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Lloyd’s to levy compulsory loan on members from 2005

Lloyd’s underwriting members will provide a compulsory loan from next year as part of a scheme to grow the Society’s central assets and improve its financial strength ratings.

Lloyd’s unveiled its Capitalisation Project proposals earlier this year which included introducing a rolling 3 percent loan on capacity while abolishing the 1.25 percent levy charged on Lloyd’s insurers. But following a period of consultation with both Lloyd’s insurers and Names’ representatives, Lloyd’s chief executive Nick Prettejohn wrote to members last week revealing that the Society would now seek a rolling loan of between 0.75 percent and 1 percent of capacity from its members, while reducing the annual levy to around 0.5 percent of capacity.

According to Prettejohn, the initiative will enable the Society’s central assets to grow to £2.1bn by 2008 – a required sum if Lloyd’s is to able to weather the regulatory test of a one-in-a-two-hundred-year event. Prettejohn explained that the loan requirements were reduced after some members complained that it would be too restrictive: “Whilst the vast majority of respondents supported the loan structure as a useful mechanism to increase Lloyd’s overall capital resources and solvency, concerns were expressed that requiring loans at a level of 3 percent of capacity per year would have a negative impact on members and their groups,” he explained.

In particular, there was concern about the potential liquidity and solvency implications of the loan structure that could build up to 10 percent of capacity over three years. Given the support for the loan concept we believe that it should continue to form part of the proposals but at the reduced rate of 0.75 percent to 1 percent for 2005,” wrote the chief executive in a 14 July letter.

According to Prettejohn, the simplest way to levy the loan would be as a proportion of capacity rather than on risk – a measure argued by some Names – or premiums written. The loans will be made by the syndicates, probably in April of each underwriting year, and will be invested in assets eligible for the Society’s solvency. In a question and answer sheet, Lloyd’s acknowledges that the “making of these loans will impact syndicate liquidity but we estimate that given the reduced size of the loan, the reduced Central Fund contribution and improved syndicate cash flow this will not be a material issue for the majority of managing agents”.

Under the rules of the Financial Services Authority’s consultation paper, the loan can only be treated as regulatory capital if repayment is discretionary although the aim will be to ensure a rolling repayment of the debt three and a half years after it is made.

Lloyd’s is also proposing to maintain the callable 3 percent of members’ capacity – the aggregate amount of Central Fund callable contributions that members are liable to pay in any one year – and it hasn’t ruled out the notion of creating a subordinated debt issue with the capital markets to improve solvency yet further.

The radical proposals spring from the Capitalisation Review Project – a joint initiative between the Franchise Board and the Lloyd’s Market Association – which was advised by the consultancy firm Deloitte & Touche. They have also been adopted in the light of the FSA’s capital adequacy proposals enshrined in its consultation paper CP04/07.

The Central Fund, which is currently funded by way of a 1.25 percent premium levy on all Lloyd’s underwriting members, is the final link in Lloyd’s chain of security, providing a mutualised safety net for all Lloyd’s policyholders in the event that the backers of a particular syndicate becomes insolvent. Despite being called upon to fund a number of corporate insolvencies in recent years, the Central Fund grew to £711mn at 31 March 2004.

As revealed in the April 2004 edition of The Insurance Insider, Lloyd’s insiders are hopeful that a bolstered Central Fund will improve the Society’s financial strength ratings to a targeted “A+” (Standard & Poor’s) and “A” (AM Best). Earlier this month, Standard & Poor’s affirmed Lloyd’s rating at “A” .

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