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The Future of Lloyd’s: Facing Up to Fundamental Challenges

Brick Wall Ahead 600x300
January 19, 2017

By James Twining
Greycoat Place LLP

Sadly, a few weeks ago, the Whitechapel Bell Foundry announced that it was to close. The company, founded during the reign of Henry VIII in 1570 and responsible for both the Liberty Bell and Big Ben, has found itself increasingly irrelevant in the modern world. Heritage and history count for nothing, it seems, when faced with the chill wind of economic reality. Hope and hard work can only keep you airborne for so long—eventually, gravity tells.

What, then, to make of the long-term prospects for Lloyd's of London, home to another famous bell?

If you talk to people in the market, they will tell you that Lloyd’s demise has been (wrongly) predicted for as long as they can remember. That surviving 300 years of war, fire, flood, and pestilence time and time again proves its continuing relevance, resilience, and fitness for purpose. That its unique business model and expertise leaves it strongly positioned for the future.

They may well be right.

I find it hard to foresee a world where there won’t be a need for a specialist underwriting such as Lloyd’s excels in. In fact, given low penetration levels in most emerging economies (which is where the bulk of global growth for the next 50 years will come from) and the penny eventually dropping for local underwriters when they realize the unsustainability of writing risks they don’t understand, I see good growth prospects ahead.

Lloyd’s ability to risk share, to compete and yet to collaborate at the same time, is unique and necessary in today’s world where risks are getting larger and more complex. Lloyd’s system of licenses and the Central Fund are an incredible boon to syndicates, allowing them to punch way above their individual weight. The Lloyd’s brand is wonderfully evocative and powerful. The ecosystem that has grown up around Lloyd’s and that supports the broader market is unparalleled. And if London is to the insurance industry what Switzerland is to watch making—and I would argue it is—then it is because Lloyd's sits right at its core.

But nothing lasts forever. And while Lloyd's efforts to modernize, to expand, and to change may not quite carry the faint echoes of chairs being dragged across the deck of the Titanic, icebergs are looming large on the horizon.

There is certainly no lack of initiatives—lots of people being very expensively hired, committees put together, structures and reporting lines tweaked. There is a grand strategy (Vision 2025) that is broadly sensible, although it suffers, like many things at Lloyd’s, from an almost wilful disregard of the views or needs of brokers, its primary source of distribution. There is even, finally, some welcome and encouraging progress on electronic trading and settlement, although bitter experience means that most people are not holding their breath.

But I would argue that there are some more fundamental issues that, if left unresolved, pose a much more existential threat to Lloyd’s long-term future.

Let’s start with Lloyd’s composition. Thanks to asbestos, the days of private capital at Lloyd’s are clearly long past. But Lloyd’s is now dominated by syndicates who are platforms for larger insurers that operate both inside and outside Lloyd’s, as opposed to pure Lloyd’s-only syndicates.

From a Lloyd’s perspective, I don’t see how this is sustainable. The interests of these two groups are very different. For the pure players, Lloyd’s is their whole world. For the larger groups, Lloyd’s is just one of the places where they may or may not choose to place risk. The former has a massive vested interest in the market’s long-term future and competitiveness. The latter can afford to be far more equivocal and, whatever they might say in public, face choices on a daily basis between what might be in Lloyd’s broader long-term interests and their own narrow commercial ones.

Take one of the more contentious elements of Vision 2025 as an example. Many brokers have railed against Lloyd’s strategy to expand its geographic reach by opening up offices around the world (most recently India), particularly in developing economies, on the basis that it is effectively duplicative of their own footprints.

From the pure Lloyd’s-only players’ perspective, however, this strategy (provided it can be successfully executed, which remains to be seen) makes sense—it gives them a cost-effective way to gain access to risks that they would never normally get to see in the faster growing economies of the world. (The idea, by the way, that that they can rely on local brokers to bring these risks back to London is, in most cases, laughable, given that it is typically more expensive for the client and forces the broker to share their commission with their London colleagues.) As far as the larger groups are concerned, many of them are already present in most of those key international markets. The fact that Lloyd’s is now there as well adds little to their offering. In fact, it probably is net-net a negative, as the entry of Lloyd’s inevitably creates a scramble for underwriting talent, pushing up local salaries and costs.

Unless there is a rapid and marked shift back towards Lloyd’s being dominated by pure Lloyd’s players, there is a real danger of Lloyd’s being very slowly and subtly steered onto the rocks. This won’t be as a result of a deliberate and coordinated strategy, but out of sheer negligence. It is an almost inevitable consequence of Lloyd’s being influenced by those who do not necessarily have its best long-term interests right at the heart of their business.

The second fundamental issue is regulation. By regulation, I don’t mean the Franchise Board, whose role in protecting the Central Fund—a vital component of Lloyd’s competitive differentiation—remains critical. Rather, I am referencing the fact that if you are a Lloyd’s syndicate today, you are effectively regulated by the Financial Services Authority (FSA), the Prudential Regulation Authority, and Lloyd’s itself.

Two is company; three is a crowd—particularly when you hear again and again from market participants that there is a certain amount of tension between Lloyd’s and the FSA in particular, with the FSA keen to underline its statutory primacy and Lloyd’s determined to protect its delegated regulatory oversight role. The inevitable result is the regulatory equivalent of gilding the lily, with Lloyd's enforcing areas such as Conduct Risk with an almost evangelical zeal in an attempt to show the Financial Conduct Authority (FCA) that it can be trusted to police its own patch.

The damage to Lloyd’s is two-fold. Firstly, it adds hugely to the syndicates’ operating costs as they invest in people and systems to meet an unnecessarily tough set of regulatory standards, which, in the same fate as befell Tantalus, retreat just out of their reach every time they threaten to grasp them.

