd's corporation "have done a good job in getting out into the market and surveying agencies to determine what the implications of the adoption will be."

Amlin is represented by Charles Phillips, its chief executive officer, on the strategy group, which was set up by former Lloyd's chairman Sax Riley. Hextall is confident that the transition to GAAP will go smoothly. "I think Lloyd's has done a good job over the last two years of making sure that they have got parallel numbers run for the global results," he said.

Putting GAAP Into Place

Despite the careful preparations, and the familiarity of Lloyd's participants with annual accounting, some shifts in attitudes will be required. Noble said that Chaucer has been encouraging its employees to think in terms of one year and not three. "We have done a lot in the way of internal presentations to managers and staff on what annual accounting is, how it works and what it means," he said.

Noble said that Chaucer has restructured its syndicates, which are about 70% supported by Chaucer money. Of the other 30%, he said, most is corporate money, with only a small amount held by individual Names. Chaucer also manages two syndicates on behalf of third-party capital. None of its money is behind those syndicates.

Wellington Underwriting is already using U.K. GAAP to report on its 56% holding in Lloyd's Syndicate 2020, which it also manages. Letsinger said that "the fact that the syndicate is going to be required to do U.K. GAAP in its reporting to Lloyd's does not necessarily bring significant differences to us from what we're already doing."

Letsinger believes that the larger Lloyd's syndicates are already determining their results on U.K. GAAP or on the similar U.S. GAAP. She said that the use of U.S. GAAP stems from the U.S. origin of so much of the corporate capital in Lloyd's.

This kind of familiarity is likely to limit the technical and procedural adjustments that will have to be made. Letsinger noted that all syndicates currently have to file annual accounting returns. She described this as the first step toward converting to U.K. GAAP The second step, she said, would be the publication by syndicates of the kind of financial statements that insurance companies already issue.

Letsinger said that Lloyd's has yet to resolve the details of profit distribution for syndicates that contain both corporate capital and Names. Under the traditional method, she said, the results would be struck after three years, with participants getting either their profits or assessments of their losses. "That's something that Lloyd's fundamentally has to determine," Letsinger said. "So it's not necessarily so much of an issue for us. We just need to understand what that framework is, how it will work and then what implications it will have on us."

The issue of distribution is not of great concern to Amlin, which controls 100% of its syndicate. Owning everything, Hextall said, "makes it easier for us as an operation in that we clearly can plan entirely within Amlin for what we want to do without consideration of third-party capital."

Hextall said that Amlin, which operates Syndicate 2001, has been involved in the Lloyd's market "in some shape or form since the 1920s." He said that Amlin became a corporate entity within Lloyd's in 1998 and has been doing annual accounting under ILK. GAAP within Lloyd's since 1999.

Hextall said that an overseas visitor to Lloyd's would find a traditional market, but one where decision makers can be easily contacted. Hextall does not believe that the Lloyd's traditions would inhibit change. "I think the management of most of the larger companies are now relatively modern in their thinking and actually quite determined to move things on," he said.