The story of Lloyd's is a tale in which a misunderstanding of the relevant business resulted in the near-downfall of an old and venerable institution - Lloyd's had been in business for 300 years before scandal hit - as well as immeasurable personal heartache.
The market's general business strategy was to sell insurance policies backed by the personal wealth of investors, known as "Names", since their signatures once appeared on the face of each of Lloyd's insurance policies. Names signed up through managers of syndicates, known as "working Names," and pledged their entire personal wealth, to cover any insurance losses the syndicate must pay out.
In exchange, the Names could expect to share in any profits the syndicate made. The Names signed on to a one-year syndicate to insure risks; two additional years were allotted for settling claims. If all claims were not settled at that point, the remaining risks (incurred but not reported "IBNR" liabilities) were insured with a syndicate from the next year, so that the Names from the prior syndicate could receive their share of the profits (or pay their share of the losses).
Of course, this practice required that the risks associated with future claims be calculated accurately, so that the new syndicate could be paid a fair premium for taking on the risks of the old one. At the time that this practice was developed, only about 100 of the Names (the working Names) were actually involved in the Lloyd's business. The other Names, known as "external Names", relied on their syndicate managing agents to protect their interests by ensuring that the IBNR liabilities were accurately calculated.
Companies who wished to purchase insurance policies from Lloyd's went to brokers who handled Lloyd's business exclusively. Lloyd's was able to write many large policies, some of an innovative nature, because the risks of the policies could then be divided among many different syndicates.
During the 1930's-1950's, Lloyd's attempted to establish a strong foothold in the U.S. insurance market. However, a "buy-American" attitude prevailed, so Lloyd's used broadly-worded policies without monetary limits to gain a competitive advantage. Unfortunately, during this time period, exposure to asbestos and other pollutants and health hazards was causing health problems that would later lead to an avalanche of claims and lawsuits.
Lloyd's membership was greatly increased (and modernised) during the 1970s and 1980s. The minimum wealth requirement for membership was reduced to 150,000, and women and foreigners were allowed to become Names for the first time. The number of Names grew from 6,000 in 1970 to 33,000 in 1990. External Names became further removed from the day-to-day business since their agreement with Lloyd's now specified that they transferred all authority to conduct insurance business to their new "members' agents" and managing agents.
During the 1980s, Lloyd's took steps to shore up its legal position. In 1982, the UK Parliament passed the Lloyd's act, granting Lloyd's immunity from most lawsuits and giving the Council of Lloyd's the authority to unilaterally and retroactively change Lloyd's by-laws, which had previously required a majority vote of Names at a General Meeting. In 1986, for the 1987 year of account, Lloyd's required members to sign a new General Undertaking in which Names agreed that any legal disputes with Lloyd's would be brought in English courts and under English law.
Major losses began to surface in 1991. The losses announced that year, for the 1988 syndicate, were 509 million pounds sterling, the largest single-year loss in Lloyd's history. Once the premium reserves were paid out, Lloyd's began demanding cash from Names in the affected syndicates, both to cover outstanding claims and to amass reserves against future IBNR claims.
Some of the Names objected to this, and began filing lawsuits against Lloyd's, and, in some cases, against their members' agents. The 1982 Lloyd's Act, however, has been highly useful to Lloyd's in staving off these claims. Courts in Texas and Colorado have both upheld the statute and refused jurisdiction. In 1995, 94% of the Lloyd's 34,000 Names accepted a settlement that put their liabilities into a new re-insurance plan called Equitas and that bound them to abstain from any legal action against Lloyd's. It is unclear whether the dissenting Names, still being pursued by Lloyd's, will have any legal recourse.
Meanwhile, Lloyd's has returned to profit: in 1998, the company reported a record profit of 1.149 billion pounds sterling for the 1995 calendar year. Its unique and historic structure, however, has changed significantly. It has been forced to allow corporations in as investors, so that the Names are now a minority. The market also suffered substantial reputational damage - the fact that Names refused to pay up was especially damaging, since Lloyd's was structured on the guarantee that these investors gave to pay all claims. Since the scandal, Lloyd's has lost considerable amounts of business to U.S. insurers and insurers in new markets such as Bermuda. These competitors have stolen a large share of segments such as property reinsurance that were once dominated by Lloyd's.
As in the case of many fiascos, Lloyd's woes arose from an intermingling of two factors. First, there was the imprudence of writing of broadly-worded policies, which opened Lloyd's up to the vagaries of unknown risks such as asbestos as well as to American litigiousness. The second component of the problem stemmed from the poor relationship between the external Names and the working Names. Many of the working Names knew nothing about insurance and were relying on the working Names to inform them of the risks. It was when the working Names felt that this relationship of trust had been violated that they refused to pay up, compounding the reputational damage to Lloyd's.