The Society of Lloyd's v Clementson
QUEEN'S BENCH DIVISION (COMMERCIAL COURT)
The Times 14 May 1996, (Transcript)
HEARING-DATES: 7 MAY 1996
7 MAY 1996
INTRODUCTION:
This
is a signed judgment handed down by the judge, with a direction that no further
record or transcript need be made (RSC Ord 59, r9(1)(f), Ord 68, r 1). See
Practice Note dated 6 July 1990, [1990] 2 All ER 1024.
COUNSEL:
G Pollock QC, P Lasok QC and R Jacobs for
the Plaintiff; J Lever QC and R Slowe for the Defendant
PANEL: CRESSWELL J
JUDGMENTBY-1: CRESSWELL J
JUDGMENT-1:
CRESSWELL J:
A THE CLAIM AND
COUNTERCLAIM AND THE POSITION OF THIS CASE IN THE LLOYD'S LITIGATION
Mr
Clementson was elected a Name at Lloyd's with effect from 15.12.76. He signed an
undertaking with the Society of Lloyd's in which he expressly
agreed that he would be bound by the provisions of the Lloyd's Acts and Byelaws
made thereunder. The Central Fund Byelaw (No.4 of 1986) empowered Lloyd's to
recover from Names monies paid out of the Central Fund as a civil debt. In this
action Lloyd's sue Mr Clementson pursuant to para 10 of the Central Fund Byelaw
(No.4 of 1986) as subsequently amended in respect of sums applied out of the
Central Fund to make good default by the defendant.
Mr Clementson (who
was described by Lloyd's as the standard bearer for 2,500 Names) contends that
the Central Fund arrangements are void by reason of art 85(2) of the EC Treaty
and accordingly Lloyd's claim under the Central Fund Byelaw must fail. The
defendant counterclaims on the following basis. It is alleged that Lloyd's, by
making and implementing the Central Fund arrangements and/or other relevant
arrangements, caused the defendant loss and damage which he would not have
suffered in conditions of undistorted competition and that the quantum of such
loss and damage is either the defendant's entire aggregated underwriting loss at
Lloyd's or inter alia his unacceptable losses and/or his losses and/or
reductions in profit resulting from opaque reinsurance, the XL spiral and/or
inappropriate RITC.
This trial follows a successful appeal to the Court
of Appeal (The Society of Lloyd's v Clementson [1995] LRLR 307,
[1995] CLC 117 judgment delivered 10.11.94) against the judgment of Saville J on
16.12.93. Saville J had held that in exercising its powers to seek reimbursement
for sums paid out of the Central Fund, Lloyd's was not engaged in activities
which are subject to arts 3(g), 5, 85 and 90 of the EC Treaty. I refer to the
report of the decision of the Court of Appeal for the detailed reasons which led
the Court of Appeal to hold that the issue as to whether Lloyd's had infringed
art 85 could not be determined as a preliminary point of law, but should proceed
to trial to be decided on the evidence.
The Lloyd's Litigation
This case forms part of the Lloyd's Litigation. It is convenient to
refer to the Lloyd's Litigation and indicate the position that this case
occupies in the Litigation.
The Lloyd's Litigation has been divided for
management purposes into the following categories:-
(a) LMX;
(b)
Long Tail;
(c) Personal Stop Loss;
(d) Portfolio Selection;
(e) Central Fund Litigation;
(f) Other Cases.
(a) LMX
Cases
In these cases Names claim that those responsible for underwriting
on their behalf were negligent in the writing of business in the London Excess
of Loss Market (the LMX) or at least in failing to make adequate arrangements to
reinsure the risks that they wrote, with the result that they are now faced with
enormous losses. The underwriting years that have given rise to the greatest
losses are 1987, 1988, 1989 and 1990. Action Groups have brought cases against
managing and members' agents and in some cases auditors and other defendants.
Trials of Feltrim (main action and 1990 year), Gooda Walker (main action), Rose
Thompson Young and Bromley have been completed. Other cases in this category are
pending.
(b) Long Tail Cases
(i) Run-Off Contract Cases
These cases are concerned with the early 1980's when a number of Lloyd's
Syndicates took over by way of reinsurance the contingent liabilities of other
Syndicates. Many of the contingent liabilities were in respect of insurances or
reinsurances of United States asbestosis and pollution risks. These risks have
generated and continue to generate huge losses on the insurances and
reinsurances taken over by the Syndicates. The cases involve a detailed
investigation into the underwriting of such risks in the early 1980's. Names
allege that it was negligent to take on this business and that both the managing
and members' agents are responsible for this negligence. Some cases in this
category include allegations of negligence in the placing and/or commuting of
run-off contracts. Limitation is raised by way of defence in a number of
actions.
(ii) Reinsurance to Close Cases
These cases concern the
closing of years into the following years where the outstanding liabilities
included contingent liabilities on asbestosis and pollution risks. It is
contended that years from about 1979 onwards should not have been closed and
that as a result the Names on subsequent years have been saddled with losses
that should have remained with earlier years. In these cases the Names have not
only sued their managing agents and members' agents but also the auditors.
Limitation is again raised by way of defence.
Trials have been concluded
in Merrett and Pulbrook 334. Other cases in this category are pending.
(c) Personal Stop Loss Cases
This category is concerned with
Syndicates which wrote Personal Stop Loss insurance for Names on other
Syndicates. The Names contend this underwriting involved the indirect
reinsurance of both LMX and Long Tail business and that the managing agents
should not have taken on such business, or at least should have arranged
adequate reinsurance. The members' agents are also being sued on the grounds
that they are contractually responsible for the alleged defaults of the managing
agents. Thus these cases cover topics addressed in LMX and Long Tail actions but
are in addition concerned with how the various Stop Loss Underwriters concerned
conducted their own underwriting.
The Kansa Names' case has been heard.
Other cases in this category are pending.
(d) Portfolio Selection Cases
In this category Names allege that their respective members' agents
either failed to advise them properly as to which Syndicates they should join
and/or as to spread of risk, or put them on unsuitable Syndicates, or failed to
advise them to leave Syndicates, when (the Names allege) it was or should have
been apparent that the Syndicates were not suitable for the Names concerned.
These cases in the main concern Names who were put on Syndicates operating in
the LMX market. Although they have in common the nature and extent of the
obligations owed by a members' agent to the Names who engage that agent, each
case turns on the particular circumstances in which the Name in question
contracted with the members' agent concerned. Some plaintiff Names in the
Portfolio Selection cases are also plaintiffs in LMX cases and accordingly
questions arise from the inter-relationship of the separate bases of claim.
Judgment has been given in two pilot cases, Sword-Daniels and Brown,(see
Brown v KMR Services Ltd; Sword-Daniels v Pitel and Others [1994] 4 All ER 385).
Other cases in this category are pending. Some claims of this type are
proceeding by way of arbitration.
(e) Central Fund Litigation
In
these cases the Society of Lloyd's claims against the defendant
Names under the Central Fund Byelaw for reimbursement of payments made from
Central Fund (withdrawal claims) or failure to maintain the required level of
security at Lloyd's (earmarking claims). The present case forms part of the
Central Fund Litigation.
Marchant and Higgins (claim by agents/pay now
sue later) was determined by an unsuccessful appeal to the Court of Appeal
against an order for summary judgment.
(f) Other Cases
There are
a number of other cases which concern the internal workings at Lloyd's. Some of
these cases raise points of general importance. The "first past the post" appeal
was heard by the Court of Appeal last year. Speeches of the House of Lords on an
appeal as to taxation issues were delivered in March.
Other cases in
this category are pending.
B THIS CASE IS CONCERNED WITH ARTICLE 85 OF
THE EC TREATY AND NOT A GENERAL INVESTIGATION INTO ALLEGED REGULATORY FAILURES
ON THE PART OF LLOYD'S
In The Society of Lloyd's v
Clementson supra it was argued that terms should be implied into the contract
made between a Name and Lloyd's, by signature of the form of general
undertaking, that Lloyd's should regulate and direct the business of insurance
at Lloyd's in good faith and/or exercise its powers of regulation and direction
for the purposes for which they were given under the contract, namely the
objects set out in s 4 of the Lloyd's Act 1911 and/or regulate and direct the
business of insurance at Lloyd's with reasonable care.
The Court of
Appeal held that necessity was the primary test for implying a term into the
contract by law and that there was no such necessity. This is not a case in
which the suggested terms were so obviously necessary to the efficacy of the
contract as to obviate the need to express them. Nor was there any ground for
regarding the contract as incomplete.
It is of fundamental importance to
note that this case is concerned with art 85 of the EC Treaty and not a general
investigation into alleged regulatory failures on the part of Lloyd's.
However, examination of the defendant's case reveals that in many
respects his case is an attempt to utilise art 85 to advance a case of
regulatory failure against Lloyd's, which the Court of Appeal's adverse decision
as to the alleged implied terms precluded, and to dress up in an art 85 guise
allegations of regulatory failure on the part of Lloyd's.
It is
necessary at all times to distinguish between alleged regulatory failures on the
part of Lloyd's and alleged infringements of art 85(1). The judgments of this
Court to date in the Lloyd's Litigation reveal negligent underwriting on an
unprecedented scale. I can well understand the wish of the Writs Response Group
(of which Mr Clementson is a member) to obtain a full independent inquiry into
the question whether regulatory failures on the part of Lloyd's have caused or
contributed to or facilitated such widespread negligence, with grievous
consequences to so many Names. But this case is concerned with art 85(1). It is
not open to Mr Clementson to use this case as an opportunity to seek the full
independent inquiry that the Writs Response Group wishes to obtain.
Nothing in this judgment is intended to belittle the seriousness of the
negligence on the part of managing agents (and members' agents) reflected in the
judgments of this Court in Feltrim, Gooda Walker, Rose Thompson Young, Bromley,
Merrett, Pulbrook 334 (and Brown and Sword-Daniels). Thousands of Names
(including Mr Clementson) have suffered grievously from negligent underwriting.
The Rowland Report stated that it was a serious mistake to permit some
individuals to join Lloyd's without appropriate resources to pay losses and that
the then current means test and criteria for Names' wealth requirements paid too
little attention to the accessibility of capital backing Names' underwriting
limits. Mr Wilshaw (who was called by Lloyd's) said that a large number of Names
who joined Lloyd's in the 1980's were not Names which his members' agency would
have recommended to join at all. He referred to one particular members' agency
who appeared not to understand what they were doing and therefore gave
inappropriate advice as to portfolio selection. Professor Bain's revised Annex F
to his fifth Report (which reflects the agreed Wilshaw "Category 3" list of high
risk syndicates for the 1989 year of account) constitutes prima facie evidence
of widespread negligent portfolio selection advice on the part of Members' Agents, but each Portfolio Selection case turns on the particular circumstances
in which the Name in question contracted with the Members' Agent concerned. The
above and other evidence in this case would be highly pertinent to an
independent inquiry into alleged regulatory failures, but my concern is with art
85.
C PRINCIPLES OF EC LAW
The relevant principles of EC law are
as follows.
A Article 85 provides as follows:
"(1) The following
shall be prohibited as incompatible with the common market: all agreements
between undertakings, decisions by associations of undertakings and concerted
practices which may affect trade between Member States and which have as their
object or effect the prevention, restriction or distortion of competition within
the common market, and in particular those which:
(a) directly or
indirectly fix purchase or selling prices or any other trading conditions...
(2) Any agreements or decisions prohibited pursuant to this Article
shall be automatically void."
Article 85(3) sets out the conditions for
exemption by the Commission from the provisions of art 85(1) of notified
agreements.
B (1) Decisions fall within the prohibition of art 85 if
they have either the object or the effect of preventing, restricting or
distorting competition; it is not necessary to show that they have this object
if they have this effect.
(2) Decisions fall within the prohibition of
the Article if they have the object or effect of preventing or restricting or
distorting competition; it is, again, not necessary to show prevention or
restriction of competition if distortion is shown.
(3) Any decision by
an association of undertakings which may affect trade between Member States and
which has as its object or effect the prevention, restriction or distortion of
competition within the common market is automatically void.
(4) art 85
has direct effect and national courts are accordingly bound to apply it.
(5) The power in paragraph (3) of art 85 to declare inapplicable the
prohibition in paragraph (1) in any given case is exercisable only by the
Commission. It is not exercisable by a national government or a national court.
Any association of undertakings seeking to show that any of its decisions which
may affect trade between Member States and which has as its object or effect the
prevention, restriction or distortion of competition within the common market is
not prohibited must accordingly notify the Commission and obtain exemption. If a
decision falls within the prohibition in paragraph (1) of the Article, a
national court cannot relieve the association from the consequences in paragraph
(2) on the ground that the decision is in all the circumstances beneficial or
economically justified.
(6) The conduct of insurance business falls
within the scope of art 85.
(As to (1)-(6) above see Sir Thomas Bingham
MR in The Society of Lloyd's -v- Clementson [1995] CLC 117 at
125).
1. Burden of proof
The burden lies on the defendant to
prove that art 85(1) has been infringed. In so far as matters need to be
established to enable Lloyd's to rely on the rule of reason, the evidential
burden of establishing those matters lies on Lloyd's.
2. Standard of
proof
Lloyd's say that the standard of proof is at the higher end of the
usual civil standard of proof on a balance of probabilities scale. The defendant
does not agree and says that the standard of proof is the balance of
probabilities.
In Shearson Lehman Hutton Inc. -v- Maclaine Watson &
Co Ltd [1989] 3 CMLR 429 at 443 Webster J said:-
"An infringement of
Article 85 carries with it a liability to penalties and fines; and I will,
therefore, apply the standard of a high degree of probability, but less than the
standard of proof in criminal matters."
In Chiron Corporation and Others
v Organon Teknika Ltd and Others (No.2) [1993] FSR 324 at 329 Aldous J referred
to the quotation from Shearson Lehman supra but said that at the stage of the
action with which he was concerned he would assume that the standard of proof
was the normal civil standard.
(See further Masterfoods Ltd t/a Mars
Ireland v H B Ice Cream Ltd [1992] 3 CMR 830 at 872-873 Keane J)
In
Rhone-Poulenc -v- Commission [1991] ECR II 867 at 954 Judge Vesterdorf acting as
Advocate General said in his Opinion:-
"There must be a sufficient basis
for the decision and any reasonable doubt must be for the benefit of the
applicants according to the principle in dubio pro reo".
I propose to
follow the same course as that adopted by Jonathan Parker J in George Michael v
Sony 13 Tr L 532 (at page 250 of the transcript) and, without ruling on Lloyd's
submission, to apply the normal standard.
3. Effect on trade between
Member States
The requirement of an effect on trade between Member
States is distinct from the requirement of an effect on competition. Both the
Court of Justice and the Court of First Instance have consistently held that, in
order that an agreement between undertakings may affect trade between Member
States within the meaning of art 85(1), it must be possible to foresee with a
sufficient degree of probability on the basis of a set of objective factors of
law or fact that it may have an influence, direct or indirect, actual or
potential, on the pattern of trade between Member States, such as might
prejudice the realization of the aim/objective of a single market between Member
States (Langnese-Iglo v Commission [1995] 5 CMLR 602).
It is irrelevant
that the agreement produces an increase in trade, even a large one, since the
aim of the Treaty is not to increase trade as an end in itself but rather to
create a system of undistorted competition (Bellamy & Child 4th Edition
pages 111-112).
Community law covers any agreement or any practice which
is capable of constituting a threat to freedom of trade between Member States in
a manner which might harm the attainment of the objectives of a single market
between the Member States, in particular by partitioning the national markets or
by affecting the structure of competition within the Common Market. Conduct the
effects of which are confined to the territory of a single Member State is
governed by the national legal order. (Hugin v Commission [1979] ECR 1869 at
1899).
As to partitioning the market and altering the structure of
competition see B&C 2-130 and 2-131. (The defendant relies on altering the
structure of competition). Trade between Member States may be affected within
the meaning of art 85(1) if the agreement alters the competitive structure
within the common market to an appreciable extent.
Subject to the de
minimis rule, it is not necessary to establish that the agreement or conduct has
in fact affected trade between Member States; it is enough to show that it is
capable of having such an effect.
As to the de minimis rule, an
agreement will not be held to contravene art 85(1) unless the Court is satisfied
that it is likely to affect trade between Member States, and to prevent,
restrict or distort competition within the common market, to an appreciable
extent.
The Treaty does not require that each individual clause in an
agreement should be capable of affecting intra-Community trade, provided the
agreement as a whole satisfies the test (Case 193/83 Windsurfing International v
Commission [1986] ECR 611).
4. Establishment of effect on trade between
Member States
The existence of an effect (or potential effect) on
intra-Community trade is to be determined by comparing the situation as it
exists, with the agreement, decisions or concerted practice in question, with
the situation as it would exist, in the absence of the agreement, decision or
concerted practice.
5. Prevention, restrictions or distortion of
competition as an object or effect
In order to attract the prohibition
in art 85(1) it must, in relation to each of the agreements, decisions of an
association of undertakings or concerted practices alleged by the defendant to
infringe that provision, be established that that agreement, decision or
concerted practice has as its object or its effect the prevention, restriction
or distortion of competition in the relevant market.
In many cases there
is no clear distinction made between "object" and "effect". Nonetheless it is
correct to consider first "the object" of the agreement before considering "its
effects". The "object" of the agreement is to be found by an objective
assessment of the aims of the agreement in question, and it is unnecessary to
investigate the parties' subjective intentions. If the obvious consequence of
the agreement is to restrict or distort competition, as a matter of law that is
its "object" for the purposes of art 85(1), even if the parties claim that such
was not their intention, or if the agreement has other objects (B&C pages
90-91). See further B&C 2-100 (where objects ambivalent).
6.
Prevention, restriction or distortion of competition - effect
As to the
effects of the agreement on competition in Societe Technique Miniere v
Maschinenbau Ulm [1966] ECR 237 the Court said:-
"This interference with
competition referred to in Article 85(1) must result from all or some of the
clauses of the agreement itself. Where, however, an analysis of the said clauses
does not reveal the effect on competition to be sufficiently deleterious, the
consequences of the agreement should then be considered and for it to be caught
by the prohibition it is then necessary to find that those factors are present
which show that competition has in fact been prevented or restrictedor distorted
to an appreciable extent"
As to rule of reason: market analysis and
"essential" restrictions see B&C page 68 2-063. The "rule of reason" applies
to agreements in the insurance sector. It may be necessary for insurers to
include an anti-competitive provision in their arrangements if it is only by
that means that effect can be given to other acceptable provisions. So in Klim v
DLG [1994] ECR 5641 the Court accepted that a rule preventing members of one
co-operative being members of a rival co-operative was not a breach of art
85(1).
However, the anti-competitive restrictions must be limited to
what is necessary to render the arrangements as a whole properly operable
(Higgins v Marchant & Elliot Underwriting Ltd at page 10 Leggatt LJ). See
further Klim supra where the Opinion of Mr Tesauro at page 1-5654 refers to
"workable competition", at page 1-5655 refers to agreements capable of
performing "a more complex function" and at pages 1-5655-6 lists examples of
cases where the Court has held that art 85(1) is not contravened by their
object, provided that in certain circumstances they do not engender
anti-competitive effects and also where the Court stated at page 1-5688 "in
order to escape the prohibition... in Article 85(1)..., the restrictions imposed
on members by the statutes of cooperative purchasing associations must be
limited to what is necessary to ensure that the cooperative functions properly
and maintains its contractual power in relation to producers".
The
franchisor must be able to take the measures necessary for maintaining the
identity and reputation of the network bearing his business name or symbol
(Pronuptia [1986] ECR 353 at 382).
A cooperative association does not in
itself constitute anti-competitive conduct. That legal form is favoured by the
Community authorities because it encourages modernization and rationalization in
the agricultural sector and improves efficiency. In order to escape prohibition,
the restrictions imposed on members by the statutes of cooperative associations
intended to secure their loyalty must be limited to what is necessary to ensure
that the cooperative functions properly and in particular to ensure that it has
a sufficiently wide commercial base and a certain stability in its membership. A
combination of clauses such as those requiring exclusive supply and payment of
excessive fees on withdrawal, tying the members to the association for long
periods and thereby depriving them of the possibility of approaching
competitors, could have the effect of restricting competition. Such clauses are
liable to render excessively rigid a market in which a limited number of traders
operate who enjoy a strong competitive position and impose similar clauses, and
of consolidating or perpetuating that position of strength, thereby hindering
access to that market by other competing traders. (H G Oude Luttikhuis v
Verenigde Cooperative Melkindustrie Coberco BA at pages 1-4 to 1-5).
In
practice, in determining whether competition is "distorted" three main
considerations are important. First, it is necessary to consider the competition
that would occur in the absence of the agreement in dispute. If the agreement
contributes to an appreciable divergence from "normal" conditions of competition
there is a "distortion" within the meaning of art 85(1). Secondly, it is
inherent in the concept of undistorted competition that "each economic operator
must determine independently the policy which he intends to adopt on the Common
Market". Article 85(1) thus requires that every undertaking must act
independently, taking its own decisions without co-operation with its
competitors. An agreement whereby competitors collaborate may "distort" competition even if competition is not "restricted", for example if the parties
exchange competitive information, or jointly subsidise selling activities, or
confer on themselves a competitive advantage denied to others. Thirdly, the
competition which art 85(1) seeks to protect is that which would occur in a true
common market in which goods and services flow freely through the Community.
Thus an agreement which hinders the integration of the single market is a
particularly important example of a "distortion" of competition within the
meaning of art 85(1). (B&C pages 99-100).
7. Effect of arrangements
to be determined in their context
The effect of the agreement, decision
or concerted practice in question is a matter of fact to be determined in the
light of all the relevant facts and the legal and the economic context.
8. Comparison of situation "as is" and "as would be"
The
existence of an object or effect to prevent, restrict or distort competition is
to be determined in the light of all the relevant facts and the legal and
economic context by comparing the situation as it exists, with the term or terms
said to prevent, restrict or distort competition, with the situation as it would
exist, in the absence of that term or terms.
9. Appreciability of effect
on inter-State trade and of prevention, restriction or distortion of competition
The effect on intra-Community trade and the impact on competition must
be appreciable. (See Beguelin Import Co and others v SAGL Import Export [1971]
ECR 949). Intra-Community trade means trade between Member States and the effect
may be actual or potential.
For a case where the Commission considered
the Rules and Regulations of the LSFM see Re The Application of the London Sugar
Futures Market Ltd [1988] 4 CMLR 138.
10. Ascertainment of
appreciability
The appreciable nature of the effect/impact is to be
determined in the light of all the relevant facts and the legal and economic
context and, in particular, by examining the nature of the alleged infringement
of art 85(1), the strength of the position on the market of the parties to the
alleged infringement, the strength on the market of competitors of the parties
and the freedom with which other undertakings may enter the market. (See
Langnese-Iglo v Commission supra).
It is necessary, at the outset, to
define the relevant market before finding an infringement of art 85. For the
purposes of applying art 85, the reason for defining the relevant market is to
determine whether the agreement, the decision by an association of undertakings
or the concerted practice at issue is liable to affect trade between Member
States and has as its object or effect the prevention, restriction or distortion
of competition within the Common Market (Case T-29/32 SPO [1995] ECR II 289 at
pages 317-318).
An undertaking with 5% of the market may be of
sufficient importance for its behaviour to be caught by art 85(1). However,
undertakings with a market share of less than 5% may still be caught by art
85(1) if, on the facts, a sufficiently appreciable effect can be demonstrated
(B&C page 119 and Case 19/77 Miller v Commission [1978] ECR 131).
11. Severance
Article 85 strikes down only those provisions of
an agreement which are anti-competitive. It is then for the national law to
decide what effect that has on the remaining provisions of the agreement.
Severance is permissible in English law where the offending parts of an
agreement can be struck out without rewriting the agreement or entirely altering
its scope and intention. If what remains stands as a contract in its own right,
it is enforceable. (Leggatt LJ in Higgins at pages 12-13). In Higgins at page 13
Leggatt LJ said:-
"Mr Vaughan has addressed no argument to the Court
either orally or in writing about severance. Instead he argues that it is
necessary to look at the whole of the Lloyd's arrangements. If then the 1988
Byelaw is anti-competitive or the SAA is anti-competitive, the whole of what is
comprehended within the arrangements is void. We agree with Mr Pollock Q.C. that
this approach is appropriate only in cases such as the cartel cases where in
order to see the scope and effect of the provisions creating the cartel the
court has to look at the whole of the context in which the offending agreement
was made".
And see Societe Technique Miniere v Maschinenbau Ulm supra
where the Court said:-
"This provision (Article 85(2)), which is
intended to ensure compliance with the Treaty, can only be interpreted with
reference to its purpose in Community law, and it must be limited to this
context. The automatic nullity in question only applies to those parts of the
agreement affected by the prohibition, or to the agreement as a whole if it
appears that those parts are not severable from the agreement itself.
Consequently any other contractual provisions which are not affected by the
prohibition, and which therefore do not involve the application of the Treaty,
fall outside Community law."
12. Damages
Lloyd's say that if
(which Lloyd's deny) the prohibition in art 85(1) gives rise to a right to
damages, damages can be claimed only by a third party to the agreement, decision
or concerted practice in question. The defendant says that in circumstances such
as the present, where the claimant could not engage in the commercial activity
in question unless he joined the association of undertakings whose decisions are
impugned and/or became a party to the agreement that is impugned, without, in
each case, any real opportunity to negotiate the terms of the impugned
arrangements, the claimant is not disentitled from recovering damages by reason
of his membership of the association and of the fact that he is a party to the
agreement.
As to damages in English law see B&C 10-037 et seq and
the Opinion of Mr Van Gerven in H J Banks & Co Ltd v British Coal
Corporation [1994] ECR 1-1209 at 1250-1251.
In Clementson supra at 130
Sir Thomas Bingham MR said:-
"If Mr Clementson is able to establish that
Lloyd's has acted in breach of Article 85, then it seems to me at least arguable
that he has a good counterclaim for damages on which he is entitled to rely by
way of set-off and that s.14 of the Lloyd's Act 1982 cannot be effective to
deprive him of that right. If it were otherwise I do not see how national courts
could help enforce the Community's competition regime, as I understand they are
expected to do. Whether s.14 may itself amount to an infringement of Article 85,
and not simply an ineffective defence to a claim for breach of Article 85, seems
to me more problematical. In the absence of evidence, however, I do not think
one can dismiss as fanciful the suggestion made by the Commission in its Notice
on co-operation between national courts and the Commission in applying Articles
85 and 86 of the EEC Treaty:
'Companies are more likely to avoid
infringements of the Community competition rules if they risk having to pay
damages or interest in such an event.' "
13. Lloyd's say that without
prejudice to their submissions referred to in 12, it is consistent with EC law
to exclude liability in damages in respect of an infringement of art 85(1) (such
liability being owed to a member of the Lloyd's community) as long as (i)
similar claims under English law are treated in the same way and (ii) claims
based on art 85(2) and claims to injunctive relief in respect of an infringement
of art 85(1) are not precluded.
The defendant says the following:-
(i) irrespective of the treatment by national law of claims for damages
for infringement of a person's national law rights, a provision of national law
cannot exclude a right to recover damages which, as a matter of EC law, that
person is entitled to recover for infringement of his EC law rights;
(ii) in any event a national court is precluded by arts 5 and 85 of the
EC Treaty from giving effect to a provision of national law if and to the extent
that that provision would exclude liability for damages for breach of art 85(1)
since, were the national court to do so, it would remove one of the potential
deterrents against infringement of art 85(1);
(iii) the foregoing is
without prejudice to the defendant's contention that this issue is concluded as
between the defendant and Lloyd's by the judgments of the Court of Appeal in
Clementson supra.
14. Lloyd's say that no right to damages arises unless
the parties to the agreement, decision or concerted practice had an intent to
injure the person concerned. The defendant says an intent to injure is not
necessary.
15. Lloyd's say that if damages can be claimed at all, they
may be claimed only in respect of the loss caused by the operation of a term of
the agreement, decision or concerted practice that is found to be prohibited by
art 85(1). The defendant says that damages may be recovered for loss caused to
the claimant by an agreement or decision to which art 85(1) applies, save to the
extent that the loss was caused by provisions of the agreement or decision that
are not unlawful because they are capable of being severed.
16. It is
common ground that questions of causation and remoteness of loss are determined
by English law.
17. As to the conflicting submissions referred to in 12
to 15 above it is not necessary to add to what the Court of Appeal said as to
these questions in Clementson supra, in view of my conclusions set out below.
D THE REGULATORY BACKGROUND
In the Society of
Lloyd's v Clementson supra Sir Thomas Bingham MR described the
regulatory background to the Lloyd's insurance market as follows:-
"The
regulatory background
Before turning to the Community law issues it is
perhaps helpful to touch, briefly and far from comprehensively, on the
regulatory background to the Lloyd's insurance market.
Under a contract
of insurance the insured pays a premium to the insurer and in return the insurer
undertakes a risk of loss which would otherwise fall on the insured. To perform
his contractual obligation the insurer must have the means to meet any valid
claim by the insured if and when it is made (together, of course, with other
claims made by other insureds). If the insurer misjudges the extent of his
potential liabilities, he may be unable to meet the claim of the insured and
this risk is compounded by the considerable time-lag which may well occur
between the time when the premium is received and the time when the insured's
loss is known or its extent ascertained. These peculiar features of insurance
business, and the bitter experience of insurance company failures, have
triggered a series of regulatory measures both in this country and abroad.
The London insurance market comprises a companies market and the Lloyd's
market. The capital of insurance companies is ordinarily provided by
shareholders whose liability is limited for each shareholder to the amount of
capital that he has subscribed. Lloyd's, in contrast, is a society of individual
underwriting names, grouped in syndicates: each name is liable to meet debts
incurred in his underwriting to the extent of his personal fortune, but each
underwrites risks for his own part and not for anyone else. These differing
forms of organisation would not readily lend themselves to an identical
regulatory regime, and have not in practice done so. The Assurance Companies Act
1909 required insurance companies to deposit sums in a specified amount with the
Paymaster General on behalf of the Supreme Court. Lloyd's underwriters were
exempted from these requirements, but only on condition that they complied with
a somewhat different regulatory regime applicable to them. This regulatory
regime required each Lloyd's underwriter also to deposit a sum of money, to be
held so long as any liability under any policy remained unsatisfied, and to
deliver an annual statement to the Board of Trade showing the extent and
character of various classes of insurance business undertaken by him. Since then
these differences of treatment have persisted and increased.
Until the
accession of the UK to the EEC the regulation of British insurance undertakings
in the UK was a domestic matter. But in July 1973 the Council adopted the first
Insurance Directive 73/239, addressed to member states which by this time
included the UK. The recitals of this directive referred to the desirability of
co-ordinating in particular provisions relating to the financial guarantees
required of insurance undertakings; to the need to extend supervision in each
member state to all relevant classes of insurance; to the need for insurance
undertakings to possess a solvency margin, related to their overall volume of
business and determined by reference to two indices of security, one based on
premiums and the other on claims; and to the importance of guaranteeing the
uniform application of co-ordinated rules and of providing for close
collaboration between the Commission and member states. The directive recognised
the existence of Lloyd's underwriters as a form of organisation not found
elsewhere. Article 14 (in the original version) placed the responsibility for
supervising undertakings solely on the home member state, which was by art. 16
to require each undertaking to establish an adequate solvency margin in respect
of its whole business. Detailed rules were laid down for calculating the
required solvency margin, part of which was to constitute a guarantee fund.
The Insurance Companies Act 1982 was enacted in part to give effect to
the obligation of the UK under the directive. Most of the detailed regulatory
provisions of the Act are directed to the companies market. Members of Lloyd's
are exempted by s. 2(2) from the prohibition in s. 2(1) on carrying on insurance
business in the UK without the authority of the Secretary of State and Pt. II of
the Act, dealing with the regulation of insurance companies, does not (by s.
15(4)) apply to a member of Lloyd's who carries on insurance business of any
class, provided that he complies with the requirements set out in s. 83 and
applicable to business of that class.
The requirements referred to in
s.15(4) were specified in subs. (2) to (7) of s. 83, which provide:
'(2)
Every underwriter shall, in accordance with the provisions of a trust deed
approved by the Secretary of State, carry to a trust fund all premiums received
by him or on his behalf in respect of any insurance business.
(3)
Premiums received in respect of long term business shall in no case be carried
to the same trust fund under this section as premiums received in respect of
general business, but the trust deed may provide for carrying the premiums
received in respect of all or any classes of long term business and all or any
classes of general business either to a common fund or to any number of separate
funds.
(4) The accounts of every underwriter shall be audited annually
by an accountant approved by the Committee of Lloyd's and the auditor shall
furnish a certificate in the prescribed form to the Committee and the Secretary
of State.
(5) The said certificate shall in particular state whether in
the opinion of the auditor the value of the assets available to meet the
underwriter's liabilities in respect of insurance business is correctly shown in
the accounts, and whether or not the value is sufficient to meet the liabilities
calculated:
(a) in the case of liabilities in respect of long term
business, by an actuary; and
(b) in the case of other liabilities, by
the auditor on a basis approved by the Secretary of State.
(6) Where any
liabilities of an underwriter are calculated by an actuary under subsection (5)
above, he shall furnish a certificate of the amount thereof to the Committee of
Lloyd's and to the Secretary of State, and shall state in his certificate on
what basis the calculation is made; and a copy of his certificate shall be
annexed to the auditor's certificate.
(7) The underwriter shall, when
required by the Committee of Lloyd's, furnish to them such information as they
may require for the purpose of preparing the statement of business which is to
be deposited with the Secretary of State under section 86 below.'
