Speakers:

Edward J. Muhl
Superintendent of Insurance
New York State Insurance Department

Nicholas E.T. Prettejohn
Head of Strategy
Lloyd's of London

Sean F. Mooney
Senior Vice President and Economist
Insurance Information Institute, Inc.

Christian M. Milton
Vice President, Reinsurance
American International Group, Inc.

Host:

Sydney M. Cone, III
C.V. Starr Professor of Law and Director,
Center for International Law

DEAN WELLINGTON: Welcome to New York Law School and to this symposium, which promises to be a rare treat. This is the first conference that our new Center for International Law has sponsored in conjunction with our old and venerable Journal of International and Comparative Law. The Center has an extraordinary director, someone whom I have known for a very long time. It also has a distinguished board of advisors, and the Chairman of the board of advisors, Lewis Glucksman, is here to support us. The Starr Foundation created a chair in the law of international trade and finance, and it gave us some seed money for this center. When we got the grant, I knew the person I wanted to be its director. When I started teaching law, he was in the class I began with. I think he also helped edit one of the first articles I published. He was based in the Paris office when I began thinking about filling the chair and the directorship, and when he happened to be in New York we had lunch. I subsequently learned that he thought that maybe this would be a good job for him. I certainly had him in mind for the position. Sydney M. Cone, III, known far and wide as Terry, is a great and distinguished international lawyer who has spent many years primarily in the practice of international finance at Cleary, Gottlieb where he has been a partner. Terry has been in the Paris and Brussels offices of Cleary, Gottlieb. He has also been instrumental in setting up offices around the world and in bringing the Russian Government to Cleary, Gottlieb as a client. He is also a scholar. This year, he produced a book entitled The International Trade in Legal Services. It is published by Little, Brown and it is a joy to read. I urge it on all of you. It is funny and it is very informative. Terry is an extraordinary addition to this institution, and I would now like to introduce him to you.

PROF. CONE: Thank you very much Harry. I do appreciate the introduction. This symposium is about the implications of the reconstruction of Lloyd's of London. A major subject because the reconstruction of Lloyd's of London is a phenomenal event. It has as a background, years of difficulty, years of litigation, years that would be consumed with problems relating to toxic torts, to mass torts, to the organization of the insurance industry. It is really one of the epochal events of our time and one of the singular successes of this year. One is always tempted to call such a phenomenon unique, and today, the day after Election Day, I feel safe in saying that it is unique in one respect. It is one success for which none of the candidates claims credit.

We are extremely fortunate to have the speakers who are here today to deal with the implications of the reconstruction of Lloyd's of London. We have Edward Muhl, the New York Superintendent of Insurance, Nicholas Prettejohn, the Head of Strategy of Lloyd's of London,1 Sean Mooney of the Insurance Information Institute, and Christian Milton of American International Group. Our first speaker is Edward Muhl, the New York Superintendent of Insurance. It is a great honor for this law school that he has agreed to come here to be with us. I give you Mr. Muhl.

MR. MUHL: Thank you very much, Professor Cone. Ladies and gentlemen, it is a delight to be here for a number of reasons. It is also really special to be here to participate in this symposium with this distinguished panel that we have. Professor Cone had indicated that this symposium, the implications of the reconstruction of Lloyd's of London, is intended to be forward looking and is less concerned with the events of the past. But I feel compelled to describe briefly some of the past events in order to discuss, what I believe, to be some of the important lessons going forward, particularly some of the implications of the reconstruction from a regulator's view.

Let me first set the stage, if I may. Picture this if you will, it is early January 1995. My very first day in the insurance department as the Superintendent of Insurance for the State of New York. I called all of my senior management team together at the time. I introduced myself to them and then I asked each for a very full briefing of anything that was pending before the department, anything of significance or importance, anything of controversy they needed to tell me about. Later that morning I was handed a report and it was the department's review of the adequacy of the Lloyd's of London U.S. trust fund. Along with this report was an order that the insurance department counsel had put together. If I had signed that order, it would have de-accredited Lloyd's of London as an accredited reinsurer and an accredited excess and surplus lines rendered in New York, basically for their failure to maintain adequate monies in trust.

