79. Insuring for the future?

Lloyd's is trying to make its business practices as sleek as its building. But will that be at the expense of the characteristics that make the market so distinctive?

“IF YOU had to invent an insurance market, you'd never invent Lloyd's,” it is often said of the 316-year-old London-based institution. Lloyd's is most famous for almost going bust in the 1990s at the expense of the individual “names” who used to provide its capital. Lately, however, it is showing signs of having made a remarkable recovery. It reported profits of £1.9 billion ($3.1 billion), more than double the previous year. And its reputation is riding high. Not only did it willingly pay huge claims after September 11th, but also it expects to have no trouble riding out the succession of hurricane-related claims currently battering the insurance market. Its final payout for hurricane Charley, for instance, was a modest £300m or so, hardly enough to dent a market that has annual underwriting capacity of £15 billion, almost half of which is directed to the reinsurance business.

Lloyd's new-found health is galvanising its bosses, who think the market can do even better if only it will shed some of its quirkier characteristics and embrace modern technology and business practices. Nick Prettejohn, chief executive since 1999, talks of changing the behaviour of the whole enterprise: “We're trying to make up for an awful lot of lost time.”

A brief walk round the market suggests he is right. Despite its modern setting, Lloyd's is replete with traditions. Brokers still march around with bulging folders of documents as they seek to place business. Encouraging them and underwriters to make better use of electronics is only one of several big changes Mr Prettejohn has in store. He rattles off eight priorities, ranging from the adoption of annual accounting (Lloyd's has traditionally reported results with a delay of three years) to obtaining more licences for doing business round the world and getting easier treatment on reinsurance from regulators in America. The most important of all, however, involves improving the performance of the 66 underwriting syndicates that inhabit Lloyd's. “People should be able to demonstrate a well-argued business plan,” he insists.

If that seems an unremarkable goal, then consider that Lloyd's is not a company, but a highly unusual market. Its syndicates are mostly backed by big insurers, which have their own chief executives and announce their own results. Despite competing against each other, the syndicates also report to the centre, which pools some of their risk. In this sense they form a unique structure—a “voluntary, mutual, capitalist society”, in the words of Graham McKean, chairman of Ballantyne, McKean & Sullivan, a firm of brokers.

Indeed, Lloyd's barely squeaked into the modern era. Between 1988 and 1992 it lost £8 billion as claims poured in from litigation in America about asbestos and pollution cases, as well as from a string of disasters. The names who provided the market's capital had unlimited exposure to Lloyd's risks. More than 1,500 of these (out of 34,000) were financially ruined. They sued for negligence, which had indeed appeared rampant. To save itself, Lloyd's embarked on a huge actuarial exercise. In 1996 it hived off all of the pre-1993 liabilities into a new reinsurance vehicle called “Equitas” and managed them separately from the ongoing business. The enraged names were offered a settlement, which most accepted.

Lloyd's breathed another day and began to change its ways. In 1994 new rules allowed companies to invest in Lloyd's syndicates for the first time. They have since largely replaced names, who now account for less than 20% of Lloyd's capital base. Many big insurers, such as America's AIG or Bermuda's XL Capital, back Lloyd's syndicates. In turn, Lloyd's has internationalised, with America providing more than one-third of premium income and Asia marked for future growth. The theory behind the switch to corporate capital was that companies could bear losses better than individuals. But premium rates stayed low in the late 1990s, and some companies considered pulling out.

Stress tested

Then came September 11th. Paradoxically, the attacks helped to resuscitate Lloyd's. The syndicates' collective bill (before receiving reinsurance payouts) ended up at around £5 billion, or one-quarter of the total for the World Trade Centre. But Lloyd's paid up and did not collapse as many feared—indeed, the market resumed writing terrorism cover within 48 hours of the disaster. The huge losses from the attacks, combined with deep confusion about which insurers were bound to which policies, helped to spur the internal agenda for change. “That tragedy concentrated people's minds,” says Mr Prettejohn.

September 11th also ushered in a long bull market for insurance. Lloyd's has taken advantage and its own financial health has improved. In August it even received a long-sought upgrade from A.M. Best, a credit-rating agency. “Lloyd's is stronger than at any time in its history,” says Robert Hiscox, chairman of an insurer that runs one of Lloyd's biggest syndicates.

Still, Lloyd's faces lots of challenges. After three strong years, rates for many types of insurance have recently begun to fall. Capital flooded into the industry after September 11th. Competition from Bermuda and elsewhere is intense. The question that preoccupies every underwriter and broker is this: will Lloyd's be able to maintain its new regime of discipline when the market turns?

To put Lloyd's ambitions in context, consider the following: few insurers have ever broken, or much moderated, the dramatic swings of the industry's fortunes. Insurers unfailingly pay lip service to “breaking the cycle”; then they proceed to slash rates and write slacker policies in order to hang on to market share. Restraint is all the harder because, unlike in other businesses, insurers only find out years later, when claims are settled, just how inaccurate was their pricing of risk.

If only everybody would slash capacity rather than rates—ie, write less business at higher rates when times get hard—then returns would be steadier. Or so the theory goes. But of course insurers cannot act as an oligopoly. Even within the Lloyd's marketplace, syndicates regularly steal each other's business by cutting rates.