Reference should also be made to s. 84 of the Act, which provides:
'(1) Subject to such modifications as may be prescribed and to any
determination made by the Secretary of State in accordance with regulations,
sections 32, 33 and 35 above shall apply to the members of Lloyd's taken
together as they apply to an insurance company to which Part II of this Act
applies and whose head office is in the UK.
(2) The powers conferred on
the Secretary of State by sections 38-41, 44 and 45 above shall be exercisable
in relation to the members of Lloyd's if there is a breach of an obligation
imposed by virtue of subsection (1) above.'
Section 32 governs the
margin of solvency which an insurance undertaking is required to maintain.
Section 33 applies where an undertaking fails to maintain the minimum margin of
solvency. Section 35 provides for the making of regulations to govern the form
and situation of the assets of an insurance undertaking. Sections 38-41, 44 and
45 confer certain reserve powers on the Secretary of State. Section 85 of the
Act governs transfers of business to and from members of Lloyd's, and s. 86
provides for the deposit by the Committee of Lloyd's with the Secretary of State
of an annual statement summarising the extent and character of the insurance
business done by the members of Lloyd's in the preceding twelve months.
In these provisions repeated reference is made to the Committee of
Lloyd's. This is a body established when Lloyd's was incorporated in 1871. Under
the Lloyd's Act 1982 the Committee consisted of the working members of Lloyd's
who had been elected to the Council. The Council was itself established by the
1982 Act and included a minority of external members of Lloyd's and nominated
members. Section 6(1) and (2) of the Act provide:
'6(1)The Council shall
have the management and superintendence of the affairs of the Society and the
power to regulate and direct the business of insurance at Lloyd's and it may
lawfully exercise all the powers of the Society, but all powers so exercised by
the Council shall be exercised by it in accordance with and subject to the
provisions of Lloyd's Acts 1871-1982 and the byelaws made thereunder.
'6(2) The Council may:
(a) make such byelaws as from time to
time seem requisite or expedient for the proper and better execution of Lloyd's
Acts 1871-1982 and for the furtherance of the objects of the Society, including
such byelaws as it thinks fit for any or all of the purposes specified in
Schedule 2 to this Act; and
(b) amend or revoke any byelaw made or
deemed to have been made hereunder.'
The Lloyd's Act 1982, although a
private Act of Parliament, must be read in conjunction with the Insurance
Companies Act 1982 which became law three months later. The two Acts reflect a
quite deliberate decision, that Lloyd's should (subject to the reserved powers
and duties of the Secretary of State) be exempted from the ordinary regime of
regulation to which insurance companies were subjected and should (subject to
these powers and duties) be left to regulate itself. Consistent with this
legislative policy of self-regulation for Lloyd's, s. 42 of the Financial
Services Act 1986 also provides that Lloyd's and persons permitted by the
Council of Lloyd's to act as underwriting agents at Lloyd's are exempted persons
as respects investment business carried on in connection with or for the purpose
of insurance business at Lloyd's.
On 24 February 1983 the Minister of
State at the Department of Trade made The Insurance (Lloyd's) Regulations 1983.
These laid down certain rules governing calculation of the solvency margin of
Lloyd's members, the form of the audit certificate required by s. 83(4) of the
Act and the statement of business required by s. 86(1) of the Act."
E
LLOYD'S
For the purposes of examination of the question whether art
85(1) has been infringed it is necessary to examine the complex legal and
economic context of Lloyd's in detail.
Section E of this judgment is
largely drawn from statements of agreed facts. I have combined the various
statements of agreed facts, made a number of additions and omitted matters that
I do not regard as material.
1. INTRODUCTION
A The Operation of
the Lloyd's Market Generally
Structure of the Lloyd's Market
1.1
The expression "Lloyd's" denotes an insurance market. This comprises an
association of separate economic entities, namely individual underwriters. Each
person accepts insurance business through an agent on a several basis for their
own profit or loss.
1.2 In 1871 the members of the Lloyd's underwriting
community were united by Act of Parliament into a Society and Corporation and
incorporated by the name of Lloyd's. The objects of the Society are as follows:
The carrying on by members of the Society of the business of insurance
of every description including guarantee business;
The advancement and
protection of the interests of members of the Society in connection with the
business carried on by them as members of the Society and in respect of shipping
and cargoes and freight and other insurable property or insurable interests or
otherwise;
The collection publication and diffusion of intelligence and
information;
The doing of all things incidental or conducive to the
fulfilment of the objects of the Society. [Section 4, Lloyd's Act 1911].
The Society does not itself accept insurance nor does it assume
liability for the business transacted by its underwriting members.
1.3
Lloyd's underwriters must be members of the Society and, with certain limited
exceptions, brokers must be approved by the Society in order to place business
with Lloyd's underwriters on behalf of their clients.
Underwriting
1.4 The underwriting members of Lloyd's are known as Names. The Name is
the 'insuring entity' that provides capital to the market through participation
in syndicates, carries the underwriting risk and earns the underwriting profit
or sustains the loss. Each Name trades individually for his or her own account.
1.5 The mix of Names by nationality remains predominantly British, and
overwhelmingly from the English-speaking world. The expression "external Names" refers to those Names who do not work in the market and "working Names" refers
to (a) a member of the Society who occupies himself principally with the conduct
of business at Lloyd's by a Lloyd's broker or underwriting agent; or (b) a
member of the Society who has gone [s 2, Lloyd's Act 1982] into retirement but
who immediately before his retirement so occupied himself.
1.6 The
amount of business a Name is permitted to underwrite is circumscribed by the
level of resources placed at Lloyd's and is referred to as an Overall Premium
Limit (OPL). This does not, however, apply to premiums received for reinsurance
to close earlier years of a syndicate on which the Name is placed where the
placing and receiving syndicate are substantially similar. Further, since 1992
under the Syndicate Premium Income (Amendment No. 3) Byelaw (No. 12 of 1991)
premiums paid under quota share agreements have been deductible when measuring
premiums against OPLs thereby increasing the effective capacity of the market.
Syndicates
1.7 Although a syndicate is an economic entity
comprising the aggregate of the underwriting capacities allocated to it by its
individual Names, it has no legal personality. In principle, a Name underwrites
his/her own risks through a managing agent (see the standard managing agent's
agreement). However, in practice an underwriting agent aggregates the
underwriting capacity of individual Names for whom it is acting, so that the
larger risks may be accepted. The grouping together of Names in this manner does
not affect the legal position of individual Names vis--vis risk. Names trade on
the basis of several liability and so are not responsible for the debts of other
Names within the syndicate.
1.8 Subject to reinsurance to close being
effected (see below), syndicates cease to trade at the end of a year and are
commonly described as annual ventures. The outstanding liabilities of the
syndicate participants and the benefits of any outstanding premiums expected are
reinsured not less than two years later, usually with participants in the
following year's syndicate. This reinsurance is known as reinsurance to close
(RITC). It has been Lloyd's policy to encourage syndicates to close years where
appropriate. However, where the managing agent is unable to make a realistic
assessment of what premium should be paid to the next year's Names on the
syndicate to take on liability for the outstanding and future claims, the
managing agent should declare an open year.
1.9 The fact that a
syndicate is limited to one year's life, has some effect on the nature of the
business that a syndicate will underwrite. As was noted at para 2.45 of the
Rowland Report (January 1992) a syndicate is restricted in making long-term
future commitments such as large multi-year insurance contracts without break
clauses. A syndicate may not buy reinsurance policies which bind future years of
account, or enter into long term contracts for physical assets.
1.10
Nonetheless, the management of a syndicate's business is effectively an ongoing
venture, carried out by a managing agent. A managing agent employs underwriting
and administrative staff who develop and run the syndicate's business from year
to year. The main duties of managing agents, and their relationship to Names are
dealt with below.
1.11 All members are required to delegate the
management and underwriting of their insurance business to the managing agents
of the syndicates in which they participate. Members are unable to take any
active part in the agent's conduct of insurance business on their behalf. (See
clause 7.3 of the standard managing agent's agreement).
1.12 Managing
agents and active underwriters depend primarily upon Lloyd's brokers bringing
insureds and cedant insurers to them. Business is also underwritten on behalf of
syndicates through binding authorities or, on occasion, through arrangements
with service companies established by managing agents to produce business such
as personal lines insurance (eg. household or motor). Binding authorities are
arrangements whereby third parties (often brokers) are authorised to accept
risks on behalf of the members of the syndicate subject to certain conditions
and limits.
1.13 The active underwriter on each syndicate is employed by
the managing agent. The main functions of the managing agent are to employ the
active underwriter and to manage the business of the syndicate; the services
provided can include general management, accounting, business development,
computer services and other shared services. The cost of the services so
provided is charged to the syndicate as part of the costs of underwriting. In
addition, the managing agent charges a fee, based on the stamp capacity of its
syndicates, and receives a profit commission on the syndicates' profits. For the
1990 and subsequent underwriting years the "vertical deficit clause" was
introduced which requires that the losses on a syndicate be carried forward one
year (until 1993, when this was changed to two years) in the calculation of the
managing agent's profit commission.
1.14 Most managing agents are now
limited companies (one or two are partnerships), which are privately owned or,
in a few cases, publicly quoted. Prior to the divestment process required by
Lloyd's Act 1982, some of the managing agencies were owned by Lloyd's brokers.
As a result of the divestment requirements, those broker-related agents were
sold off, frequently to the owners of the agency.
1.15 Active
underwriters were required by s 21 of the Underwriting Agents Byelaw (No. 4 of
1984) to be directors of the managing agency, which employs them, and in some
cases are the chairman of the agency.
Raising of capital and serving the
capital base
1.16 Over the past 30 years, a second agency function has
evolved within the Lloyd's market: the members' agency function. Originally, the
managing agent fulfilled the role of introducing new Names to the market and
managing their affairs as underwriting members. In the 1960s agents emerged
whose function was to introduce new Names, and advise them on syndicate
selection and other issues.
1.17 Some members' agents operate, so far as
Lloyd's agency functions are concerned, exclusively as members' agents and are
referred to as independent agents; others are owned by, or are members of a
group that includes a managing agent in which case they and the managing agent
are referred to as combined agents. Some of the independent agents are part of
broking groups, who were able to retain ownership of members agencies when they
were required to sell off their managing agencies by the divestment provisions
of Lloyd's Act 1982.
1.18 Members' agents are remunerated on a similar
basis to managing agents, receiving both a fee based on allocated capacity and a
profit commission. In 1990, the horizontal deficit clause was introduced,
whereby profit commission for a members' agent was calculated from the net total
of profit/loss in any one year for each name across the syndicates in which the
name participated.
1.19 The functions of the members' agents today are,
broadly speaking, threefold: to raise new capital for the market by introducing
new Names; to advise new and existing Names on syndicate selection and secure
the required access to syndicate capacity; and to provide administrative
services to the Names in their capacity as such in respect of their personal
accounting, tax and investment needs.
The production and placement of
business
1.20 Business is brought to Lloyd's by the worldwide networks
of the Lloyd's brokers. A Lloyd's broker is a partnership or corporate body
permitted by the Council to broke insurance business at Lloyd's on behalf of its
clients. Most of the largest broking firms in the world own a Lloyd's broking
subsidiary. Lloyd's brokers do not place all of their business through the
Lloyd's market. They also deal with UK insurance companies and overseas
insurance markets.
1.21 The Lloyd's broker is the final link in a chain
from the policyholder to the Lloyd's underwriters which may include a number of
other intermediaries. The remuneration payable to the Lloyd's broker (usually
expressed as a percentage of the premium payable by the insured) may be shared
amongst all the intermediaries. The Lloyd's broker is normally responsible for
preparing the documentation which is used for presenting the risk to
underwriters (the "slip"). A typical risk will be placed with a number of
syndicates, with one particular underwriter (the "leader") setting the premium
rate, approving the policy wording and, frequently, underwriting the largest
"line" - or percentage - of the risk. (See also para 2.8 below in relation to
"Respect of Lead" agreements) In most cases, once the risk has been placed, the
broker issues a cover note setting out the basic terms and conditions of the
insurance, and the proportion of the risk accepted by each insurer. There may be
many participants in the cover from outside the Lloyd's market. However, there
will only be one policy document for the participating Lloyd's syndicates. That
document is usually prepared by the broker, and checked by the Lloyd's Policy
Signing Office (LPSO), by which it is issued. It is also a further feature of
the international wholesale insurance market that reinsurance may be placed by a
broker in advance of underwriting a direct insurance. This is particularly so in
respect of treaty reinsurance, such as quota share, where a generic reinsurance
programme will be purchased in the expectation of business in relation to
specific risks, and where the rate for direct insurance can be properly
ascertained once the cost of laying off a proportion of that risk has been
assessed.
B Governance
The Council of Lloyd's
1.22 The
Council of Lloyd's is the body charged with the management and superintendence
of the affairs of the Society and the power to regulate and direct the business
of insurance at Lloyd's [s 6(1) Lloyd's Act 1982]. To that end, the Council is
empowered to:
(i) make such byelaws as from time to time seem requisite
or expedient for the proper and better execution of Lloyd's Acts 1871 to 1982
and for the furtherance of the objects [s 4 Lloyd's 1911 (set out in para 1.2
above)] of the Society, including such byelaws as it thinks fit for any or all
of the purposes specified in Sch 2 of the Act; and
(ii) amend or revoke
any byelaw made or deemed to have been made thereunder [s 6(2) Lloyd's Act
1982].
1.23 The composition of the Council was established by Lloyd's
Act 1982, as comprising 16 working Names, 8 external Names and 3 Names nominated
by the Council and confirmed by the Governor of the Bank of England. In July
1987, following the Neill Report, this composition was altered to 12 working
Names, 8 external and 8 nominated Names. The composition of the Council has
subsequently been changed (in accordance with the Council's powers under Lloyd's
Act 1982 to vary its composition) to permit the appointment of 6 working Names,
6 external Names and 6 nominated members. The Chairman and Deputy Chairmen of
the Council are elected on an annual basis by the Council [s 4 Lloyd's Act
1982]. Under s 6(4) of Lloyd's Act 1982, any byelaw passed by the Council may be
amended or revoked at a general meeting of the Society of
Lloyd's by a majority of those voting, provided these represent a third
of the total membership of Lloyd's. This procedure may be invoked by 500 Names
serving a notice in writing on the Council. The Council may delegate certain
powers to the Committee by special resolution (see para 1.24 below).
The
Committee of Lloyd's
1.24 Until January 1993 the Committee of Lloyd's
was comprised of the 12 working members of the Council [s 5(1) Lloyd's Act
1982]. The market association chairmen also attended meetings of the Committee.
By means of special resolution, the Council delegated certain functions to the
Committee, namely:
(i) the making of regulations regarding the business
of insurance at Lloyd's; and
(ii) the carrying out or exercise of any
duties, responsibilities, rights, powers or discretions imposed or conferred
upon the Council by any enactment (other than an enactment in the Act) or
regulation made in pursuance thereof or by any other instrument having the
effect of law or by any other document or arrangement whatsoever, whether or not
such enactment, regulation, instrument, document or arrangement was in force or
in existence on the day when the Act came into force, in so far as such
delegation was not prohibited by any enactment, regulation, instrument, document
or arrangement [s 6(6) Lloyd's Act 1982].
The functions previously
performed by the Committee of Lloyd's are now divided between the Lloyd's Market
Board and the Lloyd's Regulatory Board (which have been in operation since
January 1993) as set out below.
The Market Board
1.25 The Market
Board has been in operation since 1993 and at present has 17 members: 11 working
members (being the 7 working members of the Council and a further 4 working
members), 3 executives from the Corporation of Lloyd's, including the Chief
Executive Officer, and 3 external members. It is chaired by the Chairman of
Lloyd's. The Market Board has the prime purpose of advancing the interests of
Lloyd's members, co-ordinating and leading in dealings with governments, media
and other outside bodies. It is responsible for the strategy to advance Lloyd's
competitiveness and for the provision of central services in areas such as
premium and claims handling, central accounting, the issuing of policies,
systems support, accommodation, overseas representation, surveying and
intelligence services. It also sets minimum standards in areas affecting the
reputation, efficiency and cost-effectiveness of the market as well as agreeing
standards of conduct applying to all types of businesses trading at Lloyd's.
The Regulatory Board
1.26 The Regulatory Board may have up to 16
members. It currently comprises six nominated members of the Council, five
external members of the Council together with four working members of the
Society who are not members of the Council and the Director of Regulatory
Services. The Regulatory Board is responsible for establishing rules for
regulation of the Lloyd's market. The rules are designed to ensure compliance
with legal requirements, the protection of policyholders and of the interests of
Lloyd's members, solvency and the regulation of contractual arrangements between
members and their agents. The Board oversees the disciplinary functions
exercisable by the Council.
1.27 In turn, the Council (and prior to
January 1993, the Committee) has delegated powers to certain committees. The
terms of reference of the principal committees are set out below.
(a)
Audit Committee
The Audit Committee was a policy and advisory committee
reporting to the Committee of Lloyd's on matters affecting the solvency of
members of Lloyd's and the security underlying Lloyd's policies. The Audit
Department of the Corporation provided administrative support to the Audit
Committee and was directly responsible to it. The Audit Committee existed from
1960 until 1983 when it was renamed the Solvency and Security Committee (SSC).
This change of name reflected a re-organisation of departmental functions within
the Corporation and the formation of a new department called the Members' Solvency and Security Department, rather than any significant change in the
Committee's area of responsibilities and functions. Equally, the
responsibilities of the Members' Solvency and Security Department were similar
to those of the Audit Department.
(b) Solvency and Security Committee
As indicated above, the SSC was established in 1983.
(c)
Solvency and Reporting Committee
The Solvency and Reporting Committee
(SRC) was formed in 1991. It assumed the role and functions of its predecessor,
the SSC, and in addition it assumed responsibility for the functions of the
Accounting & Auditing Standards Committee.
The SRC's terms of
reference have been varied from time to time. However, in general terms, its
responsibilities and functions remain essentially the same from year to year.
The composition of the SRC has also varied from time to time. Until recently, it
was chaired by a Deputy Chairman of Lloyd's. It includes underwriters, managing
and members' agents, accountants, auditors and the Director of Lloyd's
Regulatory Services Group. In summary, its terms of reference embrace the
requirements of the Names' annual solvency test and DTI returns, and the records
to be kept by syndicates and underwriting agents pursuant to those requirements.
The SRC is also concerned with other security requirements applicable to Names,
the monitoring of syndicate premium income, policyholder protection, the rules
relating to credit for solvency of reinsurance ceded and the requirements of the
Insurance Companies Acts.
(d)"O" Group
The "O" Group existed
from the 1970s to the early 1990s. It had no terms of reference as such but was
effectively a small committee set up to monitor Council papers. It included the
Chief Executive, Chairman and Deputy Chairman, and the group heads whose task
was to review the papers submitted for consideration at Council/Committee
meetings and discuss amendments etc to the papers.
(e) Membership
Committee
The Membership Committee existed from about 1978 to 1984. It
was a policy and advisory committee reporting to the Committee of Lloyd's on
matters relating to membership requirements. It also had responsibility for
taking decisions upon membership matters in accordance with the guidelines or
policies established by the Committee of Lloyd's.
Functions of the
Corporation of Lloyd's Services
1.28 The Corporation of Lloyd's is the
executive and administrative arm of the Society of Lloyd's. It
is divided into a number of directorates, including:
*Finance. This
division is responsible for the Corporation's financial and taxation affairs and
represents the interests of the society in taxation issues affecting Names or
syndicates. It also provides certain financial services to the market, including
the publication of Lloyd's Statutory Statement of Business.
*Marketing.
This division has primary responsibility, under the Market Board, for
relationships between the market and the Corporation, Lloyd's image at home and
overseas, and further developments of business in those countries which are
important to Lloyd's. Departments include International, Marketing,
Communications and Market Planning.
*Regulatory Services. The
Corporation's function in the self-regulation of Lloyd's is largely performed by
departments within this division. Responsibilities include registration and
continued supervision of underwriting agents and Lloyd's brokers, approval of
arrangements for the introduction of business, registration of auditors, and
handling of customer complaints.
*The Legal Services Department provides
legal advice to the Council and Corporation. It is also responsible for the
conduct of investigations and for the conduct of proceedings before the Lloyd's
Disciplinary Committee and Appeals Tribunal.
*Central Services Unit
(CSU). CSU is responsible for membership matters, Names' funds at Lloyd's and
provision of market services.
*Systems and Operations. This division
provides computer and telecommunications services to the market and is
responsible for developing systems to aid both the market and the Corporation in
their work. Lloyd's Policy Signing Office and Lloyd's Claims Office are major
departments within this division.
*Human Resources and Support Services.
This division is responsible for the pension, personnel, training and property
departments within the Corporation.
Society Regulation
1.29 The
second main function of the Corporation is to administer the regulatory
framework for the Society. Under the principles of self-regulation confirmed by
the Neill Report, there is a complex regulatory regime. (See further s 3 below).
The Regulatory Services Directorate at Lloyd's administers this regulatory
process and is also responsible for the review of brokers and agents within the
market to ensure compliance with the regulations.
Additional
Underwriting Agencies
1.30.In 1979, the Committee of Lloyd's ordered the
establishment of a corporate vehicle known as Additional Underwriting Agencies
Limited (AUA) to take over the task of running the liabilities of syndicates
where the managing agents had failed. Originally, the Corporation of Lloyd's ran
AUAs with assistance from underwriting and managing agency staff in the market.
Where the failure of a managing agent now occurs, it is more usual for the
Corporation, on establishment of a "run-off" vehicle, to sub-contract the task
of running off the liabilities to an appropriate underwriter who acts as Lloyd's
agent.
Lioncover
1.31 As a result of large losses suffered by
the Names on those syndicates managed by PCW Underwriting Agencies Limited
(caused mainly by the fraud of its active underwriter), Lioncover Insurance
Company Limited (Lioncover) was formed in 1987 by the Society (as a wholly-owned
subsidiary under its control) as a vehicle to reinsure the liabilities of
syndicates formerly managed by PCW (later Richard Beckett Underwriting Agencies
Limited). It subsequently also reinsured WMD Underwriting Agencies Limited, an
associated agency. 73 syndicates were managed by these agencies. They wrote
broad-based marine, non-marine and aviation accounts, including a large exposure
to non-marine long-tail casualty business.
All PCW syndicates and Names
are reinsured to close into Syndicate 9001. This is a syndicate formed
specifically to enable Names on PCW syndicates to obtain reinsurance to close,
thereby ending their involvement in the PCW syndicates for regulatory and tax
purposes and enabling them to be released from membership of Lloyd's. Syndicate
9001 conducts no other business. Lioncover (as retrocessionaire) entered into a
whole account retrocession agreement with Syndicate 9001 (as retrocedant). #44
million was paid from the Central Fund to Lioncover to meet future liabilities
as they arose. In the event of a shortfall between the assets and liabilities of
Lioncover, the shortfall is recoverable from Lloyd's at Lioncover's request
under the terms of a bond given by Lloyd's to Lioncover. During 1989, #30.1
million was paid from the Central Fund to Lioncover to meet a shortfall.
1.32 In addition the Society itself has given indemnities to each of the
members of Syndicate 9001. It also entered into cost funding agreements with
each of the managing agents from time to time of Syndicate 9001 - currently
Syndicate Underwriting Management Limited (SUM) (formerly Additional
Underwriting Agencies 4 Limited) and previously Additional Underwriting Agencies
3 Limited (AUA3).
Centrewrite
1.33 Centrewrite Limited
(Centrewrite), a wholly owned subsidiary of the Society, and under its control,
was formed in 1991 to provide reinsurance, on an arms-length, unlimited basis
for syndicates in run-off and for individual members of such syndicates. Since
1993 it has underwritten Lloyd's members' Estate Protection Plans (EPP). Any
shortfall that occurs in the funds of Centrewrite has been and will be met from
the Central Fund or other assets of the Society.
Lioncover and
Centrewrite are authorised by the DTI as insurance companies. AUA3, as a former
substitute members' and managing agent, is not authorised as an insurance
company. Lioncover, Centrewrite and AUA3 are wholly owned subsidiaries of the
Society.
C Market Representation
1.34 In addition to the
committee structure, there is a series of market associations which represent
the interests of the various market constituencies: there are separate
associations for each underwriting market. They are independent from the
Corporation of Lloyd's and not under its control. They are: the LUA (marine),
the LUNMA (non-marine), the LMUA (motor), the LAUA (aviation). These different
categories of business are dealt with further below.
(a) LUA: Lloyd's
Underwriters Association was formed in 1909 and acts officially for all marine
underwriters at Lloyd's in all matters relating to their business. The committee
of the association meets regularly to discuss the underwriting and general
administrative problems which affect marine insurance. It frequently makes
recommendations to all members of the association with a view to improving the
efficiency and profitability of marine insurance. Also, the association keeps
its members supplied with all pertinent information that is likely to have some
bearing upon the underwriting of marine insurance at Lloyd's.
(b) LUNMA:
In 1910 what is now Lloyd's Underwriters' Non-Marine Association Ltd was formed
'with the object of meeting periodically to consider matters relating to fire
and non-marine business at Lloyd's'. One of the chief functions of that
association was then, and still is, to circulate information to non-marine
underwriters relating to non-marine business throughout the world. It is not,
however, the purpose of the association to involve itself in underwriting. The
association works closely with the Council of Lloyd's, enabling Lloyd's
underwriters to transact non-marine business throughout the world. Membership of
the association comprises all the active underwriters at Lloyd's underwriting
non-marine business and they elect a board.
(c) LMUA: The introduction
of compulsory third party insurance in 1930 led directly to the formation of the
Lloyd's Motor Underwriters' Association in June 1931. The problem of
compensating the victims of untraced and uninsured motorists was identified many
years ago and the association played an important role in the formation of the
Motor Insurers' Bureau. Membership of LMUA comprises all Lloyd's syndicates
transacting compulsory motor insurance in the UK and they elect a committee.
(d) LAUA: Lloyd's Aviation Underwriters' Association was formed in 1935
to represent the interests of the Lloyd's aviation market. Membership comprises
underwriters of any Lloyd's syndicate writing aviation business. A committee
acts on behalf of the members as a whole, keeping them informed and sometimes
making recommendations designed to improve the efficiency of the market.
(e) LUAA: Lloyd's Underwriting Agents' Association was formed in 1960 to
look after the interests of underwriting agents and to examine and report on
matters which might be referred to it by the Chairman or Council of Lloyd's. The
association has no regulatory power. The association acts as a forum for its
members and, when necessary, speaks collectively on their behalf. The
association is represented on a number of standing and ad hoc committees and it
liaises with the various departments of the Corporation of Lloyd's on matters
affecting agents and the names for whom they are responsible.
(f) BIIBA:
The British Insurance and Investment Brokers' Association was originally the
British Insurance Brokers' Association (BIBA) until the name was changed to the
present one in January 1988. BIBA had been formed from what had been known as
the British Insurance Brokers' Council. The decision to form the British
Insurance Brokers' Council was taken earlier by the four former insurance
broking associations (the Association of Insurance Brokers, the Corporation of
Insurance Brokers, the Federation of Insurance Brokers, and Lloyd's Insurance
Brokers' Association). On 1 January 1978, the membership of the four
associations was transferred to BIBA and the old organisations dissolved to
leave a single national body representing the interests of insurance brokers in
the United Kingdom. The purpose was to ensure that, for the future, united
action was taken on measures to protect and promote the interests of the British
insurance broking industry and that a single representative body existed able to
react to or express opinion on matters affecting the industry.
(g) LIBC:
The Lloyd's Insurance Brokers' Committee is an autonomous committee of BIIBA. It
is the direct successor of Lloyd's Insurance Brokers' Association, which was
formed in 1910. In 1978 the committee of Lloyd's Insurance Brokers' Association
became Lloyd's Insurance Brokers' Committee of BIBA. The interests of Lloyd's
brokers remain in the hands of a committee of 16, elected by Lloyd's brokers
themselves. While the LIBC is, in fact, one of the regional committees of BIIBA,
in so far as matters affecting the interests of members of the Lloyd's region of
BIIBA (ie. Lloyd's brokers) are concerned, it is autonomous. It therefore
continues to represent Lloyd's brokers on, inter alia, all matters peculiar to
their relationships in the Lloyd's community. Through numerous technical
sub-committees, the LIBC for Lloyd's brokers (and BIIBA for all member insurance
brokers) provides a service on a very wide range of matters.
Names are
represented through the external members of the Council but they have also
sought representation through other channels, eg the Association of Lloyd's
Members (ALM).
2. CATEGORIES OF BUSINESS CONDUCTED AT LLOYD'S
2.1 The business of Lloyd's is traditionally divided into four principal
categories: marine, non-marine, aviation and motor. Managing agents often
describe the syndicates they manage by reference to the main category in which
they have traditionally operated. However, these descriptions are not
comprehensive and do not define syndicates which frequently write a broader
range of business than those titles might suggest. A more precise description of
the business which has been written by each syndicate, and an outline of the
business which is expected to be written in the following two years, is required
to be given by the active underwriter in his annual report to members of a
syndicate.
2.2 Each syndicate writes a different mix of business, with
each category of business carrying different risks. There is an important
distinction between "short-tail" and "long-tail" risks. The term "short-tail" is
applied to business on which claims generally arise and are settled relatively
soon after the risk is accepted and the premium paid; "long-tail" denotes
business for which the notification or the settlement of claims, or both, may
take many years.
2.3 Lloyd's syndicates underwrite both "direct
business" (where the policyholder has a direct interest in the underlying risk
insured) and "reinsurance" (where the policyholder is an insurance company or
another Lloyd's syndicate). Reinsurance can be of an individual risk (a
facultative reinsurance) or a portfolio or specified part of risks previously
written or yet to be written (treaty reinsurance).
2.4 The insurance
industry is international and, in many areas, highly competitive. In the
calendar year 1991 over 60 % of Lloyd's premium income was derived from
policyholders located overseas, including some 35 % from the United States and
Canada and 14 % from other Member States of the EC.
2.5 In many
countries, insurance can only be provided by locally-based licensed insurers.
However, Lloyd's underwriters have been authorised to provide insurance under
local insurance legislation in a number of countries including Australia,
Canada, New Zealand and South Africa. In many of the countries where Lloyd's
underwriters are so authorised, they are required to fulfil a number of local
requirements, which may include the appointment of a general representative, the
maintenance of local deposits and the filing of statistical reports.
2.6
In other countries, Lloyd's underwriters are able to accept business without
having to be licensed insurers. For example, in the USA, although licensed to
write direct insurance only in Illinois, Kentucky and the US Virgin Islands,
Lloyd's underwriters are eligible (except in Kentucky and the US Virgin Islands)
to accept excess or surplus lines business (ie. business which locally licensed
insurers are unable or unwilling to underwrite) in all states.
2.7
Lloyd's underwriters are also able to write reinsurance of insurance companies,
even in countries where they are unable to write on a direct basis.
2.8
Respect of Lead Agreements, which dealt with the basis upon which marine hull
risks were renewed as between the lead underwriter and the following market were
in operation from the mid 1970s to 1991.
2.9 Lloyd's position in
reinsurance remains especially strong, particularly in the specialist risk
areas. Lloyd's continues to enjoy a high reputation in the US for handling
difficult risks, which many domestic carriers are unwilling to underwrite, eg.
D&O, medical malpractice and bankers' bond business.
3. DEVELOPMENT
OF SELF-REGULATION AT LLOYD'S
3.1 Lloyd's was established as a society
of underwriters in 1811 when a Deed of Association was executed by the members
at that time. By 1871, the business of Lloyd's had increased in size to the
extent that it was considered necessary to promote an Act of Parliament to
establish the Society of Lloyd's in a more permanent fashion.
Lloyd's Act 1871 incorporated the then members and all persons subsequently
admitted as members into the Society of Lloyd's. That Act, with
a few basic amendments, established the Committee of Lloyd's as responsible for
managing the affairs of Lloyd's and laid down the framework upon which Lloyd's
affairs have been conducted during the ensuing 110 years. It laid down (inter
alia) and confirmed two fundamental rules for Names, that underwriting must be
conducted only in the Underwriting Room and a Name shall be a party to a
contract of insurance underwritten at Lloyd's only if it is underwritten with
several liability, each underwriting member for his own part and not for
another, and if the liability of each underwriting member is accepted solely for
his own account.
3.2 During the late 19th and early 20 Century, the
market saw the development of new forms of underwriting and Lloyd's Act 1911
extended the object of Lloyd's to include the carrying on by Names of insurance
business of every description (previously it had been limited to marine
business). The Act also introduced the power of the Corporation to suspend
temporarily any Name if the Committee considered him to have been guilty of any
act or default discreditable to him as an underwriter.
3.3 Lloyd's Act
1925 gave enabling powers in respect of the making of byelaws by the Society and
modified some of the rules governing the operation of the Committee. A further
Lloyd's Act, Lloyd's Act 1951, was promoted to give the Society full powers to
borrow money. Several parts of the Acts referred to above were repealed by
Lloyd's Act 1982, the purpose and provisions of which are dealt with further
below.
The Cromer report
3.4 In the late 1960s the market was
struggling with severe underwriting losses and a falling membership. The
Committee therefore asked Lord Cromer to head a Working Party to investigate and
recommend "what should be done to encourage and maintain an efficient and
profitable Lloyd's underwriting market of independent competing syndicates,
which would be of a size to command world attention". The report was delivered
to the Committee of Lloyd's at the end of 1969. The recommendations of the
Cromer Report that were implemented were the reduction of the means test applied
to UK External Names from #75,000 to #50,000, the rationalisation of Names' deposit arrangements and the reorganisation of deposit ratios. The Cromer Report
also made certain recommendations in relation to the remuneration of agents and
the issue of the conflict of interest inherent in joint ownership of brokers and
managing agencies. The Cromer report was made available to the Names in October
1986.
