Chapter 10: The Lloyd's market

Question 1

Describe briefly what Lloyd’s is.

Answer 1

Lloyd’s of London is a marketplace made up of members who provide capital and accept liability for risks that are underwritten in return for their share of any profits that are earned on those risks.

Lloyd’s is a key player in the worldwide general (non-life) insurance and reinsurance market, with some £35.5 billion of gross written premium in 2018. It is licensed to underwrite business in over 70 territories and can cover risks in over 200 countries, according to local rules.
Lloyd’s accepts a wide variety of different business lines – including property, casualty (liability), marine, energy, motor and aviation – on both a direct and reinsurance basis.

Lloyd’s is also well known for providing insurance on very large, complex or unusual risks, for which it can be difficult to obtain cover elsewhere. Examples are cover for kidnap or ransom, fine art, wind farms, private space shuttles and sports events.

Question 2

Define a Lloyd’s syndicate, and explain the relationship between members and syndicates.

Answer 2

A Lloyd’s syndicate is a group of members that collectively coinsure risks for one specific calendar year.

Each syndicate often specialises in a particular type of insurance.

Each member who belongs to a particular syndicate will contribute capital to that syndicate and will accept a portion of the insurance risks written by the syndicate, the share of each member being predetermined according to the amount of capital they have contributed. The profit or loss made by the syndicate is then shared among its members in these proportions.

Question 3

Define syndicate

Answer 3

A syndicate is a collection of one or more members who have agreed to back the underwriting activities of a particular underwriter for one specific calendar year.

Question 4

Define Managing agent

Answer 4

A managing agent is a company specifically established for the purpose of operating a syndicate, ie employing the underwriting staff and managing the syndicate on the members’ behalf.

Question 5

Define Integrated Lloyd’s Vehicle (ILV)

Answer 5

An Integrated Lloyd’s Vehicle (ILV) is where a syndicate consists only of a single corporate member, which is owned by the same company or is part of the same corporate group as the managing agent.

This arrangement allows an insurance company to have control of the underwriting of the risks in the syndicate.
With the growth of corporate membership, insurance groups have bought up all the participation rights in a number of syndicates.
It makes sense to talk of these syndicates in the same way as if they were insurance companies. Legally, the syndicate only exists for one year at a time, and the roles of managing agent, member and syndicate remain separate. These syndicates are known as ‘Integrated Lloyd’s Vehicles’ (ILVs) or aligned syndicates.
There are still many syndicates with both corporate and private members who have no links with the managing agent: these are known as ‘unaligned’ syndicates.
Of the 99 active syndicates at the end of 2018, 15 of these are special purpose arrangements (SPAs). These are also referred to using their historical names of ‘sidecar syndicates’ and ‘special purpose syndicates’. An SPA is a syndicate that writes a quota share of the business of another Lloyd’s syndicate.

Question 6

Define a member’s agent

Answer 6

A members’ agent advises private members on which syndicates to be subscribed to, and carries out much of the administration for them.

Question 7

Define subscription system

Answer 7

The subscription (or slip) system is the face-to-face system used within the London market to coinsure risks.

Question 8

Define Lead Market

Answer 8

The lead market are syndicates with underwriters that tend to set the premium rates and underwriting terms for risks under the subscription system.

Question 9

Define Premium Trust Fund (PTF)

Answer 9

A Premium Trust Fund (PTF) is the accumulated fund for a particular syndicate and year of account, into which all premiums received are paid, and out of which expenses and claims are paid.

Question 10

Reinsurance to Close (RITC) premium

Answer 10

The reinsurance to close (RITC) premium is the premium paid by a syndicate to reinsurer the outstanding liabilities. It is usually paid at the end of the three-year period to another party, usually the same syndicate, but in the next open year of account.

Question 11

Define Funds at Lloyd’s (FAL)

Answer 11

Funds at Lloyd’s (FAL) is the capital fund of a member, used as security to support the member’s total Lloyd’s underwriting business. The amount of capital is specified by Lloyd’s and it is held by Lloyd’s in trust.

The capital is held by Lloyd’s in trust, and Lloyd’s has absolute authority to use it to pay claims or other liabilities arising from the member’s activities at Lloyd’s. The capital fund of a member is called Funds at Lloyd’s (FAL).
FAL may be lodged in two main ways: 
assets or 
via a letter of credit (a guarantee by a bank to provide funds when called upon to do so by Lloyd’s).

