A SOLVENCY PERSPECTIVE: CONCERNS OF INSURANCE CARRIERS IN DEALING WITH LLOYD'S AND THE LONDON MARKET

I.   INTRODUCTION

II.   LLOYDS

III.   ISSUES FOR OTHER INSURERS

IV.  SAMPLE COVERAGE CHART

INTRODUCTION

Lloyd's has been actively involved in the United States insurance industry for nearly 100 years.(1) As demonstrated by the Sample Coverage Chart at the end of this article, Lloyd's role in the United States insurance market is both persuasive and dramatic.  As the chart also depicts, a large percentage of Lloyd's activity in the United States insurance market involves supplying companies with umbrella and/or excess policies of insurance.

LLOYDS

Lloyd's Economic Outlook

In the past two years, much has been written about the financial woes besetting the Lloyd's “Names,” the wealthy individuals who provide the underwriting capital.  After nearly two decades of profit, Lloyd's reported losses of £507,000,000 for the 1988 year of account, and more than £2 billion ($3.4 billion United States) for 1989, the latter representing the largest overall loss in Lloyd's three centuries of existence.(2)

The majority of losses were suffered by a relatively small number of syndicates, particularly those managed by the now defunct agencies of Gooda Walker, Feltrim, Rose Thompson Young and Devonshire.(3) These losses occurred in what is known as the re-insurance or LMX spiral.(4) Although passing along some of the risk through reinsurance is generally perceived as a good insurance practice, the LMX spiral disaster arose from the repeated reinsuring of risks within a relatively few syndicates.  Many catastrophic losses , including those caused by Hurricane Hugo, the Exxon Valdez disaster, the Pan American air tragedy at Lockerbie, and the explosion of the Occidental Petroleum's oil rig Piper Alpha , occurred during the 1980s, and each resulted in billions of dollars worth of claims.(5)

This succession of bad luck devastated certain syndicates because the reinsurance risks were concentrated, rather than spread among various groups.  The Names, many of whom now face financial ruin, are understandably angry, and have been advised that they will win lawsuits for negligence against those responsible for the underwriting decisions. (6)

The results of Lloyd's apparently dire financial straights are murky at best.  The most significant immediate concern is that of decreasing capital.  Because of the recent losses, the number of Names resigning has increased, while the number of new Names being recruited has fallen.  Consequently, underwriting capacity has dipped to around £8.8 billion, far below the 1988 level in real terms.(7) Due to a weak exchange rate, the decrease in underwriting capacity in terms of United States dollars is worse yet, falling some fifty percent from 1988.(8) Lloyd's lack of underwriting capital is particularly distressing in light of higher insurance rates which may otherwise make future years at Lloyd's extremely profitable.(9)

A proposed solution to Lloyd's underwriting capacity problems calls for the recruitment of corporate members.  As it now stands, the Names, who are simply wealthy individuals, place their personal worth at stake when agreeing to supply the underwriting capital.  The inclusion of corporate underwriting capital has not, however, proven easy.  Many believe that an amendment could take years.  Moreover, the tax breaks and the exemption Lloyd's currently enjoys from the United States Securities Law may be jeopardized.(10)

Another major problem confronting Lloyd's is the question of what can be done to help the Names whose financial lives now lay in ruin. The first source of aid would seem to be the relatively large number of names who were not involved in the LMX spiral and, thus, suffered little or no recent losses.  The more prosperous Names have not, however, been receptive to talk of a marked rescue.  That is particularly true in light of the recent extra levy, which required Names to pay an additional 1.66 percent of underwriting limits for each of the three years of account from 1990 to 1992, and which doubled the Central Fund to £1 billion.(11) A second potential avenue of relief involves the Names' claims of negligence against the Lloyd's members and agents, whom the Names hold responsible for the LMX spiral fiasco.  The negligence claims were strengthened by two recent reports, one on Gooda Walker and the other on Feltrim, which determined that Names' interest were not adequately protected; the managing agents were incompetent and uniformed; and the underwriters responsible for reinsurance used poor judgement insofar as the reinsurance risks were concentrated in a few syndicates.(12)