The Fisher report
3.5 In 1979, the Committee of Lloyd's
established a working party, chaired by Sir Henry Fisher, its terms of reference
being:
"To enquire into self-regulation at Lloyd's and for the purpose
of such enquiry to review:
(i) the constitution of Lloyd's (as provided
for in Lloyd's Acts and Byelaws);
(ii) the powers of the Committee and
the exercise thereof; and
(iii) such other matters which, in the opinion
of the Working Party, are relevant to the enquiry.Arising from the review, to
make recommendations".
The principal recommendation of the Working Party
was that:
"... the constitution is no longer appropriate and the
Committee's powers are inadequate for self-regulation in modern conditions. We
have, therefore, recommended that the Committee of Lloyd's should promote a new
private Act of Parliament so that the constitution of Lloyd's can be brought up
to date and the powers of self-regulation enlarged." [Letter of Working Party
presenting Report to Lloyd's Chairman dated 23 May 1980].
3.6 The report
of the Working Party (the Fisher Report) contained a draft bill to amend Lloyd's
Acts 1871-1951. That draft was the basis of the bill put forward to the Lloyd's
membership for approval at a meeting on 4 November 1980. On 27 November 1980,
the Committee presented the draft bill to Parliament for passage as a private
Act of Parliament. The Bill received royal assent on 23 July 1982.
The
Neill report
3.7 In January 1986 the Financial Services Bill was
published and did not include Lloyd's within its scope. However, during the
second reading of the Bill, the Secretary of State for Trade and Industry
announced that Sir Patrick Neill, would head an inquiry into the administrative
and disciplinary framework of Lloyd's and the operation of Lloyd's Act 1982. The
terms of reference of the Neill Committee were:
"to consider whether the
regulatory arrangements which are being established at Lloyd's under the 1982
Lloyd's Act provide protection for the interests of members of Lloyds comparable
to that proposed for investors under the Financial Services Bill".
3.8
The Neill Committee reviewed the byelaws and codes of conduct made since 1983
and concluded that the Council had transformed the self-regulation at Lloyd's
and had acted with energy and determination. The Committee did not recommend
that the regulation of membership of Lloyd's should be brought under the
auspices of the Securities and Investments Board. Nor did it recommend any
amendments to Lloyd's Act 1982; it stated that its recommendations could be
effected by byelaws and resolutions of the Council.
3.9 The Committee
expressed a number of views on the relationship between external and working
members of Lloyd's and made a total of 70 recommendations. These related to the
following areas:
(i) the constitution of the Council of Lloyd's: in
particular, it recommended increasing by four the number of members nominated by
the Governor of the Bank of England and reducing by four the number elected from
working Names;
(ii) admission to membership;
(iii) the
relationship between Names, members' agents and managing agents: in particular,
the structure and terms of the standard agency agreement;
(iv) syndicate
accounting and disclosure;
(v) registration of underwriting agents,
Lloyd's brokers and syndicate auditors;
(vi) conflicts of interest:
especially in relation to common ownership of managing and members' agents;
(vii) enforcement of the system of regulation;
(viii)
compensation and complaints by Names.
Recent Reports
Commercial
future of Lloyd's
3.10 In 1991, the Council of Lloyd's appointed a Task
Force under the Chairmanship of Mr David Rowland to consider the future
organisation of the Lloyd's market. Its terms of reference were to "examine and
assess the advantages and disadvantages of the present basis on which capital is
provided to support underwriting at Lloyd's" and to review the issues of the one
year syndicate structure and of individual membership with unlimited liability.
The Task Force made a series of recommendations, in relation to reforms to the
current structure of the market, the management of old and open years, changes
in the agency system, limited liability capital, and strengthening distribution
channels. These included a recommendation that the Council should "make a
commitment to consider the concept of value for syndicate participations in
three years' time, and evaluate the case for further development of the idea in
the light of market conditions and the degree of support from Names" (Rowland
recommendation no. 47).
Regulatory issues
3.11 In February 1992,
the Chairman of Lloyd's asked Sir David Walker to enquire into allegations that
syndicate participations at Lloyd's were arranged to the benefit of working
Names and to the disadvantage of external Names; and into the operation of the
LMX spiral. The report provided by the Walker Committee made a number of
recommendations, the most significant being in relation to Lloyd's systems of
premium income monitoring and the assessments of the riskiness of particular
types of business.
4. NOTIFICATION TO THE EC COMMISSION
4.1 From
1978, Lloyd's retained Mrs Liliana Archibald as a consultant to advise it on EC
matters in the light of forthcoming regulatory changes at the EC level (which
ultimately took place in, inter alia, the Second Non-Life Directive). Mrs
Archibald had previously been a senior official at the EC Commission.
4.2 On 15 November 1982, Sir Peter Green, the then Chairman of Lloyd's,
wrote to Mr John Ferry, then the Director for Competition responsible for the
matter.
4.3 Following the enactment of Lloyd's Act 1982 until 1984, all
the byelaws then in draft form were submitted to the Commission on a rolling
basis, including the Recovery of Monies Paid Out of the Lloyd's Central Fund or
the Funds and Property of the Society Byelaw (No. 5 of 1984), which provided for
recoveries of payments made under the Central Fund Deed by way of civil debt.
The Central Fund Deed had also been submitted. This process of consultation was
referred to in Lloyd's Annual Report and Accounts 1983. Under the heading of
"Review of the Corporation's Activities" it was stated that "The Society is
concerned to seek appropriate approvals for Lloyd's under the competition rules
of the Community ... the External Relations Department has maintained a close
liaison with the European Commission and the European Parliament and the
Community is therefore well informed about our regulatory plans."
4.4 On
23 May 1984, Mr Abramson, a former Department of Trade official was retained as
a consultant to start work on a notification. Mr Abramson was stood down in late
1984. He has since died.
4.5 On 20 September 1984, the two EC Commission
officials responsible, Mr Norbert Menges and Mr Franco Giuffrida, visited
Lloyd's to see it in operation.
4.6 Subsequently, on 2 October 1984, Mr
Menges wrote to Lloyd's.
4.7 Lloyd's did not proceed with a formal
notification. A comfort letter was not issued.
4.8 On 28 February 1995,
Lloyd's notified the Central Fund Byelaw (No. 4 of 1986) to the EC Commission.
5. BECOMING A MEMBER OF LLOYD'S
5.1 In order to be eligible to
underwrite insurance at Lloyd's, an individual must apply and be accepted as a
member of Lloyd's. Preliminary application is made through a members' agent with
the sponsorship of an existing member. If this preliminary application is
approved by the Council, the applicant will be asked to provide information in
relation to his means. He will also be required to attend a Rota Committee
interview. The Rota Committee comprises representatives of the Council who
inquire into, and assure themselves of (inter alia) the applicant's awareness
and understanding of the concept of unlimited liability. Applicants who are
approved by the Rota Committee must then be elected as members by the Council.
5.2 The terms of a Name's membership of the Society of
Lloyd's are governed by a standard form agreement known as the General
Undertaking. Under the terms of this, the Name agrees to comply during the:
"period of membership with the provisions of Lloyd's Acts 1871-1982, any
subordinate legislation made or to be made thereunder and any direction given or
provision or requirement made or imposed by the Council or any person(s) or body
acting on its behalf pursuant to such legislative authority and shall become a
party to, and perform and observe all the terms and provisions of, any
agreements or other instruments as may be prescribed and notified to the Member
or his underwriting agent by or under the authority of the Council."
The
long form and short form undertakings between Mr John Clementson and the
Society of Lloyd's are dated 1 January 1977.
Means
5.3 The amount of premium income which a Name may accept and thus the
level of business he may write is determined by the level of means which he has
proved to Lloyd's, and the level of his funds at Lloyd's. The minimum means
requirements for external Names for the period 1971-1992 are set out in bundle
28, App 11.
Mini Names
In 1976, a new category of Names, known
as "Mini-Names" was introduced. A Mini-Name was permitted to become a member of
Lloyd's if he could show 50% of the funds normally required, but was also
subject to a corresponding limitation on the amount of business he could
underwrite. The Mini-Name category was abolished in 1984.
A table
setting out the minimum means and funds at Lloyd's requirements between 1971 and
1995 is at bundle 28, App 12.
5.4 On admission to Lloyd's, Names are
required to provide to Lloyd's a Statement of Means setting out the assets they
have to support their level of underwriting. The statement must be signed by an
independent professional. Only assets which are beneficially owned by a Name may
be included on the Statement of Means: they must normally have been possessed by
the Name for 12 months prior to the date of the statement, must not be charged
or encumbered in any way and must not be used in any way which may restrict
their availability for the purpose of the individual's membership of Lloyd's.
Acceptable assets for Means
5.5 Assets for the purposes of
confirmation of means are prescribed by the Council (under the Membership
Byelaw) and are divided into 2 main groups:
(i) Assets which must
constitute not less than 60% of the qualifying level of means. These include
listed UK securities, unit trusts, government stocks and National Saving
Certificates, cash, bank and building society guarantees, letters of credit,
life policies and gold;
(ii) Assets which must not exceed 40% of the
qualifying level of means, including freehold and leasehold property (from
September 1994 this no longer includes the Name's principal residence).
From the early 1980s, a Name's principal private residence could be used
for general means purposes. A market bulletin issued on 4 November 1981 covering
membership requirements for 1983 specifically confirmed that the member's own
home could be used as collateral for bank guarantees/letters of credit. This
practice was discontinued by a market bulletin issued on 26 September 1994.
Maintenance of Means
5.6 Names are required to maintain at all
times the value of their means at the level required by the Council. If the
value falls below this qualifying level, Names must advise Lloyd's specifying
the amount of the deficiency and they may be required to provide a new Statement
of Means or reduce their underwriting.
Re-confirmation of Means
5.7 Subject to the above, a Name's Statement of Means remained valid for
a period of 3 years from the underwriting year to which the statement related.
Reconfirmation of means at the end of each three year period was formerly
requested in a form approved by the Council. Since the early 1990s, this
requirement to reconfirm means has been discontinued although the Council
retains a discretion to require such reconfirmation if it sees fit.
Funds at Lloyd's
5.8 Under the Membership Byelaw, the Council
has powers to prescribe the amount and form of security to be provided by a Name
in respect of his underwriting business at Lloyd's. This security (which is
additional to the amounts held in a member's Premiums Trust Funds) comprises a
Name's funds at Lloyd's . A Name's funds at Lloyd's will include his Lloyd's
deposit, personal reserve fund and special reserve fund. The amount of a Name's
overall premium limit is calculated as a percentage of the individual's funds at
Lloyd's in accordance with ratios laid down by the Council of Lloyd's.
5.9 All assets comprising a Name's funds at Lloyd's must be beneficially
owned by the member, be readily realisable and free from any charge or
encumbrance, unless the Council otherwise agrees.
Capacity
5.10
The introduction of mini-Names facilitated an immediate growth in the market's
capacity.
A graph illustrating the scale of the over-supply of capital
is at page 52 exhibit 42 of the Rowland Report.
5.11 The security of the
Lloyd's policy and the protection of the Central Fund requires that Lloyd's
takes steps to ensure that means are maintained at a level appropriate to
support the members' underwriting.
There are some Names for whom
membership is inappropriate, even if they could pass the means test.
Capacity growth can, inter alia, be curbed by increasing deposit ratios
and/or increasing real wealth requirements.
A graph (Baillie-Hamilton)
on probability of exceeding a loss threshold is found at page 87 exhibit 47 of
the Rowland Report.
The DTI's rgime
5.12 The DTI's rgime is
designed primarily to protect the policyholders and ensure that they get paid;
not to protect capital. The DTI do not accept responsibility for Names in so far
as they are suppliers of capital. When assessing the solvency of Lloyd's, the
DTI takes into account the provisions in the accounts of syndicates, the capital
already committed by Names which is callable to meet claims, the unconditional
guarantees that are callable and the Central Fund but not any further claims
that might be made on Names.
Names' debts
5.13 As Names have
unlimited liability, the calls for additional funds can be financially disabling
for members of a syndicate with very heavy losses. As at the end of 1994 Names
owed #732 million (1993 #630 million) in respect of amounts that had been called
and remained outstanding. Names' debts were approximately #1.1 billion at the
end of 1995. In broad terms the basis of allocation of debt credits in R & R
will be to assist those Names who, by virtue of having suffered
disproportionately large losses, will have the greatest difficulty meeting their
"finality" bills.
6. LEGAL RELATIONSHIP BETWEEN NAMES AND THEIR AGENTS
6.1 s 8(2) of Lloyd's Act 1982 provides that Names may only underwrite
insurance at Lloyd's through an agent.
For these purposes, there are
three types of agents, a members' agent, a managing agent and a combined agent.
The role and duties of a Members' Agent
Lloyd's Membership
Manual (1988) describes a members' agent as:
"an agent to whom members
delegate complete control of their Lloyd's affairs and who enter into sub-agency
agreements with managing agents to place Names on their syndicates".
For
the 1990 year of account, this has been superseded by a direct contract between
Names and their managing agents, executed by the members' agent on their behalf.
Members' agents do not underwrite any risks. Their primary role is to
introduce prospective Names to Lloyd's and to act as an intermediary between
Names and managing agents. Members' agents are regulated by the Underwriting
Agents Byelaw (No. 4 of 1984) which requires registration of members' agents and
sets out rules for the ownership and control of such agencies. The Agency
Agreements Byelaw (No. 8 of 1988) prescribes a standard form contract which must
be entered into between a Name and any members' agent appointed.
6.2 The
prime role of a members' agent is to manage a Name's Lloyd's affairs other than
the actual management of the underwriting. The main duties of a members' agent
are:
*advising Names on their suitability for membership;
*advising and guiding Names through the election process;
*advising which syndicates to join and in what amounts;
*dealing
with any changes in a Name's overall premium limit;
*dealing with the
administration of the investment of a Name's personal and special reserve funds;
*dealing with the annual solvency test and other statutory and
regulatory requirements;
*accounting to Names for the results of their
underwriting, including payment of profit and collection of losses or interim
cash calls; and
*keeping the Names informed at all times of material
factors which may affect their underwriting.
The role and duties of a
Managing Agent
6.3 The Lloyd's Membership Manual describes a managing
agent as "an agent responsible for managing a syndicate and appointing the
active underwriter". The principal role of a managing agent is to determine the
underwriting policy of the syndicates it manages and to make arrangements for
the underwriting of risks. Managing agents must appoint and supervise one or
more individuals to be the active underwriters for each of their syndicates,
pricing and accepting risks on behalf of the syndicate members, and placing
reinsurance.
6.4 The role of a managing agent includes the approval and
supervision of arrangements for:
*the acceptance and pricing by the
active underwriters of the risks to be underwritten and the receipt of the
premiums agreed with brokers;
*the agreement and settlement of claims
made against the syndicate;
*the negotiation and management of the
syndicate's reinsurances;
*the management of the investments held in the
premiums trust fund of each syndicate member;
*the management and
control of the syndicate's expenses;
*monitoring and controlling the
premium income earned by the syndicate and taking reasonable steps to ensure
that members' syndicate premium limits are not exceeded;
*the
maintenance of accounting records and statistical data for the syndicate and the
preparation and audit of the syndicate's accounts;
*making, where
necessary, cash calls on members to provide for underwriting losses;
*compliance with relevant domestic and overseas taxation and legislative
requirements;
*the approval of the premium for and effecting the
reinsurance required to close each year of account; and
*communicating
with members' agents.
6.5 Underwriting agents may also act as "combined
agents", performing both the role of members' agents, and the role of managing
agents.
Legal Relationships between Names and Agents
6.6 The
legal relationship between Names and their agents is governed by the terms of an
agency agreement and by the common law. The structure of the various types of
agency agreement was changed in 1990, when the Agency Agreements Byelaw (No. 8
of 1988) took effect.
6.7 Until 1990, each Name entered into one or more
agreements with an underwriting agent, who was either a members' agent or a
combined agent. The agreement governed the relationship between the Name and the
members' agent, or between the Name and the combined agent acting as members' agent.
The standard form agreements with members' agents and managing
agents were set out in the Agency Agreements Byelaw (No. 1 of 1985).
6.8
Where the combined agent also acted as managing agent for the Name, the
agreement would govern the relationship between the Name and the combined agent
acting as managing agent. Where the agreement was between the Name and the
members' agent, or between the Name and the combined agent who did not act as
managing agent for that Name, the members' agent would enter into a sub-agency
agreement with a managing agent. Under that agreement, the members' agent
delegated the underwriting authority which the Name had bestowed upon him to the
managing agent.
6.9 Until 1990, there was no direct contractual
relationship between a Name and his managing agent (unless the members' agent
also acted as managing agent). However, the House of Lords in Henderson and
Others v Merrett Syndicates Ltd and Others [1995] 2 AC 145, [1994] 3 WLR 761,
upheld the Court of Appeal's judgment that the delegation of the conduct of
underwriting business did not remove the implicit promise by the members' agent
that the work of the managing agent would be carried out with reasonable care
and skill. In addition, managing agents were under a similar, non-contractual
duty to Names to exercise reasonable care and skill.
6.10 The Agency
Agreements Byelaw (No. 8 of 1988) was implemented on 7 December 1988 and applies
to the 1990 and following years of account. It prescribes forms for three
standard agency agreements and provides that it is compulsory for contracts
between Names and their agents to be in one of these three standard forms:
(a) Sch 1:the Members' Agent's Agreement, between the Members' Agent and
the Name. This authorises the agent to enter into the Managing Agent's Agreement
on behalf of the Name, and to enter into the Agents' Agreement with the Managing
Agent;
(b) Sch 2:the Agents' Agreement, between the Members' Agent and
the Managing Agent. This sets out the relationship between the two agents to
enable them to fulfil their obligations to the Name eg. providing the other with
certain information (unnecessary where there is a combined agent); and
(c) Sch 3:the Managing Agent's Agreement, between the Managing Agent and
the Name. This authorises the Managing Agent to conduct the underwriting
business on behalf of the Name.
6.11 The 1988 Byelaw therefore
introduced with effect from the 1990 year of account a direct contractual
relationship between the Name and his managing agent. The Members' Agent's
Agreement and the Managing Agent's Agreement introduced by that Byelaw include
express contractual duties of care and skill and fiduciary duties.
Working arrangements in practice
6.12 A members' agent will
recommend the syndicates which a new member should join, which should in
principle provide a balanced spread of business (subject to any specific
requirements that Name may have) on syndicates throughout the main markets at
Lloyd's with a view to that Name's risk/return profile. Policies vary between
agents as to the minimum and maximum percentage of OPL which Names should have
on syndicates. The final decision as to whether to join a recommended syndicate
rests with the Name.
6.13 The members' agent should monitor the
syndicates on which it has placed Names and will make recommendations to Names
as to whether they should increase their participation on a syndicate, join a
new syndicate, reduce their participation or withdraw.
6.14 The active
underwriter of the syndicate and at least two directors/partners of each
managing agent were required by s 23 of the Underwriting Agents Byelaw (No. 4 of
1984) to participate in the syndicates managed by them.
6.15 Although
many Names remain with the same members' agent throughout their membership of
Lloyd's, it is possible to transfer to another members' agency. The new agent
may not have a relationship with the managing agents of the syndicates on which
the member participated and may be unable to negotiate such a relationship. A
transfer of members' agent may therefore involve a change in the Name's
syndicates.
7. STRUCTURE OF NAMES' ASSETS AT LLOYD'S AND SOLVENCY
REQUIREMENTS FOR UNDERWRITING
Part I: Names' Assets
Deposits
7.1 The Lloyd's deposit is held in trust by Lloyd's (governed by the
Lloyd's Deposit Trust Deed or Lloyd's Security and Trust Deed). A separate
deposit, known as the Lloyd's life deposit, is required if a Name underwrites
life business.
Maintenance and Re-Confirmation of Deposits
7.2
The Corporation of Lloyd's carries out an annual check as at 31 December to see
whether the value of a Name's Lloyd's deposit has been maintained. A Name will
be required to make any shortfall good by the following 31 October. Names
failing to comply are required to reduce their level of underwriting to an
amount commensurate with the value of their deposit. Names must provide the
requisite additional deposits if they wish to regain their former levels of
underwriting.
Acceptable Assets for Deposit
7.3 A Name's deposit
may be provided by means of certain specified assets, including: bank guarantees
or letters of credit, building society guarantees, cash, life company guarantees
and policies and certain other approved securities. Names who were foreign
nationals were required until 1970 to provide their deposits by way of
securities. In 1970, bank guarantees and letters of credit were permitted as an
alternative. A market bulletin issued on 22 November 1976 restricted non-UK
residents to bank guarantees/letters of credit only. From 1 January 1987, new
overseas Names were permitted to provide deposits containing securities.
Special Deposits/Premium Limit Excess Deposit
7.4 Any Name
exceeding his premium income limit in a particular year may be required to
establish an additional Special Deposit in the form of a bank guarantee/letter
of credit or cash. This will be held under an appropriate Deed but kept separate
from the securities forming the Name's normal Lloyd's Deposit.
Personal
Reserve Fund
7.5 This fund is a reserve of cash or certain specified
investments, held under the terms of the Name's Premiums Trust Deed, which may
be retained by a members' agent (at the Name's discretion) as a reserve against
future liabilities and expenses from the Name's underwriting business carried on
through the agent. This reserve may be built up by the members' agent retaining
a proportion of the Name's profits.
The Special Reserve Fund (SRF)
7.6 The SRF enabled Names, within limits, to accumulate reserves from
their underwriting profits, which, when transferred into the SRF would then be
taxed only at the basic rate (rather than the higher rates) of income tax. Such
reserves were to be used to meet underwriting losses. Payments into the SRF had
to be approved by the Inland Revenue. Payments out of the SRF were required to
be made to cover losses certified by the Inland Revenue, although payments
could, within limits, be made on a provisional basis in respect of estimated
losses. The SRF was required to be held on trust, with one trustee being the
Corporation of Lloyd's, and the other being the Name's members' agent. (With
effect from the 1992 underwriting year, the SRF arrangements have been changed.)
Premiums Trust Fund (PTF)
7.7 Every member of Lloyd's is
required to hold all premiums received by him or on his behalf in respect of any
insurance business in a trust fund in accordance with the provisions of a trust
deed approved by the Secretary of State for Trade and Industry. This requirement
is imposed by s 83(2) of the Insurance Companies Act 1982.
7.8 Premiums
trust fund monies can be used to pay any underwriting liabilities and any
expenses incurred in connection with or arising out of underwriting. For these
purposes liabilities include losses, claims, returns of premiums and reinsurance
premiums, while expenses include any annual fee, commission and other
remuneration of a member's underwriting agents, any tax liabilities arising in
respect of the premiums trust fund or its income, and subscriptions and Central
Fund contributions or levies imposed by the Council.
7.9 The premiums
trust deed provided for separate treatment of overseas underwriting business,
for which the Lloyd's American Trust Fund (LATF) and Lloyd's Canadian Trust
Funds (LCTF) have been established. Those trust funds received the premiums on
US dollar or Canadian dollar policies issued in any country by Lloyd's members
and paid any losses, expenses, claims, returns of premiums, reinsurance premiums
and other outgoings in connection with the member's American or Canadian dollar
business respectively.
7.10 The way in which the assets described above
are used as part of Lloyd's overall chain of security is described below.
Part II: Lloyd's Chain of Security
7.11 The purpose of security
is to protect policyholders. Lloyd's has frequently publicly explained its chain
of security and referred to the role of the Central Fund in it. [Mr Clementson
does not accept that the order set out below in para 7.12-7.15 has invariably
been followed.]
The First Link
7.12 The first link in the chain
of security is the premiums trust funds. To protect the interest of
policyholders all premiums are initially paid into premiums trust funds managed
by the managing agent of the syndicate. Payments from these funds may be made to
meet claims, reinsurance premiums or underwriting expenses: profit may not be
distributed to Names unless and until the underwriting account for the year has
closed, and therefore at or after the end of three years.
The Second
Link
7.13 The second link is Name's funds at Lloyd's which must be
provided by the Name as security for his underwriting, as described above. Funds
at Lloyd's comprise the three trust funds in which Name's assets may be held:
the Lloyd's deposit, the Special Reserve Fund and the Personal Reserve Fund held
under the terms of the premiums trust deed (see above).
The Third Link
7.14 The third link is the personal wealth of individual Names. As
stated above, each individual Name is required to show a minimum level of
personal wealth, but Names are further liable to the full extent of their wealth
to meet any claims arising from their underwriting business.
The Fourth
Link
7.15 The fourth link is the Central Fund of the Society. The fund
is available to the Council of Lloyd's to meet Names' liabilities in connection
with their underwriting at Lloyd's. For this purpose, the Fund is not for the
protection of the Name, who remains responsible for his liabilities to the full
extent of his wealth. The Central Fund has also been applied by the Council to
prevent or redress members' failure to meet their underwriting liabilities. It
also performs a function in enabling members to pass the annual solvency test,
as set out below. The Central Fund has also been used (i) to support Lioncover
and Centrewrite (ii) to provide, by way of loans to syndicates, a stand-by
facility to fund deposits in overseas jurisdictions and (iii) to provide support
for the hardship arrangements introduced by Lloyd's for members in financial
difficulty.
The Central Fund Arrangements have enabled Names to pass
solvency.
A summary of investor protection arrangements and other means
of ensuring the security of insurance companies in the UK and elsewhere is set
out in bundle 28, App 13.
Mutual Guarantee Policies
7.16 Mutual
Guarantee Policies (MGPs) were introduced in 1909 as a statutory requirement in
respect of Lloyd's non-marine policies. The statutory requirements were repealed
in 1946, but the Committee of Lloyd's extended the scheme in a modified form to
marine insurance in 1948 when premium limits were increased. Under the terms of
the scheme, every underwriting member of Lloyd's undertook to furnish a MGP
subscribed by other members. The policy ran for one year, commencing on 1
January of the year of risk. MGPs were calculated by reference to the member's
premium income (subject to minimum limits) . The MGPs would only be called upon
after the Central Fund had been exhausted. Although each Name was required to
enter into a MGP on an individual basis, the MGPs were, in practice, issued on a
syndicate-to-syndicate basis whereby members of one syndicate would guarantee
the obligations of the members of another syndicate. A member was prevented from
guaranteeing himself or other members of his syndicate.
There were three
types of MGP, each in standard form:
*The Group Policy - used where more
than one member of the syndicate was named on the schedule;
*The Single
Name Policy - used where (as the title suggests) there was only one member named
for the syndicates covered; and
*The Additional to Deposit Policy - used
in respect of a single member to insure against risk over and above that covered
by a Single Name Policy. In practice, only a few ADPs were taken out each year.
Lloyd's set out minimum requirements as to the amount required to be
covered by the MGP:
*Non-Marine: The guarantee was required to cover the
amount by which the member's premium income exceeded 90% of his premium limit.
*Marine and Aviation: The guarantee was required to cover the amount by
which the Name's premium income exceeded 50% of his premium limit.
The
Cromer Report recommended the abolition of the MGPs for the following reason:
"We understand that no one has ever been called upon to implement a
guarantee policy. Even in severe losses in an individual case in 1923/24, before
the institution of the central fund, ad hoc arrangements were made. If Lloyd's
suffered a disaster or a series of disasters which eroded the private means of
members and swallowed up the central fund, it is not clear what the guarantee
policies would in fact be worth. The annual renewal of policies involves a great
deal of work. We recommend that they should be abolished."
The Fisher
Report concurred with this recommendation. Acting thereon, MGPs were abolished
in 1982. Members' contributions to the Central Fund were subsequently increased.
Other Assets
7.17 The other assets of the Society of
Lloyd's are also available to meet underwriting liabilities in the last
resort.
Part III: The solvency test
7.18 The solvency
requirements in relation to insurance companies are set out in s 32 of the
Insurance Companies Act 1982 (the ICA), which implements art 16 of the First
Council Directive on Non-Life Insurance (the Directive). Thus, the section
provides that insurance companies shall maintain a margin of solvency of such
amount as may be prescribed by or determined in accordance with regulations made
for the purposes of that section.
7.19 Under the ICA, Lloyd's is
required to meet an annual solvency test. The annual solvency test is conducted
at two levels. The first is at individual Name level (the Name level test). The
second concerns Lloyd's collectively (the global test) whereby all members of
Lloyd's taken together must satisfy the solvency margin requirements under the
Insurance Companies Act.
(a) The Name level test
7.20 Under the
provisions of s 83 ICA, each Name is required to provide annually to the Council
of Lloyd's and to the Secretary of State for Trade and Industry a certificate of
solvency signed by an approved auditor. The certificate, which is in a
prescribed statutory form, states (inter alia) that the Name has sufficient
assets to meet his known and estimated future underwriting liabilities in
respect of his insurance business at the previous year end.
7.21 In
order to provide this certificate, Lloyd's carries out an annual solvency test
in relation to each Name individually, drawing on information provided by
managing agents at syndicate level and by members' agents at individual name
level. (see below). The requirements of this annual solvency test, are set out
in the Instructions (prescribed by the Council) that Lloyd's issues to all
managing agents and recognised auditors. These Instructions include rules
relating to the valuation of liabilities which are approved annually by the
Secretary of State for the purposes of s 83(5) of the ICA (the Valuation of
Liabilities Rules).
7.22 Every managing agent is obliged to submit an
audited syndicate return (the syndicate return) in prescribed form giving
details of the insurance transactions for each syndicate which it manages. The
syndicate return must be completed in respect of all open years of account, all
run-off years of account and all years of account closing as at the relevant
year end in order to reflect the total insurance business transacted by the
underwriting member. The information required in the syndicate return is
prescribed under the Solvency and Reporting Byelaw. Part 1 of the syndicate
return must be audited. The syndicate return will specify the syndicate's result
for solvency purposes which is determined by reference to the Valuation of
Liabilities Rules and rules relating to eligible assets.
7.23 Under the
Valuation of Liabilities Rules, two tests must be applied in relation to each
year of account to determine the minimum reserves that must be established for
solvency purposes. Test 1 is a premiums based test; and Test 2 is a claims based
test. The reserves used for the solvency test for each year of account must be
the greater of the Test 1 or Test 2 calculation.
7.24 Test 1 depends on
determining net premium income for each class of business for each year of
account, and then applying an appropriate multiplier (specified in the
Appendices to the Instructions) to reflect the statistically determined
appropriate reserve for that class of business and for that year. Premium income
for these purposes is calculated as gross premiums less brokerage, premium taxes
and levies, discount, returns and premiums payable in respect of reinsurance
ceded.
7.25 Provided that the level of reinsurance ceded is kept at the
threshold specified in App G of the solvency instructions, the reinsurance
premiums may be fully deducted from the gross premiums and no special reserves
need be set up. That threshold is called the "permitted reinsurance limit". The
relevant thresholds, as set out in App G, are 20% (for all reinsurance), an
additional 10% (for certain reinsurance in respect of which security for
outstanding claims has been given) and an unlimited amount for reinsurance
written by Lloyd's insurers. Where the threshold is exceeded, additional
reserves are required as specified in App G (see 12 below).
7.26 Test 2
reserves are determined by establishing a net reserve for each year of account,
being the syndicate's gross reserve less recoveries in respect of reinsurance
ceded. This involves an estimation of outstanding liabilities, including
liabilities incurred but not yet reported (IBNR). Test 2 reserves are estimated
by reference to a combination of factors including historical development of
claims, actuarial projections and the underwriter's own judgment and they
reflect all costs relating to claims, the estimated effects of inflation,
possible bad debts relating to reinsurance recoveries and additional reinsurance
premiums payable. Subject to the amount of expected recoveries under any
reinsurance policy, there is no limit on the credit that may be taken for
reinsurance ceded by a syndicate, whether within or outside Lloyd's. Test 2
reserves are the reserves used for RITC purposes (see 14 below).
7.27
The individual member level of the solvency test involves the members' agents.
They are required to submit an audited asset return (the asset return) giving
the valuation of assets held by them on behalf of every member underwriting
through the members' agent, including personal reserve funds, special reserve
funds, any Lloyd's deposit and the amount of any anticipated qualifying stop
loss recoveries. On receipt of the audited syndicate returns and asset returns
from managing and members' agents (together with a further return from Lloyd's,
in cases where it holds members' assets) the information contained in the
returns is processed by Lloyd's through the central solvency system to produce a
solvency statement in respect of every member for the purpose of the solvency
test. The value of the member's Lloyd's deposit held by the Corporation of
Lloyd's is included in the solvency calculation to offset the member's
underwriting liabilities.
7.28 The solvency statement shows the member's
net underwriting result and the amount of eligible assets available to meet any
net liability arising. The net result of these two amounts is the member's final
solvency position. This solvency statement is then sent to the individual Name's
members' agent.
7.29 Every member who has a solvency shortfall (ie who
has insufficient assets at Lloyd's to meet his underwriting liabilities) is
required to make sufficient assets available to clear the shortfall. If the
member fails to do so, Lloyd's "earmarks" the Central Fund on his behalf to make
up the shortfall. This enables that member to satisfy the requirements of the
Name level solvency test ie by showing sufficient assets to meet his liabilities
even if some of the assets are provided by the Society of
Lloyd's from its central resources. Failure to clear Central Fund
earmarkings by providing additional funds would result in a Name who, at the
time of earmarking of the Central Fund, was an active underwriting member of the
Society, being suspended from underwriting at Lloyd's with effect from the
following 1 January.
"Earmarking" solvency deficits against solvency
surpluses/assets
7.30 In relation to the 1989 and prior years solvency
tests, Lloyd's operated a process known as "earmarking" (distinct from a Central
Fund earmarking) which matched any losses or deficiencies arising from the
solvency test against a member's available assets, surpluses and profits (ie
funds available for solvency purposes) in a predetermined order to cover the
member's liabilities. These assets included the member's Lloyd's deposit, SRF
and any personal reserves.