After reading the report, and it was a relatively large report, I called the governor and asked him who was his second choice for my job, because I was about to demand a recount. New York is basically a port of entry of Lloyd's for the United States because we oversee all the U.S. trusts. We also control its status as an eligible writer in the United States market as well as in the excess and surplus lines. I asked my senior management if they realized what would happen if I signed the order. The general answer was very simply that Lloyd's would be de-accredited. I responded by saying, "If I sign this order, the insurance world as we know it would change."

I then asked my staff how many New York license companies had the bulk of their reinsurance recoverables through Lloyd's, and how many countrywide. The answer was that New York had fifty-one companies and countrywide we figured about 300 companies. So if I sign that order, Lloyd's and its reconstruction effort at the time would have failed and we would have fifty-one insolvent New York insurance companies and, at a minimum, 300 insolvencies countrywide. All U.S. major airports, including the likes of Kennedy, Newark and La Guardia, would have no coverage or recoverables because they insured directly in the E and S market through Lloyd's. Furthermore, the New York Port Authority and the Long Island Railroad would be without recoverables and insurance on the direct basis due to a possible lack of capacity in this industry if Lloyd's were to fail. This had the potential to be the most cataclysmic event that the insurance world had ever seen. And all of this on my first day on the job. My timing, I would suggest, was absolutely unbelievable.

We set out to find a solution to this monumental problem because we did not like the alternatives. If we were to pull the plug, capacity would dry up for at least two years, prices would skyrocket across the board, and how do you deal with 300 insolvencies of primary insurers all at the same time? Our primary responsibility, however, was to protect U.S. policyholders' interest. Lloyd's American Trust Funds are there because New York State Insurance Department requires Lloyd's to put up in each of these trusts $100 million for the excess and surplus lines, and another $100 million for reinsurance. In addition, we require Lloyd's to put up dollar-for-dollar on all U.S. liabilities on a gross basis whatever they insure. We examined the trust and found $13 billion to be in trust. That is a little bit shy of what they were supposed to have at the time, shy by about $7 billion net. I elected to immediately stop the bleeding by requiring Lloyd's to create two new trusts and to fully fund these trusts on a dollar-for-dollar gross basis on all U.S. business written from that point forward. So we were able to stop the problem from escalating. We then set out to deal with the problems of the past.

We worked with Lloyd's on their new company, later called the Equitas project, which was simply a mechanism to marshal assets and to pay claims of policyholders, including U.S. policyholders. As the domiciliary regulator of LATF, Lloyd's American Trust Fund, the New York Insurance Department was required to approve any transfer of funds from LATF to fund Equitas. We wanted to achieve several objectives. The primary one, as I mentioned before, was to protect U.S. policyholders' interest. Another objective was to represent the other forty nine state regulators in this effort. Yet another objective was to make the Equitas project work.

The negotiations we entered into were very intense and at times were quite sensitive. These negotiations literally came down to within minutes to midnight London time on the day that the deadline was set. We had open phone lines to Lloyd's, to the Department of Trade and Industry ("DTI"), to several U.S. and British law firms, and to Citibank as trustee of the Lloyd's U.S. trust. Prior to approving the partial transfer of monies, we required the incorporation of a number of safeguards, including an additional $1.2 billion, basically $800 million in cash and $400 million collateralized guarantees, to be contributed to the Equitas trust to support solely U.S. dollar denominated liabilities. We are very proud of the work that we did and it was a gratifying experience to work closely with the British regulators at the DTI, Lloyd's, the Equitas officials, particularly David Rowland, Lloyd's chairman, the Federal authorities, and the representatives of the Canadian government. Our efforts resulted in the reconstruction effort going forward with what we believe is a stronger Lloyd's of London-well positioned to compete both in the worldwide reinsurance market as well as in the surplus lines markets. The Equitas project itself, although not perfect, represents the best solution to a difficult process. Equitas, in my opinion, is the best chance for U.S. policyholders to receive full payment on all of their claim activity.

