THE PAST FEW YEARS HAVE SEEN unprecedented changes in the world's most venerable insurance institution, Lloyd's of London. In a market that once prided itself on the unlimited liability of its members, more and more of today's underwriting is by those with limited liability. Further, the massive liability arising from American asbestos, pollution and health-related claims has been transferred to a limited liability company, the assets of which, many policyholders' attorneys believe, are insufficient to the task. It wasn't always that way.
In the immediate aftermath of the San Francisco earthquake of 1906, so the story goes, underwriters at Lloyd's of London, who had only recently begun to write significant amounts of insurance in the American market, began themselves to tremble at the magnitude of their possible exposure. Were there exclusions upon which they could rely? According to the lore, Cuthbert Heath, the underwriter who had led the way in developing the U.S. business, stepped in and said, "Pay the claims, regardless."
True or apocryphal, the fact is that Lloyd's long enjoyed a reputation for fair, impartial and prompt claims-handling. The mass tort claims that U.S. policyholders began to present to London in the 1980's changed all this. From 1988 to 1992, inclusive, Lloyd's losses amounted to nearly £8 billion, the equivalent of US$12.56 billion.1
Coupled with this change, stories of negligence and even malfeasance by market insiders began to circulate. As cash calls on the individual investors in Lloyd's, known as "names," increased, names instituted litigation to recoup their losses from those actively involved in day-to-day operations. By 1993 and 1994, it appeared that Lloyd's was in deep trouble, with the potential to undermine not only the worldwide insurance market, of which it was a pillar, but also its historic role in helping to shore up Britain's long-standing international balance of payments problems by the influx of capital from around the world that it earned.
Reform became the order of the day. In order to understand the context of these reforms, and how they impact U.S. companies that do or have done business with Lloyd's, it is necessary briefly to outline the traditional structure of the London insurance market.
The London Market — as people in the insurance business and their lawyers traditionally refer to it — consists of two parts. One comprises insurance companies that are headquartered in, or have offices in, London. The other part is Lloyd's. It is Lloyd's whose structure is unique.
The most important fact is that Lloyd's is not an insurance company.2 Rather, Lloyd's consists — and, before the recent reforms, only consisted — of a large number of individual men and women whose personal capital backed their underwriting activities — the "names." Names were fully liable personally for claims made on policies to which they subscribed; though a name's liability was several, rather than joint-and-several, no devices limiting liability were permitted.
In order to make names' capital available for underwriting, names are grouped together in syndicates. From the point of view of the names themselves, as a device to spread their own risks, individual names were members of a number of syndicates. From the point of view of the market, syndicates are the way in which the capital of the names is aggregated so that prospective purchasers of insurance can feasibly access it. From a business point of view, syndicates appear to continue for many years, because the same insurance professionals conduct business year in and year out. In fact, syndicates change each year. This is because the full complement of names whose capital is involved varies from one year to the next.
Syndicates, thus, are neither corporations nor partnerships; they are really nothing more than a collection of people who have granted authority to the same companies — the "managing agents" — to conduct insurance business on their behalf for a single calendar year. Names on a particular syndicate have no relationship with one another. Thus it is the names, and not the syndicates, who back Lloyd's policies.
Another important characteristic of the London Market is that it is a subscription market. From the standpoint of liability for claims, this means that London Market Companies, and Lloyd's syndicates that subscribe to insurance for any particular risk, each underwrite only a small percentage of any policy. From the standpoint of the customer wanting to place insurance, this subscription format allows access to enormous capacity. Whereas the U.S. broker might have to contact a number of different insurance companies in different locations to place a large risk domestically, huge capacity is available, at one place, in London. In 1998, Lloyd's' capacity alone amounts to some £10.2 billion, equal to approximately $16.8 billion.3
Corporate Names
From the time the underwriting of marine insurance began in Edward Lloyd's coffeehouse 80 years before the Declaration of Independence, until the onset of the recent crisis, Lloyd's underwrote insurance solely based upon unlimited personal liability of its individual members. In the traditional parlance of Lloyd's, this meant that each policy was backed by the entire personal wealth of each name "down to the last gold cuff link." On January 1, 1994, this changed. As of that date, Lloyd's has allowed so-called corporate names — i.e., members with limited liability — to participate in underwriting.
