See after the jump for more.
From the Economic History Society's Long Run blog:
Rapid structural change resulting from system collapse seems to be a less common phenomenon in insurance than in the history of other financial services. One notably exception is the crisis that rocked Lloyd’s of London, the world’s oldest continuous insurance market, in the late twentieth century.....MUCH MORE
Hitherto, explanations for the crisis have focused on catastrophic losses and problems of internal governance. My study argues that while these factors were important, they may not have resulted in institutional collapse had it not been for multiple delusions of competence among the various parties involved.
Lloyd’s was a self-governing market that comprised investors – known as ‘names’ – who put up their personal assets to back the insurance written on their behalf, and accepted unlimited individual liability for losses. Names were organised into syndicates led by an underwriter and a managing agency. Business could only be brought to syndicates by brokers licensed by Lloyd’s. Large broking firms owned most of the managing agencies and thereby controlled the syndicates, giving rise to serious conflicts of interest.
In 1970, Lloyd’s resolved to expand capacity by lowering property qualifications for new names. As a result, the membership exploded from 6,000 to over 32,000 by 1988. Many new names were less well-heeled than their predecessors and largely ignorant of the insurance business. Despite a series of scandals involving underwriters siphoning off syndicate funds for their own personal use, the number of entrants kept rising thanks to double digit investment returns, the tax advantages of membership, and aggressive recruiting.
While capacity was increasing, underwriters competed vigorously to write ‘long-tail’ liability and catastrophe business in the form of excess loss (XL) reinsurance. Under these contracts, the reinsurer agreed to indemnify the reinsured in the event of the latter sustaining a loss in excess of a pre-determined figure. The reinsurer in turn usually ‘retroceded’ (laid off) some of the amount reinsured to another insurer.
Many Lloyd’s underwriters went into this market despite having little experience of the business. Some syndicates doing XL reinsurance retroceded to other XL syndicates, so that instead of the risks being dispersed, they circulated around the same market, becoming increasingly opaque and concentrated in a few syndicates. This became the infamous London Market Excess of Loss (LMX) spiral.
By 1990, over one quarter of business at Lloyd’s was XL reinsurance. The spiral offered brokers, underwriters and managing agents the opportunity to earn commission and fees on every reinsurance and retrocession written.
It also enabled underwriters to arbitrage the differential between the premiums they charged for the original insurance, and the lower premiums they paid for reinsurance and retrocessions. A later inquiry also showed that those writing at the top of the spiral accepted, out of ignorance or carelessness, premium rates that were far too low for the higher layers, in the belief that these were virtually risk-free....
Lloyd's never did completely recover and even now is struggling. See June 14's "Insurance: Lloyd's Risks Becoming Irrelevant".
Additionally:
May 1
Insurance/Shipping: "Lloyd’s of London Plots New Course as Storm Clouds Gather"
March 2018
Re/insurance "Business as usual is not sustainable, says Lloyd’s Chairman"
