Lloyd’s Meet the USA, USA Meet Lloyd’s

What do you think of when someone mentions the name “Lloyd’s”? Do you think of prized legs belonging to supermodels? Do you think of a large insurance company which everyone has heard of, but few understand? Have you wondered how Lloyd’s might provide a selling opportunity, but you don’t know how to contact the “home office”?

Lloyd’s is one of the largest insurance market places in the world. Its design and operational processes are rooted in more than 300 years of tradition and business. Although it is one of the world’s oldest insurance organizations, it is also one of the world’s most misunderstood organizations. Many terms and practices used in the insurance industry have evolved from Lloyd’s. Let’s explore the basics:

More than three centuries ago, the principal form of commerce between nations was shipping. Newly discovered territories and routes around the known world opened up a whole new dimension in commerce. Yet perils in the shipping business were numerous. Pirates, uncharted or poorly charted waters, adverse weather, and other factors meant that cargo could be easily lost or destroyed in transit.

London was the main point of global travel and commerce. Many ships either began or ended their travels in London. As a result, a unique idea began to form along the docks. What if a cargo vessel worth $10,000 sank? The loss could be extraordinarily detrimental to the owner. However, what if each cargo owner participated in any loss?

Five people losing $2,000 would not be annihilation to any one person. Furthermore, the support of others sharing the same risk might allow for MORE and perhaps even RISKIER adventures to be realized.

The concept of writing down the details of a particular risk with specifically named perils and having any or all of the risk-takers (the wealthy traders) write their name under the risk, is the basis of the term underwriter. This process became more sophisticated over time, but it is still the fundamental basics of the Lloyd’s market.

What has changed in 300 years? Answer: Many things – and few things.

Each wealthy individual has been replaced with a single entity called a syndicate, or underwriter. Each syndicate is made up of either individual or corporate funds. A syndicate may be as large as some of the largest insurance companies in the USA. Today there are about 135 Syndicates who transact business at Lloyd’s.

Mystery #1 solved: Lloyd’s is not an insurance company. It is an insurance market. No one buys insurance from Lloyd’s. They buy insurance from various underwriters at Lloyd’s. This is similar to a stock exchange. No one buys stock from the New York Stock Exchange, they buy stock from the companies who transact business at the NYSE!

When a risk is being shopped at Lloyd’s today, the same basics apply. The risk is written down and sanctioned representatives (called Lloyd’s brokers) take the risk around the market seeking 100% support. When the Lloyd’s broker seeks out syndicates to cover the risk, it might require only one syndicate taking 100% of the risk, or as many as 100 syndicates each taking 1% of the risk.

This process may sound tedious. And it is. However, it is the foundation of the Lloyd’s process.

Why would they do this? Most insurance companies retain a portion of the risk and obtain reinsurance for the remainder. The public is typically unaware of the reinsurance and it is the liability of the front carrier. At Lloyd’s the process is similar, except instead of one reinsurer, most policies are protected by numerous insurers/reinsurers. This too, may sound tedious, yet in many situations it is the only way to get a unique risk insured.

There is, however, more than one way to accomplish this task. There is another entity called a Lloyd’s correspondent, or coverholder. If there are programs that might be written on a more regular basis, the underwriters might assign the “power of the pen” to a Lloyd’s correspondent with the authority to underwrite specific risks. The contracts held by a correspondent are usually renegotiated annually. Thus, the process of obtaining 100% of the risk is reduced to a one-time-per-year activity.

Correspondents are not granted unlimited authority. Their authority could range from a single, simple program to multiple programs and authority to underwrite, issue and provide claims administration. Furthermore, Lloyd’s does not write risks, that you would access through the traditional insurance markets. For example, you will never see a standard auto or major medical plan from Lloyd’s. Lloyd’s may reinsure these types of plans, but they would not provide the direct coverage. Why?

Because many years ago, Parliament recognized that if Lloyd’s was allowed to insure anything and everything, the shear size and global reach (even centuries ago) could wipe out the regular insurance market. Thus Parliament enacted rules, that forbid Lloyd’s from issuing “permanent” insurance. Permanent means long-term and/or guaranteed renewable types of coverages. Thus, Lloyd’s contracts are typically written for short terms such as 12 months or less. However, some parts of the market may have renewable provisions for as much as 10 years.

The Lloyd’s market is famous for insuring such things as Betty Grable’s legs and The Empire State Building. Insuring such unique risks give rise to the image that Lloyd’s will insure anything. There is a saying that goes “There is no such thing as a bad risk only a bad premium”. However, Lloyds Underwriters still look for profitable types of cases.

Mystery #2 solved: The Lloyd’s market does not necessarily insure ANY risk. However, due to the extensive and unique resources, Lloyd’s is a place to look to when there is a unique risk.

“I’ve heard that Lloyd’s had many financial problems. Saw it in the press. Big losses!” Yes that is true! However, these reports missed the forest for the tree.

Lloyd’s accounting is (and always has been) three years in arrears. The large losses noted in the press began about 1991/92 and lasted until 1995. The results sounded devastating. However, what did not occur to anyone reading the story in 1992, was that these losses were losses related to events that occurred in 1989! A full three years earlier!