This change has worked a genuine revolution in the workings of Lloyd's. How rapidly the change has taken place may have surprised even some market insiders. Despite the much stiffer capital requirements imposed upon incorporated names, for the 1998 year of account, these names provide £6.004 billion ($10.006 billion), or approximately 60% of overall market capacity.4 But the shift to corporate underwriting should not be a surprise: Most people would rather enter any business venture, let alone one with the uncertainty of underwriting insurance, on a limited rather than an unlimited liability basis.
Although, even in the present crisis, Lloyd's has never yet defaulted on any claim — meaning that it has never been financially unable to pay a covered claim — it is undeniable that the increasing weighting of underwriting by corporate names, with limited liability but backed by much more substantial capital than is and was required of individual members, provides a significant measure of financial stability for the future. The future of Lloyd's, and the London Market, thus appears bright. The one dark cloud on the horizon is the ability to pay outstanding liabilities on asbestos, pollution and health hazard claims, known in London as the APH claims. This leads to the other new institution that has arisen at Lloyd's: Equitas.
Enter Equitas.
Beginning with its 1993 Business Plan, and augmented by a 1995 document called "Reconstruction and Renewal," Lloyd's announced its intention to create a company whose aim would be to pay — or, in insurance parlance, run off — the APH claims against policies written in policy years before 1993, the so-called "old years." In September 1996, the group of companies collectively known as Equitas began its operations. Officially, at least, Equitas is independent of Lloyd's and is outside the Lloyd's regulatory regime.
Equitas was funded by money that Lloyd's required names to pay, by funds held by Lloyd's itself and by contributions from bankers and accountants who arguably had some responsibility for the massive losses. Equitas' only source of funds on a going — forward basis is recovery from reinsurance that syndicates had purchased on policies, against which claims are made, elsewhere in London or in the world market.
Notwithstanding its stated aim of performing this runoff, Equitas in fact was designed to address the three constituencies aggrieved, or at least threatened, by the crisis of the early '90s: the names who were faced with huge cash calls to satisfy the outstanding liabilities, Lloyd's underwriters — who feared that massive defaults on the APH claims could destroy their prospects for future business — and Lloyd's policyholders with claims against policies written in the old years.
Since Equitas pays liabilities directly, and since names who have contributed to Equitas have been permitted to resign from Lloyd's, names have benefited from an end of immediate cash calls and practically speaking, the possibility of a permanent end.5 Whether Equitas will have sufficient funds to pay all APH claims — the concern of policyholders — is a different matter.
In the wake of the huge losses of the late 1980s and early 1990s, groups of disgruntled names formed action committees to challenge past underwriting practices and suggestions of self-dealing by Lloyd's insiders. Ultimately, these groups of names instituted litigation in the English courts against the managing agencies that ran the syndicates that had been primarily involved in insuring the American business that led to the APH claims.
Quest for 'Finality'
But the names wanted more than damages. Equally important, they wanted "finality," — meaning an end to the seemingly never-ending requests for further cash to pay claims. Thus, in addition ultimately to offering the names a £3.2 billion financial settlement, Lloyd's marketed the Equitas idea to the names as a way to achieve finality. The implication was clear that once Equitas was funded, Equitas, and not the names, would be responsible for the old-year claims.
There was a bit of sleight of hand here, for Lloyd's never promised that names would be relieved of ultimate liability, because it was unable or unwilling to seek the policyholder consents that would have been required to create valid novations that would have extinguished the names' liability. Instead, it adopted the fiction that Equitas "reinsure" the names, a fiction that is designed to insulate Equitas from having to appear in its own name in US courts, and which is beginning to be hotly litigated in coverage cases around the country. Names were given little choice about agreeing to the creation of Equitas, and Lloyd's successfully gained orders in the English courts requiring them to pay their "Equitas premium."6 APH claims were to be paid directly by Equitas, out of Equitas funds.
When the need to create some form of a runoff company for the APH liabilities first began to be discussed, the metaphors regularly used were that a "firebreak" needed to be built between the old years' and today's insurance business, or that a "ringfence" had to be built around the old years' liabilities. This was a concern neither of policyholders who had claims nor of names who had to pay. Rather, the moving force here was the concern of current underwriters, who wanted questions neither about the solvency of Lloyd's nor about its reputation for the fair handling of claims, to get in the way of future business. In their point of view, the creation of Equitas allowed them to foster a perception in the market that current business and the APH claims from the old years existed in two different universes. In this light, therefore, Equitas should be viewed as a major peg in the ongoing marketing strategy of Lloyd's.