7.31 For the purposes of the solvency test,
the member's Deposit was divided into three parts: the First Reserve, the Second
Reserve and the "Failsafe". Prior to the 1990 year of account, the failsafe
amounted to 25% of a Name's deposit. Since 1990, it has amounted to 10% of a
Name's OPL.
7.32 In addition to those assets referred to above a number
of further funds (which were not automatically included in the solvency test)
are also available to cover a member's liabilities; these comprised a member's
Premium Limit Excess Deposit, bank guarantees provided as part of a member's
certified means, and (subject to certain restrictions), anticipated recoveries
under a member's Personal Stop Loss and Estate Protection Plan policies. The
order in which a member's assets were earmarked depended on whether the
liability to be covered arose in respect of open year deficiencies or closed
year losses, and is set out in the table below.
DEFICIENCIES LOSSES
(Open Year) (Closed Year)
Funds Active Non-Active Active
Non-Active
Member Member Member Member
Closed year
profits 6 7 1 1
Open year
surpluses 1 1 N/A N/A
Other assets
Personal
reserves, 5 5 2 2
Special
Reserve Fund 4 4 3 3
Deposit first
reserve 3 3 4 4
Deposit
second
reserve 2 2 N/A 5
Deposit
fail-safe N/A 6 N/A 5
7.33 The First Reserve could be earmarked
in full to cover open year deficiencies (including deficiencies on years of
account which were in run-off) or closed year losses. The Second Reserve could
be earmarked in full to cover open year deficiencies only. The failsafe could
only be absorbed when a Name had died, resigned or otherwise ceased
underwriting.
7.34 The Deposit failsafe was therefore the fund of last
resort available for earmarking after all the Name's other assets (including
Special and Personal Reserves, and the assets specified in para 7.32) had been
taken into account and before the Central Fund was earmarked. If the failsafe
was earmarked the Name had to provide additional funds to clear the earmarking
of the failsafe, failing which his level of underwriting in the following year
of account would be proportionately reduced. This is the so-called "coming into
line" requirement.
Reduction in underwriting where Deposit is earmarked
7.35 Where the First Reserve of a Name's Deposit for an active Name was
earmarked to cover a deficiency on a closed year (ie. a loss), that earmarking
had to be cleared by the Name providing additional funds. Failure to do this
would cause a proportional reduction in the Name's premium limits (ie a
reduction of his underwriting limits) for the following year of account.
7.36 Where the First or Second Reserve was earmarked to cover a solvency
deficit in relation to an open year, the earmarking did not have to be cleared
and the Name could continue underwriting to the same premium limit regardless of
the earmarking.
Reduction in underwriting where Special Reserve Fund is
earmarked or released
7.37 A Name was also permitted to earmark his
Special Reserve Fund to cover a closed year loss or open year deficiency.
(However, where a Name had taken his Special Reserves into account in setting
his overall premium limit, all earmarkings to cover a closed year loss or
deficiency at the end of the third and subsequent year of an underwriting
account (but not a naturally open year deficiency) had to be removed. Where such
earmarkings were not so removed, the Name's premium limit in the following year
would be proportionately reduced).
Post 1990
7.38 From the 1990
solvency test, no sequence of earmarking on members' assets has been applied. A
Name's net underwriting position is compared with all the combined assets of the
Name. If the liabilities exceed the assets, the member has a shortfall.
7.39 The First and Second Reserve elements of the deposit were abolished
but a similar process was maintained for handling deficiencies. Specifically,
losses on closing years or deficiencies on run-off years may be earmarked
against funds at Lloyd's but must be cleared in order to avoid a reduction in
the Name's level of underwriting. Deficiencies on open years may be earmarked
against funds at Lloyd's (except the failsafe) without a reduction in the Name's
capacity to underwrite.
7.40 However, if an open year deficiency causes
earmarking of the failsafe then, unless extra funds are made available by the
Name, he will suffer a reduction in his capacity to underwrite proportionate to
the earmarking of the failsafe.
(b) The Global Test
7.41 All
members of Lloyd's taken together must satisfy annually the solvency margin
requirements under the ICA. For this purpose, the assets and liabilities of all
the members of Lloyd's are aggregated. Assets include each Name's funds at
Lloyd's, the assets in his premium trust funds and the value of his other assets
as shown in his most recent means test, together with the Central Fund and other
net assets of Lloyd's. Liabilities are the aggregate of those reported as at the
preceding year end for the most recent year of account, the two intervening open
years and any run-off years of account.
(c) The Statutory Statement of
Business (SSOB)
7.42 Lloyd's is required under s 86(1) of the ICA to
lodge a Statutory Statement of Business (SSOB) with the Secretary of State for
Trade and Industry every year, in the form prescribed by the Insurance (Lloyd's)
Regulations 1983. The SSOB summarises the extent and character of the insurance
business done by all members of Lloyd's in the twelve months to which the
statement relates. Even where a Name cannot continue to underwrite because he
has failed to provide sufficient funds, in order for Lloyd's to file the SSOB it
must ensure that (taking account of any Central Fund earmarking which has
occurred) each Name's assets are sufficient to meet that Name's liabilities.
7.43 The information required in order to complete the SSOB is provided
by managing agents in the syndicate return referred to in para 7.22 above.
8. STRUCTURE OF SYNDICATES' FINANCES
Three Year Accounting
System
8.1 Lloyd's operates a three year accounting system. The results
of underwriting in any year are normally not determined until a further two
years have elapsed, and distribution to members of underwriting profit or profit
arising from investments comprised in the premium trust funds can only be made
after the end of the third year and then only when the relevant year of account
has been reinsured to close as described below. At the close of a year of
account, members' underwriting liabilities allocated to the year are usually
reinsured by way of RITC. Until the RITC is effected (at the earliest, at the
end of the third year of the account ie two years after the end of the year of
account) no profits of the relevant year of account can be distributed to
members.
A Syndicate Income
Premiums
8.2 Syndicates
receive as their main source of income premiums, deposit premiums, and
additional or reinstatement premiums and investment returns.
8.3 Deposit
premiums represent the minimum premium which the underwriter is prepared to
accept in return for underwriting the risk. Deposit premiums are usually
received by a syndicate during the period covered by the policy, often within
the first twelve months of the account.
8.4 Many Lloyd's policies allow
the insured to reinstate their insurance cover following a claim, by payment of
a further premium known as a reinstatement premium.
8.5 Additional
premiums are payable under a particular type of reinsurance contract known as a
quota share treaty. Under a quota share treaty, an insurer will cede to a
reinsurer a predetermined proportion of the risks he has underwritten. The
reinsurer therefore receives a fixed proportion of the premiums and pays the
same proportion of the claims resulting from the risks underwritten. When a
syndicate has underwritten a proportion of another insurer's risks by way of a
quota share treaty, it will receive a payment based upon the expected premium
income of the reinsured. Where subsequently the reinsured receives more premiums
than was anticipated (or receives reinstatement premiums), the reinsuring
syndicate will receive their share of these premiums as additional premiums.
8.6 Reinstatement and additional premiums can be received at any time
until the liabilities relating to the risks insured are exhausted. This can be
many years after the policy period has expired.
Reinsurance to Close of
a Preceding Year of Account
8.7 A year of account will receive a
reinsurance premium from the preceding year of account in return for assuming
the liabilities of the preceding year (together with any years reinsured into
the preceding year). The premium will typically be credited to the third year of
the account.
Reinsurance Recoveries
8.8 When a syndicate pays
claims on policies which have been reinsured, it will claim a recovery from its
reinsurers. Reinsurance recoveries are usually received a few weeks or months
after payment of the reinsured claim for facultative reinsurance (reinsurance of
individual risks). The time lag may be longer for treaty reinsurance (quota
share or excess of loss, sometimes many years longer for excess of loss where
recoveries will not start to become payable until the total retentions of the
reinsured are exhausted).
Investment Income
8.9 Premiums are
usually received before claim payments are made and Lloyd's has created
regulations which control how premium income is invested. Lloyd's accounts for
insurance business in three currencies, namely sterling, United States dollars
and Canadian dollars. Any premiums received in other currencies are immediately
converted to sterling. As stated above, Lloyd's has created three premium trust
funds into which premium income must be paid, the funds being invested
predominantly in government bonds. Income from these investments is received
into the trust fund throughout the period during which the year of account
remains open. When the year of account is closed, the trust funds will be used
to pay the RITC premium, with any surplus being distributed to Names as profit.
8.10 Investment return is also received in the form of realised capital
gains and losses. This return accrues until the RITC is paid and is taken into
account in the syndicate result.
B Syndicate expenditure
Reinsurance Premiums
8.11 Syndicate underwriters take out
reinsurance protection for a number of reasons. The primary reasons are to limit
their exposure to large catastrophic losses, or to reinsure particular risks
within policies written to which they do not wish to be exposed. Premiums are
paid to reinsurers in the same manner as any insurance policy and both deposit
and reinstatement premiums may be payable.
Claims
8.12 Claims
payments are made once the syndicate has been notified of the loss and has
agreed to pay its share of the claim. The period between acceptance of the
claim, and payment of the claim can vary widely, depending on the type of risk
underwritten. The time lag between policy inception and claim payment is known
as the tail. The tail can be very short, for example where a satellite launch
policy covers only the first five seconds after lift-off. The launch is either
successful, or is a failure, and the result is known immediately. Other policies
can have very long tail claims, for example employer liability insurance. Claims
are currently being made in the Lloyd's market against employer liability
policies written in the 1930s and 1940s. The reason for the long delay is that
the claims are being made for asbestosis sufferers who were exposed to asbestos
dust many years ago, but whose asbestosis symptoms are only now manifesting
themselves.
8.13 Each class of business tends to have a characteristic
length of tail, with accidental damage policies having a relatively short tail,
whilst policies providing legal liability cover have a long tail. Claims may
also be received some time after the year in which the policy was accepted where
the policy covers a period of more than one year (for example where cover has
been purchased for a long-term construction project which lasts several years).
Run-off
8.14 Where an account goes into run-off the RITC premium
is not paid, the premium trust funds are maintained and no distribution of
profit to Names is permissible.
Syndicate expenses
8.15
Syndicates do not own assets such as offices or computers. Such assets are
acquired by the managing agent for use by the syndicates. The expenses relating
to the operation of the syndicates are generally paid by the managing agent and
are then re-charged to the syndicate years of account. In performing the
re-charge exercise, the managing agent must ensure that the principle of equity
between Names on each syndicate and year of account is maintained. Some charges
are directly debited to the syndicate's bank account such as charges levied by
Lloyd's.
8.16 The largest expense is salaries and related costs and
accommodation costs. The salary will be a flat rate and is determined by the
managing agent.
8.17 Graphical illustrations of:
(i) Premiums
received and reinsurance premiums paid;
(ii) Claims paid and reinsurance
recoveries made; and
(iii) Syndicate expenses,
over a three year
period for a typical Lloyd's syndicate are set out in bundle 28, App 15.
The costs of underwriting
8.18 The deductions from the premiums
received by the syndicates on behalf (ultimately) of the Names, will include
some or all of the following:
(a) claims paid out of the premiums trust
funds and return premiums;
(b) reinsurance premiums paid by the
syndicate, including related brokerage;
(c) the fees, expenses and
commissions of the managing agent and/or its sub-agents and/or the members' agents (if any);
(d) the expenses of running the syndicate;
(e)
the fees and expenses of the trustees of the premiums trust funds;
(f)
contributions and levies paid to the Central Fund;
(g) fees payable to
Lloyd's and certain taxes ;
(h) the costs of Lloyd's overseas
representatives and of maintaining overseas deposits, where applicable;
(i) other fees and expenses payable to the Corporation or its
subsidiaries for specific services provided to the syndicate.
9.
REINSURANCE AND THE XL MARKET
Introduction - XL and LMX Business
9.1 Under an excess of loss (XL) reinsurance contract, the reinsurer
agrees to indemnify the reinsured in the event of the latter sustaining a loss
in excess of a pre-determined figure, (the "deductible"). The reinsurer is
liable for the amount of the loss in excess of the deductible up to an agreed
amount, the deductible being the amount retained, (or "retention"), for the
reinsured's own account. The purpose of excess of loss reinsurance is thus to
limit the exposure of the reinsured on any loss, whether this arises from a
large individual risk or through an aggregation of losses from a number of risks
affected by a single event or loss occurrence.
9.2 XL protection may be
obtained through "whole account" or "general" reinsurance, which provides cover
for all or a proportion of losses, net of recoveries, on underlying policies. In
practice, cover will normally be purchased in layers, rather than through one
single policy. "Specific" XL treaties provide protection in respect of specific
portfolios of business accepted by the reinsured (eg. hull, cargo, oil rigs).
The term XL can be used to describe all these types of excess of loss business.
9.3 In providing cover to primary insurers, accepting reinsurers may
themselves accumulate exposures higher than they wish to retain. To meet their
requirements for protection, the retrocession of excess of loss reinsurance
developed as a mechanism that was intended to spread exposures more widely.
9.4 LMX is not a term which is uniformly used. It is excess of loss
reinsurance written by London market entities. It is written by both corporate
reinsurers and Lloyd's syndicates. The nature of LMX business is the same as
that of other excess of loss treaty reinsurance. LMX business is distinguished
from other excess of loss business in that it is, depending on usage, (i)
reinsurance underwritten by underwriters operating in the London market of risks
originating in this same market, as opposed to general excess of loss business
that is reinsured on a worldwide basis, or (ii) is an excess of loss reinsurance
written in London of an excess of loss contract. The "London" distinction is
thus almost entirely a geographical and cultural phenomenon, encouraged by
certain brokers who specialised in this business and reflecting their knowledge
of and trading relationships with the parties involved.
The "Spiral"
9.5 Writing high level XL on XL business on a catastrophe account is
high risk. The working of the "spiral" which developed in the 1980s was complex,
and it is convenient to describe it only in a simplified form. The phenomenon of
what is described as the "spiral" was not new or peculiar to the operation of
the market in the 1980s. Before Hurricane Betsy in 1965, a similar "spiral" had
developed in the London market, and the losses that followed that catastrophe
demonstrated the effect of the spiral. The lesson had been forgotten by the
1980s. Many syndicates which wrote excess of loss (or "XL") cover took out XL
cover themselves. Those who reinsured them were thus writing XL on XL. They, in
their turn, frequently took out their own XL cover. There thus developed among
the syndicates and companies which wrote XL business a smaller group that was
responsible for creating, in relation to some risks, a complex intertwining
network of mutual reinsurance, which has been described as a "spiral". When a
catastrophe led to claims being made by primary insurers on their excess of loss
covers, this started a process whereby syndicates passed on their liabilities,
in excess of their own retentions, under their own excess of loss covers from
one to the next, rather like a multiple game of "pass the parcel". Those left
holding the liability parcels were those who first exhausted their layers of
excess of loss reinsurance protection. Following Hurricane Alicia in 1983, the
non-marine market introduced higher retentions, co-insurance and the exclusion
of XL of XL business from whole account or general programmes written. The
marine market did not take similar measures.
9.6 So far as the
individual syndicates were concerned, the effect of the spiral was to magnify
many times the number of claims flowing from a particular loss. This is because
claims were repeatedly made in respect of the same loss as it circulated in the
spiral. For example, claims in respect of the Piper Alpha loss exceeded by a
multiple of about 10 the net loss that was covered on the London market.
9.7 This gearing effect did not result in an ultimate payment of a
greater indemnity than the initial loss. As the loss passed through the spiral,
however, it impacted repeatedly on successive layers of reinsurance cover (which
it progressively absorbed), and once the total underlying retention was
breached, ultimately concentrated on those reinsurers who found their cover
exhausted.
The spiral effect of claims was, however, diminished or
extinguished by individual retentions, whether before reinsurance protection
commenced or after it had been exhausted, by co-insurance and by 'leakage' to
reinsurers who did not reinsure with the same insurers. The effect of the spiral
was, however, significantly to reduce the comfort that could properly be derived
from being exposed only to what appeared to be a very high layer of loss.
9.8 Lloyd's Underwriting Claims and Recovery Office saw 43,000 claims on
11,500 excess of loss policies in respect of the Piper Alpha loss. In the case
of Piper Alpha, gross claims transactions totalled about $15 billion for the
whole of the London market, whereas the actual loss was $1.4 billion.
There was a claims turnover of ten times the actual loss in relation to
the Exxon Valdez claim
Growth of the LMX market during the 1980s
9.9 Certain underwriters identified commercial opportunities in writing
substantial LMX business in the 1980s. It was perceived that there was an
opportunity to write profitable LMX business in circumstances in which
underwriting capacity was increasing rapidly and other underwriting business (eg
marine) was sluggish or in decline. However, the business involved exposures and
a need for judgments different from those with which many of these underwriters
were familiar. In the event, a number of Lloyd's syndicates and others in the
London market suffered very heavily from their decision to write such business.
Further details of the nature of the XL "spiral", and the reasons for the heavy
losses suffered, are contained in the decisions of Phillips J in the Gooda
Walker and Feltrim litigation. The parties have agreed the facts set out in
those judgments relating to the manner in which the business was written on
those syndicates, and the findings of Phillips J as to the negligence of the
underwriters concerned.
9.10 There was also an increase in the number of
companies in the so-called "fringe" market in London at this time. Many of the
companies that then went into reinsurance were highly inexperienced in
reinsurance and were used by the brokers to drive prices down or to get
unacceptable clauses accepted. One reason that brought people into the market
was the opportunity for so-called "cash flow" underwriting. The 1980s were a
time when returns on investment were high. A high cash flow would produce high
investment returns. This led to some reinsurers pricing reinsurance at rates
that would in normal circumstances have been considered too low in terms of pure
underwriting rates of return. The big continental reinsurance groups in many
cases also made pure underwriting and overall losses on specific catastrophe
accounts but were able to spread the losses across other segments of business.
There were only a very few years when they lost large amounts overall. The worst
hit were those who did not have a spread of business; this also applied to the
worst hit syndicates in Lloyd's. Continental reinsurers generally had the
benefit of equalisation and other reserves which was a great help to enable them
to weather the bad years by spreading their losses over more than 12 months.
9.11 Gross premiums for business written in the 1988 account showed a
61% increase by comparison with premiums for business written in the 1983
account, with a growth of 201% in premium income of the LMX syndicates over the
same period. Gross premium income of the LMX syndicates as a proportion of
Lloyd's total gross premium income rose from 13.1% for the 1983 account to 24.6%
in 1988 and 26.4% in 1990. Premium rates for LMX business fell substantially in
the 1980's.
9.12 In the period 1987 to 1990, insurance and reinsurance
markets were impacted by an unprecedented number of major catastrophe losses,
viz 1987, North European storms; 1988, Piper Alpha and Hurricane Gilbert; 1989,
Hurricane Hugo, the San Francisco Earthquake, Exxon Valdez, and Phillips
Petroleum; 1990, North European storms. The cumulative impact of these losses
was severe on both companies and syndicates. For the 1987 Northern European
storms, Piper Alpha, Hurricane Hugo and the 1990 Northern European storms,
companies (including direct insurers and major reinsurers) carried 69%, 45%, 64%
and 64% of the liability respectively, but still leaving substantial losses for
Lloyd's syndicates. On the basis of the syndicates analysed in the Walker
Report, losses were concentrated on a relatively small number of syndicates:
although 87 syndicates were writing significant LMX business in 1988 or 1989 -
in one case 93% of that syndicate's stamp capacity - 95% of the losses
attributable to those syndicates for the 1988 account were encountered on 12 of
those syndicates and 79% of the losses of the LMX syndicates for the 1989
account were attributable to 14 of them. [Walker Report, para 2.1]
Profitability of LMX business
9.13 In the 1980s premium rates
for LMX business fell substantially. In circumstances of apparently reasonable
profit levels (in the years between 1965 and 1987, the worldwide reinsurance
market was relatively undisturbed by major catastrophes, thus generally leaving
reinsurers with a 22 year span of profitable results) and increasing capacity,
premium rates in 1987 and 1988 had fallen to only 10% of those being charged ten
years earlier and were reduced in higher layers as a consequence of the
perceived diminution in exposure. [Walker Report, para 2.20(b)]
Catastrophe reinsurance rates have risen since 1989. The expectation of
the world-wide reinsurance industry in April 1995 was that substantial
withdrawals of capacity from the industry as a whole that had taken place would
keep reinsurance rates hard over the medium term.
The risks
9.14
The high risk nature of the spiral exposures accepted by the syndicates and the
level of reinsurance purchased to protect them was not appreciated by many
Names. Had the Names been better aware of the risks involved they might have
ceased or reduced their participation.
Gross inter-syndicate reinsurance
premiums
9.15 Gross inter-syndicate reinsurance premiums as a proportion
of Lloyd's total gross premiums passing through Lloyd's Policy Signing Office
rose from 9.1% in 1984 to 14% in 1988 and 16.1% in 1990.
10. THE
ASBESTOS ISSUE
10.1 In the early 1980s, there were several types of
claim causing underwriters concern. These included Agent Orange (a defoliant
used in the Vietnam War, which contained dioxin which is alleged to have
carcinogenic properties), DES (diethylstilbestrol - a synthetic oestrogen given
to pregnant women to avoid miscarriage, which has been blamed for cancer
abnormalities occurring in children), Love Canal (a pollution problem at a
residential site near Niagara Falls), the Dalcon Shield (an intra-uterine
contraceptive device), environmental pollution and asbestos.
10.2 The
concern of the London market (ie. Lloyd's and London insurance companies) in
relation to asbestos developed as a result of the many uncertainties relating to
the unknown potential number and size of asbestos-related claims. These unknowns
were brought to underwriters' attention via inter alia, reports which they had
been receiving from their own US attorneys, through wide-spread press comment at
the time, and through discussions with other underwriters.
10.3 As a
result of an initiative taken by then leading non-marine underwriters, Mr Robin
Jackson and Mr Rokeby Johnson, a working party was formed in August 1980 which
became known as the Asbestos Working Party (the AWP). Interested underwriters
were advised of the AWP's formation and were invited to subscribe to it. By
December 1981, 88 Lloyd's syndicates and 23 companies had subscribed to the AWP.
10.4 The functions of the AWP were, primarily, to:
(a) provide a
forum for discussing problems relating to asbestosis claims and to seek market
agreements to assist underwriters in their handling of claims;
(b)
advise on coverage matters when requested to do so by the leading underwriters;
(c) consider facultative reinsurance as well as direct insurance;
(d) explore solutions to the asbestosis problem otherwise than by
litigation or traditional claims handling; and
(e) assist in the
establishment and development of a database to provide claims information for
reserve purposes.
10.5 The AWP did not undertake any executive function
and it acted in an advisory capacity only. It considered that it was not its
place to usurp the functions of underwriters and others to whom it communicated
in the market with regard to information that came to hand.
10.6 The
AWP, which was not a Lloyd's initiative but rather a London market initiative,
had no agency or other legal relationship with Lloyd's, and Lloyd's is not, and
never has been, responsible for the acts or omissions of the AWP.
10.7
At a meeting of Lloyd's Panel Auditors on 10 November 1981, when discussing 'any
other business', reference was made to asbestos-related claims. It was agreed
that the topic would be raised again in the new year. At their next meeting, on
15 January 1982, the asbestos situation was again discussed.
10.8 On 24
February 1982 Neville Russell, on behalf of themselves and five other firms of
auditors on the Lloyd's Panel, wrote to the Manager of the Underwriting Agents
and Audit Department. The letter asked Lloyd's for instructions on the issue of
reserving for asbestos claims. At that time, the auditors did not know their
respective clients' positions.
10.9 As a result of this letter a meeting
took place on 9 March 1982, between representatives of Lloyd's Underwriting
Agents and Audit Department, Lloyd's Audit Committee, the Panel Auditors and the
AWP. The AWP representative, Mr Nelson, provided an update of the asbestos
situation. The meeting was informed that it appeared that substantial
uncertainty remained as to the number and size of asbestos-related claims.
10.10 On 18 March 1982 the Deputy Chairman of Lloyd's wrote to all
underwriting agents. On the same day the Manager of Lloyd's Underwriting Agents
and Audit Department, Mr Randall, wrote to all Panel Auditors. Both of these
letters referred specifically to asbestos-related claims and, inter alia, the
reserving issues arising therefrom.
11. CENTRAL FUND BYELAW (No.4 of
1986)
11.1 The Lloyd's Central Fund is held and administered by the
Society of Lloyd's in accordance with the Central Fund Byelaw
(No. 4 of 1986) (the Byelaw). Members contribute to the Fund each year based on
a percentage of their gross allocated capacity.
11.2 As part of Lloyd's
solvency procedure, certain assets of the Fund may be used to cover underwriting
deficiencies of Names at the preceding 31 December to enable them to pass the
solvency test and meet the requirements of the Department of Trade and Industry.
Evolution of the Central Fund Byelaw:
(i) The 1927 Agreement
Constituting the Central Fund
11.3 The 1986 Central Fund Byelaw (No. 4
of 1986) replaced the Central Fund Agreement of 1927.
11.4 This embodied
the provisions of the guarantee scheme (the immediate predecessor of the 1927
Agreement). The Fund was set up to meet the liabilities of members who had been
declared in default of their obligations, and was also available for the
"advancement and protection of members", at the Council's discretion. It was
funded through contributions from members based on premium income of the
previous year.
11.5 The catalysts that provoked the making of the 1927
Agreement were the Burnand (1903) and Harrison (c.1923) cases. Both involved
deliberate fraud on the part of the underwriters and caused considerable losses
for Names. As a direct result, the Chairman in the mid 1920s, Mr Arthur Sturge,
suggested that #200,000 be subscribed by all underwriters in proportion to their
premium incomes.
11.6 Clause 3 of the 1927 Agreement stated as follows:
"The Central Fund shall consist of (a) #49,988-8s-0d now in the hands of
the Society and arising from earlier guarantee schemes which have now been
discontinued (b) the contributions of the Subscribing Members hereinafter
mentioned (c) the investments for the time being representing such fund and
contributions and (d) any other monies which may be at any time added to the
Central Fund".
11.7 The Central Fund was held and administered by the
Committee of Lloyd's (and, following the recommendation of the Fisher Working
Party, the Council (see below)), on behalf of all members in accordance with the
1927 Agreement and subsequent amendments.
(ii) The Report of the Fisher
Working Party: May 1980
11.8 The 1927 Deed was replaced by the Central
Fund Byelaw (No. 4 of 1986) as a result of the findings of the Fisher Working
Party in 1980.
11.9 The Fisher Working Party recommended that the
Council of Lloyd's should be given express power by an amendment to Lloyd's Acts
to maintain the Central Fund, to decide (and to alter from time to time) the
purposes to which money in the Fund may be applied, to require members of
Lloyd's to contribute to it, and to fix the rate of contribution and to alter it
from time to time.
11.10 Whether or not this was done, they considered
that the 1927 Agreement required consideration by the Council with a view to
possible revision. In particular the Council should review:
"(a) the
purposes for which money in the Fund may be used;
(b) the investment of
the Fund in the light of the purposes for which the money in the Fund may be
required;
(c) the provision that money in the Fund may not be applied in
payment of claims on policies underwritten by a Member until he has been
declared to be in default;
(d) the rates of contribution fixed by the
1927 Agreement, and the procedure for increasing contributions in case of need;
(e) the practice in relation to the formalities required for adhesion to
the 1927 Agreement."
11.11 Fisher Task Group 19 was given the task of
considering these recommendations. It recommended that:
(i) Names should
be required as a condition of membership of Lloyd's to consent to variation of
the Central Fund 1927 Agreement
(a) removing the maximum contribution
limit of 0.45% of premium income and empowering the Committee by regulation to
levy contributions at rates to be determined;
(b) removing the proviso
against increasing the financial liability of Names;
(c) enabling future
modifications or variations to the Central Fund 1927 Agreement to be effected by
Byelaw rather than by Deed;
(ii) the 1927 Agreement should be amended to
allow payment of claims without a declaration of default where Names subscribing
a risk cannot be identified;
(iii) the default declaration proviso in
Clause 10 should not be immediately removed but by amendment to Clause 15 (to be
agreed to by Names in a supplemental deed) the Council should be empowered
subsequently to remove it by byelaw;
(iv) a Byelaw should require all
Names to subscribe to the Central Fund.
11.12 All the Task Group
recommendations were agreed by the Committee with two modifications: first, they
proposed a maximum rate of contribution of 21/2% of premium income to the
Central Fund, and secondly, they proposed that it remain necessary for a member
to be declared in default before his claims could be met by the Central Fund.
11.13 The recommendations were considered by the Council on 21 March
1983. The Council approved the recommendations made by the Task Group save that
it agreed with the Committee that the default declaration provisos should not be
removed. The Council did not, however, agree to the suggested maximum rate of
contribution, but deferred a decision until a final decision had been taken as
to the future form of the Fund.
11.14 The Council also approved the
Committee's proposal that, as from 1984, the basis for calculating the levy
should be gross premium income (ie. without deduction of reinsurance premiums
paid) instead of net premium income. It was calculated that the change was
equivalent to increasing the levy on net premium income from 0.45% to 0.60% and
that this increase was an amount which was not less than the premium which Names
would have been required to pay for the guarantee policies which ceased to be
required in respect of years of account later than 1981 (and the premiums on
which ceased to be paid in the 1984 year of account).
(iii) The Central
Fund Byelaws
Recovery of Monies Paid Out of Lloyd's Central Fund Byelaw
(No. 5 of 1984)
11.15 The 1984 Byelaw was passed as a result of the
anticipated failure of many Names (especially those on the PCW Syndicates) to
make good audit deficiencies before the deadline for the filing of the Lloyd's
solvency certificate.
11.16 Lloyd's was advised that a proportion of the
Central Fund could be earmarked as being available to meet deficiencies; because
of the large numbers involved, it was felt that it was prudent to pass a byelaw
at the same time requiring the Name to repay to the Society, on demand, any
payment made out of the Central Fund on the Name's behalf, in the event of his
defaulting.
11.17 This byelaw provided that where a sum had been paid
from the Central Fund to meet a member's default, the member should repay the
Fund if called upon to do so: it gave Lloyd's the right to bring proceedings to
recover such sum as a civil debt where the member did not make repayment. Clause
1 of the Byelaw stated that:
"..any such Member shall on demand pay
forthwith to the Trustees of Lloyd's Central Fund and/or the Society (as the
case may be) any amounts ...applied in respect of or on account of or for the
benefit of that particular Member".
Recovery of Monies Paid Out of
Lloyd's Central Fund Byelaw (No. 2 of 1985)
11.18 This byelaw was passed
to afford the Society the necessary rights of recovery from the Names who had
benefited from Central Fund payments.
11.19 The 1984 Byelaw was
considered insufficient in two ways: (a) it was limited to the recovery of
Central Fund monies applied in the payment of claims "on any policy" and did not
cover the expenses of paying those claims; and (b) it incorrectly assumed that
Central Fund monies would be used to discharge liabilities then assessed as
being due from each "insolvent" Name: in fact these liabilities were being met
by third parties from the funds and borrowings of other Names or from the funds
of the Central Accounting system. Therefore, Central Fund monies were not being
employed in the payment of claims but in the repayment of third parties whose
funds had been drawn upon for the payment of the insolvent Names' liabilities.
11.20 Thus the new byelaw (No. 2 of 1985) differed from the old byelaw
in two ways:
(i) in order better to establish the right of the Society
to use its own assets to discharge underwriting members' liabilities, the
proposed byelaw made it clear that Society assets may be used for this purpose;
[Byelaw No. 2 of 1985, clause 2]
(ii) the form of the amendment proposed
with respect to the recovery of Central Fund monies, was to introduce a
provision which: (a) permitted the recovery of any monies paid out of the
Central Fund, regardless of the precise nature of the application of the payment
provided that the payment was attributable to a particular member from whom
recovery was sought; (b) widened the use of the byelaw to permit recovery where
Central Fund monies were not directly used to discharge the underwriting
liabilities of a member; and (c) covered the situation where the Society itself
took over the responsibility of the underwriting agent and, for example,
incurred expenses in ascertaining outstanding liabilities.
The Central
Fund Byelaw (No. 4 of 1986)
11.21 This byelaw replaced the Central Fund
Agreement 1927.
11.22 It provides for the management, investment and
application of Lloyd's Central Fund under the direction of the Council of
Lloyd's.
11.23 It requires that as a condition of underwriting insurance
business at Lloyd's, members contribute to the Central Fund and gives the
Council the right to raise levies and fix the rates of contribution at its
discretion.
11.24 paras 7 and 10 re-enact the provisions of Byelaw No. 2
of 1985 which empowered the Society to apply monies out of funds and property of
the Society (other than the Central Fund) for the purposes specified in para 8
of the Byelaw, and to recover from members monies paid out of the Central Fund
or from other funds of the Society as a civil debt. For the first time, these
provisions gave the Council a power to raise an unlimited levy.
The
Central Fund (Amendment) Byelaw (No. 10 of 1987)
11.25 This byelaw
allowed the Council of Lloyd's to charge interest on late contributions to the
Central Fund.
The Central Fund (Amendment No. 2) Byelaw (No. 9 of 1988)
11.26 This byelaw gives the Council the right to start legal action to
recover the amount of the Central Fund earmarked in a member's name as a civil
debt, where assets have been earmarked to enable the Name to meet the
requirements of the annual solvency test, notwithstanding that no payment has
actually been made out of the Central Fund on behalf of the member.