But there are lessons to be learned from these extraordinary events. In fashioning answers to difficult problems we kept asking ourselves, how did these problems escalate to the point where we were at the brink of a serious solvency issue? How did Lloyd's basically fall prey to these difficulties? In hindsight we find that it was a combination of several significant factors. Not the least of which was complacency, and incompetence in some cases. Then there was retro-liability involving asbestos and environmental claims in the United States and natural disasters such as Hurricanes Andrew and Hugo and the Northridge quake. These were coupled with the losses at Piper Alfa and the Valdez oil spill. Finally, there was the reinsurance ceeding amongst themselves without adequate information and without knowing that the Names were reinsurancing themselves in many instances.

One of the most significant issues revealed to our staff during the investigative review process was a problem with the process that actually made Lloyd's so unique in the first instance. This was their usual but actually unusual accounting process, or maybe I should say their lack of accounting. In fact, some of the syndicates actually did not know what their exposures were. We must remember that Lloyd's has a long and proud history. It is an institution steeped in its origins and its traditions. An underwriter in the 17th or 18th century would be very comfortable with Lloyd's in the 1990s because not much had changed over that period. But insurance and reinsurance transactions have become substantial and complex and require a greater degree of sophistication in monitoring, in measuring, and in general information processing. Many of the Lloyd's syndicates lack the sophistication which resulted in the escalation of many of their problems. Fortunately, Lloyd's has now come into the modern age and is now using computers. The New York Insurance Department is also requiring Lloyd's to file individual quarterly and annual financial statements for every syndicate writing either reinsurance or excess in surplus lines. We are requiring separate trust funds for each syndicate writing U.S. risks. We are also requiring syndicates to separate their reinsurance business from their excess lines business and to file statements reflecting their experience in each market.

These requirements have added a crucial element of accountability and transparency that was missing in the past. It is important to create a system of checks and balances to determine whether the process is working as intended. It is also important for the underwriters to use all of their skills in assessing the risk exposure and pricing it properly. They cannot afford to use unskilled or ill-prepared individuals in this very critical role. The management has a responsibility to test the system to determine compliance with policy and good insurance practice and not become complacent with process or tradition. It is important for Lloyd's and Lloyd's syndicates, particularly for their credibility, to make their accounting systems even more transparent. We believe that it is important for Lloyd's to abandon their traditional three-year accounting in favor of a one-year approach. Such a move will make it easier for customers, investors, analysts and regulators to assess the financial strengths and weaknesses of the organization. Their problems can be identified earlier and hopefully the misdeeds of the past will not be recreated.

Lloyd's has over the years prided itself on being self-regulated. The DTI conducts solvency tests and provides some overall regulation through a very talented and very dedicated staff. The DTI, though, does not examine Lloyd's itself or its syndicates, and this has the potential of creating a very large credibility problem. Personally I am not an advocate of over-regulation because there are significant dangers to the market that are associated with over-regulation as there are with under-regulation. Balance is very important, but I sense that no one, including the British government, wishes to go through this maze a second time. I believe that if the system of self-regulation were to continue, there should at least be a limited review and compliance oversight through Lloyd's, but by an independent, reporting to Lloyd's. The system of testing, if you will, gives management yet another view in order to avoid the mistakes of the past.

The new Lloyd's is now positioned for significant market rebound in my opinion, and its importance to the U.S. market and its significance to the world of insurance generally is quite great. I have come to understand how small our world really is because we are dealing in a global insurance marketplace and there is an absolute interdependence of the players within that market. Professor Cone, I will be more than pleased to answer questions.

SPEAKER: Could you clarify your position on Lloyd's self-regulation as opposed to overregulation?

MR. MUHL: Well, I believe that they need to become a bit more transparent than they are. The self-regulation has served them to the degree that it has over these years. I understand their desire to continue with self-regulation, but I believe that there ought to be, if there is going to be a continuation of self-regulation, some outside audit review. This would in fact aid Lloyd's to review itself and then to report back to management their findings that maintains the degree of self-regulation. But it also adds an element of outside review that could aid and assist them to avoid the problems that they have experienced in the past.