The greatest concerns about Equitas come from those who have claims on Lloyd's policies written in the old years. This is due to Equitas' thin solvency margin. When Equitas commenced operations, its total assets of £16 billion exceed its estimated gross liabilities of £15.4 billion by a meager £588 million ($964 million). According to the financial report just released in November of Equitas first 18 months of operations — through March — the solvency margin had increased to £718 million ($1.2 billion) — or an increase from 5.6% when Equitas was established to 8.5%.7
This is a bit of the old "good news-bad news" scenario. Naturally, policyholders are delighted to see an increase in Lloyd's' solvency ratio. But since Equitas is engaged only in the claims side of the insurance business, and receives no premium income, these figures can only mean two things. First, the worldwide financial markets in which Equitas' funds are invested have been doing very well, although Equitas has only just begun to move out of fixed-income investments. Second, most policyholder lawyers familiar with Equitas would say that it means that Equitas' manner of handling claims has become much less forthcoming.
At its inception, Equitas made it perfectly clear that the traditional method of handling Lloyd's claims was no longer the order of the day. At Lloyd's, the stated policy had long been to handle claims openly and fairly. At Equitas, the policy is "fair but firm." The shift is more than a shift of nuance. Insurance companies, of course, always make money by paying claims as slowly as their marketing needs and the requirements of state bad-faith laws permit: Television commercials to the contrary do not so much mask this reality as demonstrate how true policyholders with claims know it to be. Policyholders with APH claims, and their counsel, have learned that "firm" in the context of Equitas' claims-handling mission statement means "contest everything that can be contested" and provide lowball settlement offers until significant time has run on the interest clock.
In an open meeting with the "reinsured" names last month, outgoing Equitas Chairman David Newbigging expressed his "personal belief" that, at the end of the day, Equitas would have a surplus which could be distributed to names as a return of premium.8 While hoping that this might be true, most policyholders' lawyers take a far more pessimistic view of Equitas' ability even to pay its outstanding liabilities. Equitas' solvency margin is still far below the 30% usually required by the U.K. government for ordinary reinsurers, and the potential amount of APH claims is still unknown.
The outlook in the short run for ultimate recovery is favorable, though policyholders will have to contend with a style of claims handling that would have been unfamiliar to Cuthbert Heath and generations of Lloyd's claims handlers. Lloyd's will doubtless survive, though in a form unfamiliar for much of its 300-year history, on a basis of funded corporate capital, rather than the personal resources of wealthy individuals. Whether Equitas will get down to the equivalent of its last gold cuff link — its last invested pound sterling — remains to be seen. Policyholders on old year's policies who delay pursuing their claims, however, may find that their Lloyd's policies are not worth the paper they are printed on.
* Stephen M. Goldman is Of Counsel in the Washington, D.C. office of McKenna & Cuneo, L.L.P., and a member of the firm's Insurance Recovery Group. Mr. Goldman has considerable experience with the London Market, and he has taken more than 200 depositions of present and retired London Insurance Market personnel.
1. Edwin Unsworth, "Lloyd's News All Good: Back in the Black. Market Focus on Getting R&R Approval," Business Insurance, July 15, 1996, at 1.
2. There is a Corporation of Lloyd's, but it is the governing body for the Society of Lloyd's, and it does not underwrite insurance itself.
3. Lloyd's: Business Information: Key Facts. See (http://www.lloydsoflondon.co.uk/entrypoints/kf_index.htm), at 1.
4. Id.
5. Resigned names are theoretically liable if Equitas fails, but the small proportion any individual name would owe on any claim may make it impracticable for policyholders to pursue them.
6. See Lloyd's Press Release LL63/98 31 July 1998, (http://www.lloydsoflondon.co.uk/businfo/media/pressreleases/1998/july/ll6398.htm)
7. Matthew MacDermott, "Equitas Encouraged by Boost in Solvency Rating," Business Insurance, Nov. 9, 1998, at 79.
8. Id.
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