Question 12

Define the Central Fund

Answer 12

The Central Fund is a fund of last resort, established to meet liabilities should a member default with insufficient assets. It is primarily funded from levies on members.

Question 13

Define the Corporation of Lloyd’s

Answer 13

The Corporation of Lloyd’s is a corporate entity, financed by members’ subscriptions, which provides central premises, administrative staff and services to enable members to transact business.

Question 14

Define the Council of Lloyd’s

Answer 14

The Council of Lloyd’s is the governing body responsible for the overall direction of Lloyd’s.

Question 15

Describe the two types of Name (or member) in Lloyd’s.

Answer 15

The two types of member in Lloyd’s are: 

 individual Names, usually wealthy individuals corporate Names, which are limited-liability companies

Question 16

Types of member and limits of liability

Answer 16

Nowadays the majority of the members (measured by premium volume) are companies (corporate members) rather than private individuals. Private members may have unlimited or limited liability, although no new unlimited liability members are admitted. Corporate members have limited liability and must be a separate legal entity to the managing agent, although they are often owned by the same insurance group.

The difference between limited and unlimited relates to what mechanisms can be used to collect liabilities. In essence, unlimited liability members can be made personally bankrupt while limited liabilities can only be collected up to the amount of capital deposited with Lloyd’s. However, should a limited liability name wish to continue writing business, they will be required to provide additional capital to cover existing losses.

Question 17

Explain the difference between managing agents and members’ agents.

Answer 17

Managing agents are responsible for managing the syndicate on the members’ behalf. They act in the interests of all members of the syndicate, which may include corporate members.
Members’ agents advise private members on which syndicates to be subscribed to, and carry out much of the administration for them. They act in the interest of the member that appoints them. Corporate members need not appoint members’ agents.

Question 18

Define the London Market.

Answer 18

The London Market is that part of the insurance market in which insurance and reinsurance business is carried out on a face-to-face basis in the City of London. It concentrates mainly on providing insurance and reinsurance cover to companies.

Question 19

Describe the slip system in London market

Answer 19

1. Insured approaches a London Market broker
2. Broker proposes a slip with the main features of the risk
3. Broker shows the slip to one or more quoting underwriters who quote a premium
4. The cedant will then select a lead underwriter and a « firm order » price for the broker with which to approach the market.
5. The lead underwriter accepts a share of the risk by stamping and signing the slip.
6. The broker then approaches other underwriters to accept the risk on the same terms. All underwriters act as coinsurers.
7. Broker continues until he or she has finished placing the risk.
8. If the written lines exceed 100% then they are reduced.
9. If it is not possible to find capacity to place 100% of the risk, an additional shortfall cover may need to be placed at different terms

One of the features that makes the London Market (including Lloyd’s) different from the personal lines insurance market is that it is a subscription market. This feature is certainly not unique to the London Market, nor is all London Market business written on a subscription basis, but it is typical there and the way it works is bound up with how London Market businesses operate.
Most types of Lloyd’s business must be sourced via a Lloyd’s broker. However, there are exceptions – for example, some syndicates sell personal lines business directly to the public, eg via direct telephone sales.
The process for writing business under the subscription (or slip) system was described in an earlier chapter.
Subscription business is just insurance, or reinsurance, written on a coinsurance basis. The whole risk is divided up proportionally and each syndicate or insurer (underwriter) takes a specified share of premium and claims. Failure by one underwriter to pay claims does not affect the liabilities of any of the others.
A particular coinsurer’s percentage share of a risk is known as their ‘line’.
Coinsurance in the London Market has traditionally been arranged through the slip (or ‘subscription’) system. A broker describes proposed risks on a standard form (known as a ‘slip’). The broker circulates the slip around the market. Underwriters then sign the slip to confirm the proportion of risk that they will accept.
There is usually (almost always) a ‘lead underwriter’ who sets the price and agrees terms for the risk on behalf of the other underwriters on the risk. The lead will also usually decide whether a claim can be paid or whether it should be resisted. The rest of the underwriters are known as ‘following underwriters’. There is not a complete split, but underwriters will quite often focus on leading or on following, as will companies or syndicates. People use the terms ‘lead market’ or ‘following market’ to indicate that to an extent individual underwriters and companies have these focuses.
So underwriters working for syndicates in the lead market tend to set premium rates and underwriting terms, whereas those in the following market tend to adopt the premium rates set by the lead underwriter.