SPEAKER: What kind of outside review?

MR. MUHL: Independent audit review taking the form from CPA audits to insurance audits, but done through the Lloyd's system.

SPEAKER: So it would still be internal?

MR. MUHL: Essentially internal. That is assuming that self-regulation continues.

SPEAKER: Do you think that they should have outside regulation?

MR. MUHL: As I have indicated, I have mixed emotions about it. I am concerned that if you have overregulation that you can cause trauma to a very delicate market system and you really do not want to do that. I believe they need to do something more than they have done in the past. But to open it up to overregulation, possibly more onerous regulation, would not do any good for the marketplace itself. There has to be a fine balance somewhere in that process. Thank you.

PROF. CONE: We also have with us today Lloyd's Head of Strategy, Nick Prettejohn. I am very grateful to Nick who flew over yesterday from London in order to be with us. He has to fly back to London this evening and I think we should all be grateful that he has taken the time to come here and talk to us about the implications of the reconstruction of Lloyd's of London.2

MR. PRETTEJOHN: Thank you very much. It is a great pleasure to be speaking at an institution that, as I saw from the "flyer" for today's event, talks about the discipline of scholarship and entrepreneurship. You would very rarely see those two words juxtaposed so favorably in my country. Therefore, it is a great pleasure to come to a country where those two words can be uttered in the same consistent breath. I am going to talk about the new Lloyd's and the issues and challenges that we face from the perspective, as Terry said, of my position as Head of Strategy. I have to say I think strategy is one of those splendid words that has fallen into severe misuse along with perhaps "Madonna," and I think perhaps after last night's TV coverage, "landslide" (reference to President Clinton winning the election).

The business plan that Lloyd's published in 1993 basically fell into two parts, firstly, to manage the problems of the past and then secondly to build the new Lloyd's. I will try to avoid the pitfalls that befell Samuel Beckett in the first performance of his great play Waiting for Godot. The critics said afterwards that it was awful, it was boring, nothing happened, twice. And so I hope these two parts will not fall into that same trap.

I will talk very briefly about managing the problems of the past and spend most of my time talking about building the new Lloyd's. Our Reconstruction and Renewal program was formulated in response to twin problems of liabilities and litigation. Coming out of that successful reconstruction, we have two things: a clean balance sheet and clear minds for the future. In terms of the clean balance sheet, Ed Muhl has talked about the establishment of Equitas. We believe Equitas to be a strong and well-reserved company that will offer policyholders the benefits of expert claims handling and a properly capitalized balance sheet. (I would like incidentally to pay tribute to Ed Muhl and his department for their ceaseless work over the period of our Reconstruction without which our Reconstruction would not have happened. They have put in an enormous amount of effort and we thank them very much indeed for that). As a result of the Reconstruction we have a new Lloyd's market which retains the historic expertise but is free of past liabilities and costs. It has secure assets, and it is free from the cloud of litigation that so got in the way of sensible commercial thinking. We have a strong ratio of net assets to technical reserves, perhaps best understood as the margin for reserving error, that compares very favorably with industry comparisons. Before the Reconstruction, we had a very weak balance sheet indeed; now we have one that can compete in a world where financial security and strength is a paramount consideration to our clients and policyholders.

I will now talk about the industry environment in which Lloyd's competes, and then about Lloyd's competitive assets against the demands of that environment. Finally, I will pick one or two of the issues and challenges that I think Lloyd's is going to face as we move forward. The industry environment in which we compete is characterized by a number of factors. First, there is increasing risk. I had the preconception when I joined the insurance industry that insurance was a dull, boring industry with no growth. My experiences at Lloyd's certainly took care of the dull and boring concern, but the no growth preconception has also been changed from my brief period in the industry. The world is an increasingly risky place, and that constitutes a fundamental engine for growth.

