When I was a kid I remember that there was a fad where people in entertainment would insure themselves with Lloyds of London. For example, an opera singer might insure her voice or a stripper might insure her breasts against sagging. These policies were frivolous and the only reason that they were taken out was to get attention in the press. At the time, Lloyds of London was the oldest and most famous insurance company in the world. They were (and may still be) the largest insurer of shipping. Lloyd's of London was also famous for being willing to take any insurance risk, provided the premium price was right. This made Lloyd's somewhat more glamorous than their staid American competitors and, as long as Lloyd's underwriters were careful that the premium matched the risk, Lloyd's was also extremely profitable. Today Lloyd's is mired in litigation and its long term survival is not assured. Adam Raphael's book, "Ultimate Risk", tells the story of the rise and fall of Lloyd's of London.
Insurance brokering and underwriting has its roots in shipping. In seventeenth and eighteenth century England, large fortunes were made by merchants, especially by those in the spice trade. Although a successful voyage could enrich the shipping syndicate that put up the money for a cargo of spices, the loss of a ship could also bankrupt them. To offset this risk, groups of investors would underwrite insurance for voyages, in return for a healthy premium. Although the underwriting premium cut into the profits of the merchants, it removed the risk of bankruptcy.
In these early days, insurance was an informal affair, conducted in coffee houses and pubs. For a commission, an insurance broker would gather together a syndicate of underwriters, who would insure the ship and its cargo against loss. The broker collected a commission on the premium paid to the underwriters and the members of the underwriting syndicate personally guaranteed the insurance policy. The risk and rewards of insurance underwriting attracted its share of gamblers, not all of whom paid off when disaster struck their policy holders.
Edward Lloyd opened Lloyd's Coffee House on Tower Street, near London's Tower Warf and the customs house, some time around 1680. Lloyd's coffee house drew its clients from the shipping trade and Lloyd started publishing "Lloyd's List", which carried shipping news. Edward Lloyd died on February 17, 1713, but the brokers and underwriting syndicates that met in his coffee house continued to meet, using the "Lloyd's" name.
Lloyd's of London would go through many changes in the two hundred years that followed, but the basic nature of Lloyd's remained unchanged from the eighteenth century: Lloyd's is a collection of underwriting syndicates, where the members of the syndicate personally guarantee the policies they write. This means that the Lloyd's syndicates keep the insurance premium (minus the broker and syndicate commissions), but are also exposed to unlimited liability if they must make good on an insurance claim. The underwriting investors are known as "Names" and the unlimited liability associated with being a Name has, historically, made being a Lloyd's Name something that has been open only to the wealthy. As Lloyd's evolved from its coffee house origins, the Society of Lloyd's evolved into a corporation that provided loose supervision over Lloyd's underwriters and the brokers that traded with them. The trading standard of Lloyd's has been "Uberrima Fides", meaning "upmost good faith". In Ultimate Risk, Adam Raphael, a journalist and a Lloyd's Name, chronicles the decline of Lloyd's "upmost good faith", which has gone hand in hand with the decline of Lloyd's itself.
During most of its existence, Lloyd's had only a few thousand Names who invested in Lloyd's syndicates. In most cases, Names investing in a Lloyd's syndicate knew nothing about the risks they were underwriting. They trusted the managing agents and member's agents who put together the underwriting syndicates and selected the policies that the syndicate would underwrite. Although Names were not always fully aware of the implications, the unlimited liability of a Lloyds Name meant that they were placing great trust in Lloyds and its agents. Historically, this trust was enforced by the common bonds of society and schooling, since Lloyds names were members of the British upper class.
Lloyd's was the ultimate "Old Boy's club". The usual arms length relationship between an insurance broker, who seeks to insure a risk and the insurance underwriter, who guarantees against the risk, did not exist at Lloyds. The potential for abuse that this represented for the Lloyd's Names became a reality in the 1980s. During this time, the number of Lloyd's names swelled from 6,000 at the start of the decade to 32,433 at the decade's close. Many of the new Names were professionals who were attracted to Lloyd's by its reputation as a safe investment that paid a good return. Most Names did not fully understand the risk that they ran investing with Lloyd's, where the potential for lose could be many times their investment. Many of these investors were placed in syndicates that were exposed to massive asbestos and pollution liability. Thousands were bankrupted.