Secondly, it fundamentally undermines Lloyd’s position as an innovator and risk taker—a position that it had successfully occupied for decades and that it desperately needs to recapture now if it is to thrive and grow in a world where many of the risks it has traditionally relied on commoditize or vanish altogether into local markets. You can be a poacher turned gamekeeper, but thinking you can be both at the same time and expecting to be excellent at either is, at best, naïve and, at worst, dangerous. Just ask the banks. One day, Lloyd’s will have to decide what it wants to be when it grows up.

The final area is cost. Lloyd’s employs nearly 1,000 people, many of them very expensively. Can someone please explain what they all do? They’re running a small insurance market, not trying to send a man to Mars!

I can only imagine how frustrating it must be for the syndicates, desperately trying to meet their budgets at a time of falling rates, low interest rates, rising competition, and increasing costs, to be handed a bill for Lloyd’s every year that only ever goes up. They must feel as if they are on a runaway train that they can’t afford to jump off but have no means of controlling. Left unaddressed, particularly at a time of low returns, it will prove corrosive to Lloyd’s entrepreneurialism and competitive edge. As Nobel Laureate Paul Krugman wrote, “Productivity isn't everything, but in the long run it is almost everything.”

The budgets are eye-watering. There is a committee for everything—queuing at boxes, rubber stamps, and tons of paper being needlessly shuffled around. Bureaucracy has been elevated to an art form that would make the Indian civil service proud. And that is, of course, precisely the problem. At its core, Lloyd’s operates—probably despite the best efforts of those who run it—like the unreformed government department that it was probably originally modeled on, except that government departments in the real world have had to deliver improved levels of service on budgets that have been repeatedly slashed. Lloyd’s just marches on and sends the syndicates the bill. I’m sure there is an example of a successful commercial enterprise that has flourished under the dead hand of a government agency, I just can’t think of one!

I realize that efforts are now being made. A 10 percent reduction in Lloyd’s costs has been promised for next year, which is a step in the right direction. But the truth is that it goes nowhere nearly far enough nor quickly enough. The syndicates should be demanding a plan that sees Lloyd’s target a 30–50 percent reduction in its cost base. Anything less, and they are being taken for a ride. Or more worryingly, they will simply find that their business is being written more cheaply elsewhere.

Part of the solution lies in stripping Lloyd’s of its expensive and unnecessary regulatory oversight role, as outlined above. I am reliably told that Lloyd's employs around 200 people in its regulatory function—the FCA regulates the entire UK insurance industry with a team of less than a hundred.

Part of the solution lies in Lloyd's being absolutely clear on what its core purpose and role are (currently, you can pick from marketplace, regulator, industry cheerleader, trade association, software provider, and many more) and then ruthlessly stripping away anything that delivers little real or perceived value to the syndicates in the context of this core purpose.

More important though is a much more aggressive implementation of electronic trading and settlement. The advances delivered through in the last 18 months, while encouraging, should not disguise the shameful lack of progress made in the previous 20 years that the market has been discussing the topic. In this, the syndicates (and the brokers) perhaps have only themselves to blame, rather than Lloyd's itself, which has been desperately trying to drive through this agenda for years.

If you go at the speed of the slowest and require consensus for every major decision, then you should not be surprised that nothing happens, or very slowly if at all. Remember Kinnect (the Lloyd’s trading platform that was shut down after 5 years of development)? The worry must be that the stakeholders in a market such as Lloyd’s only really respond decisively and rapidly in the face of a crisis. The problem is that the stable doors are usually better closed before the horse has bolted!

A far more muscular approach is required, with Lloyd's imposing a set of standards and setting a timetable by which everyone has to comply or simply stop trading. Some will argue that a broad market consensus has now emerged, which negates the need for such a heavy-handed approach, but that is to underestimate the market's ability to shoot itself repeatedly in the foot on this topic. Those who don’t participate now in the hope of jumping on board later when others have made the investment and taken the project risk should be heavily penalized when they do eventually ask to be included to eliminate the free-rider risk. Here, somewhat ironically, the key to enforcing the change may well rest with the big brokers who, between them, control well over 50 percent of the volume, rather than Lloyd's itself—if they move unilaterally to this new set of standards, just see how quickly the whole market falls into line.

The equity bond and currency markets went through this change decades ago. Is insurance truly so different? Of course, there is a need for face-to-face broking for some risks, and you damage this part of Lloyd's unique offering at your peril. But at the moment, the tail is wagging the dog. In "Lloyd's of London: Future Risks," a May 2016 article in the Financial Times by Oliver Ralph, Bronek Masojada, CEO of Hiscox, was quoted as saying that "80% of what is done [at Lloyd’s] could be handled electronically." If true—and few are better placed than he to know—that is a devastating statistic.

The world need's Lloyd's. To misquote Mark Antony, I come to praise the market, not bury it. But it's long-term future is tied to facing up to fundamental challenges around structure, regulation, and cost, rather than just focusing on solving more immediate issues, such as Brexit, where Lloyd's needs to plan for the worst and hope for the best. The important must not be sacrificed on the altar of the urgent.

For an organization born in a coffee house, Lloyd's seems willfully unwilling, or perhaps unable, to wake up and smell the beans!

© James Twining 2016

James Twining is a former Board director and Group Commercial Director of JLT Group Plc, having previously worked at McKinsey, as an entrepreneur and an investment banker. While exploring his next opportunity, he has established Greycoat Place, a consultancy providing confidential advice and support to Boards of financial services companies looking to accelerate the growth of their businesses in the digital age. He can be reached at [email protected] and his other thought leadership articles on the insurance industry can be found at, which is where this article first appeared.

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