(iv)
Contributions to the Central Fund
11.27 In summary:
*from 1972
until 1984, Names made annual contributions of a maximum of 0.45% of their net
written premiums of the previous year;
*in 1984, the assessment was
changed (from 0.45% of net premiums) to a maximum of 0.45% of gross premiums. It
was calculated that the change was equivalent to increasing the levy on net
premium income from 0.45% to 0.60% and that this increase was an amount which
was not less than the premium which Names would have been required to pay for
the discontinued guarantee policies;
*in 1987 the basis of assessment
changed to gross allocated capacity.
1992 Special Levy
11.28 On
3 June 1992, in view of the existing and anticipated heavy losses in the market,
the Council of Lloyd's resolved that a special levy of #500 million be made on
the Names for payment of further contributions to the Central Fund (ie in
addition to the annual Central Fund contribution) in order to ensure that there
were sufficient funds in the Central Fund to enable solvency requirements to be
met and to meet claims of policyholders that had to be met centrally where there
had been a failure or refusal to pay by Names. The levy was made on members at
the rate of 1.66% of their gross allocated capacity for the underwriting years
of account 1990, 1991 and 1992.
Total resources of Lloyd's, percentage
breakdown of Lloyd's total resources and earmarking of the Central Fund (1970 -
1993).
11.29 The following tables show the total resources of Lloyd's,
percentage breakdown of Lloyd's total resources and earmarking of the Central
Fund (1970 - 1993).
Total resources of Lloyd's
#m as at December
31 each year
Premium Funds at Confirmed Central Other Total
Trust Lloyd's Personal Fund(*) Central Resources
Funds Wealth
Assets
1982 4,248 1,072 1,750 108 100 7,278
1983 5,052 1,358
1,931 134 114 8,589
1984 6,724 1,655 2,268 194 141 10,982
1985
6,839 2,078 2,591 229 120 11,857
1986 8,200 2,605 3,300 301 132 14,538
1987 8,096 3,166 3,256 269 146 14,933
1988 8,655 3,522 3,492 313
168 16,150
1989 10,388 4,257 3,700 404 248 18,997
1990 9,806
4,418 3,036 377 279 17,916
1991 12,258 4,652 2,643 445 263 20,261
1992 16,663 4,497 1,880 1,147 252 24,439
1993 19,650 4,718 1,749
904 283 27,304
(*) :Before earmarking. In 1982 and 1983, after provision
for taxation.
The proportions of Lloyd's total resources represented by
each of these elements in each year are shown in the next table.
Percentage breakdown of Lloyd's total resources
% Breakdown of
Lloyd's total resources
Premium Funds at Confirmed Central Central Total
Trust Lloyd's Personal Fund Assets Resources
Funds Wealth
1982 58.4 14.7 24 1.5 1.4 100
1983 58.8 15.8 22.5 1.6 1.3 100
1984 61.2 15.1 20.7 1.8 1.2 100
1985 57.7 17.5 21.9 1.9 1.0 100
1986 56.4 17.9 22.7 2.1 0.9 100
1987 54.2 21.2 21.8 1.8 1.0 100
1988 53.6 21.8 21.6 1.9 1.1 100
1989 54.7 22.4 19.5 2.1 1.3 100
1990 54.7 24.7 16.9 2.1 1.6 100
1991 60.5 23.0 13.0 2.2 1.3 100
1992 68.2 18.4 7.7 4.7 1.0 100
1993 72.0 17.3 6.4 3.3 1.0 100
Earmarking of the Central Fund (1970 - 1993)
Year Net assets
before Earmarkings (#m) Central Fund
earmarking (#m) balance as at
31 December (#m)
1970 21.2 0.4 20.8
1971 24.3 0.6 23.7
1972 28.5 0.6 27.9
1973 29.1 0.7 28.4
1974 23.0 0.2 22.8
1975 35.9 0.1 35.8
1976 38.8 ---- 38.8
1977 52.3 ----
52.3
1978 58.1 0.1 58.0
1979 59.8 0.5 59.3
1980 72.5 0.8
71.7
1981 83.4 0.8 82.6
1982 108.8 0.5 108.3
1983 135.8
1.7 134.1
1984 173.4 6.2 167.2
1985 211.5 64.8 146.7
1986 279.2 237.3 41.9
1987 254.4 24.0 230.4
1988 303.6
12.9 290.7
1989 384.5 21.8 362.7
1990 376.2 30.3 345.9
1991 438.0 67.9 370.1
1992 1,113.0 354.9 758.1
1993
903.7 661.6 242.1
There was a belief that valid claims on Lloyd's
policies would always be paid.
11.30 The continued success of Lloyd's
depends inter alia upon its reputation and the security of its policy. One
reason for the success of the Lloyd's market has been the security of the
Lloyd's policy and the perception of that security. Lloyd's has never failed to
pay a valid claim. This reputation is part of the foundation of Lloyd's success.
Despite recent problems, Lloyd's continues to be well known among insurance
clients for whom it is synonymous with security, reliability and innovation.
Lloyd's strength has been demonstrated by its ability to withstand a period of
unprecedented losses and maintain its record of always paying valid claims. The
chain of security and structure in place at Lloyd's has ensured that all
liabilities of failed syndicates to date have been duly met. The cumulative
global losses since 1988 exceed #8 billion but despite this, the market has
continued to pay all valid claims. As far as Lloyd's customers and competitors
are concerned, Lloyd's has encouraged the belief that a Lloyd's Policy will
always pay any valid claim. Security at Lloyd's is guaranteed by Lloyd's
mechanisms including the Central Fund.
The Central Fund is the ultimate
safety net at Lloyd's whereby all the members have in practice made up the
deficiencies caused by individual defaulting Names.
The fact that valid
Lloyd's policies have always been paid is a great competitive strength for
Lloyd's, in particular against the background of the fragility and failure of
some corporate reinsurers in the 1980's. (see The Walker Report).
In
practice, brokers and assureds did not at the material times carry out credit
risk assessments of individual Names.
11.31 Insureds, including other
Lloyd's syndicates, generally did not assess the creditworthiness of a syndicate
providing them with reinsurance protection. All participants in the market have
benefited from the security and the brand name of Lloyd's. The protection of
policyholders and the passing of the solvency test is critical to Lloyd's
competitive position and the attitude adopted to Lloyd's by regulatory
authorities around the world. Standard & Poor's "stability ratings relating
to Lloyd's syndicates" do not constitute credit ratings of Lloyd's syndicates.
12. PERMITTED REINSURANCE LIMITS
12.1 The provision relating to
permitted reinsurance limits referred to in para 72 of the Points of Defence and
Counterclaim formed part of the instructions to auditors for the conduct of the
annual solvency test. The first audit instructions were issued in 1908 and
included the following provision:
"in cases where the reinsurances
amount to 20% of the premium income, the auditor must satisfy himself that the
reinsurance policies form a good asset".
12.2 No distinction was drawn
between Lloyd's and non-Lloyd's policies. This provision was amended from time
to time in the following years. A summary of the relevant amendments is set out
below.
1922 The percentage limit was reduced from 20% to 10% of premium
income.
1924 The wording of the audit instructions was amended to state
that "if reinsurances exceeded 10% of the gross premium income less brokerage
and discount, the full amount thereof cannot be allowed, and the auditor must
apply to the Committee for instructions". No distinction was made between
Lloyd's and non-Lloyd's reinsurances.
1932 The percentage limit was
raised from 10% to 15%.
1940 Auditors were additionally requested to
furnish particulars of the extent to which the excess above the then 15% limit
was represented by reinsurances at Lloyd's.
1945 The percentage limit
was reduced from 15% to 10%.
1948 The clause was amended to read:
"Where the reinsurance premiums exceed the limits set out above (10%),
only that portion (if any) of the excess which is represented by reinsurances
effected at Lloyd's on terms as original may be deducted in calculating premium
income for the purpose of applying the audit test and no deduction may be made
in respect of the balance of the excess".
1964 The limit was increased
from 10% to 121/2%.
1966 The limit was increased again from 121/2% to
15%.
1968 A further limit of 5% of gross premiums less brokerage and
discount was introduced in respect of reinsurance where the reinsurer had agreed
to cover its proportion of outstanding losses.
1975 The current wording
and limits were introduced and set out in App G to the instructions issued by
the Council of Lloyd's for the Annual Solvency Test.
With effect from 31
December 1975, the definition of "permitted limits" for the purposes of
calculating permitted reinsurance limits under App G was amended to enable
premiums on all reinsurance effected at Lloyd's to be taken into account.
Previously, only reinsurance effected at Lloyd's "on terms as original" was
taken into account. The phrase "terms as original" is difficult to define, but
for this purpose it is understood to have been intended to refer to proportional
reinsurance only.
At the same time, the reinsurance requirements in
relation to the calculation of premium income limits were discontinued (as set
out in bundle 28, App 20).
The notification to the market of these
changes was dated 11 December 1975.
By way of example App G of the
Instructions for the Annual Solvency Test of Underwriting Members of Lloyd's -
31.12.89 provided:-
"Appendix G - Permitted Reinsurance Limits
The permitted reinsurance limit in respect of reinsurance ceded is the
sum of:
(a) 20% of the gross premiums less brokerage, discount and
returns; plus
(b) Premiums on all reinsurances effected at Lloyd's; plus
(c) A further 10% of gross premiums less brokerage, discount (in the
case of motor business within the United Kingdom and the Republic of Ireland,
commission not exceeding 25%) and returns in respect of reinsurances where
reinsurers have agreed to cover their proportion of outstanding losses, either
by cash loss reserves established with the syndicates concerned, or by a letter
of credit drawn on a bank approved by the Council of Lloyd's for this purpose.
For the purposes of ascertaining whether a syndicate has exceeded the
permitted reinsurance limit, the Sterling, U.S. dollar and Canadian dollar
accounts are to be combined. The permitted limit is to be applied to each of
marine, non-marine, motor and aviation business as a whole, and not to the
separate audit categories comprising such business.
Where outstanding
losses have arisen, the underwriter must take the necessary steps to obtain cash
loss reserves or letters of credit before taking advantage of the additional 10%
reinsurance allowance in (c) above.
The additional reserves to be
created on reinsurance premiums in excess of the permitted reinsurance limit
are:
Year of Account
1987 10%
1988 25%
1989 60%
Where a syndicate exceeds the permitted reinsurance limit, the
additional reserve may be created in Sterling, U.S. dollars or Canadian dollars
regardless of the currency which gave rise to excess."
On 23.12.92 a
market bulletin announced changes to the Instructions for the Annual Solvency
Test of Underwriting Members to apply to the years of account 1992, 1991 and
1990. As at 31.12.92 the additional reserves to be created on reinsurance
premiums in excess of the permitted reinsurance limit were
Year of
account
1990 nil
1991 10%
1992 25%
12.3 The
Reinsurance limits recognise the increased risk that could result from utilising
security outside Lloyd's. The Reinsurance limits for audit apply for reasons of
security. The Reinsurance limits applied at the material times in the 1980s
equally to Excess of Loss and other reinsurances and were not limited to
reinsurances at Lloyd's on terms as original, because Lloyd's security was
deemed to be good.
13. PREMIUM INCOME LIMITS/QUOTA SHARE REINSURANCE
13.1 Until 1969, the premium income limit calculation used to determine
a syndicate's allocated capacity, was made on a gross rather than net basis, ie
without deduction of any reinsurance premiums paid by the syndicate. Deductible
reinsurance allowances were introduced in about 1969.
13.2 From 1969
until the Syndicate Premium Income Byelaw (No. 6 of 1984) was passed, deductible
reinsurance allowances for the purpose of calculating a syndicate's allocated
capacity were set by the Audit Committee and the Committee of Lloyd's. From 1984
until 1990 Lloyd's reverted to calculating premium income limits on a gross
basis. In 1990, the basis of the calculation changed to net premiums and
deductible reinsurance allowances were reintroduced. A summary of the allowances
set in each year from 1972 to 1993/94 is set out in bundle 28, App 20.
13.3 Mr Clementson actively underwrote from 1 January 1977 until 31
December 1991. During this period, the quota share reinsurance allowances drew a
distinction between Lloyd's and non-Lloyd's reinsurance (in relation to some or
all types of business) between 1978-81 and 1990-92.
14. REINSURANCE TO
CLOSE
The Reserving Process - The current position
14.1 At the
close of a year of account, members' underwriting liabilities allocated to the
year are usually reinsured by way of RITC. Unless and until the RITC is effected
(at the earliest, at the end of the third year of the account ie two years after
the end of the calendar year corresponding to the year of account) no profits of
the relevant year of account can be distributed to members.
14.2 Against
the payment of a RITC premium, all syndicate members' undischarged liabilities
in respect of risks allocated to the relevant year of account (including
liabilities in respect of RITC of any preceding year of account) are reinsured
without limit in time or amount into a succeeding, (usually the next) year of
account of the same syndicate; they may also, on occasion, be reinsured to close
by another syndicate. When RITC is underwritten by a successor syndicate, the
premium is set by the underwriter of both syndicates, acting for the Names of
both years of account. The Syndicate Accounting Byelaw (No 18 of 1994,
previously No. 11 of 1987 and No 7 of 1984) requires the premium set to be fair
and equitable between the two syndicates.
14.3 The premium for
reinsurance to close is determined by reference to the total estimated
outstanding liabilities (including IBNR risks) in respect of risks allocated to
the closing year of account, including undischarged risks from previous years
which have been closed by RITC into that year of account.
14.4 The
managing agent currently derives his express authority to assess and conclude
RITC from the agency agreement prescribed by the Agency Agreements Byelaw (No. 8
of 1988) which provides that he may effect a contract of reinsurance to close
under which:
(i) the reinsuring members agree to indemnify the reinsured
members against all known and unknown liabilities of the reinsured members
arising out of insurance business underwritten through the Managed Syndicate and
allocated to the earlier year; and
(ii) the reinsured members assign to
the reinsuring members all the rights of the reinsured members arising out of or
in connection with that insurance business (including without limitation the
right to receive all future premiums, recoveries and other monies receivable in
connection with that insurance business);
and to debit the reinsured
members and credit the reinsuring members with such reinsurance premium in
respect of the reinsurance to close as the agent, subject to any requirements of
the Council, thinks fair. Previously, the agent's authority derived from the
agreement prescribed by the Agency Agreements Byelaw (No. 1 of 1985).
14.5 The agent also has the power to reinsure liabilities into any year
that remains open, or not to close the year at all but to leave it in run-off
(subject to the provisions of the Run-off Years of Account Byelaw (No. 17 of
1989) see para 14.9 below). These requirements are contained in, inter alia,
byelaws, market bulletins and notices issued to the market. Whilst the managing
agent must have proper regard to the interests of both groups of Names (in the
reinsured and reinsuring years of account of the syndicate), no Name or group of
Names has, or can have, the right to approve or veto the RITC. However, Names
are entitled to request information regarding the RITC.
14.6 The
Syndicate Accounting Byelaw (No. 11 of 1987) imposes a duty that the premium set
between different years of account of the same syndicate should be equitable
between Names. The RITC must be fully documented and audited by independent
auditors.
14.7 A Name has been regarded by the DTI as ceasing to conduct
insurance business when all his open years have been closed by RITC. Because
RITC is treated as ending a Name's involvement in a syndicate for regulatory and
tax purposes, it is effectively the mechanism whereby a Name is able to be
released from his membership of Lloyd's.
Run-off Accounts
14.8 A
run-off account is a year of account which has not been closed by RITC at the
usual time. This may happen for a number of reasons, but usually as a result of
uncertainty as to future levels of liability and a consequent inability to fix a
premium which is fair as between the reinsured and the reinsuring members. In
these circumstances, closure of the year of account may take a number of years,
during which, without the consent of the Council, there can be no release to a
member of funds at Lloyd's nor of profits arising from the underwriting or
investments of a syndicate to which the member belongs.
14.9 The Run-off
Years of Account Byelaw (No. 17 of 1989) imposes a number of duties on managing
agents:
(i) to commission a report from an independent actuary;
(ii) to prepare a run-off year of account report which will contain
details of why the year is to be left open (the syndicate auditor will then
report on the managing agent's run-off report);
(iii) to communicate any
run-off decision to all relevant members' agents and, as soon as possible
thereafter, to convene a syndicate meeting at which the reasons for the run-off
decision may be examined by members; and
(iv) to close any run-off year
of account covered by the byelaw as soon as possible.
14.10 The byelaw
then goes on to specify measures which are to be complied with, mainly by
managing agents. The steps prescribed by Pt B are largely administrative and are
designed to assist the managing agent in deciding whether to close years of
account of syndicates managed by it. Where no such decision is taken, the steps
prescribed by Pt C (which are the subject of a measure of discretion on the part
of the Council) have effect and place managing agents under restrictions so long
as any relevant year of account remains open.
Development of RITC
14.11 Until the 1960s, RITC was rarely evidenced in writing, consisting
instead of accounting entries made by the managing agent as between the
reinsured and reinsuring years of account. Since the 1960s, there has been
gradual standardisation of the RITC wording, and since the mid-1980's a series
of byelaws have been introduced to codify RITC practices as set out below.
Syndicate Premium Income Byelaw (No. 6 of 1984)
14.12 This
byelaw provides that RITC premium paid is not treated as premium income of the
reinsuring syndicate, if the reinsuring syndicate is the same as the reinsured
syndicate, so that the RITC premium is then disregarded for the purposes of
calculating premium income limits. Where the reinsuring syndicate is different,
the RITC premium will be treated as premium income of the reinsuring syndicate
unless the Council, at its discretion, determines that the premium for the RITC
should not be taken into account when assessing whether the reinsuring syndicate
is within its premium limits, which the Council may do if the RITC qualifies as
a transfer of assets (ie if the reinsuring syndicate is simply effecting a
takeover of the business of the reinsured syndicate).
Agency Agreements
Byelaw (No. 1 of 1985) and (No. 8 of 1988)
14.13 See above.
Reinsurance to Close Byelaw (No. 6 of 1985)
14.14 para 2 of this
byelaw provides that a Name shall accept or place RITC only from or through a
Lloyd's broker or the managing agent of the reinsured or reinsuring Names.
Paragraph 3 provides that RITC agreements must be evidenced in writing.
Syndicate Accounting Byelaw (No. 7 of 1984) and (No. 11 of 1987)
14.15 These byelaws defined RITC as;
"an agreement under which
underwriting members ('the reinsured members') who are members of a syndicate
for a year of account ('the closed year') agree with underwriting members who
comprise that or another syndicate for a later year of account ('the reinsuring
members') that the reinsuring members will indemnify the reinsured members
against all known and unknown liabilities of the reinsured members arising out
of insurance business underwritten through that syndicate and allocated to the
closed year, in consideration of:
(i)a premium; and
(ii)the
assignment to the reinsuring members of all the rights of the reinsured members
arising out of or in connection with that insurance business (including without
limitation the right to receive all future premiums, recoveries and other monies
receivable in connection with that insurance business)".
Syndicate
Accounting Byelaw (No. 18 of 1994)
14.16 This sets out the current
definition of RITC as follows;
"reinsurance to close" means: (a) an
agreement under which underwriting members ("the reinsured members") who are
members of a syndicate for a year of account ("the closed year") agree with
underwriting members who comprise that or another syndicate for a later year of
account ("the reinsuring members") that they will indemnify the reinsured
members against all known and unknown liabilities of the reinsured members
arising out of insurance business underwritten through that syndicate and
allocated to the closed year, in consideration of: (i) a premium; and (ii) the
assignment to the reinsuring members of all the rights of the reinsured members
arising out of or in connection with that insurance business (including without
limitation the right to receive all future premiums, recoveries and other monies
receivable in connection with that insurance business); or (b) an unlimited
syndicate run-off reinsurance contract between members of a syndicate for a year
of account and Centrewrite Limited, Lioncover Insurance Company Limited or any
other authorised insurance company designated by the Council for the purposes of
this definition whereby the company agrees to indemnify the members of the
syndicate for a particular year of account against all known and unknown
liabilities arising out of insurance business underwritten through the syndicate
and allocated to that year of account."
The RITC provisions
14.17 The Central Fund is potentially available to meet the obligations
of a member of Lloyd's who defaults on his liabilities under an RITC agreement,
and to that extent it underpins the RITC mechanism and has been able to support
the RITC system. Where a member defaults on an RITC obligation, it is open to
the agent to apply for payment from the Central Fund rather than seeking to have
recourse to the Names on the year of account in which the policy was written.
14.18 The existence of 253 open years of account erodes the wealth and
commitment of those members of those syndicates who remained members of other
Lloyd's syndicates. Problems have arisen because syndicates had closed years
with inadequate RITC which had to be funded by the current Names out of current
trading and the continuing deterioration of this situation was proving serious.
(Standard & Poor's: The Profile 1993 p 15)
The Merrett litigation
The parties have agreed that my judgment given on 31 October 1995 in
Merrett can be referred to as evidence of the facts found in it in relation to:
(i) the regulatory background relating to RITC (see in particular pages
84-110 of the judgment);
(ii) the manner in which the RITC was carried
out on the relevant syndicates, and the manner in which it should have been
carried out;
(iii) the findings as to the negligence, or (where
relevant) the lack of negligence, of the underwriters concerned.
15.
PERSONAL STOP LOSS
15.1 The trends in PSL are set out in the Rowland
Task Force Report.
15.2 In October 1987 the figures estimated by seven
brokers relating to the PSL market were as follows:
(i) number of PSL
clients (1989) 15,000
(ii) total limit of PSL liability placed at
Lloyd's
(excluding the effect of retrocessions)(1986) #1,418m
(iii) total PSL premium income (1986) #11.5
(iv) number of
syndicates writing more 14
than 1% of their syndicate's net
premium income (1985)
(v) number of specialist PSL syndicates. 3
15.3 In 1978 syndicate auditors were required to report to Lloyd's where
PSL insurance business exceeded 3% (1% in 1980) of a syndicate's MPI. This
enabled Lloyd's to keep a check on the volume of PSL written at Lloyd's. On 20
September 1993, as a result of a recommendation made by the Syndicate 387 Loss
Review, Lloyd's banned the establishment of new specialist PSL syndicates.
16. RECENT DEVELOPMENTS AT LLOYD'S
Members' agents pooling
arrangements
16.1 A members agent's pooling arrangement (or MAPA) is an
arrangement whereby a members' agent pools underwriting capacity and the members
participating in the arrangement share rateably in participations across a
spread of syndicates. It can enable members to diversify their risk by writing
smaller lines across a large range of syndicates. Individual members may choose
whether or not to participate in a MAPA operated by their members' agent, to
continue underwriting on the traditional basis or to underwrite partly on one
basis and partly on the other.
High level stop loss cover
16.2
In 1993, Lloyd's introduced a scheme to provide stop loss cover against
individual members underwriting losses. Each individual member is required to
contribute an annual levy (of an amount determined by the Council) to the high
level stop loss fund, which may be made available to pay members underwriting
losses. (However, the scheme does not provide a guarantee of reimbursement, and
if the funds available in the high level stop loss fund are insufficient to meet
all demands on it, liability to discharge the losses will remain with the
member.) The scheme is to be discontinued with effect from the 1996 year of
account.
New arrangements for EPP
16.3 Since 1993, Centrewrite,
a wholly owned subsidiary of the Society of Lloyd's (see
paragraph 1.33) has extended its activities to underwrite the Lloyd's members
estate protection plan (EPP) to enable the estates of deceased members to be
wound up.
Corporate capital
16.4 With effect from the 1994 year
of account, Lloyd's has admitted corporate capital (in addition to individual
members) to strengthen the capital base and to support long term growth in
capacity. The requirements in relation to the admission of corporate members are
set out in a document entitled "A guide to corporate membership" published by
Lloyd's in September 1993.
Risk Profiling
16.5 The Regulatory
Board is attempting to guard against problems which arise from undue and
unrecognised aggregation such as occurred in the LMX spiral. In particular, it
plans to introduce systems of risk profiling to assist the assessment and
control of aggregation and for syndicate monitoring. Every syndicate will be
required to produce a "disaster plan" showing the impact of realistic disaster
scenarios. These will in theory reveal syndicates with very high aggregate
exposure. Syndicates intending to write business in certain categories exposed
to catastrophic losses will be required to notify their supporting members' agents of that intention and must disclose (a) the maximum amount of capacity to
be utilised and (b) the maximum aggregate liability to the syndicate which will
be accepted, both gross and net of any reinsurances. (Lloyd's Business Plan
April 1995).
Risk Based Capital ("RBC")
16.6 The Walker Report
recommended the introduction of a system of risk weighting as a means of
preventing repetition of the LMX losses and as a tool to improve monitoring of
syndicates. In August 1995, Lloyd's published a paper entitled "Risk Based
Capital for Lloyd's: a consultative document" outlining proposals for the
introduction of risk based capital at Lloyd's, whereby funds at Lloyd's required
to support a member's underwriting would depend on the classes of business
underwritten and the syndicates on which that member participates. Lloyd's has
sought the views of the market on these proposals, and that consultation process
is continuing.
In theory the fact that more supporting capital is needed
for a particular risk code would make the writing of that business (all other
things being equal) less attractive than would be the case without the capital
increase and so the RBC formula would in theory act as a brake on the deployment
of capital to less desirable areas.
The introduction of the RBC system
would in theory provide members with more information as to the nature of the
risk associated with specific classes of business within their underwriting
portfolios. In theory, the RBC system should serve to focus members' minds on
the risk/reward ratio of membership.
Syndicate auctions
16.7 In
August 1995, Lloyd's launched a scheme for allocating capacity by auction. A
series of four weekly auctions for the 1996 year of account were held, and
capacity was traded on 99 syndicates.
Lloyd's: reconstruction and
renewal
16.8 In May 1995 Lloyd's published a document entitled "Lloyd's:
reconstruction and renewal" ("R&R"). This document (to which reference
should be made for its full terms) lays out a plan for the reconstruction and
renewal of Lloyd's. It aims to achieve two complementary goals: first, to
resolve the problems of the past; second, to build a strong market for the
future. #450 million is to be raised from members as part of R & R in the
form of a special contribution from those underwriting in 1993, 1994 and 1995
which can be offset against future Central Fund Contributions. The contribution
by members of #450 million towards R & R would translate into a charge of
approximately 1.5% of capacity for each of the three years of account.
To finance Reconstruction & Renewal, including the costs of
settlement, Lloyd's proposes to draw first on the existing resources of the
Society, specifically the assets of the current Central Fund.
Events
over the years leading up to 1992 caused serious damage to the confidence not
only of Names who had suffered large or catastrophic loss but also of those who
will have to contribute to the relief of the biggest losers and the maintenance
of the Central Fund.
(See further R & R Progress Report October 1995
and subsequent R & R publications).
17. LLOYD'S MARKET SHARE
17.1 According to Statistics Relating to Lloyd's 1995 Lloyd's share of
World Non-Life Premiums (Gross Basis) was as follows:-
1984 1985 1986
1987 1988 1989 1990 1991 1992 1993 1994
Lloyd's Share of the
World Direct &
Facultative
-Marine 20.6% 20.2% 19.8%
18.7% 19.1% 17.6% 18.2% 16.4% 15.6% 15.7% --
-Non-Marine
1.3%
1.4% 1.4% 1.4% 1.3% 1.3% 1.6% 1.9% 1.8% 1.7% --
-Aviation19.8% 9.5%
20.8% 21.3% 19.4% 18.9% 19.8% 26.8% 27.4% 26.2% --
-Motor 0.5% 0.6% 0.6%
0.6% 0.7% 0.6% 0.6% 0.8%. 0.9% 0.9% --
Total Direct &
Facultative
1.9% 1.9% 1.8% 1.8% 1.7% 1.5% 1.7% 2.0% 1.9% 1.9% --
Total Direct (e)
1.5% 1.5% 1.4% 1.5% 1.4% 1.3% 1.4% 1.5% 1.4%
1.4% --
Total Treaty
Reinsurance
4.2% 4.1% 3.8% 3.6%
4.0% 4.2% 4.6% 4.5% 3.9% 4.3% --
Total
Reinsurance (e)
6.1% 6.1% 5.5% 5.2% 5.6% 5.5% 6.1% 6.6% 6.1% 6.9% --
18 LOSSES
AT LLOYD'S
18.1 Losses at Lloyd's 1988 to 1991 were as follows.
1988-1991
(i) Pre-tax loss to Names after syndicate expenses but
before Annual subscriptions
and levies, Agents' fees and Agents' profit
commission ("Personal Expenses")#5.356 billion
(ii) Annual subscriptions
and levies, Agents' fees and Agents' profit commission #1.584 billion
(iii) Pre-tax loss to Names #6.940 billion
Annual subscriptions
and levies, Agents' fees and Agents' profit commission increased the pre-tax
loss to Names before Personal Expenses by, on average, 30%.
Estimation
of Lloyd's losses for the years 1989 to 1992
18.2 It is difficult to
produce precise figures for Lloyd's losses by category of business because of
(i) definitions of business type' are not precise and (ii) Lloyd's records do
not break down figures between categories of business. Thus the following table
is based upon the losses suffered by individual syndicates which have been
identified on the basis of where that syndicate's major problem lies.
Year Syndicates with "Spiral"
latent liability Syndicates
writing
(in particular
Asbestos and a Cat Book but not
Pollution) including casualty
XOL business
1989 (299)
(1226)
1990 (388) (1402)
1991 Pure 0 (403)
Run-Off Years
(616) (268)
1992 Pure 0 (139)
Run-Off Years (589) (39)
Total (#M) (1892) (3477)
Source: Chatset
Generally,
"Spiral Syndicates" have been taken as including those syndicates which effected
retrocessional business in the London Market.
The definition of "Spiral
Business" does not correlate with what may be necessarily understood as "LMX" business. Chatset does not believe that it is practical to precisely determine
"LMX" losses given the problems of data and terminology.
Chatset has
also calculated the losses suffered by the 14 major syndicates in the "LMX" market over a similar period and these amount to #2.25bn.
The losses in
the previous four years (1985 to 1988 inclusive) suffered by syndicates with
latent liability was approximately #1685m, making an approximate total over the
eight year period of #3577m.
F THE WITNESSES
The witnesses
called by the defendant
Professor BAIN.
Professor Bain is an
academic economist, specialising in monetary economics and the economics of the
financial sector. After graduating in Economics from Cambridge University in
1959, he held research and teaching posts at Cambridge and Yale Universities,
before taking up a two year secondment at the Bank of England. From 1966 to 1984
he held professorial posts, first at the University of Sterling and then at the
University of Strathclyde. He then moved to the City as Group Economic Advisor
at Midland Bank, and held that post from 1984 to 1990. Since October 1991 he has
held a part-time professorial post in the Department of Political Economy at the
University of Glasgow and has been a (non-executive) Board Member of Scottish
Enterprise. He was a member of the Wilson Committee on the City, a member of the
Monopolies and Mergers Commission and of the Advisory Committee on Science and
Technology.
In his first report Professor Bain considered Lloyd's
arrangements and the relevant markets, the Lloyd's policy and the Central Fund,
direct consequences of the Central Fund arrangements, solvency regulations, the
excess of loss spiral and reinsurance to close.
In his second report
Professor Bain considered Lloyd's consultative report "Risk-Based Capital for
Lloyd's" (August 1995) and replied to the expert reports served on behalf of
Lloyd's under the headings the Central Fund, moral hazard, markets for
insurance, causes and effects of changes in capacity, the reinsurance provisions
and RITC.
Professor Bain's third report was an interim report as to
effect on trade between member states and his fourth report replied to the joint
report of Professor Yamey and Mr Aaronson as to effect on trade between member
states. Professor Bain's fifth report was on CSU data analysis.
Professor Bain helpfully, at a late stage in the trial, revised Annex F
to his 5th report to reflect the agreed Wilshaw "Category 3" list of syndicates
for the 1989 year of account.
Professor Bain's conclusions are set out
in Ch 8 of his first report, although these were to some extent
supplemented/modified in his subsequent reports and in evidence.
Professor Bain is highly intelligent and extremely articulate. He has
considerable expertise in the field of applied economics. He is not however an
expert in the workings and practices of Lloyd's. Professor Bain was not assisted
by the fact that the defendant called no expert evidence from the market.
In considering Professor Bain's five reports and oral evidence it is
essential to distinguish between matters falling within and without Professor
Bain's area of expertise. Professor Bain was not always inclined to observe this
distinction. Further at times he had a tendency to assume the role of advocate.
In considering Professor Bain's five reports and oral evidence it is
further essential to distinguish between those parts of his evidence which are
relevant to the issues I have to decide in relation to art 85, and those parts
of his evidence which are relevant to (and which might usefully be deployed in
connection with) an inquiry into alleged regulatory failures on the part of
Lloyd's. This case is concerned with art 85 and not a general investigation into
alleged regulatory failures on the part of Lloyd's - see B above.
At one
point in his evidence Professor Bain said "in my (first) report I have
frequently used "causation" where perhaps if I had spelt it out fully I would
have said the Central Fund "permitted" certain things to happen and in the
circumstances that existed these things, as a result of other factors as well as
this permissive regime did happen... I am not saying that the Central Fund
caused anybody at Lloyd's to... retain for themselves bad business. I would say
that the Central Fund permitted people to do that".
In his first report
Professor Bain said "The Central Fund Arrangements and the Reinsurance
Provisions were the principal causes of the (LMX) spiral". When asked whether,
when he read the judgment of Phillips J in Gooda Walker, he felt any doubt about
his conclusions as to the cause of the spiral, he said "Not at all". When asked
whether the argument to the effect that losses flowing from the spiral had been
caused, not by negligent underwriting but by the Central Fund, might not have
been a useful point for the Gooda Walker defendants to have taken, his answer
was "The points run by (lawyers) are a source of amazement to me".
