What is going on at Lloyd's and will it go bust?

William Gleeson untangles the latest crisis and predicts big changes for a very British institution

Is Lloyd's about to shut up shop?

Not quite. Lloyd's is suffering from a cash crisis as thousands of its members - or names - refuse to meet their liabilities to policyholders. The hole in Lloyd's finances can be measured in billions and its bosses need to act fast to put a rescue plan in place. Without it, in theory, insurance law means Lloyd's could go under before the end of this year. In a nutshell, the debt problem suggests Lloyd's is heading towards failing its annual solvency test in August.

What is the solvency test?

Under UK and European law the test is required in order to protect policyholders from insurers who are unable to meet valid claims. For Lloyd's it compares the known assets of each name with his or her share of syndicate losses. If a name has a shortfall, it must be made up from Lloyd's centrally held assets. If the total of earmarkings from central assets exceeds the money available then then Lloyd's must close. The only way out of this is if other names agree to pay the defaulting names' losses.

But isn't Lloyd's returning to profit these days?

Not quite yet. Since the disastrous years of 1988 to 1992 it has made efficiency savings, and insurance premiums have risen in the last two years. So it is on course to announce next May its first profit in five years, when it reveals the 1993 year of account results (there is always a delay of three years for Lloyd's results). Before that, however, next month Lloyd's will report another massive loss, again to be measured in billions.

And it has to find the money from its names, who are in no mood to pay up. Lloyd's is financed by 33,000 private individuals who pledge to pay valid claims from policyholders to the full extent of their personal wealth - unlimited liability. But following years of enormous losses, thousands of names are refusing to meet their share of the losses.

Hasn't that all been sorted out?

No. The losses and their consequences take many years to work their way through the system. By last August, at the time of the last solvency test, insolvent names had refused to pay £1.35bn of debts. Next month Lloyd's is expected to report a loss of £1.5bn. This will take the total loss to £9bn over the past five years. However, ongoing claims from cover issued in earlier years will eventually add another £10bn, taking the total to £19bn.

What sort of losses are still accumulating?

There are two types hitting the market at the moment. The first set, known as longtail losses, came to light in the early Eighties and continue to cost syndicates £1bn a year. A longtail loss arises from policies that were written, in some cases, as long ago as the Forties. They gave wide- ranging general liability cover to US businesses, including asbestos manufacturers. Insurers, including Lloyd's, are now being hit by claims for asbestosis, a deadly lung disease, from workers who made and used asbestos. The other type of longtail claim is for the cleaning up of badly polluted industrial sites in the US. This has been brought about by retrospective environmental legislation.

And the second type of loss?

An unprecedented run of disasters in the late Eighties and early Nineties hit the market hard and caused much of the recent headline losses. They included the storm in southern England in October 1987, the Piper Alpha oil rig explosion which costs hundreds of lives, Hurricanes Hugo and Andrew in the US, the California earthquake, the Exxon Valdez oil spillage off the Alaskan coast, and a string of other expensive catastrophes. Most of this has worked its way through the market, hence Lloyd's confidence that it is returning to profit.

Why won't names pay up?

Some cannot. Having handed over every penny, they find they their debts are still accumulating. Others won't pay, angry at the way they have been treated by Lloyd's. They have won legal cases in which they argued they were the victims of negligence, and have been awarded hundreds of millions of pounds in compensation. Other names have started fraud and misrepresentation cases against Lloyd's: they argue that the asbestos losses were covered up. This has created a legal merry-go-round: until these claims are dealt with, Lloyd's cannot pursue names through the courts to secure payment of debts.

So are we heading for a crunch point?

Lloyd's is working on a rescue plan to be announced in the next few weeks. This will probably include proposals to ask names for even more money - a levy, as it is known in Lloyd's parlance. The plan will offer an out- of-court settlement to names. It will also try to construct a ring-fence to protect future investors at Lloyd's from the past losses

How much would it matter if Lloyd's did go bust?

Lloyd's is now a relatively small proportion of the insurance industry - only 2 per cent of the the world's non-life insurance business. However, in the City, thousands of jobs depend on it, and it contributes £1.7bn to the UK's balance of payments.

When will all this happen?

If Lloyd's cannot pass its 1996 solvency test then technically it will be unable to trade at the start of 1996. However, Lloyd's normally has to secure investors for the next year's insurance business in the autumn. If it is to convince investors to stay next year, Lloyd's will need its rescue plan to be seen to be working before the end of the summer.