Billions of dollars in losses were concentrated in about a third of the Lloyd's syndicates. Most of the Names who ended up investing in these syndicates were passive investors in Lloyd's, referred to as "outside Names". While these syndicates piled up huge losses, bankrupting the Names that invested in them, other syndicates, largely subscribed by Lloyd's insiders, racked up huge profits, in many cases in excess of thirty percent a year. As these facts were disclosed, there was a storm of litigation, which continues today. In the "San Jose Mercury News", on February 22, 1996, there was a small article in the Company News section:
"California regulators sued Lloyd's of London late Wednesday, claiming the insurance company misled more than 500 investors in the state.
The lawsuit, filed in state Superior court in Los Angeles, is the largest legal action brought by a state against lloyd's.
The California department of Corporations is asking the judge to issue a temporary restraining order and permanent injunction prohibiting Lloyd's from selling investments in the state. A hearing on the restraining order is scheduled for next week.
Like lawsuits filed by other states, California claims Lloyd's violated state securities laws by misleading potential investors. Lloyd's began opening its once exclusive syndicates to new investors in the early 1980s, and thousands were attracted by the company's reputation. Many investors recruited during the 1980s claim Lloyd's never told them they could be liable for huge losses from asbestos and other environmental claims.
Lloyd's officials weren't immediately available for comment."
Ian Kaplan - 2/96, revised 5/96
See also Risky Business: An Insider's Account of the Disaster at Lloyd's of London by Elizabeth Luessenhop and Martin Mayer
The changes that have racked Lloyds have also been rippling through the rest of the insurance industry.
It didn't take Jon Rotenstreich long to find the evidence he needed to justify a thorough shake-up of TIG Holdings Inc., a big insurer. The new CEO merely took a stroll through the company's parking garage, where stood a dozen top-of-the-line Lexuses, replete with gold trim, hubcabs and tailpipes. They were part of a 500-car corporate fleet, much of which Mr. Rotenstreich says had no meaningful business use.
"It was an entitlement culture," he says.
Indeed, virtually the entire insurance industry once was an entitlement culture. Fat and happy, insurance companies were content to sell their life, health, property and liability policies to businesses and individuals with little thought to how times were changing. But they couldn't insure their own financial health. And now they are being shaken to the core.
The nation's large, old, multiline insurers -- supermarket sellers of insurance, offering virtually all things to all people -- have been battered by an array of forces, ranging from hurricanes and earthquakes to toughened regulatory oversight and court rulings exposing them to giant pollution and asbestos claims. But for all those forces, the true undoing for many of them was slowness to adapt to what was happening around them.
Behind the Curve: Old, Multiline Insurers, Beset By competition, Hurry to Restructure by Leslie Scism, The Wall Street Journal, May 10, 1996.
The survival of the Lloyd's of London insurance market seems unlikely. Although change among insurance companies like Aetna has been slow, it has been much more rapid than change in the venerable institution of Lloyd's of London. Liabilities continue from the 1980s and Lloyd's Names have had such huge losses that it seems improbable that anyone would invest with Lloyd's in the future, at least under the old terms of unlimited liability. Further, many Names are embroiled in law suits with Lloyds. Some articles from The Wall Street Journal covering Lloyds developments after the period documented in Ultimate Risk are included below.
During the 1980s Lloyd's breached its promise of trust and about 30% of those who invested in Lloyd's suffered massive financial losses, while Lloyd's agents and Lloyd's insurance market insiders make substantial profits. As suggested above, I am pessimistic about Lloyd's future. The way they operate is anachronistic. They took advantage of their investors. However, in the last year Lloyd's has returned to operating profitability and some sophisticated investors have invested in the Lloyd's market. The insurance industry magazine Rough Notes tends to be more optimistic than I have been.