I
refer to the National Justice Compania Naviera SA v Prudential Assurance Co Ltd
("The Ikarian Reefer") [1993] 2 Lloyd's Rep 68 at 81 where I summarised the
duties and responsibilities of expert witnesses in civil cases. (Proposition (4)
is subject to the qualification that it is not always possible to confine each
expert to his area of expertise - see the National Justice Compania Naviera SA v
Prudential Assurance Co Ltd ("The Ikarian Reefer") [1995] 1 Lloyd's Rep 455 at
496, Stuart-Smith LJ). The problems with Professor Bain's evidence underline the
importance of adherence to the guidelines in the Ikarian Reefer.
The
witnesses called by Lloyd's
Liliana ARCHIBALD.
There was no
dispute as to the contents of the statement of Liliana Archibald (although the
defendant disputed its relevance).
Liliana Archibald was EC advisor to
Lloyd's from 1978 to 1985. Her statement dealt with Lloyd's and the European
Commission under the headings:- initial contacts with the Commission, late
1979-early 1980: contacts with the Commission over Market Agreements and the
draft letter from the Chairman of Lloyd's to the Chairmen of the four Market
Associations, the Fisher Report and the Lloyd's Bill, informal clearances and
notification, chronological summary of contacts relating to informal clearance
and the Commission's various positions on notification.
Liliana
Archibald explained the position relating to the Central Fund as follows:-
"at no time did the Commission indicate that either the Central Fund
arrangements, or the way it was funded, would pose any concern in relation to
the competition provisions of the Treaty of Rome. I understand from the files
that the Central Fund Byelaw (No. 4 of 1986) was never actually sent to the
Commission during the process of informal clearances. However, the Commission
had received copies of the Central Fund Agreement of 1927, and the Byelaw
entitled "Recovery of Monies Paid Out of the Lloyd's Central Fund or the Funds
and Property of the Society" (No. 5 of 1984), which were the precursors to the
Central Fund Byelaw that is now in issue. This Agreement and Byelaw taken
together do not differ substantially from the Central Fund Byelaw No. 4 of
1986..."
Mr Robin WILSHAW.
Mr Wilshaw provided a report as an
expert Lloyd's underwriter. He has been involved in the Lloyd's market for over
30 years. He has had long experience in the underwriting of both direct
insurance and reinsurance with the underwriting agency of R J Kiln & Company
Ltd., where he was employed from 1969 until his retirement in 1992. His
experience has been in the non-marine market, where he specialised in writing a
short tail account.
Mr Wilshaw dealt in his main report with the nature
of XL reinsurance in the non-marine market, the factors determining the way in
which risk was priced and placed in the Lloyd's market, the effect of the
Central Fund on the underwriting of business in the Lloyd's market, the
necessity for and mechanics of the Lloyd's system of RITC, the factors affecting
underwriters' decisions in relation to the purchasing of reinsurance cover, the
effect of the Reinsurance Provisions on the purchasing of reinsurance cover and
the losses suffered at Lloyd's relevant to the present proceedings. Mr Wilshaw
also provided an expert report in reply.
Mr Wilshaw has provided expert
reports (and in some cases given evidence) in a number of LMX and Portfolio
Selection cases (categories 1 and 4 in the Lloyd's Litigation). Mr Wilshaw's
witness statements in other cases are collected together in bundle 41.
I
was impressed by Mr Wilshaw's approach to assisting the Court as an expert
witness. I consider that his evidence was generally balanced and reliable. He
did not hesitate to criticise managing agents, members' agents and Lloyd's where
criticism was due and yet provided practical and credible answers in relation to
the workings of the Central Fund and the Instructions for the Annual Solvency
Test, drawn from his experience as an underwriter.
Dr Peter FREY.
Dr Frey has been active in the reinsurance market since 1959 when he
joined Bavarian Reinsurance Company, in Munich, a member of the Swiss Re Group.
He became Chief Executive Officer of Bavarian Re in 1975, a position which he
held until 1992. From 1993 until the end of March 1995 he was responsible for
all activities of the Swiss Re Group outside Zurich. Throughout his career he
was competing with Lloyd's and engaged in buying reinsurance from Lloyd's.
Dr Frey provided an impressive view of the markets, Lloyd's and risk
adjustment from a continental perspective.
Mr Raymond SALTER.
Mr
Salter has been involved in broking for 40 years. In March 1993 he retired as a
Director and Deputy Chairman of Willis Faber Dumas Ltd., the major international
insurance and reinsurance broking arm of the Willis Corroon Group, one of the
world's largest insurance broking groups.
Mr Salter provided helpful
expert evidence, based on his experience of broking insurance, particularly
reinsurance. He dealt with the broker's role in the market, price and risk
sharing, the placing of insurance business: the importance of security, the
Central Fund and solvency and premium income limits.
Mr Tony BERRY.
Mr Berry was called as an expert marine excess of loss underwriter with
particular experience in the underwriting of LMX business. Mr Berry has been
involved in the XL market for the past 30 years, primarily underwriting marine
XL reinsurance. He is currently Managing Director of Cotesworth & Co Ltd and
the Active Underwriter of Syndicate 536.
Mr Berry's main report
summarised some relevant aspects of the nature and history of the XL market (and
the spiral) and the key factors involved in writing XL business and explained
what factors in his view gave rise to the heavy losses sustained by much of the
XL market in the late 1980's and early 1990's. In addition Mr Berry commented on
certain of the defendant's allegations.
As to XL business Mr Berry's
main report considered writing XL business, relevant controls (the use of
Probable Maximum Loss factors, aggregate exposures and experience) and reasons
for the losses in the XL market in the late 1980's (the unprecedented number of
major man-made and natural catastrophes occurring during this period and
underwriting practices).
Mr Berry pointed out in his report that the
term LMX business is commonly used in relation to the cover provided to London
domiciled insurers or reinsurers. There are two possible definitions of the term
"LMX". The first, (the definition to which Mr Berry adheres) is that of London
market Excess of Loss business - ie. the reinsurances of Lloyd's syndicates and
insurance or reinsurance companies underwriting in the London market. The second
definition adhered to by some underwriters (with which Mr Berry disagrees) is
that LMX is limited purely to London market XL of XL ie. so-called "spiral" business.
Mr Berry provided a second report in reply.
Mr Berry
said that the underwriting techniques which he applied were those which he was
taught by some very good people back in the 1960's, lessons which he learnt
following Hurricane Betsy. His basic premise was not to underwrite on a rate on
line basis and to control aggregate liabilities. PML from the aggregates was
derived daily and there were very tight controls on the book. He was more than
prepared to say no. He did not feel under an incentive to use all available
capacity. He said "I believe that, as far as the capacity given to me by the
Names was concerned, I had to use my professional judgment as to whether or not
I should apply the extra risk, because obviously that capacity, the deposits,
are already invested, and whether it is worth, in my view, on the risk
reward/ratio, to take the extra risk." The above principles were key, in Mr
Berry's opinion, to proper underwriting. Other people in the market were not
following those principles. Other people in the market regretfully were being
rate on line driven. The problem with the 3% rate on line is that it takes no
account of whether the underlying exposures on each of the individual risks at
3% on line are all the same. Mr Berry said that a fundamental basis of proper
excess of loss underwriting is to ensure that the underwriter reinsuring with
you has an interest in the outcome. In the late 1980's people were not running
sufficient retentions. Quite often you would not be given details of the
underlying programme.
If everybody in the market had followed his
approach the losses would still have occurred, but if they had occurred at
syndicate level they would have been less, because rates would have been higher.
Mr Berry struck me as a thoroughly practical underwriter who had
benefited from a good apprenticeship and who continued to apply the principles
he had learned many years ago. As he put it one of the reasons for the losses
that Names suffered in certain syndicates caught up in the spiral, was that some
underwriters did not have a sufficient feel for or understanding of the business
at a time of world wide over-capacity.
Mr Jeremy DICKSON
Mr
Dickson is a chartered accountant and a partner in the firm of Coopers &
Lybrand. For over 25 years he has been engaged in a number of large auditing
engagements and since 1970 has concentrated on audits in the insurance industry.
Mr Dickson has been the audit partner on the audits of various Lloyd's
syndicates and brokers. As to Lloyd's syndicates he has been concerned with one
long tail syndicate, but his experience does not extend to LMX syndicates.
Mr Dickson provided s V1 of Mr Aaronson's second report, which considers
Reinsurance provisions under the headings Permitted Reinsurance Limit and First
Non-Life Directive.
Mr Robin AARONSON
Mr Aaronson is a partner
in the firm of Coopers & Lybrand and a specialist professional adviser on
the economics of competition. He was formerly a member of the Government
Economic Service (GES), which he joined following completion of a Masters degree
in economics at the London School of Economics. In the GES he served first at H
M Treasury and then, for a period of three years, at the Monopolies and Mergers
Commission (MMC) where he was one of the two Senior Economic Advisers on the
permanent staff. In this capacity he advised members of the Commission on the
economic aspects of some twenty cases referred to the MMC for investigation. Mr
Aaronson's work at Coopers & Lybrand has included consultancy advice to the
European Commission. Throughout 1994 he directed a study for Directorate-General
IV of the Commission, which developed a methodology for carrying out market
definition in cases involving insurance.
Mr Aaronson's first report
considered market definition, non-life insurance business - worldwide structure
and trends, Lloyd's syndicates in the context of worldwide non-life insurance
business, inter-syndicate competition, Lloyd's syndicates' performance in
context, Lloyd's Central Fund and other assets and reinsurance/retention
practices. Mr Aaronson's second report considered impact of risk-adjusting
Central Fund contributions, sources and uses of capacity at Lloyd's, capacity:
Lloyd's and corporates, solvency regulations - the 50% rule and the 20% rule and
commentary on the data in Professor Bain's first report. Mr Aaronson's third
report was a joint expert report with Professor Yamey as to the effect on trade
between member states. Mr Aaronson's fourth report replied to Professor Bain's
report dated 5.1.96. Mr Aaronson's fifth report contained analyses of mini-Names
and "1983 joiners".
Mr Aaronson struck me as a careful witness who was
generally fair in the answers which he gave. It is necessary to distinguish
between matters falling within his area of expertise as an economist and matters
as to which he was dependent on the reports and evidence of the market
practitioners. Subject to this I found Mr Aaronson's evidence persuasive as to
many of the issues with which he dealt.
Professor YAMEY
Professor Yamey was a Professor of Economics at the London School of
Economics from 1960 to 1984, in which year he retired with the title Professor
Emeritus. He was elected a Fellow of the British Academy in 1977. His
publications include books and articles on the economics of monopoly and
restrictive practices. He was a member of the Monopolies and Mergers Commission
from 1966 to 1978, during which time he was co-signatory to some thirty reports.
In his first report Professor Yamey analysed the economic aspects of key
features of the Lloyd's system for supplying insurance services, considered the
place of Lloyd's in the insurance markets defined in Mr Aaronson's first report
and examined the allegation that the Central Fund arrangements led to
"under-pricing" of insurance and reinsurance business by Lloyd's syndicates and
the proposition that Names' contributions to the Fund should not be strictly
proportional to their premium incomes but, instead, should reflect differences
in the likelihood that their liabilities may have to be paid by the Fund.
In his second report Professor Yamey commented on the main arguments and
analysis Professor Bain put forward in his first report as regards the Central
Fund arrangements under the headings:- contributions to the Central Fund,
adjusting for the risk of Central Fund drawdowns, capacity and premium levels,
distortion of competition and did failure to have risk-adjusted Central Fund
contributions have adverse effects?
Professor Yamey also provided a
joint report with Mr Aaronson as to the effect on trade between member states.
Professor Yamey was an impressive witness.
G THE DEFENDANT'S
SUBMISSIONS
Mr Lever QC on behalf of the defendant submitted as follows.
There was distortion of competition, most notably in the distinct category of
reinsurance business constituted by the provision of catastrophe cover. The
distortion was appreciable. In what was essentially international business,
there was an effect on trade between Member States and that effect was
appreciable. A substantial proportion of all Names suffered large losses in the
years 1988-91; to a substantial extent those losses were attributable to their
having been over-exposed to risk; the over-exposure to risk was the very thing
to be expected to result, in the conditions of the 1980s, from the removal by
Lloyd's of the normal constraint of counterparty credit risk assessment.
The defendant's case in relation to LMX losses, in the form of a flow
chart, was as follows:-
The Central Fund Arrangements led to the absence
of counterparty credit risk assessment which in the absence of any Constraints
led to moral hazard which led to the risk of agents acting incompetently which
risk eventuated to an appreciable extent such that Names participated
inappropriately on high-risk syndicates in appreciable numbers which increased
capacity in those syndicates to an appreciable extent which reduced rates and
lowered retentions which caused adverse selection attracting yet more high-risk
business at low rates and with low retentions thus distorting competition and
affecting trade [the pure Defence] so that when catastrophes occurred the
natural consequence was that losses fell on those Names [the Counterclaim].
The defendant's 14 propositions
The defendant's case was set out
in 14 propositions as follows.
PROPOSITION 1
(a) The Central
Fund Arrangements attracted the operation of art 85(1);
(b) the elements
in the Central Fund Arrangements by reason of which the Arrangements attracted
the operation of art 85(1) are
(i) the provisions for the maintenance of
a Central Fund with power to apply it to inter alia the payment of Names' Lloyd's liabilities;
(ii) the provisions for raising contributions and
levies to or for the Central Fund;
(iii) Lloyd's decisions to exercise
those powers as they were exercised;
(c) para 10 of the Central Fund
Byelaw forms an integral and unseverable part of the Arrangements created by the
provisions referred to at (b) above and is rendered unenforceable by art 85(2)
and/or cannot be enforced by Lloyd's since the sums sought to be recovered arose
as a result of Lloyd's infringements of art 85(1);
(d) Lloyd's
infringements of art 85(1) through the making and operation of the Central Fund
Arrangements (alone or in combination with the Other Relevant Arrangements) give
rise to the cause of action pleaded in the Counterclaim.
The defendant's
submissions in support of this Proposition included the following.
For
the definitions of the Central Fund Arrangements and the other Relevant
Arrangements, see 5 Schedule to the PDC. The Central Fund Arrangements distorted
competition (see paragraph (c) below) and para 10 of the Central Fund Byelaw
1986 cannot be severed from the provisions for the maintenance and use of the
Central Fund to provide a system of mutualization of last resort and de facto
guarantee by Lloyd's of Lloyd's policies. Lloyd's cannot contend that even if
the Central Fund Arrangements attract the operation of art 85(1), they are
entitled to enforce para 10 of the Byelaw because by so doing they are not
distorting competition; that was precisely what Lloyd's argued before Saville J
and the Court of Appeal rejected the argument.
With regard to distortion
of competition in the relevant insurance markets, the defendant relies on the
raising of contributions and levies at the same rate for all Names
indiscriminately as constituting a failure to operate a Constraint (PDC, para 2
(iv) (a)) rather than as an independent infringement of art 85 (1); whereas he
had contended that in the market for syndicate participations the raising of
contributions and levies in that way itself had the effect of distorting
competition; but this distortion is no longer relied upon.
The Central
Fund Arrangements have, as an effect, "prevention, restriction or distortion of
competition within the common market" in that they vary the conditions of
competition between Lloyd's and other insurers and do so in a way that does not
mean merely that Lloyd's syndicates operate in the marketplace like other
insurers (whereas without the Central Fund arrangements they could not operate
in the marketplace at all).
If as a matter of law (contrary to Professor
Bain's view as a matter of economics), distortion of competition requires a
deleterious effect on the competitive position of an actual or potential
competitor and not also the creation of competition of an abnormal kind, the
characterisation of the effects of the Central Fund Arrangements as
competition-distorting is unaffected - the capacity of Lloyd's as a whole and of
high risk syndicates in particular was artificially inflated, prices were
thereby driven down and, in turn, the amount of high risk catastrophe business
written by Lloyd's syndicates was inflated; it is self evident that the effects
cannot have been confined to Lloyd's.
PROPOSITION 2
The Central
Fund Arrangements opened the door to the realisation of moral hazard on the part
of Lloyd's active Underwriters and thereby distorted competition.
The
defendant's submissions in support of this Proposition included the following.
Moral hazard exists wherever there is a risk that one person may
avoidably cause loss to another; the risk may be aggravated because the first
person has an incentive to act in a way that may cause such loss but an
incentive to act in such a way is not a necessary condition for the existence of
moral hazard (a householder, unless intending to perpetrate a fraud on his
insurer, has no incentive to leave his house open to burglars, yet moral hazard
may operate on his behaviour in avoidably so doing).
In a developed
society there are many constraints on realisation of moral hazard, ranging from
social disapprobation to the most severe criminal penalties.
In the
field of financial services, a particularly important constraint on the
realisation of moral hazard that normally exists is counterparty credit risk
assessment ("CCRA"). CCRA greatly limits the ability of an undertaking operating
in the field of financial services avoidably to cause loss to those with whom
the undertaking does business. Thus, in conditions of undistorted competition,
because of CCRA, in order to gain and maintain business, an insurer needs to
establish a reputation that it does not (whether because the underwriter is a
gambler, is negligent or is plain stupid) underwrite business beyond the
resources that are available to the insurer to support the insured risks in so
far as they are perceptible. Thus, in conditions of undistorted competition,
CCRA and reputation are two sides of the same coin: reputation depends on
favourable CCRA and the need for reputation constrains the ability of an
underwriter, for whatever reason, to get business beyond the resources that are
available to the insurer to support the perceptible risks.
By contrast,
at all times material to these proceedings, because a Lloyd's underwriter was
(even from Day 1 of his operations) able to underwrite Lloyd's Policies with the
de facto guarantee of Lloyd's to back those Policies, every Lloyd's underwriter,
whether a gambler, negligent or plain stupid, had the ability to get business
without being susceptible to CCRA and therefore without the necessity of
establishing a reputation for not writing business beyond the resources
available to support the underwritten risks so far as they were perceptible.
PROPOSITION 3
Because of Proposition 2, the door was opened to
the admission by Lloyd's of individuals as Names, being individuals who did not
have the assets required to support underwriting at Lloyd's at all (moral hazard
operating on the behaviour of Lloyd's itself).
The defendant's
submissions in support of this Proposition included the following.
In so
far as Lloyd's membership comprised individuals who, in circumstances in which
CCRA had operated, would have been wholly unacceptable to customers as a source
of security for the policies written in their name, Lloyd's arrangements
distorted competition. Yet a significant proportion of those in fact admitted to
membership by Lloyd's in the second half of the 1970s and in the 1980s were
precisely the sort of people whom, for all Lloyd's or customers knew, no sane
customer would have accepted as a source of security for an insurance policy,
let alone a policy providing cover in a high risk area.
Bain V
establishes that large numbers of such Names appeared on policies written by
high risk syndicates and, in particular, Wilshaw-classified Category 3 LMX
syndicates. Even for full External Names, the minimum required shown means fell
even shorter in real terms below the minimum recommended by Cromer in 1969 -
itself a reduction of one-third on the pre-existing minimum - so that by 1989
the minimum was only some 30% of Cromer's recommended minimum.
In the
years 1976 to 1983 persons who demonstrated only half the (in real terms much
reduced) means required to be shown by a full External Name were attracted into
Lloyd's. As the "kick" to membership through the admission of Mini-Names was
running out, a new "kick" was provided by allowing Names to use bank guarantees
secured on their principal residence as security in their totality both as shown
means and for use as their Lloyd's deposit.
The Court does not have to
decide how many financially inadequate Names were admitted: all that is relevant
is that one of the effects of the Central Fund arrangements was to enable such
Names to join Lloyd's who would otherwise either not have been able to do so or
would not have been minded to do so.
PROPOSITION 4
Because of
Proposition 2 and/or Propositions 2 and 3, the door was opened to the placing of
Names by Members' Agents on syndicates when the Name did not have the assets
required to support such membership of the syndicate having regard to the nature
of the syndicate's business, the Name's line on the syndicate in question and
the Name's exposure to risk on other syndicates (moral hazard on the part of
Members' Agents).
There was in place no effective substitute for the
normal market discipline of counterparty credit risk assessment to prevent the
operation of moral hazard resulting therefrom.
The defendant's
submissions in support of this Proposition included the following.
It
was because syndicate underwriters and their Managing Agents were not
constrained to reject unsuitable Names as members of their syndicates or to
decline excessive participations by even Names who were in principle suitable
for membership of their syndicates, that Members' Agents were able to place
their Names as they did. Bain V, as revised, shows that no alternative
constraint operated to prevent a substantial proportion of Members' Agents
placing a substantial proportion of Names on Category 3 LMX syndicates (i) when
they should not have been on them at all or (ii) if any participation was
appropriate, when their actual participation was grossly excessive. This is the
danger of having a system which removes the normal market discipline of CCRA
without having any effective alternative constraint in place.
If,
because CCRA of Lloyd's syndicates was impracticable, moral hazard and the kind
of aberration that occurred in the 1980s were unavoidable (and therefore may
recur), the consequence is that the application of art 85(1) to Lloyd's
arrangements is unavoidable (and Lloyd's must satisfy the EC Commission that the
best arrangements that can be devised are such that Lloyd's, with some
inevitably concomitant distortion of competition, is better (within the terms of
art 85(3) EC) than no Lloyd's at all). No such balancing operation is open to a
national Court faced with the question whether art 85(1) applies.
The
problems could have been at least substantially mitigated by the adoption of
constraints - which might have been a great deal less elaborate than the scheme
proposed in the Consultative Document. What was required was a system under
which, making some allowance for the reduction in risk that could be achieved
through diversification of a Name's Lloyd's portfolio and for the relationship
between a Name's APL and the means that he chose to disclose to Lloyd's, a Name
with a higher proportion of his portfolio in syndicates that were identifiable
ex ante as high risk syndicates was permitted to write less business than a Name
with the same Funds at Lloyd's whose portfolio was more heavily weighted with
syndicates that were identifiable ex ante as lower risk syndicates. The fact
that it would have been difficult, and probably impossible, to devise a
conceptually perfect system is not a reason for treating as acceptable the
omission to introduce any system such as would at least have substantially
improved the situation.
Lloyd's recognised in principle the need to
monitor and control Names' risk exposure - hence the establishment of Premium
Income Limits. But the PIL system was manifestly irrational in the sense that no
reasonable man applying his mind to the relevant considerations could have
adopted it: thus -
(i)two Names with the same shown means, the same
funds at Lloyd's and equally diversified portfolios could write the same premium
income, even though the one was much more heavily exposed than the other on
syndicates that were ex ante identifiable as high risk syndicates; and
(ii)no attempt was made to adjust PILs when, as a result of even major
changes in premium rates, any given premium income exposed a Name to much more
(or much less) risk than previously.
PROPOSITION 5
Because of
Proposition 3, the overall capacity of Lloyd's including its capacity in the
relevant markets was artificially inflated and excess capacity developed,
thereby contributing to a depression of premium rates at Lloyd's to levels below
the true risk/cost and distorting competition.
The defendant's
submissions in support of this Proposition included the following.
Between 1983 and 1988 real total gross capacity at Lloyd's doubled, the
increase in nominal terms (money of the day) amounting to 156%. Elections of new
members in 1982 to 1987 (ie. of those who commenced underwriting in 1983 to
1988) numbered 15,366 and by 1989 a half of the active External Names had joined
in the preceding 6 years.
A substantial proportion of the increase was
attributable to the admission of Names who commenced underwriting with an APL
precisely consistent with their having shown only the minimum required means.
Until 1990 there was a fixed ratio of a Name's PIL to his shown means; and from
1985 onwards total gross 'allocated capacity' amounted to upwards of 97% of
total gross capacity so that generally speaking Names allocated the whole of
their PIL.
By the 1980s the minimum required shown means were grossly
inadequate whether measured by
(i) what had been thought appropriate in
the 1960s (upwards of #600,000 at 1990 values);
(ii) what was
recommended by Cromer in 1969 as a reduced minimum (still over #350,000 at 1990
values);
(iii) what common-sense would regard as the minimum required to
support unlimited liability in a market that traded in risks (even in the 1980s
someone who could show #100,000 of means, perhaps in the value of his home,
could scarcely have been characterised as rich on that account); and
(iv) the minimum that Lloyd's itself in 1990 recognised to be required
for external membership, namely #250,000.
There is no evidence to
support the speculation that, in the 1980s, on a substantial scale, External
Names may have shown means in excess of the minimum required yet have chosen an
APL of just the amount that was supportable on the basis of the minimum required
shown means. The only direct evidence of means shown is provided by the
statistics at App 6 to the Neill Report. Those statistics show that 55% of all
External Names in 1986 had shown means of less than #150,000 (the top relevant
wealth band being #100,000 - #149,999, so that many in that band are likely to
have been External Names who showed the then required minimum means of
#100,000).
Post 1982 External joiners contributed nearly 60% of the
increase in Lloyd's capacity in the period 1983-1988.
With this huge
influx of new Names, very substantial overcapacity opened up at Lloyd's in the
mid-1980s: it is shown in graphical form in Exhibit 32, (entitled "Oversupply of
capital") of the Rowland Task Force Report (which is agreed).
The
general excess capacity would have been exacerbated in 1988 and 1989 when
External Names (other than "Foreign") were permitted to write up to 5 times
their Lloyd's Deposit instead of the previous limit of 4 times and "Foreign" External Names were permitted to write up to 3.57 times their Lloyd's Deposit
instead of the previous limit of 2.86 times.
Further, throughout the
1980s the problems relating to asbestos and pollution were worsening, the risks
involved in exposure to deterioration increased and, accordingly, the capacity
of those exposed to such risks to write new business was commensurately less;
but no account was taken of such exposure in calculating a Name's PIL. See now
the Chatset estimate of losses suffered over the period 1985 to 1992 of
syndicates so exposed of #3,577m.
If there is too much capacity and too
little demand, rates come down. Exhibit 32 to the Rowland Task Force Report,
showed the oversupply over capital at Lloyd's. The oversupply of capacity
resulted in conditions in which pricing was driven down.
Given Lloyd's
importance in the marketplace these developments were bound to have, and had,
substantial consequences.
PROPOSITION 6
Because of Propositions
3 and 4:
(a) the capacity of, and business written by, high risk
syndicates at Lloyd's, operating in the relevant markets, were artificially
inflated, thereby distorting competition and increasing Lloyd's aggregate
exposure to catastrophe losses; and
(b) excess capacity for the
transaction at Lloyd's of high risk business developed, thereby contributing to
a depression of premium rates at Lloyd's for such business below the true
risk/cost of such business, giving rise to adverse selection and further
distortion of competition.
The defendant's submissions in support of
this Proposition included the following.
Mr Rowland told the House of
Commons Treasury and Civil Service Select Committee that:
"Some Names
who joined Lloyd's in the 1980s were unable to obtain places on
older-established syndicates and joined syndicates, some of whose underwriters
(as demonstrated by the judgments of Phillips J in Gooda Walker and Feltrim)
acted negligently."
The capacity of LMX syndicates was greatly increased
and their gross premiums rose by 200% over the period 1983-1988 and the
proportion of total Lloyd's gross premium income accounted for by LMX syndicates
doubled to over a quarter by 1990 and this occurred despite a very substantial
decline in LMX premium rates.
The Lloyd's CSU statistics and the work of
Mr Wilshaw have enabled Professor Bain to demonstrate that by 1989 over 50% of
the stamp capacity of Wilshaw-classified Category 3 LMX syndicates was
attributable to inappropriate and excessive participations such as could not
have occurred if counterparties had had any concern with the creditworthiness of
the body with which they were dealing, viz. the syndicate.
The 50%
figure in fact substantially understates the artificial inflation of the
capacity of Category 3 LMX syndicates since it treats as excessive only the
excess over 10% of Names' portfolios accounted for by Category 3 LMX syndicates:
in fact many of the Members of such syndicates should not have been on them at
all and very few of their members should have been on them to an extent
exceeding 5% of their portfolio. By 1989 about #1 billion of Category 3 LMX
syndicate capacity was contributed by Names who should not have been on such
syndicates at all or by the accrued excess of their participations over and
above the maximum to which they should have been exposed.
Moreover by
1989 more than 50% of all External Names had exposure to Wilshaw-classified
Category 3 LMX syndicates in excess of 10% of their APL which again demonstrates
the systemic nature of this aberration.
It was not only Category 3 LMX
syndicates the capacity of which was inflated by the participation of Names who
should not have been on such syndicates at all or whose participation was
excessive. The same was true of at least the specialist PSL syndicates.
There was nothing to prevent Names whose position at Lloyd's in 1988 and
1989 was liable to deteriorate dramatically because of worsening of IBNRs on
long tail syndicates of which they were members from participating without limit
subject only to their not writing in the aggregate an amount of new business in
each of those years in excess of:
(i) 2.5 times their shown means; and
(ii) 5 times their Lloyd's Deposit.
[Subject to a ceiling of
#1,000,000 and #1,300,000 respectively].
The combination of excess
capacity at Lloyd's, the artificial inflation of capacity of high risk Lloyd's
syndicates, skilful brokers who were unconcerned with the creditworthiness of
the syndicates with which they placed business, however risky and at whatever
rates, a general shortfall of demand relative to capacity (not confined to
Lloyd's) and "adverse selection" had the now well known but predictable
disastrous consequences.
PROPOSITION 7
The Reinsurance
Provisions infringed art 85(1). The defendant's submissions in support of this
Proposition included the following.
The Reinsurance Provisions referred
to are the relevant provisions of the 1989 instructions and their predecessors
and the Syndicate Premium Income Byelaw (No. 6 of 1984) as amended and the
previous required practice which they reflected and which (a) permitted Names
and syndicates to take full credit for all reinsurance effected at Lloyd's, and
(b) further distinguished between reinsurance effected at Lloyd's and elsewhere
(see E 7.20 to 7.25 and 12.1 to 12.3 above).
Because the Reinsurance
Provisions ex facie imposed an obligation to provide additional reserves where
reinsurance with corporate insurers, no matter how strong, exceeded a specified
limit but not where reinsurance was placed with any Lloyd's syndicate, the
Reinsurance Provisions had as an object the prevention, restriction or
distortion of competition; and they also had that effect.
The
Reinsurance Provisions, by treating all corporate reinsurers alike and less
favourably than Lloyd's syndicates, lacked objective justification, failed to
respect the principles of Equal Treatment of Equal Situations and
Proportionality and could not be saved by any application of any Rule of Reason
however formulated.
Further or alternatively the operation of the
Reinsurance Provisions must be taken into account in assessing the loss and
damage caused to the Defendant by the Central Fund Arrangements which were their
raison d'Itre.
The Reinsurance Provisions are relevant as Lloyd's
arrangements which depended for their rationale on the Central Fund Arrangements
(which were thought to make unlimited reinsurance within Lloyd's somehow
risk-free) and which aggravated the effects of the Central Fund Arrangements
that are relied upon for the purposes of the Counterclaim.
When in 1975,
Lloyd's removed the pre-existing restraint (through the operation of Premium
Income Limits and the Permitted Reinsurance Limits) on unlimited reinsurance
within Lloyd's, it abandoned
the principle that a good underwriter
should seek to make a profit on his gross book, using reinsurance protectively
not aggressively. In the result, Lloyd's ended up with the Reinsurance
Provisions that lasted until the end of 1992 with disastrous consequences. Not
only did the Reinsurance Provisions restrict reinsurance outside Lloyd's,
however secure the reinsurer (thus penalising those who paid more for better
security), but also created a situation which encouraged unlimited reinsurance
within Lloyd's. Any system which permits let alone encourages intra-reinsurer
reinsurance risks creating a spiral.
The environment in the mid-to-late
1980s was "an accident waiting to happen". The Reinsurance Provisions guaranteed
that, when the accident happened, Lloyd's syndicates involved in the higher
levels of retrocession in which a spiral is most prevalent would inevitably be
part of (and an important part of) that spiral.
It would have been
entirely practicable to have required additional security for the purposes of
Test 1 solvency margins in the case of second class corporate reinsurers in the
same way as has been done in allowing quota share reinsurance with some but not
all corporate reinsurers for the purposes of premium income monitoring.
In that the relevant parts of the Reinsurance Provisions (Annex G to the
Solvency Instructions - Test 1) operates at its most penal in the first two
years, it must have a direct impact on the initial placing of reinsurance in the
case of any syndicate that has a particularly heavy need for reinsurance.
To suppose that the need to provide potentially substantial additional
security in certain circumstances (reinsuring outside Lloyd's beyond a limited
extent rather than within Lloyd's) did not affect the minds of syndicate
underwriters who had heavy reinsurance needs would be to deny the normal
operation of normal economic considerations in the present circumstances.
Additionally the discriminatory preferential treatment of inter-syndicate
reinsurance (which Lloyd's treated as being - without limit - acceptable)
relative to corporate reinsurance was calculated to engender and must have
engendered a psychological attitude on the part of syndicate underwriters that
unlimited reinsurance within Lloyd's was good practice whereas limitation of
reinsurance outside Lloyd's was also good practice.
Equal treatment of
equal situations is a fundamental principle of EC law; discrimination otherwise
than for objectively sufficient reasons is inconsistent with the principle. The
principle applies in the context of the rules on competition of the EC Treaty,
and in particular arts 85 and 86. An agreement between undertakings, a decision
of an association of undertakings (or the act of an undertaking in a dominant
position) which, without objective justification, discriminates between
comparable persons infringes the rules on competition of the Treaty.