Second, the industry is showing considerable signs of consolidation. In the reinsurance industry, the top ten reinsurers now count for about half of the world reinsurance business, and that is up from twenty five percent, ten years ago. There has been a major period of consolidation in the industry and it is still going on, driven in large part by the concerns about balance sheets and security that I mentioned earlier. Third, as with many industries, technology is having a considerable impact. It is changing the way insurance products get distributed as lines of communication between client and insurer get shorter. It is also changing the role of intermediaries and creating the potential to reduce cost throughout the insurance system. However, in the short run, it creates a competing upward pressure on costs because companies are forced to invest to take advantage of increased technological capability. Fourth, customer needs are changing. Major corporations are increasingly self-insuring and thinking about traditional insurance in different ways. Therefore, insurers and reinsurers are having to re-evaluate the way they do business. Our strategy must reflect what our customers are thinking, and their thinking is changing quite dramatically in some areas. Finally, the whole nature of capital is changing: it is no longer simply enough to provide the traditional insurance capital. One has to be able to think about the alternative sources of insurance capital, for instance, the alternative that can be provided by the capital markets.

In summary, the minds of the traditional players in the insurance industry, whether they are brokers or underwriters, have to focus on what value they are actually bringing. Are we simply providing capital to bolster our client's balance sheets or are we really providing expertise? That all adds up to a fundamental change; I am an optimist because I believe that fundamental change brings considerable opportunities for those who have the right capabilities.

My belief is, now that we are clear of the Reconstruction program, Lloyd's has the set of competitive assets which, if we can address some of the challenges that I will talk about later, can provide us with a unique competitive proposition in the world insurance industry. Let me spend a minute talking about the assets that I believe that Lloyd's can bring to this intensely competitive arena. The first of those is underwriting talent. The studies of the industry that we have seen, for instance, by McKinsey and other knowledgeable commentators, all focus on the paramount importance of underwriting capability. In other words, the ability to identify and price profitable risks. I believe that the surviving Lloyd's market is in a good position to deliver the underwriting talent that clients need. Having been through the attrition caused by incompetence, complacency, and inadequate management controls that were so well described by Ed Muhl earlier, we now have underwriters, who have acknowledged world expertise and a very strong track record. This is true in areas like medical malpractice, directors' and officers' liability, and catastrophe insurance or reinsurance, as well as in the traditional marine insurance and aviation markets where we are world leaders.

This expertise has translated into a very powerful profit performance for those underwriters who have survived the period of considerable attrition and hideous losses of the late 1980s and early 1990s. This chart shows the performance of the syndicates that survived into 1996 versus the overall market (see appended chart entitled Lloyd's Profits/Losses 1986-95. Result after Personal Expenses/Gross Capacity ). The bar on the left shows the performance of the surviving market and the bar on the right shows the average for the market. You will see a significant period of profitability during the mid to late 1980s, and again in 1993, 1994 and 1995. But look at the middle period when the market was making severe losses, shared outside by the London market and indeed the global industries. Our surviving businesses barely made a loss at all; that is the ultimate testimony to the power of those businesses as we go forward.

The second competitive asset we have is in our broking network and its loyalty around the globe. I will not pretend for a moment that the role of the Lloyd's broker does not have to change. The whole broking industry is going through a period of fundamental change, and the value that traditionally has been added by intermediaries has been brought into increasing question. They are having to redefine their business in the same way as the underwriters. But nonetheless, the loyalty and strength of the Lloyd's broking community is a major competitive asset.

We have a very strong and long-standing set of customer relationships, and the value of those customer relationships cannot be understated. That, I think, is ultimately what people mean when they talk about the strength of the Lloyd's market. It is the ability to come back year after year, talking to our clients, understanding their needs and doing business with them. Many of the key clients and key customer relationships that we have in the Lloyd's market are the result of decades of work and relationships. There is no more powerful indication of that fact than the ability of the Lloyd's market to retain premium income during the period when our difficulties were probably the best publicized difficulties in the world commercial arena. The fact is, Lloyd's has managed to hold on to an extraordinary business through a period where it has been under intense scrutiny, and indeed competitive attack. So I think the performance of the Lloyd's market both in terms of the profitability of the survivors and the retention of business bodes well for the future.