Unfortunately, the errors and omissions policies which insure the members and managing agents against negligence claims do not come close to providing adequate funding to compensate the Names.(13) Thus, the lawsuits brought by the Names against the managing agents and members loom heavily over Lloyd's future.  These lawsuits will not, however, be brought directly against Lloyd's, which is apparently immune from most actions due to the Lloyd's Act of 1982.(14)

On a more positive note, a recent study conducted by Hoare Govett Investment Research states that the reserves from which claims are met are substantial in relation to both United States and other United Kingdom insurers. Lloyd's American Trust Fund currently contains approximately $10 billion, while the total deposits held at Lloyd's is more than $8 billion.  This does not take into account the fact that the Names, many of whom possess substantial wealth, may be personally liable for claims.  Further, a claim may be paid from Lloyd's Central Fund, which now stands at approximately $1.8 billion.(15) Thus, although Lloyd's current economic status may be less than bright, it appears that Lloyd's past success, combined with prudent planning, may provide the cushion necessary to weather these tough times.


The London Market

Lloyd's, of course, is not the only United Kingdom provider of insurance to United States companies.  Other underwriters in the London Market have been financially troubled for similar reasons.  Most notably, KWELM (Kingscroft, Walbrook, El Paso, Lime Street and Mutual Re), whose business was largely written through the Weavers underwriting agency, has collapsed.  That collapse has resulted in a profound insurance company insolvency, and its failure has affected many United States policyholders.  It is difficult to predict whether such a monumental failure will happen to other financially unstable agencies and companies.  Without questions, even the thought that such events could occur creates significant concerns for other insurers.

We need to examine a few of the more significant issues affecting other insurers involved in coverage claims.


ISSUES FOR OTHER INSURERS

Drop-down Issues

A policyholder faced with an insolvent insurer may seek to have the solvent overlying insurer drop down in place of the insolvent insurer.  The relevant factor in determining whether such drop down should occur is the language in the overlying insurer's policy.  Drop down is unlikely to be imposed where the overlying policy contains express language disclaiming liability where an underlying insurer becomes insolvent.(16) Nor is drop down likely where the excess policy states that it applies in excess of specified underlying limits or upon the exhaustion of underlying limits.(17) However, an excess insurer may be required to drop down where its policy provides coverage in excess of the amount recoverable or collectible from the underlying insurers.(18)

The problem, of course, is drop-down claims will frequently result in further litigation.  In an area of the law where lawsuits are already a major concern, drop-down issues will make the litigation crunch even worse.

Negotiation of Joint Defense Agreements

Because the extraordinary number of cases has caused transactional costs to continually spiral out of control, it makes sense for insurers to share litigation expenses.  As a major player in this area of litigation, Lloyd's and London companies are a part of the joint insurer effort.

If Lloyd's financial underpinnings and the financial future of other London companies are less than secure, how solid will the joint defense effort be from a cost-sharing perspective?  How should agreements be negotiated?  Should Lloyd's or other London companies continue to be a contributing member of a joint defense group?  Is it fair not to include them merely because they have recently experienced losses?  Isn't it possible everyone is overreacting to their financial condition and future?

On the other hand, concern about ability to continue joint defense participation may largely depend on the particular syndicate or underwriter involved.  If a financially unsound syndicate or underwriter is involved, the defense group needs to have a contingency plan which will refocus efforts and resources if the syndicate or underwriter becomes insolvent.  Planning ahead will help to deal with the insolvency, if it happens.

Effect on a Joint Defense Groups' Willingness to Settle a Case if Lloyd's or a London Market Underwriter is Involved

How does one settle a case if Lloyd's or a London company is a defendant?  Is it possible to globally end a case or does prudence dictate separate settlements must be reached?  Who assumes the risk in a global settlement if the Lloyd's or London underwriter can't fulfill the obligations of the agreement?

From an insurer advisor's perspective, we think global settlement agreements must make absolutely clear that the obligations agreed to by each settling party cannot be shifted to anyone else.  The risk of insolvency by a Lloyd's syndicate or a London company should not be borne by a solvent insurer which has bought its peace with a policyholder.

If there is any concern at all about the solvency of a Lloyd's syndicate or a London company, it's probably better to conclude settlements with separate, not global, agreements.