Is the plan likely to succeed?

There are all sorts of hurdles Lloyd's must jump before any plan will succeed. A levy will need the support of the names, who will be reluctant to vote to give more money to meet other people's debts. The authorities will also have to get the backing of the underwriters and the brokers who bring business to Lloyd's. Some may think they are better off outside Lloyd's.

Does all this make any difference to my house or car insurance?

There is some domestic business written at Lloyd's but most cover issued by the market is for other businesses, such as shipping companies. Providing the plan works then the answer is no, it won't make any difference.

1987-1989 Oil, wind and fire overwhelm Lloyd's. North-west Europe ravaged by storms. North Sea oil rig Piper Alpha explodes. Hurricane Hugo destroys large stretches of East coast of America. Exxon Valdez oil tanker spills its load over the Alaskan coastline. Cost of these four events to Lloyd's: approximately £9bn.

1989-1990 Lloyd's has no idea of the scale of the losses caused by the unprecedented run of major disasters, as well as multiple claims for asbestosis from policies written as early as the 1940s. Estimated costs: £19bn.

1991 Lloyd's horrified by its first non-profitable

year (1988). Loss of £1/2m stirs public unease. Early signs of panic among the names.

1993 Losses for 1990 announced, out of control at £2.9bn. Lloyd's underwriter Roy Bromley shoots himself. His syndicate has losses of more than £54m. Names claim that 30 members have died prematurely after financial ruin. Lloyd's puts the number at seven.

1994 Losses for 1991 announced - standing at £2.5bn. Names start legal actions against Lloyd's for negligence.

1995 Lloyd's reaches crunch point. Rescue scheme urgently needed. Results for 1992 due next month.

Lloyd's of London is as much a part of Britain's heritage as roast beef and Trooping the Colour. The market traces its origins to the 17th century. For most of this century it has acccounted for a sizeable chunk of Britain's invisible earnings, much of it from insuring the world's ships and maritime trade. For years, while the money rolled in, nobody really bothered to question whether Lloyd's was in a fit state to survive in the late 20th century.

The trouble is that in almost every respect other than its financial returns - its management, its source of funds, its way of doing business, and more recently its ethics - Lloyd's of London has shown in the last five years that it is hopelessly out of touch with the requirements of operating a modern competitive business.

Those inside the market have belatedly recognised the fact. Management at Lloyd's is in a race against time to try to put in place a reformed structure before the old one finally collapses under the weight of financial losses, past incompetence and inherent anachronism.

If the market is to survive into the next century, it will be a quite different place to the tradition-bound (yet profitable) market it was even 10 years ago. If it does not survive, the core of its profitable underwriting business will almost certainly be taken over by new insurance companies, operating in a completely different legal framework. (At the moment, Lloyd's is still governed by its own Act of Parliament).

The most immediate casualty looks like being Lloyd's most distinctive contribution to the financial world, that of the "name". Names are private investors who put up the capital with which Lloyd's trades. In return for various tax breaks and the potential for profits, they accept unlimited liability for any losses.

The number of names has fallen sharply in the past few years, from the Eighties peak of 33,000 to 14,800 today. At least a quarter have been ruined financially by their involvement in Lloyd's.Even before the latest crises, it was becoming obvious that to finance a supposedly sophisticated international insurance business purely from wealthy individuals was not a realistic long-term option. Lloyd's has already started to recruit capital from corporate investors, raising £2bn in the past two years. Many insurance experts think the market could be almost entirely financed by corporate capital within a few years.

The price of that will be to see further changes in the way the market operates: a task force set up by Lloyd's itself three years ago to suggest reforms for the future was scathing about the amateurish, clubbish way in which Lloyd's has traditionally been run. Another certainty about the future Lloyd's is that any new investors will be legally shielded from the losses of the past.

If Lloyd's fails to put together a rescue plan there is still likely to be an insurance business based in London around Fenchurch Street. Many current underwriters, with their skills and knowledge of marine, aviation and reinsurance business, will start their own free-standing companies.

But their style of business will bear little relationship to the curious customs that made Lloyd's not just the most successful, but also the most idiosyncratic insurance business in the world.

The one up-to-date thing that Lloyd's does have is its headquarters building, designed by Richard Rogers. What it needs to find is a way of doing business that fits its modern environment.