As CEO of the venerable insurer Lloyd's of London, Richard Ward oversees $33 billion in premiums each year, underwriting such valuables as actress Ugly Betty's smile, soccer star David Beckham's knees and singer Celine Dion's vocal cords.
It's all part of the tradition at the 321-year-old Lloyd's, which is described as a British insurance market rather than an insurance company, because it serves as a meeting place for a variety of agents to pool and spread risk. Over its long history, Lloyd's has written policies covering everything from the legs of 1940s movie star Betty Grable to the potential paternity liabilities of 1980s rock star David Lee Roth to the tongue of Gennaro Pelliccia, chief taster for the U.K.'s Costa Coffee coffee chain. Not to mention the first commercial air flight, the first commercial space flight, and all manner of bridges, oil rigs, fleets, real estate holdings in climactically dangerous regions and corporate investments in politically unstable countries.
As Ward noted during a recent Wharton Leadership Lecture, "It's a very large and varied range of activities we get involved in. Basically, what we do is insure things other people can't or won't."
But for all the unusual policies written by Lloyd's 50 component franchises, Ward said, the key to success is a simple lesson that ought to be followed by individual investors, multinational banks and anyone else in business: Understand your risks. Lloyd's employs an army of researchers to study such data as the ages of the jets in the Sultan of Oman's private fleet and the threats that might have disrupted the 2008 Olympic Games in Beijing.
If this collection of brains can't understand something, Ward figures, that's reason enough to stay away from it. "When we don't like a risk, we don't write it." It's a lesson Lloyd's learned the hard way in the years before Ward took the helm at the world's most famous insurer three years ago. "In the past at Lloyd's, we used to write a lot of financial institution risk," Ward noted. "We provided a lot of cover to two great names, Enron and WorldCom. As a result of that, we paid out some really large claims."
But also as a result of that, Lloyd's made "a conscious decision to scale back our exposure to financial institutions because we were uncomfortable with that type of risk," Ward said. "We didn't really understand it that well. And if you don't understand it that well, don't do it. We scaled it right back to the extent that now, with the subprime problem, the [Bernie] Madoff problem, the [R. Allen] Stanford problem, we find very little exposure to those institutions, to those organizations and to those subprime claims. So, [regarding] all the problems arising out of the financial crisis, we will be able to [conduct] business as usual."
The 'Names'
The venerable insurer had weathered two major storms over the decade before Ward took the helm, including one in the mid-1990s, as claims for years of asbestos exposure in U.S. buildings began to come due. "We found ourselves having to pay out claims totaling over $15 billion," Ward said. "In the 1990s, $15 billion was an enormous sum of money."
The losses did in fact wipe out many of the wealthy individual members -- known as the "Names" -- who, under Lloyd's unusual structure, pledge all of their personal wealth to underwrite the policies of its syndicates. Some of the Names, in turn, accused the insurer of perpetrating a massive fraud by recruiting new members without revealing the huge claims that were looming. The ongoing proceedings, Ward said, represent the longest court case in British history.
Lloyd's eventually revamped its organizational structure, ending the recruitment of new "unlimited liability" Names and spinning off pre-1993 business, at great expense, into a new vehicle called Equitas. To pay for this, Lloyd's unloaded assets, including its landmark London building. "We sold absolutely everything except the silver," Ward said. "It's a very important lesson for us: As a result of being able to take those toxic liabilities and the good liability and create that new vehicle, we were able to trade forward."
Then, in 2001, the terrorist attacks on the United States and the subsequent calamities in the travel and transportation industries threatened Lloyd's again. As the largest insurer of the World Trade Center, Lloyd's was stuck with $11 billion out of the $40 billion in total claims. "One day after the World Trade Center, we had the same people sitting there saying, 'We're about to go bankrupt. We can't pay this $11 billion,'" Ward said. "It's quite extraordinary that so soon after the problems of the 1990s, we were faced with a similar problem."
The immediate issue was liquidity: American regulators worried that Lloyd's didn't have enough cash to stay in the market. After hectic meetings in Washington, the crisis was averted. But, said Ward, "that was truly the defining moment for us where the management of Lloyd's at the time said, 'Hold on, we are going to have to do things very, very differently going forward if we want to survive as a business.'"
One example of the style that would have to end: Although Lloyd's was insuring the World Trade Center, no actual policy had been written beyond the term sheet -- a problem that was common across the industry. "When you end up as a business leader and you're told by your chief risk officer that you've got a policy, ask to see the policy," Ward advised his audience.
Lloyd's eventually put in a new management structure that Ward calls "the McDonald's of Lloyd's." Like the fast-food chain, it's a franchise structure. "Ronald McDonald is able to put in standards across the whole of the McDonald's franchise and get everyone to do the same thing," Ward said. What's good for Big Macs and fries is good for risk standards, too. "Anybody who wants to write business inside the Lloyd's market does it according to the standards we set."
In the new world of Lloyd's, Ward noted, "if you're Company A and you're writing risks inside Lloyd's, we look at the risks that you're writing, and then we look at how your risks plus everyone else's risks add up together to what the aggregate exposure is [in order to make sure] that first, the capital you have is sufficient to support your business, and second, the capital the market has is sufficient to support the risks across the whole market."
In 2005, when losses from hurricanes Katrina, Rita and Wilma added up to $60 billion, Lloyd's share was $16 billion -- even higher than the $11 billion in claims it faced after 9/11. But whereas the 2001 attacks ultimately cost the Lloyd's market $5 billion in losses, the risks were now sufficiently diversified that the market's overall losses were just $160 million. Ward called the new discipline "life changing."
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COMMENTARY: This is the first time that I have covered the mysterious, and often misunderstood English insurer, that insures things other insurer's won't touch.
What I found interesting about LLoyd's is that they are not an insurance company in the traditional sense, but an "insurance market." The Lloyd's market is described as follows:
Lloyd's is the world's leading specialist insurance market, home to over 50 managing agents and over 80 syndicates*, which offer an unrivalled concentration of specialist underwriting expertise and talent.
Lloyd's brokers bring business to the market. The risks placed with underwriters originate from clients and other brokers and intermediaries all over the world. Together, the syndicates underwriting at Lloyd's form one of the world's largest commercial insurers and a leading reinsurer.
The market structure encourages innovation, speed and better value, making it attractive to policyholders and participants alike. Immediate access to decision-makers means that answers on whether a risk can be placed are made quickly, enabling the broker to provide fast, good value solutions.This diagram is a basic representation of the structure of the market and its participants. A detailed description of the participants can be found below.
I wonder what kind of handicap or risk factor Lloyd's would've given the U.S. economy, the Top 16 U.S. banks, and Wall Street. Would Lloyd's insure the U.S. economy now given the current recession?
It is hard to believe that Lloyd's has been around for 321 years, especially an insurance company that takes a gamble everytime it underwrites insurance for something. The U.S., as we know it today, did not exist 321 years ago. We are a bunch of British colonies, and most of the country east of the Mississippi was unexplored.
If there is anything that we can learn from those conservative Brits is reflected in Lloyd's approach to risk management--if you don't understand the business or degree of risk associated with that business or thing, walk away or just don't do it. I like this common sense approach. Corporate bigwigs and VC firms can learn something from this.
Courtesy of an article dated November 24, 2009 appearing in http://knowledge.wharton.upenn.edu/article/2388.cfm
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