PF&M ANALYSIS: A LOOK AT LLOYD'S The history of Lloyd's began with Edward Lloyd's coffeehouse in 1688. His clientele included merchants and ship owners who had both cargo and vessels needing insurance protection when at sea. Mr. Lloyd s establishment quickly evolved into a meeting place where these businessmen searched for insurance brokers to place coverage for a variety of "perils of the sea" through financial arrangements with wealthy and reputable businessmen. Character and integrity were important because these wealthy businessmen "underwriters," who agreed to invest in the ships and cargoes, put up their personal fortunes as collateral to pay their share of any covered claim. On the other hand, these underwriters shared in the profits if the voyage was successful and without an incident. Note: The term "underwriter," according to some accounts, came from the practice of persons agreeing to insure a ship and/or its cargo by writing his name (signature) "under" the name of the applicable vessel. Lloyd's of London has long been identified with British history and the growth of worldwide commerce. Lloyd's is an international insurance market, located in London, England. Its members cooperate and compete with one another and with other insurance organizations. The major market groups at Lloyd's consist of: Aviation includes airports, global aviation, general aviation, aviation products, satellite, war and terrorism coverage
Casualty includes accident and health insurance, D&O, employer s liability, general liability, medical malpractice and other professional liability Energy includes traditional sources such as oil rigs (on and off-shore), refineries and green (renewable) energy (such as solar and wind). Marine includes cargo, hull, marine and liability Motor includes company fleets, collectible and vintage vehicles, high-value (such as unique and custom) vehicles as well as high-risk driver exposures Property Reinsurance In addition, Lloyd s has a market that handles short and long term life insurance. The Corporation of Lloyd's is a society originally incorporated under the Act of Parliament of 1871. The Corporation is not an insurance market or placement facility itself. It provides the premises, shipping information services, administrative staff and other facilities that enable the Lloyd's insurance market arrangement to transact insurance business efficiently and effectively. These transactions are actually done by thousands of Lloyd's members. Approximately one-third of the membership is actively involved in the market s insurance transactions. The remaining members are considered not active, meaning that they provide capital but do not actively place business in any Lloyd s market. The underwriters are members of more than 80 underwriting syndicates and only they can accept and transact business. Each syndicate is managed by an underwriting agent and his representative who operate within the underwriting room at Lloyd's, accepting business on behalf of the members of that syndicate. Some agents underwrite for more than one syndicate. Most syndicates write either Marine or Non-Marine business but some write both. Note: Lloyd s also has several, additional managing agents who are dedicated to handling syndicates that are running off its business. LLOYD'S FINANCIAL LIABILITY The financial liability structure supporting a Lloyd's policy is unique and unmatched anywhere else in the financial world. Lloyd's maintains substantial deposits of money and financial instruments in several layers, called the Chain of Security. It consists of individual syndicate and collective assets that help guarantee prompt payment of covered losses and claims. Underwriting Deposits New Lloyd s members must make an initial deposit of cash or certain approved securities. The amount of this deposit is based on the anticipated volume of business to be underwritten and it must always keep pace with the volume of business each member accepts. The Committee of Lloyd's, elected by its members to administer and attend to its financial affairs, establishes the maximum annual premium income for each member. If a member exceeds the established and approved premium limits, the Committee requires an appropriate deposit increase to support the larger premium volume. These deposits are held in trust and are available only as security for incurred losses and other underwriting liabilities. Premiums Trust Fund The members deposits are handled under a fund in accordance with a trust deed approved by the United Kingdom Department of Trade and Industry. The trust funds can be withdrawn for only the following reasons: to pay claims to return premiums to pay for reinsurance to pay expenses to distribute ascertained profits If a member becomes insolvent, all remaining available trust funds are used to pay any liabilities owed to that member s policyholders. The general creditors of a member have no claim on that member's trust funds until all outstanding policyholder
obligations have been completely met. Underwriting loss reserves are increased and added to from the underwriting profits of a member. Lloyd's Central Fund The Central Fund is intended to meet the remaining underwriting liability of a member declared insolvent or having inadequate security and personal assets to meet his underwriting commitments. It is funded by mandatory, annual contributions from all members and, when needed, is supplemented by a levy or assessment applied to every member or syndicate. Lloyd s Annual Audit and Accounting Method Each Lloyd's member is subject to an annual audit. Its objective is to identify and address any weaknesses or shortcomings in the financial structure of a given syndicate. The Committee of Lloyd's examines the underwriting accounts of each member. If the audit reveals insufficient funds or assets, the member must either provide additional security in amounts required by the Committee or cease all underwriting operations. Lloyd's is unique in this area in that it uses a three-year accounting method. That method is based on underwriting years of the account, each covering risks where the premium was accounted for