In 1989, ‘90 and ‘91 this country suffered a major recession. MOST companies were showing large losses. Executive Life, Mutual Benefit Life, and many others began to disappear or merge. This was the time that impacted the disability markets the worst. It was a global problem. Compounding the financial picture of the time, there were a few major losses that occurred between 1989 and 1994: Pan-Am Flight 103 … the wreck of the Exxon Valdez … Earthquakes in San Francisco, Northridge, and Mexico City … the Piper Alpha Oil Rig Fire … Hurricanes Andrew, Iniki, and Gilbert.

These were real losses, larger than anything the world has ever seen in such a short time period. The other issue, which was never expanded upon, is the structure of Lloyd’s financially. First there is the individual “Name”. These are people who have sufficient wealth and have passed a minimum financial test and who pledge their ENTIRE personal wealth, down to the last penny if necessary, to protect the insured. This is real investing!

The next level of security comes from the underwriting syndicate. Each year, the corporation of Lloyd’s audits each syndicate. Based upon the amount and mix of the business of the syndicate, each syndicate then reserves a certain amount for losses. In addition, most syndicates also secure reinsurance on their own programs, thus providing added strength. The next level is the Central Reserve Fund.

A long time ago, Lloyd’s figured that if there were ever major losses requiring individual “names” to pay more from their personal assets, not all “names” would be able to come up with cash in a short time. (Even Donald Trump does not keep a million in cash on hand!) Generally speaking, an asset would have to be sold to generate cash. Thus the creation of the Central Reserve Fund. This fund was established so that in the event of catastrophic loss, it could take care of any claims paying ability and the underwriting “names” would eventually make a payback to the Central Reserve Fund. The next level is the North American Trust Accounts. (Explained more in a moment).

In the past few years a new vehicle was created – corporate capital. Corporate capital works at the same level as the “name”, but provides a tool with limited liability. Today, corporate capital accounts for about 50% of the financial capacity of business at Lloyd’s.

Mystery #3 solved: Lloyd’s losses are REAL losses. Many insurance companies will show losses if the interest rates dip. Lloyd’s losses are tied directly to losses.

Mystery #4 solved: Lloyd’s financial strength comes from the numerous levels of security.

Some may say, “I don’t trust sending my premium overseas”. Many decades ago, regulations were passed that now require Lloyd’s to deposit all premiums from North American risks into trust accounts held by several large banks. The largest is Citibank in New York. Premiums are transferred into these accounts and are left there for a period of three years. Within three years, Underwriters should be able to resolve any claim. At that time, the money can then be sent to London. Today, the value of this trust account is more than $12 Billion.

Mystery #5 solved: Premiums sent to Lloyd’s stay in the U.S. for several years and are not sent straightaway to London.

Perhaps you might ask, “If Lloyd’s is so big, why does it only have an A.M. Best rating of “A” and S&P rating of only “A+”?

Answer: How do you rate a marketplace? Remember, Lloyd’s is not an insurance company. The rating agencies were not even able to rate Lloyd’s until about 5 years ago. What the rating companies do is rate the one point where the ENTIRE market is mutualized: The Central Reserve Fund. Even the rating does not apply to each syndicate, just the entire market as a whole.

Mystery #6 solved: The seemingly low ratings are somewhat deceptive.

“I heard you need special licensing to sell Lloyd’s. Is that right?” This is a Yes and a No answer. Lloyd’s is considered a “non-admitted” carrier in 48 states. The other two, Illinois and Kentucky, have accepted Lloyd’s as an admitted carrier for many years. In these states, the processing of business is the same as any other traditional carrier. In the other 48 states, Lloyd’s is written through a process called surplus lines as a “non-admitted” carrier.

Why would a state consider Lloyd’s to be a non-admitted carrier?

Historically, it is the same problem the rating companies have had: How do you admit a market place?

Property and Casualty agents are well versed with surplus lines. The life and health agent rarely sees surplus lines, thus the impression that Lloyd’s cannot be sold. Keeping in mind that there are variations from State to State, the spirit of the surplus lines process is that a state cannot prohibit individuals from securing the insurance coverage they need.

What a state can do is regulate what is marketed and how it is marketed. However, if the traditional marketplace does not or cannot offer the type of insurance an individual needs, then the state allows for the sale and placement of coverage through surplus lines. Contrary to popular belief, this is not a
shady side of our business. In fact, it is a huge part of our industry. Surplus lines is just a misunderstood side of our business, especially in the accident and health markets.

Mystery #7 solved: Lloyd’s products as a non-admitted carrier can be secured.

Yes, there is a great deal of mystique behind Lloyd’s, even to the people who work inside at Lloyd’s. Yet without a doubt, Lloyd’s has pioneered the modern insurance company and many of the terms and business processes we take for granted in the insurance industry.

Thomas R. Petersen has received the professional designations of RHU, disability financial planner (DFP) and associates of life and health claims (ALHC). He has a master’s in business administration, with an emphasis in international business, from Pepperdine University. He is also a diplomat and life fellow of the American Board of Forensic Examiners.

Petersen is a member of NAHU, NALU, the California Association of Licensed Investigators and the World Association of Detectives. He is the author of Disability Sales.