Effect on Other Carriers Above Lloyd's or a London Market Underwriter on a Coverage Chart

Insurers who are significantly near the top of a coverage chart have typically taken a lower profile in the litigation.  That makes sense, since the risk of being included as a real player in the case could be remote, depending on the size of the claim.  But what happens if the underlying coverage layers are principally part of the London Market?  Can an insurer comfortably rely on the belief that the key defendants below, especially if that key defendant is Lloyd's, or a London underwriter, will really do what is necessary to properly defend the case?  Will corners be cut by a financially unsound defendant who wants to save transactional costs?  Who should direct the defense efforts if an insurer is well above Lloyd's on the coverage chart?  Do positions on coverage charts matter as much today as they did in the past?  Will they matter at all tomorrow?

Once again, the answers to these questions depend on the financial integrity of the specific underwriter involved.  If the syndicate is financially solid, not much will likely change--except for the continued concern about how “solid” the syndicate really is.  If the particular defendant below is a financial risk, it's safe to believe corners will be cut.  Other decisions will then be required, despite one's position on a coverage chart.

What the Future Holds If Lloyd's And the London Market Are Really In Financial Jeopardy

Because the London Market has historically been such a significant factor in the insurance world, financial problems at Lloyd's and in the London Market generally will certainly affect other carries as well as policyholders.  Will entire cases be stayed if a London defendant is under insolvency protection?  How will spectacular insolvencies (like the collapse of Kingscroft, Walbrook, El Paso, Lime Street and Mutual Re) affect the progression of coverage litigation in the United States?  Can our courts deal with the spill over effects of these problems?

These, and many related concerns, are a new problem.  After all, for centuries everyone operated under the belief that the London Market, and especially Lloyd's, always paid valid claims.  That belief has never been shaken.  Have we already seen the worst of the insolvencies?  The next few years will tell us the answer to that concern.  In the meantime, it's prudent advise to brace for more unwanted financial difficulties and to plan around those previously unexpected, unanticipated problems.


SAMPLE COVERAGE CHART

15M 3d Layer Excess
5M part of 15M
LONDON
3d Layer Excess
5M part of 15M
XYZ COMPANY
3d Layer Excess
10M part of 15M
STU COMPANY
10M 3d Layer Excess
5M part of 10M
LONDON
5M 2d Layer Excess
LONDON
2d Layer Excess
LONDON
2d Layer Excess
MNO COMPANY
2d Layer Excess
LONDON
1M 1st Layer Excess
JKL COMPANY
1st Layer Excess
JKL COMPANY
1st Layer Excess
GHI COMPANY
1st Layer Excess
LONDON
1st Layer Excess
LONDON
500,000 Umbrella
LONDON
Umbrella
LONDON
Umbrella
DEF COMPANY
Umbrella
DEF COMPANY
Umbrella
HIJ COMPANY
100,000 Primary
ABC COMPANY
Primary
DEF COMPANY
Primary
ABC COMPANY
Primary
ABC COMPANY
Primary
DEF COMPANY
1965 1966 1967 1968 1969

FOOTNOTES

  1. 60 Minutes, “Lloyd's of London,” March 7, 1993, transcript vol. XXV, No. 24, p. 8. [Hereinafter, 60 Minutes].
  2. Lloyd's of London: Corporate Cure?, The Economist, Jan. 30, 1993 at 72 [Hereinafter, Corporate Cure?].
  3. Lloyd's Unlimited Suffering, The Economist, June 20, 1992 at 71.
  4. Undermining the Foundations, The Economist, June 20, 1992 at 71. [Hereinafter, Undermining the Foundations].
  5. 60 Minutes, supra note 1, at pp. 6-7.
  6. Undermining the Foundations, supra note 4, at 71.
  7. Corporate Cure?  supra note 2, 72.
  8. Id.
  9. Id.
  10. Id.
  11. Undermining the Foundation, supra note 4, at 71.
  12. Time to Sue, The Economist, Oct. 17, 1993 at 86. [Hereinafter, Time to Sue].
  13. Undermining the Foundations, supra note 4, at 71.
  14. Time to Sue, supra note 12, at 86.
  15. Alison Watts, et al., Litigating with Lloyd's of London and the London Companies Market, 1993 A.B.A. Sec. Lit. Ins. Cov. Lit. Meeting, §8 at 27-28.
  16. Marialuisa S. Gallozzi, Insurer Insolvencies in the London Market: Consequences for the United States Policy Holder (see page 1).
  17. Id.
  18. Id.

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