A set of proposals designed to take Lloyd's of London into the 21st century has met with a mixed response.
In 1996, Lloyd's of London chose September to implement its Reconstruction & Renewal (R&R) plan, an ambitious and innovative programme to salvage the tattered market from its legacy of long-tail liabilities and the infamous spiral. R&R spawned Equitas, the reinsurer of Lloyd's pre-1993 liabilities and what, at the time, promised to be a new order at the world's oldest insurance market.
Things did not prove to be so easy, however. Six years on, the market is facing £7bn in losses and has dozens of open years - syndicate years unable to close their books because of problems in quantifying their exposures or the unwillingness of other syndicates to take on the liabilities. In the meantime, corporate investors had come in - and a number had exited again - while the Central Fund, the `mutualisation' element of the Lloyd's model, was increasingly being called upon to settle the losses of Lloyd's members unable to do so themselves.
It appeared that the lessons of the past had not been translated into the market of the future, and that if change did not happen fast, it was unlikely there would be a market in the future.
Current Lloyd's Chairman Sax Riley, who will retire his post at the end of this year, in April last year put together a team from different parts of the market to look at the alternatives for the market. Called the Chairman's Strategy Group (CSG) and supported by management consultancy Bain & Co, the team issued a package of radical measures to lead the market into the 21st century. The initial proposals were issued at the beginning of this year, followed by a period of consultation with the market and Lloyd's membership. Several of the original proposals, in particular the recommendation to end unlimited liability membership (an old chestnut which continues to provoke outrage among traditional Names), were found sufficiently unpalatable that they were either dropped or substantially amended. At a recent meeting of the Association of Lloyd's Members (ALM), Mr Riley explained how one of these proposals was received by the membership: "In 2001, our opinion research showed that most Names would only chose to stay in the market for the next 2-3 years. We set out to find a methodology that would allow this to happen, and would give them a guaranteed exit when they wished to leave. That is why we created the idea of sale and leaseback and floated it into the market early in 2002 to gauge the reaction and for pricing, When it became clear that a Grand Canyon existed between the members and managing agents over pricing, we listened ... and took the proposal off the table. This is how we have tried to operate throughout this consultation process."
One of the problems of the consultation process has been its closed nature. Lloyd's has been very protective of the proposals, trying to keep them within the market and membership rather than out in the wider world. Nevertheless, in recent weeks, with a looming Extraordinary General Meeting (EGM) in mid-September to vote about the reforms, the lobbying started, and more details of the proposals emerged. Mr Riley's performance at the ALM meeting, referred to above, was part of a campaign to convince members - in particular the traditional unlimited liability Names - that these changes were in their own interests as well as the interests of the market as a whole.
In what Lloyd's itself described a "passionate declaration of support for the package of reforms," Mr Riley outlined changes to the proposals made as a result of the consultation with Names. "Names raised questions about the level of protection they had under the ongoing regulatory system," he said. "We responded by creating a Compliance Committee with the protection of members' interests as one of its central roles." This committee, he explained, is to provide the membership, and the ruling Council of Lloyd's, with the reassurance that the proposed `Franchise Board' is doing all it should.
Of all the proposals tabled for the reformation of Lloyd's over recent years, the Franchise Board is one of the most radical. This new board will supersede the current Regulatory and Market Boards, both implemented in the 1990s, with the stated aim to "create and maintain a commercial environment at Lloyd's in which the long term return to all capital providers is maximised." A search is currently underway to find the Franchise director to run this part of the organisation, and the board will report to the Council of Lloyd's which, under the Lloyd's Act 1982, is ultimately responsible for all aspects of the running of the market.
Under the proposals, the Council of Lloyd's is to set out a series of goals and principles for the Franchise Board, covering:
A `franchise business plan' will set out the strategy to achieve these goals and principles.
Although the CSG proposals are aimed at clarifying the Lloyd's structure and operations, it was almost inevitable that more sub-groups would be suggested. These include the Compliance Committee, to be chaired by a nominated member of the Council of Lloyd's (a Council member who is not a member of Lloyd's and who is appointed by the Bank of England), and with the remit to:
In addition, the Franchise Board will set up a Market Supervision Advisory Committee to provide independent advice on "certain key decisions" including those which "will encompass contentious business conduct issues including, for example, the application of the agency circumstances regime and managing agents' fees."
To add to this, the Franchise Board is to set up a `Capacity Transfer Panel', overseeing transfers of syndicate capacity, and in particular looking at mandatory offers and minority buy-outs - both of which affect traditional Names.
New regulatory regime?
Lloyd's regulatory environment has changed dramatically in recent years, most recently by the Financial Services and Markets Act 2000 which, to a certain extent, brought the market's regulation under the auspices of the Financial Services Authority (FSA). Nevertheless, ultimate responsibility still lies with the Council of Lloyd's, under the Lloyd's Act 1982. In a letter to members sent at the end of August as part of the lobbying process, Mr Riley wrote: "As the consultation document makes clear, the FSA approach to insurance regulation generally is undergoing a fundamental reappraisal. In the short term, it proposes to apply a full risk-based regulation to Lloyd's and the market subject to the confines of the current FSA handbook. In the medium term, the FSA intends to work closely with Lloyd's to develop improvements to the regime, where appropriate, in the context of any relevant EU developments and the FSA's wider review of its approach to insurance regulation generally."
There is no doubt that regulatory changes are taking place at both the UK and European level, and these will affect Lloyd's. Whether a change is required to the Lloyd's Act is unclear, and many members have expressed their concern that approving the proposed CSG reforms will lead to a reform in the Act. At the same time, whether the UK Government feels that Parliamentary time will be best used in passing a reformed Lloyd's Act is uncertain at best.
One of the biggest problems of Lloyd's that has faced investors and corporate members in recent years has been the three-year accounting system. As part of the CSG proposals, Lloyd's aims to move to annual accounting on an International Accounting Standards basis from the beginning of 2005. Other reforms to the capital structure of the market include: the closure of access to Lloyd's of new unlimited liability members from the beginning of next year; an acceleration of the closing of open years of account; the support of new investment in Lloyd's; the support of the transition of syndicates from spread capacity to integrated Lloyd's vehicle basis; and the early release of surpluses to support ongoing underwriting before annual accounting is put in place.
All these proposals were put to a vote of Lloyd's members at the EGM in September. The vote was held on a capacity-weighted basis, under which 80% of attendees voted in favour, claimed as a "decisive mandate to implement our proposals for modernisation," according to Mr Riley.
However, the ALM claimed that although the capacity-weighted vote led to a yes, 3,356 members voted against it, compared to 1,393 voting in favour. "This means two things," stated the ALM. "Firstly, there is little prospect of the proposed new Lloyd's Act in the near future. Secondly, Lloyd's will have to reconsider its controversial regulatory proposals, which in any event have yet to be approved by the FSA."