Why Lloyd's is peering into the abyss

LLOYD'S has survived earthquakes, terrorist attacks, tornadoes, wars, floods and thousands of maritime catastrophes, but the 308-year- old insurance market is on the verge of oblivion after the middle-class professionals, shire county gentry, aristocrats and royals who back it have angrily refused to support its losses.

Consequently, Lloyd's, hit by a growing cash crisis, is facing the possibility of having to close its doors to new business at the end of this year - or of asking its members for a cash subscription that could run into billions.

The row over what to do could come to a head at the annual general meeting to be held at the Royal Festival Hall on London's South Bank in a month's time.

This latest threat to Lloyd's - the most serious it has faced so far - is caused by the fact that the market's insurance syndicates are having to meet claims but are finding that their names, the investors who finance the syndicates, either cannot or will not meet their liabilities. And the courts are reluctant to bankrupt names, many of whom are suing their syndicates for negligence.

Added to this fear are new doubts that some other insurance companies - known as reinsurers, which owe Lloyd's syndicates money, will be unable to meet liabilities. Some reinsurers are not paying because they, too, are on the brink of insolvency.

Peter Middleton, the chief executive of Lloyd's, said: "The Council of Lloyd's is currently exmaining all aspects of the society's operation. As part of this exercise it is studying a wide range of options. Lloyd's is seeking to produce a settlement of all outstanding litigation, to bring finality to the Lloyd's affairs of many members, and to secure a profitable future. No decisions have yet been taken, and any reported `final decisions' or `actions' by the council are pure speculation."

The bad debt problem is threatening the solvency of the whole of Lloyd's. In common with all UK insurers, the market must pass an annual solvency test. At Lloyd's the test means ensuring that each of the markets's 33,000 names has enough assets to meet the liabilities for which he or she is responsible. When a name does not have enough assets, a part of the Lloyd's central fund has to be earmarked to support that name's solvency. If the name persists in not meeting the debt the central fund must pay the policyholder.

There are between 7,500 and 9,000 insolvent names at Lloyd's. Last September, when the most recent solvency test was completed, these people had liabilities £1.35bn higher than their assets.

The market's authorities have decided that a cash call on the market's backers - or special levy, as Lloyd's calls it - is essential to the survival of the market. Any levy will need to meet the approval of the names, who have the right to vote on it, and it is far from certain that they will agree to it.

An alternative under consideration is to ask those whose businesses depend on the market's survival to finance the Lloyd's bad debts. Possible contributors include the underwriters and the broking businesses.

There is also a question over whether any plan will carry the support of the market's professionals, particularly the underwriters, who may be tempted to get out now rather than to struggle through more years of uncertainty.

One source at the centre of the decision-making said: "If they choose not to pay, then they will lose the market."

However, the issues threatening the solvency of Lloyd's are riddled with complexities that go beyond the simple issue of a levy and make it far from certain that the market can survive - even if a sizeable levy can be raised.

As well as more cash, Lloyd's needs a fast settlement to the litigation plaguing the market as names sue Lloyd's professionals for negligence. The names have already won cases that could yield them up to £1bn in court awards. More are going through the courts, and the sorry saga of litigation is expected to continue for at least another two years.

Lloyd's is understood to be putting together an out-of-court settlement, which would apply marketwide. They need to do this because, as things stand, there is a danger that names will keep court awards rather than use them to meet unpaid Lloyd's losses. Lloyd's could make it a condition of any offer that such money is applied directly to losses.

While providing the chance to negotiate on settlements with Lloyd's, the new offer would also allow names room to discuss claims against the market professionals.

In return for reaching a deal, Lloyd's would promise not to pursue the name for more money in future. The central resources of Lloyd's will be made available to help names.

However, it is doubtful whether Lloyd's has the resources to finance a sufficiently high offer to names, compared with the money that could be won through the courts - last year names turned down a £900m offer.

If the deal does not work, Lloyd's may have to close. But if it is to survive, even in a reconstituted form, it needs to convince future investors as well as

policyholders that it can protect them from the burden of the unpaid losses from the past. Otherwise, investors will stay away from the market. The Lloyd's plan is to set up a new insurance syndicate to take on old liabilities.

However, there are huge difficulties in doing this - not least in quantifying the amount of capital that will be needed to support the new syndicate and in persuading names to back it.

Lloyd's will also have to convince the Department of Trade and Industry, the government department responsible for the insurance industry, that the new syndicate will be able to meet all the losses.

Eventually, all these old losses will be reinsured by Equitas, a company Lloyd's has been working on for the past two years. Equitas will not be ready to start in time to save the market by the end of the summer.

Although Peter Middleton, Lloyd's chief executive, is working on a rescue plan, the details have yet to be finalised. Indeed, it still doubtful whether any rescue will be attempted. Unless Mr Middleton can take the names and the market's professionals with him, the whole thing will not work.

Plans to give an armour-plated guarantee to future investors that they will not be hit by past losses will need the approval of the DTI and will need to meet the requirements of the Lloyd's Act 1982.

For legal reasons, the Lloyd's executive body simply may not be permitted to ring-fence in the way it hopes.

"The time has come to make a decisive move to put an end to past problems, and if this means closing down the market called Lloyd's, then so be it," said one insider, expressing a widely repeated view.

In its place a new set of businesses, run by many of the same players who currently trade at Lloyd's, could emerge. The new businesses would not be backed by the traditional name with unlimited liability.

Instead, there would be simple insurance firms that have raised their own capital.

Lloyd's is open today only because it has persuaded the DTI that it can recover names' debts by changing the market's rules to allow it to tap into litigation awards made to names. The award money would then be used by Lloyd's to meet names' unpaid losses.

Whether Lloyd's should be allowed to scoop names' awards is the subject of legal proceedings that started in the High Court just before Easter.

Names claim the rule change is retrospective and is an attempt to turn Lloyd's into a priority creditor.

Many names have incurred bank debts to pay some of their Lloyd's losses, and they want to be free to use court awards to pay off bank debts. The names' legal challenge makes it uncertain that Lloyd's can recover these awards.

Sources say the DTI is no longer prepared to countenance such a large number of imponderables as a pretext to keep Lloyd's afloat.

Nor is it just the DTI that must be placated. Foreign insurance regulators, particularly such powerful ones as the New York Insurance Department - the regulator for New York state - must be satisfied that Lloyd's has the resources to continue writing insurance business within its jurisdiction. NYID has regulatory control over £6.4bn of the Lloyd's assets, by far the biggest single chunk.

The NYID is far from convinced that Lloyd's is solvent. Last summer and autumn it sent a team of investigators to London to examine the solvency of the market. Although it said its report would be published before Christmas, it has still not been released.

In early February the powers at Lloyd's appear to have decided that they had to address the problems that commentators had been warning about for some time.

Early this month Peter Middleton presented a discussion document to the Lloyd's ruling council outlining the critical problems facing the market. He warned the council that action would have to be taken and be seen to be working before the end of the summer. The meeting that followed was a long and, some say, stormy one.