during a specific calendar year. Losses paid during the second and third years of coverage revert back to the original year of the account, rather than being debited to the year of loss payment. No collected premiums are released from an underwriting year of account as a profit until after the end of the third year. At that time, the account is closed and the required reserves carried forward to a later year to meet any unsettled losses for that year. The annual audit requires a check of loss experience for both open and closed years at their respective stages of development or maturity. Open years are checked at the 12th, 24th and 36th months of their existence. It is believed that the three-year method has a number of advantages when compared to a one-year system. The three-year method makes closing an account after 36 months more accurately reflect mature losses and earned premium and any return premiums accounted for more accurately. With this approach, a greater proportion of losses on the account will have been settled and remaining outstanding losses will be more accurately measured. Finally, this approach provides a more accurate means to establish loss reserves at the end of each year. Audits address a wide array of concerns including: Accounting and General Finance Accounting Transactions Aggregate, Risk and Premium Bordereaux Analysis Claims Compliance and Governance Documentation IT and Data Security New recommendations Review of any previous recommendations Underwriting The audit report also includes extensive appendices with additional details and supplemental information. INSURANCE PLACEMENTS AT LLOYD'S Lloyd's transactions involve millions of premium dollars every day and come from every continent. Authorized Lloyd's brokers,
coverholders (an authorized intermediary) or open market correspondents are the only parties with direct access to the Lloyd's market. When a Lloyd's broker begins to arrange coverage on behalf of a client, it is done using a slip (a relatively simple document that gives the basic details of the risk to be placed). The broker then goes into the Underwriting Room of Lloyd's and approaches one or more lead syndicate underwriters who specialize in the type of risk he is trying to place. The underwriter asks pertinent questions about the risk and, if interested in providing coverage, suggests a rate for the exposure. Negotiations then begin in earnest to arrange for the optimum price and coverage terms. Often, more than one syndicate participates in coverage or other syndicates are sought if agreeable terms are unavailable. When all parties agree on a premium or rate, the underwriter "takes a line" by writing on the "slip" the share of the risk he accepts for his syndicate, along with the premium or rate and his initials. If the cover required is large, as is often the case, the "lead" underwriter usually accepts part of the risk instead of all of it. The broker then moves around the Underwriting Room with the "slip" and attempts to persuade other underwriters to take portions of the risk at the same rate or premium until the commitments cover 100% of the risk or exposure. At times, the broker will "over complete" the risk. This is done to provide room for needed future limit increases as well as to give as many underwriters as possible the opportunity to participate on the risk. The proportion of participation by each syndicate is then adjusted so that the coverage totals 100% (along with allowance for future coverage increases without involving other underwriters). The degree of trust and confidence between brokers and underwriters is illustrated by the "slip." Initially, the "slip" is the only written evidence of an agreement to insure between the parties. The broker knows that a legitimate claim will be honored, if necessary and before an insurance policy is issued, when the "slip" contains the initials of the underwriters. In years past, all insurance policies at Lloyd's had to be personally signed by the individual underwriters accepting a share of the risk. Today, the Lloyd's Policy Signing Office checks policies and compares them against the "slips," signs them on behalf of the involved syndicates and marks them with its official seal. THE LLOYD'S UNDERWRITING ROOM The hub for underwriting activities at Lloyd's of London is its modern headquarters building. The 20-story glass and steel building is located in the heart of the London financial district. The London Insurance Market Network is the name given to the vast array of electronic technology used at Lloyd's and throughout the London market. It includes a number of services, such as electronic mail, electronic data interchange, interactive inquiries and access to commercial information databases, among others. This screen-based electronic interchange allows the Network to embrace the global market to include standardized information, requests for quotes, claims advice, settlement services and funds transfers. Electronic technology has replaced much of the personal contact that used to be essential to making coverage commitments characteristic of the Lloyd's system for more than three centuries. In spite of this development, personal contact, communication and commitments continue because these characteristics are part of the trust and integrity of the Lloyd's arrangement and system. The Underwriting Room at Lloyd's has retained the traditional layout and arrangement of functions that existed when it first began. One wall is devoted to the Casualty Board, referred to as the "chamber of horrors." This is where special reports, faxes and telegrams from around the world are posted with news of maritime and aviation casualties and more general disasters and occurrences such as strikes, floods, earthquakes, hurricanes or tornadoes and catastrophic fires. The underwriters take special note of these events and the events of a given day profoundly affect the atmosphere and working of the Lloyd's insurance market. This information is the result of the work of the Lloyd's Intelligence Department, widely recognized as the world's fastest and most accurate news gathering system. Reports are compiled and submitted by Lloyd's brokers, not insurance producers, around the world and are dispatched by the latest or most effective method of communication. The center of the Room contains a lectern that holds the Casualty Book. This is a large volume in which a clerk enters the major