Much to my surprise, Lloyd's survived. Lloyd's is still underwriting
insurance and has, apparently, returned to profitability. The
majority of Names have joined an agreement which has limited their
liability (although in some cases at substantial cost). Some Names,
especially in the United States, are still in litigation with Lloyd's.
Many of Lloyd's newer investors are large European insurance
companies. I would be interested in reading an article that fully
outlined where Lloyd's new capital came from and what its new
structure is. Lloyd's was (and may still be) an anachronism that could
only exist in Great Britian. But Britian is increasingly part of the
world markets. It would be interesting to know if Names still
underwrite insurance. Certainly what happened in the recent past
should give any individual thinking of investing in Lloyd's pause.
November 1, 1997
Lloyd's of London won a legal battle Friday (July 31, 1998) and can go after #150 million ($245 millon) from some 500 investors who lost a fortune in the market but don't want to pay up. The investors, known as "names", are individuals who, in keeping with Lloyd's tradition, had put up their entire personal wealth as collateral to back the companies insurance policies. When the market lost #8 billion ($13 billion) from 1988 to 1992, many of the names complained they had been cheated by Lloyd's insiders and refusted to pay their bills. Lloyd's won a judgement against the investors in March and on Friday the Court of Appeal refused to let the names keep fighting.
The Wall Street Journal, pg. A10, August 3, 1998
Comments in italics are mine:
For many of the Names who lost the judgement, this means bankruptcy. They will lose their houses and everything else they have spent their lives building up. Lloyd's response would be, no doubt, that they should not invested with Lloyd's had they been unwilling to bear the risk (drop you knickers, bend over and take your strokes, Old Boy). However, none of these investors understood that they were underwriting massive asbestos and pollution liability. In fact, Lloyd's did not tell the names what they are underwriting, in any detail. Most of these Names invested because they trusted Lloyd's and its traditions. I remain curious about whether Lloyd's has maintained the tradition of "Name" underwriting and if so, whether they have any safeguards in place to stop this sort of abuse from happening again. It will be a generation before members of the British professional and upper classes forget what it can mean to be a Lloyd's Name.
Lloyd's of London Moves to Boost Its Central Fund
Lloyd's of London, which was forced to rack up billions of dollars in losses in the late 1980s and the early 1990s, insured its own central reinsurance fund for as much as #500 million ($806.8 million) over the next five years. The policy, underwritten by several key industry players including Chubb and Swiss Re, provides for up to #350 million of cover a year once Lloyd's fund has paid out #100 million. The move by the giant insurance market, which insures everything from ocean liners to the voices of world famous opera singers, is being seen as an effort to lure more capital to the market. And more importantly it would act as a buffer to prevent investors in Lloyd's, both individuals and the market's growing number of corporate backers, from shelling out additional money once the central fund has been exhausted - a scenario that had occurred only a few short years ago.
The centuries-old Lloyd's was quick to note that it hadn't run out and bought insurance in anticipation of a new round of steep losses. Nevertheless, those who closely watch the insurance industry have predicted for some time that the venerable market will slip into the red for 1998. It will be awhile though before those figures are reported - Lloyd's posts it results three years in arrears.
The Wall Street Journal, pg. A17, April 20, 1999
Lloyd's does not seem to disclose its capital structure - specificly the capital that goes into the various insurance pools. But given the hints in the press and the conclusions that can be drawn from Lloyd's recent history, it is safe to assume that Lloyd's has moved toward being a market for corporate insurance underwriting. The old days, of old boys who invested their inherited wealth in the Lloyd's market, are largely gone. A number of these old boys were bankrupted. The players left in the Lloyd's market are large insurance companies pooling assets to underwrite corporate risk. By removing the risk of unlimited liability, Lloyds has removed the last barrier that would give prudent investors in the insurance market pause. Lloyd's structure is still unique, but it has adapted to the new realities in the insurance industry.
April 20, 1999
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