In
relation to the application to the Reinsurance Provisions of the principles of
equal treatment of equal situations and the prohibition of discrimination
without objective justification, guidance is to be found in certain decisions of
the EC Commission in the field of insurance. Thus in Nuovo Cegam [1984] 2 CMLR
484 at paras 16 and 20 of its decision, the EC Commission held that an
obligation on members of a group of insurers to place their reinsurance with
other members of the group infringed art 85(1) and had to be removed before an
exemption could be granted. In Teko OJ 1990 L13/34 the Commission noted, at
paras 21 and 23 of its decision, that art 85(1) applied where the operations of
an association of insurers led to a practice whereby members brought their
reinsurance into the group and only exceptionally reinsured outside the group
even though there was no rule requiring reinsurance within the group and members
were free in principle to seek external reinsurance cover. In Assurpol OJ 1992 L
37/16 the Commission held, at para 31 of its decision that an obligation on
members of a group of insurers to propose for reinsurance only reinsurer members
of the group attracted the operation of art 85(1).
PROPOSITION 8
The RITC Provisions are to be taken into account in assessing the loss
and damage caused to the Defendant by the Central Fund Arrangements which were
their raison d'Itre.
The defendant's submissions in support of this
Proposition included the following.
The defendant no longer relies upon
this aspect of his case as a separate head of claim but he does say that:
(i) when considering the distortions created by the existence of the
Central Fund arrangements it is necessary to consider the entire environment in
which those arrangements were operated including the absence of any reserving
risk charge in determining capacity; and
(ii) Names' systemic
over-exposure to risk was exacerbated by the absence of any such reserving risk
charge.
PROPOSITION 9
By reason of their actual or potential
effects (and in the case of the Reinsurance Provisions, by reason of their
object) the Central Fund Arrangements and the Reinsurance Provisions have
attracted the operation of art 85(1) at all times since the accession of the
United Kingdom to the EEC (now the EC) on 1 January 1973.
The
defendant's submissions in support of this Proposition included the following.
Proposition 9 is simply intended to define the time since when art 85(1)
has applied to the Central Fund Arrangements and the Reinsurance Provisions.
Until the 1980s distortion of competition was, at least largely, potential
rather than actual. Potential, as well as actual, restriction of competition
attracts the operation of art 85(1). The point is of academic rather than
practical significance since well before the time when Lloyd's sought to invoke
para 10 of the Central Fund Byelaw of 1986 the distortion of competition had
eventuated. Equally the Counterclaim relies on actual and not merely potential
distortion of competition, so again the antecedent potential distortion is of no
practical consequence. Nevertheless the correct analysis is that by reason of
potential distortion of competition by the Central Fund Arrangements, those arrangements technically attracted the operation of art 85(1) from the date of
the accession of the United Kingdom to the Community, ie. 1 January 1973. A
fortiori the Reinsurance Provisions attracted the operation of art 85(1) from
the same date.
PROPOSITION 10
The magnitude of the effects
referred to at Propositions 2-8 above and the volume of business that they
affected are such that the prevention, restriction and/or distortion of
competition within the relevant markets were appreciable and, by reason of the
international nature of those markets, the effect on trade between Member States
was appreciable.
The defendant's submissions in support of this
Proposition included the following.
In looking at the statistics it is
necessary to bear in mind that some reinsurance is not open to international
competition and that some of it is transacted by protected local reinsurers who
do not engage in international competition. Even if all reinsurance is taken
together Lloyd's share has still been about 6% over the decade 1984-1993 ie.
over the 5% level frequently referred to in connection with the de
minimis/appreciable effect condition.
AS to Marine and Aviation
insurance in the decade 1984-1993 Lloyd's average share of the Marine market
(direct and facultative) was 18% and of the Aviation market (direct and
facultative) 22%.
PROPOSITION 11
The very thing to be guarded
against as likely to result from the creation of moral hazard caused by the
elimination by the Central Fund Arrangements of CCRA, by itself and/or combined
with the effects of the Reinsurance Provisions and/or the RITC Provisions, was
that, in circumstances such as developed in the 1970s and 1980s, avoidable
losses would be caused to Names through their exposure to risks that their
available assets were insufficient to support: pleas by Lloyd's of novi actus
intervenientes and/or other extrinsic causes are therefore unsustainable.
The defendant's submissions in support of this Proposition included the
following.
Where a distortion of competition is brought about as a
result of the creation of moral hazard and is relied on as a cause of action
sound in Damages, it is almost inevitable that the direct cause of the loss
suffered by a claimant under art 85(1) will be a harmful act by a third party -
the creation of the moral hazard being the creation of the opportunity for the
third party to cause avoidable harm to the claimant. Unless one is to rule out
more or less a priori the sustainability of such a cause of action, the fact
that the direct or proximate cause of the claimant's loss was a breach of Duty
by a third party (here a Lloyd's Agent) is entirely to be expected - and
certainly not a ban to the action against the creator of the moral hazard which
Lloyd's seems to believe it to be. The relevant question is whether the acts of
the third parties (ie. here Lloyd's Agents) constituted the very thing that the
creation by Lloyd's of the moral hazard complained of had made likely.
PROPOSITION 12
The Rule of Reason, however formulated, is
inapplicable to the Central Fund Arrangements because:
(i) they did not
simply enable a Lloyd's syndicate to operate on the market in the same sort of
way as an insurance company that had assets comparable to those that were
available (without recourse to the Central Fund) to the syndicate but, on the
contrary, enabled Lloyd's Syndicates to engage in conduct of a kind and on a
scale that would have been impossible for such a non-Lloyd's insurer in
conditions of undistorted competition; and/or
(ii) Lloyd's failed to
take any, or any sufficient steps to remove or mitigate the effects of moral
hazard created by the elimination of CCRA and indeed was itself affected by that
moral hazard.
The defendant's submissions in support of this Proposition
included the following.
There are two reasons why Lloyd's cannot rely on
the Rule of Reason however formulated.
First, the Central Fund
Arrangements whether viewed alone or in conjunction with the Reinsurance
Provisions, manifestly did not result merely in Lloyd's syndicates operating in
the market like comparable insurance companies; instead they enabled the
syndicates to operate in a way that was inconsistent with normal operations in
normal competitive conditions. Thus, Lloyd's relevant arrangements fail any Rule
of Reason test because they did not merely enable the persons concerned to
operate in the market place in a manner which was equivalent to, and on a par
with, other undertakings which were not governed by the arrangements in
question.
Second, Lloyd's relevant arrangements were not, as required by
any formulation of a Rule of Reason, the minimum necessary for any legitimate
purpose. In this context "minimum necessary" means "fashioned so as to cause the
minimum prevention, restriction or distortion of competition", required for some
pro-competitive purpose.Thus, even if, in general terms, provisions of some kind
are "necessary", the EC Commission will not treat the arrangements as being
thereby taken outside art 85(1) if something less would suffice. Once one is in
the realm of weighing up the advantages conferred by going beyond the bare
minimum that is necessary as against any disadvantages in so doing, one moves
from art 85(1) to art 85(3) - the application of which is, of course, outside
the jurisdiction of a national court.
PROPOSITION 13
1 s 14 of
the Lloyd's Act is not available to deny the Names a remedy in damages against
the Society of Lloyd's.
2 s 14 of the Lloyd's Act is
not available to deny the Names a remedy in damages against the Society
of Lloyd's as a matter of res judicata.
The defendant's
submissions in support of this Proposition included the following.
The
Court of Appeal reversed Saville J's affirmative answer to Preliminary Issue
3(c)(i) with regard to s 14 of Lloyd's Act 1982. The issue was dealt with by
only Sir Thomas Bingham MR who said ([1995] CLC at page 130 E-G):
"If Mr
Clementson is able to establish that Lloyd's has acted in breach of art. 85,
then it seems to me at least arguable that he has a good counterclaim for
damages on which he is entitled to rely by way of set-off and that s.14 of the
Lloyd's Act 1982 cannot be effective to deprive him of that right. If it were
otherwise I do not see how national courts could help to enforce the Community's
competition regime, as I understand they are expected to do. Whether s. 14 may
itself amount to an infringement of art.85 and not simply an ineffective defence
to a claim for breach of art.85, seems to me more problematical. In the absence
of evidence, however, I do not think one can dismiss as fanciful the suggestion
made by the Commission in its Notice on co-operation between national courts and
the Commission in applying articles 85 and 86 of the EEC Treaty:
'Companies are more likely to avoid infringements of the Community
competition rules if they risk having to pay damages or interest in such an
event'"
Steyn and Hoffmann LJJ. concurred.
The first of the
grounds relied upon by the Master of the Rolls stands without further comment by
the Defendant. With regard to the second of the grounds, the extent, if at all,
to which Lloyd's was influenced in its conduct by a belief that it enjoyed a
statutory immunity from liability for damages for breach of art 85(1) is a
matter wholly within the knowledge of Lloyd's and no officer or official of
Lloyd's has been called to give evidence on the matter. In any event, the first
ground of the Master of the Rolls judgment is by itself determination of the
issue irrespective of the state of mind of Lloyd's itself.
PROPOSITION
14
The Defendant is a person who is entitled to invoke art 85(1) as a
basis for claiming compensation from Lloyd's.
The defendant's
submissions in support of this Proposition included the following.
If an
association of undertakings takes a decision that infringes art 85(1) and that
thereby injures someone, whether or not because it prevents, restricts or
distorts competition by that person or because it prevents, restricts or
distorts competition by a third party to his disadvantage, the injured party is
entitled to sue the association.
H LLOYD'S SUBMISSIONS
Lloyd's
response to the defendant's 14 propositions was as follows.
PROPOSITION
1
Lloyd's rejects Proposition 1 for the reasons set out below.
PROPOSITION 2
The first part of Proposition 2 ("the CF
Arrangements opened the door") reveals a yawning chasm at the outset of the
argument. It is no longer the case, as was originally asserted quite
unequivocally by Professor Bain, that the Central Fund caused any distortion of
competition. The case now put is that the Central Fund merely allowed distorting
events to occur. This shift occurred very noticeably during Professor Bain's
cross-examination, when he abandoned the language of causation and adopted the
language of permission. There is nothing in any of the European authorities
which gives support to the idea that Art 85 renders illegal and void an
agreement or decision which does not cause a prevention restriction or distortion of competition but merely allows subsequent events or behaviour to
produce such a consequence. Principle must suggest that such cannot be the
correct approach, and the language of Art 85 - "which have as their object or
effect" - plainly imply a definite causal link.
Without a direct and
definable causal link between the Central Fund and the alleged distorted
effects, the defendant's case necessarily fails.
The second part ("to
the realisation of moral hazard on the part of Lloyd's active underwriters")
introduces the protean concept of moral hazard. The definition provided by the
defendant that moral hazard exists wherever there is risk that one person may
avoidably cause loss to another is hitherto unknown, useless as an analytical
tool and unjustifiable. A definition couched in these terms is so all-embracing
as to become meaningless.
Apart from the fact that it is difficult to
see how the mere existence of the Central Fund renders it any more likely that
an underwriter will behave recklessly or negligently, such an underwriter is
subject to so many other constraints or disincentives as to render any supposed
effects created by the existence of the Central Fund negligible.
The
essence of the defendant's argument revolves around the absence of counterparty
credit risk assessment, ie the theory is that if CCRA took place the moral
hazard inherent in the position of an active Lloyd's underwriter would not lead
to the infliction of avoidable loss on another, sc a Name. This wholly
artificial construct is wrong inter alia for the reason that it is not the
existence of the Central Fund which explains the absence of CCRA in the case of
a Lloyd's underwriter, but rather the practical impossibility of carrying out a
CCRA in the case of a Lloyd's syndicate.
The third part ("and thereby
distorted competition") involves a complete non-sequitur. There is no logical
connection between the existence of a moral hazard, whether naturally occurring
or created, and a distortion of competition. The proposition that competition is
distorted if individuals in a market are not prevented from acting in a way that
involves avoidable risk of loss to other willing participants in the market is
one that only has to be stated for its absurdity to become evident.
A
clear and comprehensible statement as to what is alleged to constitute a
distortion of competition is lacking.
All that the defendant has shown
is that Lloyd's is different to a corporation; an obvious fact that is clearly
recognised by European legislation. There is nothing in competition law or
European legislation that suggests that every type of competitor must adopt the
same structure. European legislation and competition law permit different
structures. It may be that each structure gives rise to different types of
"moral hazard" as defined by the defendant; the absence of individual CCRA in
the case of Lloyd's or indeed any partnership, and the absence of unlimited
liability in the case of corporates. There is no legal or rational reason for
saying that Lloyd's "distorted competition" because it did not conform to a
corporate structure, any more than saying that corporates "distorted
competition" by not conforming to the Lloyd's structure. For the same reasons
the defendant is mistaken to focus on the supposed lack of CCRA. CCRA is
impossible at the individual level. To enable an individual market such as
Lloyd's to function it is therefore necessary to provide an alternative, namely
CCRA of the body of Lloyd's Names as a whole.
PROPOSITION 3
The
first part of Proposition 3 ("because of Proposition 2") implies a causal
connection between propositions 2 and 3 so that the latter follows logically
from the former. This is not the case. There is no logical connection between an
alleged moral hazard operating on active underwriters and the prior decisions of
the Society of Lloyds as to whom to admit to membership.
Equally there is no logical connection between an alleged distortion of
competition and the admission of Names.
The second part ("the door was
opened to the admission by Lloyd's of individuals as Names ...who did not have
the assets required to support underwriting") highlights again the lack of any
relevant causal connection between the various parts of the defendant's
argument. It is not suggested that proposition 2, or any constituent part
thereof, caused the admission of any particular type of Name, simply that it
allowed it to happen.
It is difficult to understand the role of the
third part - "moral hazard operating on the behaviour of Lloyd's itself" - in
the argument.
PROPOSITION 4
The first part of Proposition 4
("Because of Proposition 2") refers to causal connection. It is impossible to
see how the supposed behaviour of Members' Agents in placing a name on a
syndicate can be regarded as the causal consequence of the active underwriter's
subsequent actions.
The second part ("and/or Propositions 2 and 3") also
asserts that causal connection and introduces Proposition 3. Since Proposition 3
identifies the relevant Names as being inadequately resourced to undertake any
underwriting at all, it does not advance the argument very far to point out that
such names were, ex hypothesi, inadequately resourced to be members of any
syndicate.
The third part ("the door was opened to the placing of Names
by Members' Agents on syndicates when the Name did not have the assets required
to support such membership of the syndicate having regard to the nature of the
syndicate's business, the Name's line on the syndicate in question and the
Name's exposure to risk on other syndicates") raises again the contrast between
causing and permitting. Apart from that, it appears to state no more than that a
Members' Agent could be in error, whether negligently or otherwise, in his
placement of Names.
The fourth part ("moral hazard on the part of
Members' Agents") identifies the risk of error on the part of a Members Agent as
moral hazard on the part of the Agent. This does not advance the argument or
lead to any obvious conclusion.
The principal fallacies in the
defendant's arguments on CCRA and the Central Fund are as follows.
The
argument assumes that the absence of CCRA, or the creation of moral hazard, is
to be equated with distortion of competition for the purposes of art 85. There
is no authority which supports this. Indeed, there are in Europe and throughout
the world numerous "guarantee" schemes, such as the Policyholders Protection Act
in the UK, which to a greater or lesser extent remove the need for CCRA in the
corporate sector.
The argument assumes that the only permissible form of
insurance undertaking is a corporate body where CCRA of the corporate body is
possible, and other forms of structure such as Lloyd's are in principle illegal
unless "constraints" are put in place to "substitute" for the removal of CCRA of
individual Names. There is no authority which supports this, and European
legislation clearly regards the Lloyd's structure as a permissible form of
undertaking.
The argument assumes that CCRA is an effective method of
preventing insurance companies from overexposing themselves; indeed so effective
that unless it is put in place at Lloyd's, there is a distortion of competition.
But the evidence is that is only a relatively recent development in the market,
it is crude, and there is no evidence that it is an effective protection against
insurance companies overexposing themselves; see the evidence of corporate
casualties in the spiral and elsewhere.
The argument assumes that the
Central Fund has "removed" CCRA from the Lloyd's marketplace. In truth, CCRA at
the individual or syndicate level is not possible, and the Central Fund has not
"removed" it.
The defendant argues that Lloyd's needed to put
"constraints" in place as "substitutes" for CCRA. There is no EC authority which
has taken this approach, and it is in any event misconceived. CCRA at the
individual level is not possible, and none of the supposed "constraints" are in
any sense "substitutes" for CCRA. They are regulatory measures which have no
connection with CCRA or its absence. The defendant is simply invoking the
absence of CCRA as a means of deploying his regulatory argument. There is no EC
authority which even hints that it is contrary to art 85 for an organisation to
operate without CCRA. Nor indeed is there any authority which suggests that any
illegality can be "cured" by appropriate constraints.
PROPOSITION 5
The second part of Proposition 5 ("the overall capacity of Lloyd's
including its capacity in the relevant markets was artificially inflated and
excess capacity developed") depends upon the concept of an "artificial" inflation of capacity. It appears to mean an actual increase in capacity brought
about by the admission into the market of Names whose limited asset base made it
unwise for them to expose themselves to the vagaries and risks of the insurance
business. The result in the market, namely an actual increase in capacity
brought about by an increase in the number of competitors, is wholly independent
of the wealth characteristics of the new competitors. No methodology or evidence
has been put forward by the defendant to enable one to judge the extent of the
alleged "artificial" inflation in capacity.
As to the third part
("thereby contributing to a depression of premium rates at Lloyd's to levels
below the true risk/cost") it is true that an increase in capacity, if
sufficiently widespread, will tend to push rates down. The extent to which any
particular excess in capacity will contribute to any particular movement in
rates is both unknown and probably unknowable. It is certainly impossible to say
whether any particular excess in capacity has influenced rates to drop below
"the true risk/cost", whatever that particular concept may signify.
As
to the fourth part ("and distorting competition") distortion of competition only
arises if the increase in capacity is "artificial" ie. comes form competitors
who ought not to be allowed to compete in the market for their own benefit. It
is not clear why a rush of rich names into Lloyd's with a consequent downward
pressure on rates should be regarded as perfectly competitive, whereas an
identical increase in capacity with identical consequences brought about by some
rich Names and some less rich Names should be characterised as distortive of
competition.
PROPOSITION 6
Proposition 6 raises similar points
to those addressed above. Further there is no evidence that premium rates at
Lloyd's were lower than rates anywhere else and there is no evidence of adverse
selection in any accepted sense of the term.
There is one further
important preliminary point. At the heart of much of the defendant's argument
lies the idea that it is in some way improper, and distortive of competition,
for a market participant to carry on economic activities which are not wholly
supported by his own capital resources. It is of the essence of competition that
a competitor is entitled to organise his affairs in such a way as to maximise
his own competitive advantages and to minimise his competitive disadvantages.
This has been recognised by European Law in a number of areas, including those
which are relevant to capitalisation. Franchising (see Pronuptia supra) is an
obvious example. The same situation obtains in the case of a cooperative: see
Gottrup-Klim supra. There are other obvious examples. A partnership places the
capital of each of its members at the disposal of each individual member. Thus
an individual partner can engage in business, and enjoys a credit rating, which
reflects the standing of the partnership as a whole, not just his own individual
capital base. In the case of Lloyd's the competitive market place is the world
insurance market. An individual, even a wealthy individual, cannot participate
in that market on the basis of his own individual resources. He can only
participate on the basis that he is admitted to Lloyd's with the consequence
that, in the last resort, the resources of other members of the market are
available, via the Central Fund, to stand behind his liabilities. There is never
any question of CCRA in relation to the individual member of Lloyd's, nor even
in relation to a syndicate. Thus an individual at Lloyd's, who inevitably
suffers various disadvantages as an individual, neutralises the major
disadvantages of his individual status by participating in a mutual support
system.
PROPOSITION 7
Appendix G, which applies only in the
context of Test 1, provides for the creation of an additional reserve where the
amount reinsured outside Lloyd's exceeds a certain level. Its specific context
is the complicated Lloyd's solvency regime.
Since this issue goes to the
counterclaim, the key question is whether the defendant has demonstrated that
the 20% rule had an appreciable effect. An argument on "object" does not advance
the case; unless there was the requisite effect, causation does not get to first
base.
The defendant has not called a single underwriting or other
witness who has testified to the rule having any effect on his or anyone else's
decision-making process.
The evidence from the market witnesses is to
the effect that the 20% rule did not have any effect at all on the decisions of
underwriters as to where to place reinsurance and certainly did not cause the
LMX spiral.
The defendant's case that the 20% rule had an appreciable
effect is no more than theory and assertion.
The 20% rule is not
anti-competitive in object, because it is merely but a small part of substantial
and complex solvency regulation, and because its overt purpose is not to
prohibit or mandate any particular course of action on the part of underwriters
but merely to assign different values for solvency purposes to acts which were
carried out in the past.
It cannot be said that the object of App G is
anti-competitive. Further, there is no evidence at all that it was or could be
anti-competitive in effect.
PROPOSITION 8
Although the Central
Fund is available to meet all of a defaulting Names's obligations (including
those obligations which the Name undertakes under a RITC), the Central Fund
Arrangements are not the raison d'tre of the RITC provisions.
PROPOSITION 9
There is no warrant for suggesting that you strike
down an agreement, decision or concerted practice which is not producing a
prevention, restriction or distortion of competition now, which one cannot even
say will, or is likely, to produce such a restriction, prevention or distortion
of competition, but about which one can only say, if the world changes in ways
which at the moment are not immediately predictable or foreseeable, then such
results might occur.
PROPOSITION 10
The relevant markets are the
worldwide marine, aviation and reinsurance markets.
The effect of the
Lloyd's arrangements (if any) must be considered in the context of the relevant
market as a whole.
Commission decisions treat reinsurance as a whole.
A fundamental objection to the defendant's case on appreciability lies
in the evidence. Lloyd's cannot be regarded as a single undertaking. Lloyd's
itself does not engage in insurance business. The Lloyd's syndicates do; and
they are in competition with each other. A simplistic test, such as the 5% test
found in Case 19/77 Miller International Schallplaten v Commission [1978] ECR
131, cannot be applied.
Dr Frey's evidence was that even Swiss Re and
Munich Re in combination could not move the market. Accordingly, it is fantasy
to suppose that Lloyd's syndicates constantly engaging in competition with each
other and with corporate (re)insurers could do so.
As to effect on trade
between member states the defendant has not demonstrated any or any significant
effect on intra-Community trade in relation to the relevant market. No causal
connection between the contested decision and any effect on intra-Community
trade has been established.
PROPOSITION 11
The counterclaim is
based upon the assertion that underwriting losses suffered by Names at Lloyd's
have been caused by breaches of art 85. Even if those breaches were to be
established, the counterclaim would fail on grounds of causation. The features
of Lloyd's which the Defendant attacks are not new; they were present during the
many profitable underwriting years prior to the late 1980's.
Causation
requires the application of commonsense: Yorkshire Dale SS v Ministry of War
Transport [1942] AC 691 at 698 and 706, Galoo Ltd (in liquidation) and Others v
Bright Grahame Murray ( a firm) and Another [1995] 1 All ER 16, [1994] 1 WLR
1360.
The commonsense view is that the effective causes of Name's losses
were the decisions taken by Names and their underwriting agents, against the
background of worldwide losses arising from eg. asbestos. pollution and
catastrophes. In general, the voluntary acts of a third party (eg. the Name or
the underwriter) will break the chain of causation: Chitty on Contracts, 27
Edition, Volume 1 paras 26-015 - 26-017.
At the very most, the alleged
breaches of art 85 might be said to have set the scene or opened the door to the
making of underwriting losses. Even if this were the case, it is insufficient to
establish causation: Quinn v Burch Brothers (Builders) Ltd [1966] 2 QB 370,
[1966] 2 All ER 283 Deeny and others v Derek James Walker and others (Gatehouse
J) (unreported - November 1995), Banque Brussels Lambert SA v Eagle Star
Insurance Co Ltd and Others [1995] QB 375, [1995] 2 WLR 607, at 621 of the
latter report (Bingham MR) Clementson (Saville J at p 87).
The
commonsense view is that underwriting decisions, together with decisions of
Members' agents and Names as to what syndicates to join, caused the losses with
which this case is concerned. The commonsense view is supported by the evidence
of Mr Wilshaw and Mr Berry, both of whom have great experience in the market.
They reject entirely the suggestion that the Central Fund or the 20% rule caused
the spiral or the losses.
Without prejudice to the above, the
defendant's damages claim should fail for other reasons.
The question of
remoteness of damage is governed by English law. It is difficult to see how
underwriting losses, particularly on LMX business, are the foreseeable
consequence of the breaches of art 85 of which the Defendant complains.
PROPOSITION 12
Professor Bain accepts that the Central Fund is
essential to the operation of Lloyd's and the point is conceded (see para 2(ii)
of the Revised Points of Defence and Counterclaim).
Since membership of
Lloyd's is the only means by which individuals can write insurance business and
Lloyd's is generally pro-competitive, it follows that the "rule of reason" applies. The limit placed on the "rule of reason" by the European Court is that
it does not exclude from the prohibition in art 85(1) restrictions on
competition that are not necessary in order to render the arrangements as a
whole properly operable.
It should be noted that, subject to that limit,
the "rule of reason" permits "restrictions of competition", that is, terms or
provisions that have a direct adverse impact on the ability of the persons
concerned to compete. In this case, there is no allegation that the Central Fund
has that effect at all. The idea that the Central Fund has "caused" the
distortion of competition has been abandoned. The only assertion now made is
that the Central Fund "permitted" distortions of competition to emerge. If a
direct restriction of competition is protected from prohibition by the "rule of
reason", it is implausible to assert that something that does not even cause a
distortion of competition but merely permits it cannot be protected by the "rule
of reason".
PROPOSITION 13
Lloyd's is entitled to immunity
pursuant to s 14 of the Lloyd's Act 1982.
PROPOSITION 14
The
defendant has been a willing participant in the various arrangements of which he
now complains. For example, he joined Lloyd's and continued as a member knowing
that contributions were assessed by reference to premium income. He paid
contributions on that basis, and enjoyed the benefits which Lloyd's membership
brought. He is not entitled to claim damages arising from an aspect of the
system in which he was a willing participant.
Further there is no
liability for damages for breach of art 85 in the absence of an intention to
injure: see Whish: Competition Law, 3 Edition, page 326.
European
Legislation
The suggestion that Lloyd's and its Central Fund is illegal
flies in the face of common sense and European legislation, which (i) permits
this unique system of trading to take place at Lloyds, thereby recognising that
it is an acceptable form of economic activity, (ii) implicitly recognises the
acceptability of mutualization and (iii) expressly recognises the Central Fund.
Lloyd's referred in particular to The First Non-Life Directive
(73/239/EC), The First Life Directive 1979 and The Insurance Companies Accounts
Directive 1991.
Approbation
For completeness I should record
that Lloyd's abandoned an argument based on the doctrine of approbation (having
regard to the position adopted by Mr Clementson in the Gooda Walker litigation).
I ANALYSIS
The scheme of this part of the judgment is as
follows. I will first consider a number of topics which call for individual
attention:-
*The relevant principles of EC law
*The Central Fund
is essential to the operation of Lloyd's
*The Central Fund is the fourth
link in Lloyd's Chain of Security
*If insurance business at Lloyd's is
conducted prudently the likelihood of losses absorbing a Name's entire wealth is
very small
*Moral hazard
*Counterparty Credit Risk Assessment
*Risk-Based Capital
*Some concerns of the Court of Appeal in
Society of Lloyd's v Clementson
*The defendant's losses
were not caused by any of the matters complained of in these proceedings.
I will then consider the defendant's 14 propositions in turn. Finally I
will deal with severance.
The relevant principles of EC law
The
relevant principles of EC law are set out at C above. I apply these principles
in reaching the conclusions set out below.
The Central Fund is essential
to the operation of Lloyd's
The Central Fund is essential to the
operation of Lloyd's. The Revised Points of Defence and Counterclaim concede in
para 2(ii) that "it was not practicable for insurance business on the scale and
of the types underwritten at Lloyd's to be transacted at Lloyd's... without
Lloyd's having or being perceived to have... Support Arrangements." (see further
Professor Bain's first Report para 3.3.6, Professor Bain's concessions to this
effect when giving evidence and the evidence of the market witnesses). The role
of the Central Fund is explained in E above.
The Central Fund is the
fourth link in Lloyd's Chain of Security
Lloyd's Chain of Security is
set out in E 7.11 to 7.15 above. The Central Fund is the fourth and last link in
the Chain after premiums trust funds (first link), Names' funds at Lloyd's
(second link) and the personal wealth of individual Names (third link). The Fund
is not for the protection of a Name, who remains responsible for his or her
liabilities to the full extent of his or her wealth.
If insurance
business at Lloyd's is conducted prudently the likelihood of losses absorbing a
Name's entire wealth is very small
In para 2.2.4 of his first Report
Professor Bain stated:-
"The Names at Lloyd's trade with unlimited
liability. In principle, therefore, each Names' entire capital is at risk. In
practice, however, if the insurance business is conducted prudently, the
probability that losses will absorb a Name's entire wealth is very small."
Professor Bain confirmed this statement in cross-examination. If
business was conducted prudently the risk of a call on the Central Fund
(following the absorption of a Name's entire wealth) would be minuscule.
Moral Hazard
The principles underlying the duty of disclosure of
material facts imposed on the assured were stated by Lord Mansfield in the
well-known case of Carter -v- Boehm (1766) 3 Burr. 1905. The concept of "moral
hazard" is frequently employed in cases involving allegations of material
non-disclosure. The first reference I have found to moral hazard in this context
is in Regina Fur Company Ltd v Bossom [1957] 2 Lloyd's Rep 466. (See further
Roselodge Ltd (formerly "Rose" Diamond Products Ltd) v Castle [1966] 2 Lloyd's
Rep 105, CA; March Cabaret Club & Casino Ltd v The London Assurance [1975] 1
Lloyd's Rep 169; Woolcott v Sun Alliance and London Insurance Ltd [1978] 1 All
ER 1253, [1978] 1 Lloyd's Rep 629; Reynolds and Anderson v Phoenix Assurance Co
Ltd and Others [1978] 2 Lloyd's Rep 440, 247 EG 995; Container Transport
International Inc and Reliance Group Inc v Oceanus Mutual Underwriting
Association (Bermuda) Ltd [1984] 1 Lloyd's Rep 476, CA; La Banque Financiere de
la Cite SA (formerly named Banque Keyser Ullmann en Suisse SA) v Westgate
Insurance Co Ltd (formerly named Hodge General & Mercantile Insurance Co
Ltd) [1990] QB 665, [1988] 2 Lloyd's Rep 513; Inversiones Manria SA v Sphere
Drake Insurance Co plc Malvern Insurance Co Ltd and Niagara Fire Insurance Co
Inc ("The "Dora") [1989] 1 Lloyd's Rep 69; Darville v Ernest A Notcutt & Co
Ltd 18.3.91, CA unreported; BPC Group Holdings Ltd v Sovereign Marine General
Insurance Co Ltd & Others 18.2.94, CA unreported; Pan Atlantic Insurance Co
Ltd and Another v Pine Top Insurance Co Ltd [1995] 1 AC 501, [1994] 3 All ER
581, HL; PCW Syndicates v PCW Reinsurers [1996] 1 All ER 774, [1996] 1 Lloyd's
Rep 241,31.7.95, CA and Group Josi Re (formerly known as Group Josi Reassurance
SA) v Walbrook Insurance Co Ltd and Others [1996] 1 All ER 791, [1996] Lloyd's
Rep 345 2.10.95, CA).
The defendant was not able to point to any
reference to any concept of moral hazard in any decision of the Court of
Justice. Mr Lever stated that the closest the defendant's legal team had come to
finding a reference to moral hazard was in the Opinion of the Advocate General
in Verband Der Sachversicherer v Commission of the European Communities [1978]
ECR 405, but in my view nothing in that Opinion provides any material support
for the defendant's case as to moral hazard.
It could be argued that
there is more scope for the defendant's novel and protean concept of moral
hazard in the case of corporates (with limited liability) than in the case of
Lloyd's (with the Lloyd's Chain of Security including unlimited liability on the
part of Names).
Counterparty Credit Risk Assessment
Central to
the defence is the allegation that the Central Fund arrangements infringed art
85(1) because "in themselves, they distorted competition by obviating the need
for counterparty credit risk assessment" (Revised Points of Defence and
Counterclaim para 2(i)(a)). The defendant's notes to Proposition 2 ("The Central
Fund Arrangements opened the door to the realisation of moral hazard on the part
of Lloyd's active Underwriters and thereby distorted competition") state:-
"At all times material to these proceedings, because a Lloyd's
underwriter was able to underwrite Lloyd's Policies with the de facto guarantee of Lloyd's to back those Policies, every Lloyd's underwriter, whether a gambler,
negligent or plain stupid, had the ability to get business without being
susceptible to CCRA and therefore without the necessity of establishing a
reputation for not writing business beyond the resources available to support
the underwritten risks so far as they were perceptible."
As to moral
hazard see above.
As to CCRA:-
(i) The Central Fund is the
fourth link in Lloyd's Chain of Security (see above). The fourth link is only
reached after premiums trust funds, funds at Lloyd's and the personal wealth of
individual Names. The Fund is not, as I emphasise, for the protection of a Name,
who remains responsible for his liabilities to the full extent of his wealth.
The Central Fund did not serve to remove any or any significant constraints on
Lloyd's underwriters inter alia because
(a) Underwriters and managing
agents depend for their income (see E at 1.13 above) and livelihood on the
syndicates with which they are concerned retaining support from a significant
number of Names. That support will be lost if a syndicate sustains serious
losses, with the result that the first three links in the Chain of Security are
called on.
(b) As the active Underwriter and at least two
Directors/Partners of each managing agent were required to participate in the
syndicates managed by them (see E at 6.14 above), such persons are subject to
the first three links in the Chain. As Lloyd's submitted, a Lloyd's underwriter
would not maintain his reputation, and could not even remain a Name, if he went
bankrupt (or refused to pay) and the Central Fund had to step in.