marine casualties of the day, as they occur, using a traditional quill pen. In the middle of this unique and unusual business setting are men wearing livery, a distinctive uniform worn by male servers, and called "waiters" as was the case with the staff in the original coffeehouse. Lloyd's is a blend of the old, traditional methods and the new, including the latest technological developments, that produces a product based on modern techniques superimposed on time-tested methods. For example, "calling," which is the way brokers contact their colleagues, dates back to the original coffeehouse days when a boy read notices from a pulpit. At a later date, a waiter called the names of brokers through a megaphone. Today, a microphone is used at the Caller's Rostrum. When a broker hears his name over a speaker system, he signals his location using screens in the Rostrum and in the Gallery using an electronic system. Underwriters in the Room sit at wooden pew-like desks, known as "boxes." These are another survivor of the original coffeehouse days. Most underwriters occupy surprisingly small spaces, but millions of premium dollars can be transacted in even the smallest box each year. Marine, Motor and Aviation business is transacted on the ground floor. Non-Marine boxes and business transactions occur in the immense gallery that circles the upper story of the Room. Lloyd's maintains its long-standing traditions and habits because they are practical and still work. A waiter is easily recognized when needed. The Casualty Book as devised is a practical and handy work reference. In a city where floor space is precious and carries premium prices, the boxes are as inexpensive, practical and convenient a use of space as anything and a more convenient and accessible arrangement in which to transact business could not be devised. The accumulated knowledge, expertise and skill of the individuals both in the boxes and between the different syndicates are a particular and special strength of the organization. It creates a special environment for the free and spontaneous exchange of ideas. In addition, Lloyd's takes a special and deserved pride in its history, its trappings and its traditions. CORPORATE CAPITAL Starting in 1994, corporate investors were allowed admission to Lloyd's as members for the first time in its history. The parties supporting this change believed that corporate investors were needed in order to reduce or eliminate further erosion of Lloyd s capital base. At the time, the market capacity of Lloyd's had dropped from over $21 billion to only $13.5 billion. The parties that expressed interest in such a corporate investment were combinations of insurance brokers and other financial entities, such as investment banks. These combined ventures were formed into companies that invested in Lloyd's. Other corporate membership came from existing names that incorporated themselves, or pooled their resources with other names to form a corporation. Corporate investors have limited liability, unlike the unlimited liability of individual names, and are protected from losses over their authorized capital at Lloyd's. Investors incorporated within the European Economic Community were required to have a minimum capitalization of 1.5 million pounds. LLOYD'S CURRENT STRUCTURE Lloyd s consists of its various members (both non-corporate and corporate) and the market, the structure that facilitates its myriad insurance and reinsurance transactions. The overall structure of Lloyd s is made up of its Council (including reporting committees) and its Directorates (see below). The Council of Lloyd s is, essentially, its executive leadership to which reports the Franchise Board (which oversees the Market Supervision and Review Committee, the Investment Committee and the Capacity Transfer Panel) as well as the following committees: Lloyd s Appeal Tribunal Nominations Remuneration
Audit Enforcement Board Lloyd s functions are facilitated by six large departments, called Directorates: Corporate Services This umbrella consists of departments that handle auditing, business and strategic planning, marketing, personnel (human resources) and governance. Finance, Risk Management and Operations Monitors Lloyd s financial stability, resources and assets use. International Markets Oversees Lloyd s international operations (other than North America), pursues business opportunities and monitors new exposures via emerging markets. Market Operations Essentially handles initiatives designed to keep Lloyd s operations (particularly work processes) efficient and competitive. North America and General Counsel Handles Lloyd s legal services, relations with U.S. managing agents, oversees Lloyd s North American operations and deals with Lloyd s government and regulatory affairs. Performance Management Oversees review of syndicate performance, monitoring asset levels with regard to risk levels and ensures compliance with underwriting and service guidelines KEEPING TABS ON THE FUTURE Many aspects of Lloyd s corporate functions involve seeking opportunities and focusing on maintaining its viability. Two specific initiatives reflect this focus: Lloyd s 360 Project This project involves, primarily, research and educational initiatives that focus on global insurance and risk topics, including hosted live and cyber presentations with subject expert panelists and debates, production of white papers and support of non-lloyd s groups. Emerging Risks Lloyd s devotes significant resources on monitoring and researching ways it can educate the public and create products to assist in handling developing risks. Recent information provided by the organization dealt with topics such as: Data Loss Bedbugs rising exposures and available insurance Impact of population growth Controlling business costs created by obesity Changes in areas targeted by hackers Social networking risks