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Treading water at Lloyd's.

THE LESSON that can be learned from Lloyd's recent announcements is that there is no better delaying tactic than setting up a task force.

Lloyd's has been having a bad time for the last few years as underwriting losses have risen and the names, or the individuals who subscribe their personal wealth to form the market's underwriting syndicates, have resigned and taken their money elsewhere.

Some action needs to be taken, but the Lloyd's establishment, like all ruling inner circles, prefers the status quo. Pressure has mounted for change, with the outside," non-market names appalled by losses and the apparent indifference to their plight of the people who run Lloyd's. Therefore, a compromise was achieved: a task force was set up under David Rowland, chairman of Sedgwick Insurance Brokers, to make recommendations for change.

That action maintained the status quo for the period during which the task force was at work. Now that it has issued its report last January, the Lloyd's Council can stop any change from going into effect for much longer by setting up working parties to look into the feasibility of implementing particular recommendations of the Rowland report. When these working parties eventually report, spearhead teams will immediately be created to weigh the pros and cons of implementing the working parties' reports on the feasibility of accepting the recommendations of the Rowland task force. It might be helpful to remember, the Rowland task force was established essentially to look into the validity of the demands for change which the outside names had been making for years. It could go on like this forever ! With some luck, most of the Lloyd's ruling elite will reach their natural retirement age before anything is done to radically alter the way Lloyd's operates. Or at least they will do if only Lloyd's survives that long as a competitive and viable force without radical revision of the way it works.

Perhaps the dire nature of Lloyd's problems will, however, force Lloyd's to change quickly and radically. If the Rowland recommendations are all implemented, will they restore the balance of risk and reward to keep the old names happy, and at the same time, attract new ones?

In the good old days, underwriters made big profits for their names. Even when Hurricane Alicia produced a bad year or two, it was only a blip on an otherwise steady profit line. Also, the Lloyd's scandals of the late seventies and early eighties had not yet occurred, nor was there a multitude of regulations to prevent them from occurring again; thus Lloyd's expense ratios were much lower in those days. Concurrently, with increased expenses at Lloyd's over the past decade, insurers have been gradually reducing expenses, thus improving their competitive position in relation to Lloyd's. Lloyd's expenses used to be about 4 percent of premium income-, nowadays they stand about 13 percent of gross premiums.

In addition, Lloyd's once offered names a unique tax break. Because the Lloyd's system only calls on names to provide capital to pay claims, the names are in fact being given a chance to "use" their wealth twice. Money invested in stocks is also used to back premium and earn a profit from under-writing. This sounds like a nice idea, but it was even better in the days when the United Kingdom's top-rate taxpayers faced a marginal tax rate of 98 percent. If there were underwriting losses, they could be offset by other taxable income. in effect, because the tax rate was so high, the Inland Revenue was underwriting the risk of underwriting losses.

But that was not the only tax break. Both names' deposits (which is the percentage of their total wealth to be lodged with Lloyd's) and incoming premiums were invested. This was because, as with all insurance, profits from investment were often needed to offset losses from pure underwriting. But as the top tax rate on capital gains was only 30 percent compared with income tax of 98 percent, names naturally preferred capital gains to investment income.

The high taxation of income and low taxation of capital gains increasingly put Lloyd's further away from the short tail, low-profit volume business to the more long tail classes which had the disastrous consequences for future underwriting. On the latter business, the Lloyd's syndicate could increase its reserves each year and create income tax losses while paying out capital gains on reserves as a low taxed income to names. Unfortunately for the names, all top United Kingdom tax rates were levelled at 40 percent by 1988; thus the capital gains tax break was at an end and underwriting profits and investment income became vitally important-just at a time when the huge underwriting losses began ! It is also more costly for a name to join Lloyd's nowadays since the deposit with Lloyd's has to be 30 percent of his proposed premium capacity compared to the old level of 20 percent. Therefore, in an attempt to restore the balance of risk and reward for names, the Rowland task force has recommended:

Maintenance of unlimited personal liability, but the introduction of high-level compulsory stop loss from January 1993. The stop loss would be funded by compulsory annual contributions from names and would pay when a name's losses exceeded 100 percent of his overall premium limit over a four-year period.

Limited liability capital introduced through corporate membership but subject to certain safeguards, a device to maintain Lloyd's capacity if too few names sign up, CentreWrite, Lloyd's central reinsurance facility established to provide run off reinsurance for syndicates, to amend its approach to the problem of giving individual names a means of escape" from Lloyd's if they want it.

* Retention of three-year accounting.

* Strengthening of names' rights.

* Introduction of Members' Agents' Pooling Arrangement (MAPA) from January 1993 to spread a name's risk across a wide-range of syndicates so as to avoid unlucky names being hit by huge losses while lucky names take home big profits.

* Wider mix of more flexible distribution channels.

* Need for substantial cost reduction.

* Additional reserves.

* A radical vision" of a structure of the agency system.

* Investigation of a system of value for syndicate participation, i.e. a system whereby names could trade their syndicate participation as if they were dealing in stocks.

* The creation of a Lloyd's market Board and a Regulatory Council to end the present situation of a combined Council in which, by analogy, the criminals not only sentence themselves but write the laws.

Perhaps the most radical of these recommendations was the last one, seeking fundamental change in the way Lloyd's is governed. Hence, it was immediately rejected by Lloyd's chairman as nonsense, and then, a day or two later, because of immense pressure from names, he softened and set up a working party to look into the matter.

One of the least important recommendations was the first - a stop-loss for names - so it was accepted immediately. In point of fact, at the recommended rate the fund will develop 2 5 million a year. Given Lloyd's current losses of I billion pounds a year, it is unlikely to solve any name's problems because if the fund is exhausted, the liability again returns to the name.

To sum up, there is probably a lot of merit in the recommendations, but we have to wait and see how many of them are implemented. Yet even if they are all implemented, Lloyd's still has the problem of dealing with its underwriting losses. The recommendations are all a waste of time unless Lloyd's starts underwriting profitability again. Fortunately, there are some signs that this is beginning to happen. Lastly, it is worth pointing out to Americans (since Lloyd's gets so much press coverage nowadays) that its security, despite the underwriting losses, is still extremely good, while in the United States hundreds of insurers have gone under in recent years.

The Council of Lloyd's met recently to discuss the task force report and endorsed its recommendation that Lloyd's be committed to steady growth in capacity, income and profits. The Council also supported the principle of the primacy of names' interests and the idea of strengthening the partnership between Lloyd's brokers and the market.

According to David Coleridge, chairman of Lloyd's, the task force's recommendation that a scheme be introduced which offers members high levels of protection against losses merits "detailed consideration," as does the proposal of introducing corporate capital directly into Lloyd's.

"Some recommendations can be implemented on a short time scale, and will be pursued urgently," he says. "Others would be dealt with on a longer time scale, including those which would require a new Act of Parliament." Mr. Coleridge congratulated the task force on the "speed and efficiency" with which it produced its report saying, "it strikes a balance between the need for continuity and the need for reform.
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Title Annotation:European Perspective; Lloyd's of London
Author:Best, Chris F.
Publication:Risk Management
Article Type:Column
Date:Mar 1, 1992
Words:1469
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