A financial institution

This report will look at Lloyds of London as a financial institution and examine the services it offers. A description of the history of Lloyds will be given and provide a background to the institution from its origins leading up to its current position as a major international insurance market. The unique structure of Lloyds will be analysed, changes that have occurred in this structure will be explained and necessary future changes will be highlighted. Lloyd’s business interests encompass a wide variety of financial services including pensions, lending, retail banking, international investment as well as many others.

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In this report we will concentrate on the Lloyds insurance market by providing analysis of insurance as a financial service, examples of recent developments that have affected insurance and Lloyds intended strategy for maintaining their position as a leading insurance provider. In the seventeenth century, insurance of ships and cargoes was often underwritten by merchants who were willing to carry part of the risk of a voyage in return for part of the premium. Commerce of various types was transacted among the merchants who met each other at various coffee houses around the city of London.

One of them, owned by Edward Lloyd, was situated near the River Thames and was frequented by merchants, ship owners and others having an interest in maritime ventures. Lloyd’s Coffee House was situated in Tower Street and was in existence by 1688. Edward Lloyd encouraged the merchants, or ‘underwrites’ (they signed their names at the foot of the insurance contracts), because it brought extra business to his coffee house. In 2002 Lloyd’s of London is an insurance market where 400 hundred syndicates including Lloyds supply a range of insurance services.

Lloyd’s sources its worldwide insurance business by operating through international insurance brokers accredited to Lloyd’s and by being capitalised partly by wealthy individuals known as “names” providing private capital and, more recently, partly by corporate institutions providing corporate capital. Historically, the unique structure of Lloyd’s has been a source of competitive advantage and a base for continuing curiosity about the potential longevity of a worldwide business, which depends significantly on private capital.

The institution is currently based in architecturally distinct, high-tech, state-of-the-art premises in the heart of the city of London. (The UK Financial System theory and practice third edition, 145-150Lloyds employ member’s agents to recruit and advise wealthy individuals known as ‘Names’. The advice is to assist Names in selecting the best underwriting syndicates to back with their capital. The member’s agents also deal with the Names administration requirements in relation to Lloyd’s business. Names normally join a number of different syndicates, each of which specialises in different sorts of risks.

Names are required to accept the principle of unlimited liability, so that if an underwriting member sustains a substantial loss, the member is liable to meet these losses from their personal assets. This Unlimited liability means Names could be bankrupted. Lloyd’s realised the need to boost confidence and encourage future names, and so they established a hardship fund to help badly affected members (The UK Financial System theory and practice third edition, 146). They take shares of the profits or losses from the syndicates they back, proportionate to their capital backing (The UK Financial System theory and practice third edition, 146).

In profitable years the money they are making available can be invested elsewhere in order to earn investment income in addition to the profits derived from the excess in the insurance premiums over the liabilities attributable to any claims (Financial Markets and Institutions Pg). The managing agents act as a financial intermediary managing the asset portfolio’s of the names. There are strict regulations as to the make up of these asset portfolios so they do not have the same scope for risk and reward as funds managed by merchant banks (The UK Financial System theory and practice third edition, 146).

There is a secondary form of profit obtained by the funds under management, in addition to the profits made in access of the liabilities attributable to the underwriting (or losses) (The UK Financial System theory and practice third edition, 146). Following many syndicate’s heavy losses the question of whether a modern international business could remain competitive whilst relying entirely on private capital was raised. In 1994 Lloyds decided to admit corporate capital for first time.

This was an opportunity for Lloyds to increase their underwriting capacity and has enhanced overall capital adequacy. By 1998 60% of Lloyds underwriting obligations were backed by corporate capital (The UK Financial System theory and practice third edition, 147)The Underwriters responsibility is to the insurance syndicates; their role is to accept insurance risks on behalf of the names or corporations providing capital backing in return for premiums. Conversely the broker’s responsibility is to the client wishing to purchase an insurance policy.

Their role is to get seek out the lowest premium from the various underwriters operating within the Lloyds market (The UK Financial System theory and practice third edition, 146). The advantage of being a Lloyds accredited broker is the vast choice of insurance companies and other financial institutions operating within Lloyds as well as Lloyds itself. This level of choice facilitates competition, which benefits the broker’s clients as it encourages lower prices and improved levels of service.

The broker will take his clients request to the ‘leading underwriter’ (first one), normally Lloyds, and discuss the required details and terms. The Underwriter will either accept or decline the risk. If he accepts the risk he will make sure that the terms and conditions of the policy are completely clear before deciding on a premium rate. It is usual for the underwriter to accept a proportion of the risk hence the term ‘leading underwriter’.

It is therefore necessary for the broker to visit a number of underwriters until the whole risk is covered (The UK Financial System theory and practice third edition, 147). The Substantial losses made in the late 80’s and 90’s also caused doubts to be raised over the managing agents. Legal action was taken by Names against managing agents for negligence with Names demanding underwriting obligations be dropped (The UK Financial System theory and practice third edition, 148).

A resolution was reached when the Lloyd’s market made a i?? 3. 2 billion out of court settlement with Names in 1996(The UK Financial System theory and practice third edition, 148). As a result in September 1996 a new company called Equitas was set up to take over more than i?? 11 billion in old liabilities incurred up to and including 1992. Equitas was not authorised to write new business, the rationale being to diminish all outstanding liabilities over time (The UK Financial System theory and practice third edition, 148).

Lloyds transferred the ownership to a discretionary trust, the trustees of which are required to work in the interests of the Names whose obligations are reinsured by Equitas (The UK Financial System theory and practice third edition, 148). Equitas has set up a new American Trust Fund (EAFT), to ensure adequate funds are available in dollars for US obligations and that Lloyds are able to include the Equitas reinsurance business in solvency tests required by the regulator (The UK Financial System theory and practice third edition, 148).

The Legal disputes are still running, especially in the USA, where an announcement was made as recently as October 2002 detailing a proposal to take legal action against Equitas. (The UK Financial System theory and practice third edition, 148). The purpose of insurance is to cover undesirable financial consequences to individuals or businesses referred to as ‘risks’. Every individual and business faces numerous and unavoidable risks such as theft or damage to property by, fire, hurricanes, floods etc.

This makes the transfer of risk to an insurance provider very attractive as heavy losses can be avoided in exchange for a known premium. A known premium is desirable because it alleviates the need for businesses to hold large funds to cover potential losses, meaning these funds can be invested elsewhere (An introduction to Lloyd’s, page 1/2). Insurers do not insure against speculative losses such as losses that arise from poor investment performance or profits that are not achieved. The insured is either in a loss or no loss situation (An introduction to Lloyd’s, page 1/2).

Each policyholder makes a fair contribution to the insurers trust funds dependant on the degree of hazard and the values or liabilities associated with that risk. “In this way insurance companies seek to spread the risk amongst all those that insure by compensating those few who suffer a loss out of the funds built up by many” (An introduction to Lloyd’s, page 1/3). It is not possible to insure against an event that is certain to occur (except for life insurance), insurance must facilitate the transfer of risk and the definition of risk requires uncertainty. (An introduction to Lloyd’s pg 1/3).