(ii)
As Dr Frey stated when giving evidence, Lloyd's had a triple A rating because of
three matters - first reputation, second a record of always paying valid claims
and third the unlimited liability of Names.
(iii) As Dr Frey pointed out
there are significant difficulties with CCRA in the insurance industry, for
example the problem of knowing whether in the case of Long Tail business the
loss reserves are sufficient and the problem of assessing the riskiness (and
changes in the riskiness) of a particular portfolio.
(iv) There are
additional difficulties with CCRA in the case of the complex structure of
Lloyd's syndicates. A person dealing with a Lloyd's syndicate deals with a large
number of Names each of whom has a different portfolio of risks. The
impossibility of carrying out CCRA at the Name or syndicate level was accepted
by Professor Bain.
(v) If insurance business at Lloyd's is conducted
prudently, the likelihood of losses absorbing a Name's wealth (and thus bringing
the Central Fund into operation) is very small.
(vi) The problems of
Long Tail business and the LMX spiral were not confined to Lloyd's. A long list
of corporate failures was produced during the trial. CCRA (to the extent that it
was practicable) did not prevent these failures.
Risk-Based Capital
RBC is referred to in E 16.6 above. The defendant's pleaded case (para
2(iv) of the Revised Points of Defence and Counterclaim) was that:-
"...The Central Fund Arrangements were not formulated so as to avoid
competition-distorting effects and Lloyd's made no attempt so to formulate them
as it might have attempted to do, in particular by the adoption of the
Constraints, that is to say:
(a) By requiring Names to make
contributions to the funding of the Central Fund Arrangements that would
properly reflect the specific risk of them having to be operated in the case of
the Names in question and the likely cost to the Central Fund if that risk
eventuated, and/or
(b) By controlling the business that was permitted to
be underwritten on behalf of a Name (for example by applying risk-based capital
principles)
so that, having regard to the personal circumstances of the
Name (such as shown means, funds at Lloyd's, PSL and letters of credit),
business would not be written of an amount and nature such as to give rise (a)
to an above-average risk to the Central Fund...and/or (b) to any appreciable
risk of any unacceptable loss."
Professor Bain changed his original
opinion so as to end up favouring (b) above (RBC) rather than (a) above
(risk-based contributions to the Central Fund).
As to risk-based
contributions to the Central Fund, in his second Report Mr Aaronson concluded
that on realistic assumptions about the degree of adjustment to Central Fund
contributions which would have been necessary to reflect the risk of a call on
the Central Fund, changes in Central Fund contributions would have been
extremely small. Although Professor Bain criticised Mr Aaronson on this point it
is significant that he changed his original view to end up favouring RBC rather
than risk-based contributions to the Central Fund.
I formed the clear
impression that the defendant's reliance on RBC gradually diminished as the
various difficulties with RBC were identified.
Professor Bain agreed
that the RBC system, the subject of the consultation process, does not deal
satisfactorily with reinsurance.
Mr Wilshaw said that there are many
problems which have to be sorted out before RBC can be made workable and
equitable.
Dr Frey was sceptical about RBC. It was he said very
difficult to get at the volatility of different classes of business. He referred
to the spearhead of development and going with fashion.
In App B to his
fourth Report Mr Aaronson considered the effect of applying RBC methodology to
Mr Clementson. He concluded that on the basis described, application of the RBC
methodology to Mr Clementson shows that his RBC percentage for 1990 would have
been 31% (as opposed to the standard 30% capital requirement).
Professor
Yamey contended that the capital charges which are levied at the Name level do
not impinge directly on the decision-making environment of the Underwriter. He
pointed out that RBC should not be discussed in the abstract. It is necessary to
balance the drawbacks and limitations of the present system against those of
alternative approaches. Professor Yamey referred to the limitations mentioned in
the consultative document itself and said that the model may be a perfectly good
indication of what has happened in the past but is not necessarily a good
indication of what will happen in the future. He referred to the difficulties of
adjusting for the probability that a Name will cause a call on the Central Fund,
noting that the system ignores any wealth held by individual Names outside
Lloyd's and yet claims to be designed to equalise the probability that Names
will cause a call on the Central Fund.
As Lloyd's pointed out RBC is in
part a substitute for the current system of portfolio selection which relies on
(competent) assessments being made by particular Members' Agents (a
non-centralised system). The role and duties of Members' Agents are explained in
E 6.1 and 6.2 above.
Reference to the judgment in Merrett shows that RBC
would not have assisted the problems of Names who at the start of the 1980's
were on Long Tail syndicates.
RBC raises highly complex issues, a number
of which are yet to be resolved. The consultation process at Lloyd's is still
continuing.
RBC methodologies are a relatively modern development (see
for example Dr Frey's evidence) and yet the failure to adopt RBC principles is
an important plank in the defendant's pleaded case that the Central Fund
arrangements have attracted the operation of art 85(1) since 1.1.73.
Some concerns of the Court of Appeal in Society of
Lloyd's v Clementson
In Society of Lloyd's v
Clementson supra Bingham MR said:-
"If it is possible that Lloyd's
underwriters have been able to attract business by offering lower premiums, in
effect gambling on the chance that a risk will not materialise, in knowledge
that, if all else fails, the Central Fund will be used to indemnify the assured,
then that would in my view make it arguable that the existence and mode of
operation of the Central Fund have had the effect of distorting competition
withinthe Common Market."
Following a full investigation of the facts, I
find that this did not happen inter alia for the following reasons. The
possibility referred to by the Master of the Rolls could not apply to the Long
Tail business written over several decades which gave rise to losses of #3577m
in the years 1985 to 1992 and which represents a very serious continuing problem
for many syndicates (see E 10 above).
As to LMX business, the judgment
of Phillips J in Deeny v Gooda Walker Ltd [1994] CLC 1224 at 1275 summarises the
reasons for the finding of negligent underwriting in that case as follows:-
"Mr Walker... was deliberately running a net exposure to risk without
monitoring the precise level of that exposure or correctly informing his Names
of this. He made no attempt to estimate how often his Names might have to face a
year of loss and he mis-appreciated the level of catastrophe that risked
bringing that result about. His rating was not based on any assessment of the
earnings his syndicate needed to make in the good years to balance the losses in
the bad, but on an acceptance of the structure and level of rates prevailing in
the market. In these respects, the plaintiffs' allegations of breach of duty are
made out."
(See further the judgment of Phillips J in Arbuthnott v
Feltrim Underwriting Agencies Ltd [1995] CLC 437 and see also Rose Thompson
Young, Morison J and Bromley, Langley J both unreported).
Professor Bain
in his second Report stated that he had seen no evidence "to suggest that the
underwriters attracted business by offering lower premiums because they knew
that, if all else failed, the Central Fund could be used to pay valid claims."
Further the possibility referred to by the Master of the Rolls was
refuted by the evidence of the market witnesses.
Finally regard must be
had to the commercial realities. In considering the level of premiums it should
be remembered that the relevant market is a subscription market in which
companies participate (see E 1.21 above). Further the Central Fund is the fourth
link in the Lloyd's Chain of Security (see above). The fourth link is only
reached after premiums trust funds, funds at Lloyd's and the personal wealth of
individual Names. The Fund is, as I have emphasised, not for the protection of a
Name, who remains responsible for his liabilities to the full extent of his
wealth. Underwriters and managing agents depend for their income and livelihood
on the syndicates with which they are concerned retaining support from a
sufficient number of Names. In addition the active underwriter of the syndicate
and at least two Directors/Partners of each managing agent were required to
participate in the syndicates managed by them. The negligent underwriting
reflected in the judgments of this court in the LMX cases is to be distinguished
from the possibility referred to by the Master of the Rolls. There is
significantly no reference to the Central Fund in the judgments of Phillips J in
Gooda Walker and Feltrim. The managing agents were the subject of very serious
criticisms in those judgments for the reasons given, but reference to the
judgments does not provide any support for the possibility that the Lloyd's
underwriters concerned "attract(ed) business by offering lower premiums, in
effect gambling on the chance that a risk will not materialise, in the knowledge
that, if all else fails, the Central Fund will be used to indemnify the
assured."
The defendant's losses were not caused by any of the matters
complained of in these proceedings
In opening it was accepted on behalf
of the defendant that the pure defence "may... be of very limited practical
significance for Mr Clementson and other Names like him", inter alia because of
the decision of the Court of Appeal in Higgins supra. The counterclaim seeks
damages for loss allegedly caused by Lloyd's infringements of art 85(1), being
loss allegedly caused by the Central Fund arrangements and Reinsurance
provisions and the RITC provisions separately or in combination.
Mr
Clementson's syndicate allocations and results 1982-1991 are found at App 24 to
the Statement of Agreed Facts. His overall result over 9 years amounted to a net
loss of #1,185,138. Mr Clementson was a Name on numerous syndicates several of
which feature in the Lloyd's litigation (although Mr Clementson was not always a
Name on years in respect of which a claim has been made). Mr Clementson's losses
were caused in part by negligent underwriting. Mr Clementson was a Name on Gooda
Walker 164/290/298 and as such with other Names obtained judgment in Deeny v
Gooda Walker Ltd supra. This provides a clear example of a case where Mr
Clementson's losses were caused in part by negligent underwriting. I refer to
the judgment of Phillips J for the detailed reasoning which led to the finding
of negligent underwriting. Mr Clementson's losses were caused by negligent
underwriting to the extent that he has already established (or establishes in
the future) liability on this basis in LMX, Long Tail, PSL or other cases
forming part of the Lloyd's Litigation. So far as I know Mr Clementson is not
pursuing a portfolio selection claim. Save as aforesaid Mr Clementson's losses
were caused by market conditions (including asbestos and pollution claims and
the unprecedented number of major catastrophe losses referred to in E 9.12
above). Even if contrary to my express findings there was any infringement of
art 85, Mr Clementson's losses were not caused by any such infringement.
The defendant's 14 Propositions
I turn to consider the
defendant's 14 propositions in turn.
PROPOSITION 1
The component
parts of this Proposition, which summarises the defendant's case, are considered
under Propositions 2-14 below. The complexity and width of the defendant's
Propositions are a reflection of the fact that the defendant's case is an
attempt to dress up in art 85 guise allegations of regulatory failure on the
part of Lloyd's (see B above).
PROPOSITION 2
("The Central Fund
Arrangements opened the door to the realisation of moral hazard on the part of
Lloyd's active Underwriters and thereby distorted competition").
The use
of the words "opened the door to" are highly significant. I have already
referred to the change during Professor Bain's cross-examination from "caused" to "permitted", hence the use of the phrase "opened the door to". In order to
attract the prohibition in art 85(1) it must be established that the agreement,
decision or concerted practice has as its object or its effect the prevention,
restriction or distortion of competition in the relevant market.
As to
"moral hazard" and CCRA see above. The defendant was not able to point to any
reference to any concept of moral hazard in any decision of the Court of
Justice.
The Central Fund did not serve to remove any or any significant
constraints on Lloyd's underwriters, inter alia because underwriters and
managing agents depend for their income (see E at 1.13 above) and livelihood on
their syndicates retaining support from a significant number of Names. Such
support would be lost if a syndicate sustained serious losses, with the result
that the first three links in the Chain of Security were called on.
European legislation and competition law permit different structures.
The particular structure of Lloyd's has been recognised by European legislation.
As pointed out above, it could be argued that there is more scope for
the defendant's novel and protean concept of moral hazard in the case of
corporates (with limited liability) than in the case of Lloyd's (with the
Lloyd's Chain of Security involving unlimited liability on the part of Names on
a Syndicate, among whom will be the active Underwriter and two
Directors/Partners of the Managing Agents).
PROPOSITION 3
("Because of Proposition 2, the door was opened to the admission by
Lloyd's of individuals as Names, being individuals who did not have the assets
required to support underwriting at Lloyd's at all (moral hazard operating on
the behaviour of Lloyd's itself)").
There is no logical connection
between Proposition 2 (opening the door to the supposed moral hazard on the part
of active underwriters) and the matters asserted in Proposition 3. The reference
in Proposition 3 to "the door was opened" again reflects the change which
occurred during Professor Bain's cross-examination from the language of
causation to the language of permission.
Important regulatory questions
arise as to whether the criteria for admission adopted by Lloyd's from time to
time were appropriate (see B above).
PROPOSITION 4
("Because of
Proposition 2 and/or Propositions 2 and 3, the door was opened to the placing of
Names by Members' Agents on syndicates when the Name did not have the assets
required to support such membership of the syndicate having regard to the nature
of the syndicate's business, the Name's line on the syndicate in question and
the Name's exposure to risk on other syndicates (moral hazard on the part of
Members' Agents). There was in place no effective substitute for the normal
market discipline of counterparty credit risk assessment to prevent the
operation of moral hazard resulting therefrom").
It is to be noted that
the defendant's case includes assertions of moral hazard on the part of Lloyd's
active Underwriters (Proposition 2), moral hazard operating on the behaviour of
Lloyd's itself (Proposition 3) and moral hazard on the part of Members' Agents
(Proposition 4).
A logical connection between Propositions 2, 3 and 4 is
lacking. The relevant order of events is admission as a member of Lloyd's,
portfolio selection advice by Members' Agents (which may or may not be given
competently) and exposure to the consequences of underwriting decisions by
active Underwriters on a number of syndicates (which decisions may or may not be
made competently). These separate processes are explained in E above.
Again Proposition 4 reflects the change which occurred during Professor
Bain's cross-examination from the language of causation to the language of
permission.
As to CCRA I have dealt with this subject above under a
separate heading.
PROPOSITION 5
("Because of Proposition 3, the
overall capacity of Lloyd's including its capacity in the relevant markets was
artificially inflated and excess capacity developed, thereby contributing to a
depression of premium rates at Lloyd's to levels below the true risk/cost and
distorting competition").
PROPOSITION 6
("Because of
Propositions 3 and 4: (a) the capacity of, and business written by, high risk
syndicates at Lloyd's, operating in the relevant markets, were artificially
inflated, thereby distorting competition and increasing Lloyd's aggregate
exposure to catastrophe losses; and (b) excess capacity for the transaction at
Lloyd's of high risk business developed, thereby contributing to a depression of
premium rates at Lloyd's for such business below the true risk/cost of such
business, giving rise to adverse selection and further distortion of
competition").
It is convenient to consider Propositions 5 and 6
together.
Professor Bain's revised Annex F to his fifth Report (which
reflects the agreed Wilshaw "Category 3" list of high risk syndicates for the
1989 year of account) constitutes prima facie evidence of widespread negligent
portfolio selection advice on the part of Members' Agents. In the fourth
category of the Lloyd's Litigation (Portfolio Selection Cases) Names allege that
their respective Members' Agents either failed to advise them properly as to
which syndicates they should join and/or as to spread of risk, or put them on
unsuitable syndicates, or failed to advise them to leave syndicates, when (the
Names allege) it was or should have been apparent that the syndicates were not
suitable for the Names concerned. These cases in the main concern Names who were
put on syndicates operating in the LMX market. Although they have in common the
nature and extent of the obligations owed by a Members' Agent to the Names who
engaged that agent, each case turns on the particular circumstances in which the
Name in question contracted with the Members' Agent concerned. Judgment has been
given in two pilot cases (Sword-Daniels and Brown) and an appeal has been heard
in the latter. There are a number of outstanding Portfolio Selection cases and
some cases of this type are proceeding by way of arbitration.
As each
Portfolio Selection case turns on the particular circumstances in which the Name
in question contracted with the Members' Agent concerned, it is not possible to
say any more by way of general conclusion on this aspect of the case than is set
out above. I emphasise however that it was one of the main duties of a Members' Agent to advise Names as to which syndicates to join and in what amounts. The
defendant's Propositions fail to reflect this important and distinct function on
the part of Members' Agents (see E 6.1 and 6.2 above).
The relevant
markets for the purposes of the defendant's art 85 case are the worldwide
marine, aviation and reinsurance markets. There was considerable discussion in
evidence as to the effects of increased capacity at Lloyd's on these markets.
Some of the difficulties in the defendant's contentions in Propositions 5 and 6
were identified by the following witnesses.
Mr Wilshaw pointed out that
Lloyd's syndicates could not buck the world trend on prices because Lloyd's is
part of the world trend in the relevant markets.
Dr Frey said that
between 1976 and 1989 German reinsurers trebled. In 1949 German reinsurers had
no market share of non-German business because they were not allowed to do
business after the war outside Germany. Now, of the fifteen largest professional
reinsurers, seven are domiciled in Germany with a market share above 20%. This
was achieved by competitive pricing.
Mr Salter distinguished between
exclusively corporate insurers' business, business where Lloyd's had a 100% and
the majority of business which is written on a subscription basis. He said that
if Lloyd's syndicates as a group, say with 45% on a slip, all took the same view
and said "these rates are too high and we are going to put them down" that would
have an influence, but individual syndicate attitudes would not move the market.
It is as always vitally important to understand how the markets worked. Mr
Salter said that the vast majority of risks in the LMX market were written on a
subscription basis. By way of example one of the largest LMX placements for a
very large syndicate, with a programme of six or eight layers of coverage (not
necessarily XL on XL), would involve about two hundred entities from the world
market, counting Lloyd's as one. In the non-marine market, a whole range of
corporate insurers/reinsurers were co-insuring with Lloyd's. There have been
significant corporate casualties as a result of the losses that occurred in the
late 1980's and early 1990's.
Mr Berry said that in the 1980's there was
undoubtedly a worldwide over capacity in excess of loss business.
Mr
Aaronson said that a particular outcome in terms of prices or availability of a
product cannot be considered in relation to one player in a market in isolation.
As to the reinsurance market he referred to the worldwide increase in capacity
which led to a softening of reinsurance rates offered by all players in the
market. No player could be insulated from that trend in a competitive market and
this led to many reinsurers making losses. This applied to corporate reinsurers
as well as Lloyd's reinsurers.
Professor Yamey pointed out that excess
capacity (whether in Lloyd's or in the corporate sector) would not force rates
below what a prudent insurer would be prepared to accept in the light of his
assessment of the risks involved. In the case of Lloyd's in particular, capacity
in terms of capital and Names admitted would not affect the decisions of prudent
underwriters.
Once again it is important to distinguish between distinct
events (in the relevant order) and distinct functions - admission as a member of
Lloyd's, portfolio selection advice by Members' Agents (which may or may not be
given competently) and exposure to the consequences of underwriting decisions by
active Underwriters on a number of syndicates (which decisions may or may not be
made competently).
PROPOSITION 7
("The Reinsurance Provisions
infringed Article 85(1)").
This Proposition is relevant to the
counterclaim.
The Reinsurance Provisions complained of are found in App
G to the Instructions for the Annual Solvency Test (see E 7.20 to 7.25 and 12.1
to 12.3 above). Appendix G applies only in the context of Test 1. It has no
application to Test 2. Reserves must be established as at the solvency test date
being the greatest of the Test 1 or Test 2 reserves or the reinsurance to close.
In relation to Test 1, wherever professional judgement and/or statistical
evidence so suggest, provision must be made over and above the minimum percentage reserves to take account of the particular circumstances of
individual syndicates.
The 20% provision in App G is not
anti-competitive in object because it forms part of a complex system of solvency
regulation; its purpose is not to prohibit or mandate any particular course of
action on the part of Underwriters but merely to assign different values for
solvency purposes to reinsurance ceded in the past.
I refer to Mr
Dickson's explanation of the 20% provision - "a fairly blunt-edged" approach -
compare the complications of rating numerous reinsurers from time to time (and
applying such ratings to individual syndicates).
I find on the evidence
called before me that the effect (if any) of the 20% provision on competition
was not appreciable and that the effect (if any) of the provision on
intra-Community trade was not appreciable. My reasons are as follows.
No
underwriting or other witness was called by the defendant in support of the
contention that the 20% provision had any effect on his or anyone else's
decision-making process.
The market evidence called by Lloyd's was to
the effect that the 20% provision did not have any effect upon the
decision-making process of Underwriters. I will refer to the evidence of Mr
Berry, Mr Wilshaw, Mr Salter and Dr Frey in turn. The evidence of these four
witnesses struck me as compelling on this aspect of the case.
Mr Berry
doubted whether Underwriters gave any attention to the details of the Solvency
Provisions. They were regarded as a back-office function to do with Lloyd's
administration and as not material to the process of generating profitable
business and ensuring good reinsurance protection. There were practical reasons
why this should be so. First, an Underwriter could not have known the overall
solvency position of his Names at any point during the year. He would not be
able to take into account the performance of the other syndicates in which the
Names on his syndicate were involved, or whether the Names were likely to have
any surplus amounts across those syndicates. Some of Names' eligible assets at
Lloyd's could also be taken into account in ascertaining their overall solvency
position - again, the Underwriter would have no way of knowing what these assets
were or how much they were. Second, an Underwriter would not have a system for
obtaining details of a Name's participation on other syndicates or be able to
monitor a Name's solvency position overall. The main factor which an Underwriter
has in mind when obtaining reinsurance protection (subject to security
considerations) is the price, because this has a direct and significant impact
on the profitability of the syndicate. Third, reinsurance programmes were
generally purchased by an Underwriter up to 15-18 months before solvency was
calculated. Reinsurance would be put in place before or at about the same time
as the business was written in order to manage the net exposure of the
syndicate. At the time the programme was placed, the Underwriter would not be
thinking about the possible implications for the Name's solvency test 1-2 years
later. Fourth, most Underwriters would not have known enough about the solvency
rules or their detailed application to identify their effects, to the extent
that such effects might be relevant to their underwriting.
Mr Wilshaw
said that at no stage in his decisions on constructing his syndicate's
reinsurance programme and choosing the reinsurers did the issue of the solvency
of his Names in general, or the issue of the solvency penalty under Lloyd's
Permitted Reinsurance Limits, ever operate as a factor. He wanted to have his
reinsurances completed at a competitive price with good security; solvency
issues were too remote and little understood to be a factor influencing his
decision. He had no idea at the time of purchasing reinsurance whether his
syndicate would have a solvency shortfall for that year (and therefore whether
the solvency penalty would have any effect at all). Furthermore, even if he had
known that for some reason his syndicate was going to have a solvency
deficiency, he would not have known how it would affect individual Names. He
would not have known their off-setting surpluses from other syndicates. He never
applied any kind of notional "discount" to non-Lloyd's reinsurance policies by
reason of their particular status under the Lloyd's solvency rules. Solvency is
dependent on many factors and was far too far removed and too imprecise for him
to take it into account when underwriting. He did not consider that the 20%
provision would have any effect on a competent Underwriter's thinking. He was
not aware at the time of people who were encouraged to insure or not insure
within Lloyd's because of the provision. He said that the amendment of App G on
23.12.92 (see E 12.2 above) could at most have only a marginal effect on the
possible emergence of a spiral in the future.
Mr Salter said that in
forty years as a broker at Lloyd's he could not recall any reference to Lloyd's
solvency regulations nor to its rules on premium income limits being made by
Lloyd's syndicates when purchasing their reinsurance cover. He was never asked
to place reinsurance exclusively or partly within Lloyd's because of solvency
considerations based on Lloyd's solvency rules. He never got the idea that
solvency considerations affected a decision to place reinsurance.
Dr
Frey said he was not aware of the 20% rule and that he did not believe that most
of his continental colleagues were aware of it. He was never aware of any
Lloyd's regulatory reason why he could not sell as much reinsurance protection
to Lloyd's syndicates as he wanted to. It was a very free market. There were
fundamental commercial and objective insurance reasons why reinsurers other than
Lloyd's may not have wished to purchase risks retroceded from Lloyd's
syndicates.
The market evidence on this subject was supported by Mr
Dickson (as a Lloyd's auditor). He said that a syndicate exceeding the PRL would
only have had an impact on a Name (via the syndicate's Test 1 and the Name's
overall solvency test) in a relatively limited number of instances. Even then,
any actual cost of this to a Name would have been limited to an "opportunity
cost" - the difference between the investment return earned on the extra assets
paid in to the deposit at Lloyd's and the return which would have been earned if
the assets had been kept invested outside Lloyd's. A call for additional capital
would be more likely to have been a problem for new joiners. In the case of a
new Name spread across ten syndicates if, when the solvency calculations are
undertaken in the second year, it is found that on one of those ten syndicates
there is a solvency shortfall, but on the others there is a surplus, the Name is
entitled to use the surplus in order to make up the shortfall.
Mr
Dickson did not consider that the PRL would ever appreciably affect
Underwriters' decisions regarding their purchase of reinsurance. The main
reasons for this were as follows. First, the PRL only applies in respect of a
syndicate if Test 1 rather than Test 2 applies for the solvency test, and the
syndicate for a year of account has exceeded the PRL for external reinsurance.
Second, Test 2 is likely to apply for the third year of account for the great
majority of syndicates (and the PRL is irrelevant for syndicates in run-off).
Third, in respect of the first and second years of account (when Test 1 is
relatively more likely to apply), the PRL only has a direct impact upon a Name
if, taking account of all relevant syndicates and years, the fail-safe element
of his/her deposit is required to cover liabilities or the Name has a solvency
shortfall. Fourth, for any such possible impact to influence Underwriters' decisions, a syndicate Underwriter would need to be aware of and react to the
prospective overall solvency positions at Lloyd's of all the Names on his
syndicate, with each Name's position depending in turn on decisions taken by the
Underwriters on all the Name's other syndicates. He would also need to be aware
of these factors when purchasing his reinsurance, which would often be early in
each year.
Further and in any event the defendant's losses were not
caused by the Reinsurance Provisions complained of. Mr Clementson's losses were
caused by negligent underwriting (to the extent that he has already established,
or establishes in the future liability on this basis in LMX, Long Tail, PSL or
other cases forming part of the Lloyd's Litigation) or by market conditions (see
above).
PROPOSITION 8
("The RITC Provisions are to be taken into
account in assessing the loss and damage caused to the Defendant by the Central
Fund Arrangements which were their raison d'tre").
The defendant does
not rely on the RITC Provisions standing alone as giving rise to a claim for
damages under the counterclaim. The defendant has correctly recognised that this
head of counterclaim was misconceived. As to reinsurance to close see E 14
above. The Central Fund Arrangements were not "the raison d'tre of the RITC
Provisions".
PROPOSITION 9
("By reason of their actual or
potential effects (and in the case of the Reinsurance Provisions, by reason of
their object) the Central Fund Arrangements and the Reinsurance Provisions have
attracted the operation of Article 85(1) at all times since... 1 January 1973").
This Proposition serves to underline the width of the defendant's
submissions. I reject it for the reasons set out above.
PROPOSITION 10
("The magnitude of the effects referred to at Propositions 2-8 above and
the volume of business that they affected are such that the prevention,
restriction and/or distortion of competition within the relevant markets were
appreciable and, by reason of the international nature of those markets, the
effect on trade between Member States was appreciable").
The relevant
markets are the worldwide marine, aviation and reinsurance markets.
For
the reasons set out above the Central Fund Arrangements (whether considered
alone or in combination with the Reinsurance Provisions) did not have as their
effect the prevention, restriction and/or distortion of competition. If there
was an impact on competition it was not appreciable.
For the reasons set
out above the Central Fund Arrangements (and the Reinsurance Provisions) have
not had an influence, direct or indirect, actual or potential, on the pattern of
trade between Member States such as might prejudice the realization of the
aim/objective of a single market between Member States. If there was an
influence it was not appreciable.
PROPOSITION 11
("The very
thing to be guarded against as likely to result from the creation of moral
hazard caused by the elimination by the Central Fund Arrangements of CCRA, by
itself and/or combined with the effects of the Reinsurance Provisions and/or the
RITC Provisions, was that, in circumstances such as developed in the 1970s and
1980s, avoidable losses would be caused to Names through their exposure to risks
that their available assets were insufficient to support: pleas by Lloyd's of
novi actus intervenientes and/or other extrinsic causes are therefore
unsustainable").
For the reasons set out above the defendant's losses
were not caused by any of the matters complained of in these proceedings. Mr
Clementson's losses were caused by negligent underwriting to the extent that he
has already established (or establishes in the future) liability on this basis
in LMX, Long Tail, PSL or other cases forming part of the Lloyd's Litigation.
Save as aforesaid Mr Clementson's losses were caused by market conditions. Even
if contrary to my express findings there was any infringement of art 85, Mr
Clementson's losses were not caused by any such infringement.
PROPOSITION 12
("The Rule of Reason, however formulated, is
inapplicable to the Central Fund Arrangements because:
(i) they did not
simply enable a Lloyd's syndicate to operate on the market in the same sort of
way as an insurance company that had assets comparable to those that were
available (without recourse to the Central Fund) to the syndicate but, on the
contrary, enabled Lloyd's Syndicates to engage in conduct of a kind and on a
scale that would have been impossible for such a non-Lloyd's insurer in
conditions of undistorted competition; and/or
(ii) Lloyd's failed to
take any, or any sufficient steps to remove or mitigate the effects of moral
hazard created by the elimination of CCRA and indeed was itself affected by that
moral hazard").
The Central Fund is essential to the operation of
Lloyd's (see above).
Bellamy & Child 4 Edition at 2-063 states:-
"The case law of the Court of Justice shows a certain tendency to adopt
a "rule of reason" approach, particularly in relation to restrictions which do
not directly impede trade between Member States. The cases also reveal two ways
in which the rule of reason can be applied. The first, established in a line of
cases from Technique Miniere to Delimitis, applies a rule of reason by stressing
that thorough analysis of the economic context surrounding the agreement and the
effect of the agreement in the relevant market is necessary to determine whether
the obligations are anti-competitive to any significant extent. The second
approach, adopted in cases from Metro 1 to Pronuptia and the Commission's
decision in Elopak/Metal Box-Odin focuses more on the terms of the agreement
itself, so that if on balance the economic advantages of the agreement mean that
the agreement can be seen to be pro-competitive overall, any restrictions which
are essential to the performance of the agreement fall outside Article 85(1)."
The "rule of reason" applies to agreements in the insurance sector. It
may be necessary for insurers to include an anti-competitive provision in their
arrangements if it is only by that means that effect can be given to other
acceptable provisions. The anti-competitive restrictions must be limited to what
is necessary to render the arrangements as a whole properly operable.
Without prejudice to the analysis set out above, if and to the extent
that it is necessary to do so, I hold that the rule of reason applied to the
Central Fund Arrangements. The Central Fund Arrangements did not go beyond what
was necessary to enable Lloyd's to function properly.
PROPOSITION 13
("Section 14 of the Lloyd's Act is not available to deny the Names a
remedy in damages against the Society of Lloyd's....").
PROPOSITION 14
("The Defendant is a person who is entitled to
invoke Article 85(1) as a basis for claiming compensation from Lloyd's").
In view of my conclusions as to Propositions 1 - 12 it is not necessary
to add to what the Court of Appeal said in Clementson supra in relation to
Propositions 13 and 14.
Severance
Article 85 strikes down only
those provisions of an agreement which are anti-competitive. It is then for the
national law to decide what effect that has on the remaining provisions of the
agreement. Severance is permissible in English law where the offending parts of
an agreement can be struck out without re-writing the agreement or entirely
altering its scope and intention. If what remains stands as a contract in its
own right, it is enforceable (see further Leggatt LJ in Higgins supra).
If, contrary to my express findings, the Central Fund Arrangements
infringed art 85(1), para 10 of the Central Fund Byelaw is severable. As Lloyd's
point out, the fact that Lloyd's has recourse against a Name in default whenever
sums are paid out of the Central Fund on his account, means that the Central
Fund does not save Names harmless from the consequences of their actions.
J CONCLUSIONS
The conduct of insurance business
1. The
conduct of insurance business falls within the scope of art 85.
The
relevant "agreements between undertakings, decisions by associations of
undertakings and concerted practices"
2. Lloyd's concede that Lloyd's is
an association of undertakings, the undertakings being the Names and the
Syndicates within Lloyd's. Lloyd's admits that its Byelaws, its decisions to
raise contributions to the Central Fund and its decisions authorising sums to be
withdrawn from the Central Fund are "decisions of an association of
undertakings" within the meaning of art 85.
The elements in the Central
Fund Arrangements alleged to attract the operation of art 85(1) are set out in
Proposition 1. The Reinsurance Provisions (as defined above) are also alleged to
infringe art 85(1).
The relevant markets
3. The relevant markets
are the worldwide marine, aviation and reinsurance markets.
"Which may
affect trade between Member States"
4. The Central Fund Arrangements
(whether considered alone or in combination with the Reinsurance Provisions)
have not had an influence direct or indirect, actual or potential, on the
pattern of trade between Member States, such as might prejudice the realization
of the aim/objective of a single market between Member States. If there was an
influence it was not appreciable.
"Which have as their object or effect
the prevention, restriction or distortion of competition within the Common
Market"
5. The Central Fund Arrangements (and the Reinsurance
Provisions) did not have as their object the prevention, restriction or
distortion of competition within the Common Market. Nor did they, in the light
of all the relevant facts and the legal and economic context, have as their
effect the prevention, restriction or distortion of competition. If there was an
impact on competition it was not appreciable. If and to the extent that it is
necessary to do so, I hold that the rule of reason applied to the Central Fund
Arrangements.
Severance
6. If, contrary to the foregoing, the
Central Fund Arrangements infringed art 85(1), para 10 of the Central Fund
Byelaw is severable.
The defendant's losses were not caused by any of
the matters complained of in these proceedings
7. The defendant's losses
were not caused by any of the matters complained of in these proceedings for the
reasons set out above.
K RESULT
Lloyd's claim against Mr
Clementson succeeds and Mr Clementson's counterclaim against Lloyd's fails.
DISPOSITION:
Judgment accordingly
SOLICITORS:
Freshfields; S J Berwin & Co