Lloyd’s has traditionally been the centre of insurance underwriting in London for over 300 years. Despite some difficulties in the last two decades, the Lloyd’s brand remains strong. It is internationally respected, has franchises in over 80 countries and is licensed to conduct business in every US state. Lloyd’s also carries a strong rating with the major rating agencies, and all underwriting is backed by the New Central Fund as maintained and held by Lloyd’s itself. Being able to take advantage of this franchise removes a considerable amount of time and cost to setting up around the world.
There are two aspects to undertaking business within Lloyd’s:- acting as an underwriting agent; and, providing underwriting capital and accepting risk. The former requires the regulatory approval of the FCA and Lloyd’s, whereas the latter only requires the approval of Lloyd’s (albeit that the FCA are consulted by Lloyd’s in this respect).
Understandably, Lloyd’s and the current market players are keen to protect this strong brand, and not to allow any dilution of it. Thus, to create a Lloyd’s managing agency anew is extremely difficult. However, to introduce new underwriting capacity is generally less difficult providing that it is seen that there is a strong business plan and that the capital provider can demonstrate that their participation in Lloyd’s adds to the strength of the market.
As a result, many new capital providers start simply by providing capital to the Lloyd’s market, and then gravitate to owning their own agency through a “turnkey structure”.
At the outset, it must be understood that this process takes a considerable amount of time, and the difficulty and related expense should not be underestimated. There are many idiosyncrasies to the Lloyd’s market that make it a unique market place, and these need to be explained and understood fully.
This note explains some of the basic aspects of the process of setting up in Lloyd’s, and is certainly not an exhaustive explanation of the whole process or all the issues that will be faced.
The Provision of Underwriting Capital
Underwriting capital, better known as Funds at Lloyd’s (“FAL”), can be provided directly by individual underwriting members, or more likely nowadays, through corporate members. These corporate members may be owned by one or more shareholders, although each shareholder will need to be approved by Lloyd’s as “controllers”.
The FAL is made available to support the underwriting of risks within a Lloyd’s syndicate. The FAL must be put into Lloyd’s by the “coming into line” date (which is usually around the middle of November) each year, and can be put in by way of:
- LOC’s (from Lloyd’s approved bank and in Lloyd’s standard form)
- Approved investments
What type of Syndicate do you wish to support?
Syndicates are not legal entities as such, and do not carry the risks themselves. The risks are carried by the underwriting members themselves that sit behind the Syndicate. A Syndicate may have one or more underwriting members, each accepting several liability for their agreed proportion of Syndicate risks.
There are various ways in which underwriting members may participate in a Syndicate. These principally are through:
- An existing syndicate – the underwriting member provides FAL to an existing syndicate. The issue here is to ensure that such FAL cannot be used to support prior years’ underwriting result especially if there has been a loss.
- A new standalone Syndicate – there is no risk of bearing past year losses, but this does require the creation of a separate new business plan that needs the scrutiny and approval of Lloyd’s
- A parallel Syndicate – this is a new syndicate set up in parallel with another existing syndicate and writes the same risks as the primary syndicate on a co-insurance basis. It can be of a whole or partial account basis.
- A Special Purpose Syndicate (SPS) - these are syndicates that do not accept primary risks, but accept risks by way of reinsurance from another Syndicate. This reinsurance could be on a whole or partial account basis
- Syndicate Reinsurance – this is not a participation within Lloyd’s although will need to be approved by Lloyd’s. It is simply an option that if an insurer wishes to understand the Lloyd’s market without setting up within Lloyd’s, and the cost and time issues that go with this, then this may be a first viable option.
Whichever option is considered best, detailed discussion with Lloyd’s is required at an early stage. For investors already familiar with the Lloyd’s market and the book of insurance risks that they wish to place through their syndicate, then a new standalone syndicate is perhaps preferable. However, an SPS can form a useful vehicle for those coming into Lloyd’s and simply wishing to understand how the market works before committing themselves to separate underwriting.
So which type of Syndicate would one choose? The factors include:
- All bear risks but none are legal entities
- SPS’s only reinsure risks – the others are direct risk bearers
- A standalone syndicate writes and controls its own risks – Parallel Syndicates and SPS do not
- SPS’s are much cheaper to run – usually only one reinsurance contract
- SPS’s do not need TOBA’s (terms of business agreements) with brokers, to be registered with Xchanging for settlement of premiums and claims monies, do not issue policies, regulation is lighter, and the application process to Lloyd’s is easier. In essence, they are much simpler and easier to run.
The application process is not especially difficult but can be time consuming. It is important that Lloyd’s are fully involved. The usual chronological order is
- Initial Discussions with Lloyd’s
- Initial Discussions with Franchise Board
- Franchise Board approve in outline
- Formal Application + Fee + Syndicate Business Plan
- Formal Approval by Franchise Board
- Submission of forms to Lloyd’s Chatham
- Submission of FAL (eg deposit of Letters of Credit to Lloyd’s Chatham)
Setting Up and Owning a Lloyd’s Managing Agency
Many parties interested in having a Lloyd’s platform wish to own their own agency. They consider this to be where the real value is within the Lloyd’s market. Indeed, having seen some of the pricing of recent M&A transactions in this market, this is undoubtedly true.
