Lloyd’s of London, the specialist market for insuring large and esoteric risks, has itself taken out £650m worth of cover in a new arrangement to protect its fallback fund against extreme losses such as a future pandemic or global financial crisis.
The five-year contract is essentially a reinsurance agreement for Lloyd’s Central Fund.
The first £450m has been financed by a newly created cell company, financed by investment bank JPMorgan. The rest of the exposure is held by a group of eight reinsurers including Germany’s Munich Re, France’s Scor and Berkshire Hathaway in the US.
Set up nearly 100 years ago, and topped up by a levy on Lloyd’s members, the near-£3bn Central Fund is there as a backstop in case a claim against any Lloyd’s member blows through its own capital buffer.
The new cover will reimburse aggregate annual losses in the fund that exceed £600m, up to £1.25bn.
“In the event that something really, really big happens, this makes it much more safe for our policyholders that we will basically pay out the claims they are entitled to receive some money for,” said Burkhard Keese, Lloyd’s of London’s chief financial officer.
Keese added that the structure would also allow the market to write more business, as the arrangement has a lower cost of capital, enabling overall premiums to grow in the region of 30 per cent to 40 per cent.
Lloyd’s Central Fund was set up in the 1920s after one underwriter in the market, Stanley Harrison, incurred debts of more than £360,000, in an event that became known as Harrison’s Folly.
The market’s chair at the time said that Lloyd’s “will never recover in our lifetime” if the money was not paid, according to Lloyd’s corporate history.
Other members paid a share of the debts, ranging from 8 pence to £10,000, establishing a principle of mutuality. The Central Fund was formally created four years later.
The new insurance cover has been placed and structured by Aon, one of the world’s biggest insurance brokers, with the first layer covered by the JPMorgan-financed cell.
Reinsurers included in the arrangement also have units within the Lloyd’s market. Overlaps have a mixed history at Lloyd’s: in the so-called LMX spiral in the late 1980s, the practice of Lloyd’s syndicates reinsuring each other on the same risk spectacularly blew up after a series of large claims saw losses ricochet around the market.
Keese said that the first £450m layer of the cover was fully collateralised, and would be held in safe assets, and the remaining risk was diversified among the group of reinsurers. Lloyd’s had conducted due diligence with the companies to make sure that funds would be available, even if one of the reinsurers had exposure to the same “tail-end” event, he said.
The cover is effective from January 2021. Lloyd’s will seek approval for the model from the UK’s prudential regulator, expected by the end of the year. Lloyd’s expects it to mean an improvement in the market’s central solvency ratio, a key measure of its robustness.
The last claim against the Central Fund was in 2007 and aggregate claims against it in any one year have never exceeded the £600m level that would be required to trigger this new contract, Lloyd’s said.
The Central Fund last had a reinsurance arrangement in 1999, but the JPMorgan-backed structure is a first for the market, Keese said.