The broker will sometimes try to over-place the risk: to receive offers for more than 100% of the risk. If this happens, then, in agreement with the insured, the shares of the underwriters are reduced (or ‘signed down’) so that they total 100%. If the broker is unable to find capacity to place 100% of the risk, the terms of the insurance may need to be renegotiated. Securing a lead underwriter with a strong reputation will typically make it easier for the broker to fully place the risk.

Question 20

Define Annual Venture

Answer 20

The annual venture (AV) is the mechanism that allows investors to provide capital to underwriters for one year at a time. Although many investors at Lloyd’s now see their involvement as continuous, the AV continues to form the legal basis of activities.
Syndicates are reformed each year, and the current members have the right to re-subscribe the same proportion of the next syndicate year. If they do not wish to do so, they may sell this right to the highest bidder in an auction.

Question 21

Three-year funding at Lloyd’s

Answer 21

For much of the business written at Lloyd’s, the long-tail nature of the liabilities implies that it can take some time before their true cost can be determined. Each syndicate year of account is therefore allowed to remain ‘open’, usually for a period of three years, before the profit or loss is finally determined for that year. During that time, premiums received on business written in the year are accumulated in a fund known as the Premium Trust Fund (PTF) out of which claims and expenses are paid.
PTFs are the premiums and other monies that members receive in respect of their underwriting at Lloyd’s, held by their managing agents in trust for them subject to the discharge of their underwriting liabilities.
At the end of the three-year period, the managing agent would usually close the fund by estimating the value of the outstanding liabilities and reinsuring them into the subsequent open year of that syndicate. The reinsurance premium paid for this is known as the reinsurance to close (RITC). An approved RITC extinguishes the liability for that syndicate year. If the receiving syndicate fails, the liability would fall to Lloyd’s Central Fund.
Once this transaction has occurred, the managing agent can determine the final result on the closing year of account, and the profit or loss attributable to each member who participated in that year. In some cases – for example, if the syndicate has ceased trading – the RITC may be paid into another syndicate or an insurance company that is approved to accept the RITC.
A year of account may be held unnaturally open for longer than three years if the liabilities cannot be reasonably quantified, due to fundamental uncertainty. In this case, the managing agent will look to close the year of account in later years, when the liabilities are more certain.
With three-year funding, no profit is usually recognised until the end of the third year. For example, for a syndicate writing business for the year 2019, profits would not usually be declared until the end of 2021.
As a result of Lloyd’s unique ‘chain of security’, the position with an RITC differs from that applying to other reinsurance contracts. If the reinsuring Lloyd’s members cannot honour their associated financial obligations, then the burden initially falls upon Lloyd’s Central Fund (as described above). Only if the Central Fund were exhausted would the Lloyd’s members for the ceding year be required to meet these obligations. For all practical (if not strictly legal) purposes, therefore, the RITC has a similar effect to a transfer of liabilities from one group of Lloyd’s members to another.

Question 22

Suggest how reinsurance to close premiums might be assessed.

Answer 22

This is effectively the same process as establishing the reserves required at the year end. Hence, an appropriate reserving method, such as the chain ladder method, could be used to assess the reinsurance to close

Question 23

Statement of Actuarial Opinion (SAO)

Answer 23

Each year, as at year end, the managing agent must produce a statement of actuarial opinion (SAO) for each open syndicate year from a signing actuary. The SAO confirms that the technical provisions held for solvency are at least as large as the signing actuary’s best estimate.
The signing actuary must be approved by the Institute and Faculty of Actuaries as having the appropriate experience to provide the opinion. While the signing actuary is usually independent of the managing agent, it is possible for an actuary working for the managing agent to fulfil this role.

Question 24

Demonstrating solvency

at Lloyd’s

Answer 24

Individual members must demonstrate solvency to the regulator and must have sufficient FAL if they wish to continue underwriting at Lloyd’s. Lloyd’s completes a ‘coming into line’ exercise twice a year, which requires members to deposit additional funds should the FAL be deemed insufficient.
In addition, Lloyd’s in aggregate must demonstrate overall solvency (that is, based on the aggregate of all members’ exposures or net liabilities) to the regulator (the Prudential Regulation Authority, PRA) by holding additional assets centrally (known as the central assets for solvency). The majority of these central assets consist of the New Central Fund (NCF). If a member’s FAL proves to be insufficient (and fails to come into line when requested to do so), then these central assets will be used to meet claims.
Therefore, the total funds available to pay the claims for the syndicates are the funds held by the syndicates, the members’ funds at Lloyd’s and the central assets.