Looking back at the past, knowing how things turned out, it is always easy to be critical of other people's mistakes. Even knowing this, I have wondered, reading about the amazing financial train wreck that Lloyd's of London has become, why anyone invested in Lloyds (for a history of Lloyds and its current difficulties, see my review of Ultimate Risk by Adam Raphael). Everyone who invested money with Lloyd's was told that they were not meerly a passive investor, but an insurance underwriter and the "unlimited liability" of Lloyds placed all of their assets at risk. Why did people who were not looking for risky intestments, invest under these conditions, which financially ruined many of them. Since many who invested with Lloyd's were experienced business people, some of whom were from the insurance industry, ignorance cannot be the explanation.
The only value of Elizabeth Luessenhop's poorly written book, Risky Business: An Insider's Account of The Disaster at Lloyd's of London, is that it answers the question of how people came to invest in Lloyd's. For over two hundred years Lloyd's had returned a handsome profit to its investors, who underwrite the insurance policies issued by the Lloyd's insurance market. The beauty of investing with Lloyds is that the investor still has use of the money placed on deposit to back an insurance policy. For example, if a policy is backed by a portfolio of stocks and bonds, the investor retains ownership and collects any interest and dividends. Only if there is a claim against the policy that cannot be covered by reserves, might the investor have to sell assets to pay the claim. This allows the Lloyd's investor to leverage their investments, although at some risk.
For many of Britain's wealthy, some of whom had land holdings that had been in their families for five hundred years, Lloyd's was an ideal investment. By investing in Lloyd's, income could be produced from land holdings, without selling any land. If there were no claims early on in the life of the insurance policy, reserves could be built up, so any claim on the policy would not force a sale of assets. The British Inland Revenue even gave special tax treatment to the capital kept on reserve.
Becoming a Lloyd's insurance underwriter, or a "Name", was until the later part of the twentieth century, only open to a select few. To become a Name, one had to be proposed for membership by another name. The assets and social connections required to join Lloyds made it an exclusive social club, which yielded the sort of dividends that the British upper class felt entitled to by birth. There was, of course, a certain amount of risk, but unlucky investors were encouraged to pay up quietly -- "Oh, bad luck old boy, wrong syndicate". Being a Lloyd's Name became a sign of both social and financial achievement.
A name who was accepted for Lloyd's membership attended a meeting known as the "Rota". Here, the new Name was solemnly informed that they were accepting "unlimited liability". If the syndicate that the Name was part of insured a ship and its cargo and the ship sank, the Name would be responsible for paying their portion of the policy claim, even if it bankrupted the Name. However, the liability of the syndicate was limited to the value of the ship and its cargo. Although this could be a huge sum of money, it was not "unlimited", and Lloyd's was famous for drafting insurance policies with premiums that reflected the risk that the underwriters took.
In the 1970s and 1980, Lloyds greatly expanded its membership to increase its available capital pool. Well to do professionals were recruited, some of whom pledged their houses to back the letter of credit required by Lloyd's. No longer was there a social compact between Lloyd's and its names, who were not part of the "old boy" network. At the same time, the insurance industry entered an era where risk became much more difficult to estimate and where some risks could truly incur "unlimited liability". The new investors were attracted to Lloyd's by its prestige. The "Names agents" that recruited Names from among British, Canadian and American professionals seduced them. The prospective Names where wined and dined, while the Names agents played up Lloyds reputation as a safe, lucrative, investment. But as mutual fund prospectuses state "past performance is no guarantee of future performance".
Many of the Lloyd's syndicates underwrote reinsurance policies that insured massive, virtually open ended, asbestos and pollution liability. The companies that these policies insured acted in nothing less than a criminal fashion, which cost the lives of thousands of workers in the asbestos industry. Since the American juries that tried these civil cases could not put the executives of companies like Johns-Manville in jail, they levied huge judgements against them. Part of these judgements ended up being covered by Lloyd's syndicates, although the Names who underwrote the reinsurance policies knew nothing of the liability they were shouldering when they invested with Lloyds. These asbestos and pollution liabilities are referred to as "long-tail" liabilities, since liability lasts for many years.
Elizabeth Luessenhop, the author of Risky Business is an American Name who has been largely ruined by the long-tail liabilities of the Lloyd's syndicates she invested in. Ms. Luessenhop is an Anglophile. She loves the way Lloyd's chairman David Rowland says the word "profits". "Its so much nicer a sound than 'making money'" she writes. Of Stephen Merrett, who was at one time the deputy chairman of Lloyd's, she writes
In our three interviews, Mr. Merrett was extremely gracious and forthcoming in his answers, even adding a bit of humor the last time. The politeness of the British is remarkable. After all, I am suing the man for a lot of pounds.
Except for her love of British accents and culture, Ms. Luessenhop had no qualifications for investing in Lloyds. She describes her financial experience as follows:
Imagine being a divorcee with four grown children, previous commercial experience limited to the grocery store and Saks Fifth Avenue, and a modest amount of cash. Longtime friends from East Hampton decide to help by offering an opportunity to join Lloyd's of London. You're told it's a safe and glamorous way to increase your income, if they accept you. You don't simply invest, you become a member of a society, a "Name".
And Lloyds is so British. She was seduced and joined a syndicate named Merrett 418. Like all outside Names (Names that do not work directly for Lloyd's) she knew nothing of the risks she underwrote. Four years after joining Lloyds she started to worry, because the premium checks she was getting were smaller than she expected. A portion of her premium was being withheld as a reserve against future losses. She decided to get out, but found out that this was not possible. Her syndicate would not close its books no schedule, because the outstanding liability could not be estimated.
Merrett 418 still hadn't closed in 1990, but I wasn't in New York for the meeting of Names. I was in England, where I had been invited to my first-ever proper English country wedding, an experience every woman should have. The women wear wonderful enormous hats, and all the men are in morning clothes, striped pants and jackets with tails. There are no groomsmen, only scads of beautifully dressed little girls, who attend both bride and groom. So I was very cheerful, still thinking of flowers and romance, when I made a visit to Sedgwick [the company where her Name's agent worked] and, in the absence Mr. Brett, who was in America, was escorted to meet a young assistant whose name was David Shepard.
When I asked Shepherd about Merrett 418, he said, without emotion, "That syndicate will never close. You have incurred asbestos and pollution liabilities, and your only way out will be to sue Sedgwick."
Risky Business is co-authored by Martin Mayer, who has a background in business writing. What ever his skills, he did not save the book from tedium. While there are several interesting accounts of the greed and rogues that contributed to Lloyd's downfall, the middle of the book bogs down with details on the groups suing Lloyds. While this may be of passionate interest to Ms. Luessenhop, who is a member of one of these groups, it makes tedious reading. Ms. Luessenhop claims to have read huges stacks of material to inform herself in her campaign against Lloyds. When it comes to clearly organizing this material into an interesting book, Ms. Luessenhop fails and Mr. Mayer does nothing to save her.
Ian Kaplan 6/96
Ultimate Risk by Adam Raphael
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