Nick Wooldridge discusses the impact of corporate capital on Lloyd's and how the market is likely to develop in the future.
Ten years ago, Lloyd's underwriters were preparing to close their 1987 year of account, a year that included the most violent storm that this country had seen in living memory, along with continually mounting claims from asbestosis and pollution. The events of the year were the starting point for the dramatic changes to the capital structure of the marketplace and the debate surrounding bespoke and corporate capital.
Over-capacity in world markets was mirrored within Lloyd's by record numbers of Names. Insurance and reinsurance rates fell. During the next three years, losses mounted, syndicates were left open, Names started to resign in droves and action groups were formed. It was clear that Lloyd's was approaching meltdown and that it needed to address a number of issues quickly.
Then chairman David Rowland and his taskforce produced their report in the spring of 1992, dramatically accelerating the chain of events started in 1990. The original objective was to examine the capital base of Lloyd's and identify the way in which it should be trading in the year 2000. This expanded to include changes required to improve the capital base, improve the market's competitiveness and develop a new structure for governance. The report contained four recommendations which have influenced the current structure of capital within Lloyd's.
The introduction of members agents pooling arrangements (MAPAs) enabled Names to diversify their risk across a broader range of syndicates at a lower cost. MAPAs have been a feature of Lloyd's capital from 1993, when they were introduced, until the present day, although capacity provided via them dwindled to £1.231 billion in 1999 from a high point of £5.84 billion in 1994.
The report also recommended that syndicates should be able to access corporate capital through qualifying quota share arrangements, with the view to convert them to limited liability membership when the relevant changes to the Lloyd's acts could be made. The concept of trading membership participations was introduced, initially to enable transparency and efficient allocation of capacity and for Names to recognise some of the value of their membership. Ultimately, the greatest benefits have been recognised more by corporate capital than by Names. Finally, it was proposed creating an “old year centre of excellence” to provide claims advice and settling services to the Lloyd's market. It could be said that the idea of this proposed centre turned into what is now Equitas.
These four proposals enabled Lloyd's to replace much needed reducing capacity over the short term, in a hard market; to lay the foundations for the future capital base, should the reductions in traditional capacity continue; to put in place a fair transfer process to both buyer and seller of capacity which has allowed corporate capacity to own 72% of the 2000 capacity of £10.158 billion, and to give that capacity the assurance that it would not be affected by events prior to 1993.
The initial trickle of new capital that resulted, amounting to £1.595 billion out of £10.898 billion in 1994, grew rapidly as the formation of Equitas became a certainty. By 1997, it had grown to £ 4.5 billion out of £10.232 billion. Ironically, much of the capital came from Bermudian companies, some formed during the early 1990s to take advantage of the lack of world-wide catastrophe capacity, whose short lives had been spectacularly successful.
Not all of the capital base was happy with the formation of Equitas. Names on the 44 syndicates which ceased trading during 1993 still had open years of account. These syndicates became known as “orphans”. During 1997, the commercial reinsurance to close market was born, backed by mainly corporate capacity. Syndicate 1227, corporately owned by the Terra Nova group, was formed with the principal objective of reinsuring these orphans and allowing remaining Names to finalise their affairs at Lloyd's, if they desired. Between ourselves and our competition, the vast majority of orphans have now been closed, all at a more competitive rate than had been predicted by some commentators.
The initial influx of corporate capital was on a spread basis, with vehicles investing across a range of syndicates but, in 1995, the concept of a dedicated corporate member came about. These members backed individual managing agents and their syndicates and have, over time, been buying out the remaining capacity on syndicates via the auction process. The “dedicateds” will convert to Integrated Lloyd's Vehicles (ILVs) when full ownership of capacity has been achieved. Regulations allow for mandatory purchase of outstanding capacity once the dedicated owns 90% of a syndicate. Some of the medium sized dedicateds have already achieved ILV status and the larger providers are hard on their heels. These ILVs will become the most common form of capital provision over time.
The most visible outcome of these developments has been the reduction in the number of syndicates from 156 in 1998 to 123 in 2000. Twenty eight syndicates merged or ceased trading for the 2000 year of account and 11 new syndicates were formed. Most of the capacity for the new syndicates was corporate. From 1998 to 2000, the numbers of individual Names dropped from 6,828 to 3,411 in the absence of new members to replace resigned or deceased Names, although some of the reduction is accounted for by conversion vehicles or Namecos, individual Names trading with limited liability.
Over the same period, corporate members have increased from 435 to 885. Although Namecos do play their part, the vast majority of the capacity is held by the true corporate vehicles. In 1999, only £732 million out of £7.170 billion was in the form of conversion vehicles in the corporate sector. As the move to ILVs continues, the position of the traditional Names will come under more pressure. Their capacity will be bought out or their syndicates merged. It will become harder for them to gain capacity on profitable syndicates.
Ironically, at the same time, the 2000 year of account is witnessing the first significant withdrawal of corporate capacity. This retraction has been caused by poor results emerging from the past and the likelihood of worse results in the future. Ten years on from the start of the process, the market again is looking at poor result projection, inadequate rates and open syndicates. The coming years will be the first test of the resilience of the corporate capital providers. How will they react?
Our own capital provider, Terra Nova, is in the process of merging with a new wave of American capital in the form of the Markel Corporation of Richmond, Virginia. The synergies between the two groups are many and subject to the approval of regulators and shareholders.
The approach taken by Lloyd's regulators appears to be fairly sanguine. They will obviously ensure that any withdrawal will be orderly, protects policyholders and retains Lloyd's reputation. They also appear confident that, with the market mechanisms in place, replacement capital will come into the market if it sees an opportunity.
The rating agencies also appear confident, with Standard & Poor's considering Lloyd's strong business position, regulatory management and capital adequacy amongst other factors in granting their A+ (strong) financial strength rating. A.M. Best likewise stresses excellent capital strength, lead position in various markets and regulatory oversight in affirming Lloyd's A (excellent) rating and financial size category XV.
Although short term result projections do not look healthy, there are signs that returns for the future capital base of the market will improve. That capital base will be corporate in the form of ILVs, insurance based, with the majority quoted on American stock markets.
Nick Wooldridge is underwriter of syndicate 1227, Lloyd's.