Lloyd's Losses Raise Solvency Issues
Best, Chris F., Risk Management
Can an insurer be the most secure in the world and still be technically bankrupt? Surely, security and bankruptcy cannot exist hand in hand. Yet this seems to be the case with Lloyd's of London, the world's oldest, most famous and, curiously, the most troubled insurance market.
Lloyd's recently reported its first loss in 21 years, which also happened to be its biggest ever-509.7 pounds million. Under the syndicates' system, which keeps a calendar year of account open for three years, the year in question is 1988. However, a fairly accurate picture for 1989 and 1990 has already emerged, and some analysts suggest that 1989 will post a loss of approximately El billion. The deficit for 1990 may turn out to be as high as P500 million.
Lloyd's Is Not Alone
Although such losses for Lloyd's is dreadful news, it is not alone. Major U.K. insurers, including Royal Guardian, Royal Exchange, General Accident, Sun Alliance and Commercial Union, have also posted dreadful results of late. However, they have not attracted the adverse publicity that Lloyd's has. Why is it that Lloyd's, which in terms of premium volume resembles a large insurance or reinsurance company, cannot experience a rough patch without its investors threatening to leave in droves?
It all boils down of course to Lloyd's unique structure in which investors, or names," are wealthy individuals who put their entire fortune and unlimited liability at the service of Lloyd's underwriters. Consequently, the capacity of a Lloyd's underwriter is a function of the financial backing of his names; the profits and losses are uniquely those of the investor.
Lloyd's also requires that the names sign up afresh each underwriting year. The name receives a share of any profits made in that year, and no reserves are set aside to cushion the effects of loss years. Thus, while insurance company shareholders have limited liability and receive dividends even when the company takes a loss, Lloyd's names are lone wolves when it comes to their inability to escape potential ruin.
Ostensibly, Lloyd's operating system can only survive if profits are produced regularly. One year's bad results in a spell of good years-provided that the losses are not too bad-can outweigh the loss, and the names will happily sign up the following year. But when names are repeatedly asked to write large checks to make up for underwriting losses, the reality of unlimited liability becomes soberingly apparent.
Indeed, the point hits home: The number of names at Lloyd's has dropped from a high of 33,500 in 1988 to 26,500 this year. …