How does one set about owning a Lloyd’s managing agency?
The simplest and quickest route is by acquisition. This is not without difficulty, cost and time. The regulatory hoops must not be underestimated, nor must the likely multiples to be paid by way of price. Further, there are simply not many agencies for sale at any one time, and competition can be fierce to acquire those that may be for sale. The other aspect of buying an agency is the need to take on the run-off of the past liabilities for the Syndicates on whose behalf it has underwritten. The time and expense of this can be considerable.
The alternatives are simple to start up from scratch, or to operate under a Lloyd’s agent providing turnkey solutions. The former will take a considerable period of time and cost, and require detailed planning. There is also the likelihood that Lloyd’s will refuse to agree – Lloyd’s has publicly stated that it does not wish for further agents to be authorised in its market.
The received wisdom is therefore that a hosting or “umbrella” arrangement under a turnkey agent is the better way to proceed. In essence, the turnkey agent agrees to warehouse the new agent under its own Lloyd’s permissions, with the usual intent that the new agent will apply for its own Lloyd’s permission within three to five years. This is all managed under a Third Party Syndicate Management Agreement (the “TPSMA”)
The typical structure for the operation of a turnkey set up is set out on the next page in diagrammatic form on the final page of this memorandum.
There are some disadvantages of the turnkey structure. It isn't simply a “plug in and play” solution – there are many aspects, such as, relating to tax, financing, and employment that must be dealt with. The costs are also not perhaps as low as setting up outside Lloyd’s.
There is a heavy need for the host agent to provide actuarial support, which often is not readily available.
The Principal Turnkey Documents
Depending upon which type of syndicate is chosen, over 50 can be expected. The principal documents include:
- Application and Controller Forms – to the FCA and Lloyd’s
- TPSMA – this is the main agreement between the host and new agent
- Member’s Agreement (standard Lloyd’s form) – between Lloyd’s and the corporate members of the Syndicate
- Managing Agent’s Agreement (standard Lloyd’s form) (MAA) – between the host managing agent and the corporate members of the Syndicate.
- Bespoke Addendum to the MAA – this sets out the bespoke specific details of commissions and fees payable to the host agent, and other variations to the standard MAA
- Shock Loss Agreement – this is simply a funding contract whereby the capital provider agrees to provide short term funding of its corporate member in the initial period underwriting by that corporate member. This is to protect against unexpected losses and cash flow losses that may arise before reserves have been built up.
- Reinsurance Contracts (at Syndicate level) – these reinsure the risks underwritten by the Syndicate, and are subject to notification and approval by Lloyd’s
- Qualifying Quota Share Agreements (at Corporate member level) – these reinsure a proportion of the result of corporate member. These are not subject to approval by Lloyd’s but carry many tax issues (such as transfer pricing) that need detailed consideration.
The Third Party Syndicate Management Agreement
The TPSMA is the most important agreement in any turnkey operation. It sets out the liabilities, duties and responsibilities of the parties in managing the Syndicate. The TPSMA requires the approval of Lloyd’s. The format of the TPSMA usually includes
- Underwriting and Named Underwriter
- Reinsurance to Close – this is the closing of the Syndicate results at the end of the third year.
- Audit – the right to audit is important.
- Investment – this may be done by the capital provider or the host agent.
- Actuarial – this is fundamental, especially with the current Solvency II projects
- Service Standards
- Contingency/Disaster Planning
- Client and Independent Audit
- Records – updating and safe keeping
- Data Protection (note “safe harbour” provisions)
- Syndicate Costs – it is important that these are clearly defined.
- Syndicate Business Planning – a Syndicate must submit its business plan to Lloyd’s for approval.
- Payment Terms
Effecting Outwards Reinsurance Programme– this will need the approval of Lloyd's'.
Professional Indemnity Insurance– against the agent’s errors and omissions.
Substitution of Agent– necessary if the host agent fails or is otherwise unable to perform.
- Client Relationship Management
- Dispute Resolution
- Change of Control Provisions
Term and Termination– this can occur in many ways, and the effects of each must be anticipated and dealt with.
- Termination by Corporate Member
- Termination by Agent
- Migration – if the initial syndicate is an SPS or parallel syndicate, there is a need to anticipate how each will migrate to a Standalone syndicate
- Cessation of Syndicate (it should be noted that a corporate member cannot be wound up by way of insolvent liquidation)
- Effects of termination and run-off
- Reinsurance to close – the corporate member may wish to prescribe how this process occurs.
- Dealing with tax issues post termination (especially US tax issues)
Current Lloyd’s Fees (for 2013)
For 2013, the Lloyd’s new central fund contributions are 2% of written premiums for each of the first three years of operation, and a Lloyd’s member’s subscription fee of 0.5% of written premiums.
It should be noted that the New Central Fund contributions are only 0.5% (not 2%) of written premiums if the new corporate member participates in an existing syndicate. Further, additional new central fund contributions of up to 1.5% will be considered where Solvency II implementation is considered insufficient
Additional Contributions of 0.75% of written premiums may be payable if written premiums exceed allocated syndicate capacity (as contained in the Syndicate Business Forecast)
The basic Lloyd’s Application fee for Corporate Membership is £25,000.