We also have a resilient capital base. Through the period of intense losses that I have referred to, we have actually been able to maintain our level of capital support. Further, if you look at the bottom three bars for 1994, 1995, and 1996, we have been able to attract a significant degree of high quality corporate limited liability capital, both from financial institutions and from trade investors. (See appended chart entitled Lloyd's Membership 1993-96 Gross Allocated Capacity Split by Type). I will come back and talk a little bit more about that without treading on Chris Milton's comments that he is going to make later on.

Finally, I think the magic ingredient that actually translates the previous competitive assets into a really outstanding competitive proposition is the structure and culture of Lloyd's. You have heard that in some ways Lloyd's did not change from 1700 to 1990. Of course, there were some dreadful consequences of that which we have spent the recent period of time wrestling with. But there are also some advantages and some merits. I think the fundamental one is the ability to organize ourselves into small responsive commercial units. I have advised major companies, I have worked in or with major companies, and as a venture capitalist I have presided over the dismemberment of major companies. I can tell you that the major companies of the world would strive very hard and probably spend a lot of money on expensive consultants trying to recreate many of the positive aspects of the Lloyd's culture. One of the aspects of the Lloyd's culture that many major companies have tried and failed to create is its small profit responsible teams where there is both a direct link with the customer and between the underwriter and the claims handling team. That is an extremely powerful asset, and as I have said, is the one which transforms those other preceding assets into something that is uniquely powerful. So, we have an industry environment that is characterized by change. I believe that change provides opportunity. I also believe that Lloyd's has many of the assets that can create that opportunity and take advantage of it. But there is absolutely no room for anything that remotely resembles the sort of complacency that Ed Muhl talked about before.

There are a number of important issues that we need to address and I will talk a little bit about those now. The first is our capital base. We have sustained our capital base, we have cleaned up our balance sheet through the creation of Equitas and the Reconstruction program and we have introduced limited liability capital. Let me talk more about the issues and the challenges that we face in terms of our capital base. What about the continued existence of our traditional capital? It has proved remarkably resilient through the process of reconstruction and period of losses, and that resilience has presented us with a dilemma because I believe that there are powerful commercial arguments that mean that the traditional form of capital (unlimited liability through the annual venture) is going to have to change over the coming period. It is a very unusual business that has to recreate its capital base each year. It is a very unusual business that has to think about whether its capital structure will allow it to invest in research and development in technology despite the fact that it is very profitable. So to me, the issue of traditional capital is going to have to be tackled progressively over the coming period, in a way that is fair and immediately transparent.

Second, we live in an insurance world which is characterized by an increasing preoccupation with its security, and we need to do everything that we can to make our chain of security and the security that we offer to our policyholders as transparent and as strong as possible. We have to do that in a way that rigorously measures risk, evaluates risk and then controls the entities that can take that risk. We have a strong commitment to a basic level of collective security. It is extremely important for Lloyd's licensing position internationally and our commercial credibility in retaining the absolute commitment of our policyholders. Anybody who is insuring with Lloyd's has to get paid so we have to maintain our system of collective security, not just by relying exclusively on mutualized assets like our Central Fund, but by making sure that our whole chain of security offers the highest quality of security to our policyholders.

Finally, we do have to address the issues that are raised by our changing capital base. There are new agendas as trade investors invest in Lloyd's underwriters, whether they are from Bermuda or from the U.S.. You can see from this chart (see appended chart entitled Change in Corporate Membership), that there has been a profound change in the sort of corporate capital that has been invested in the market. When we started with the introduction of corporate capital it was "spread" vehicles who were investing, but recent investment has been "dedicated" capital (capital backing a particular syndicate or particular agency), and it is increasingly coming from trade investors. I believe that the market can only be improved by the influx of corporate capital and trade capital. The market will be strengthened in terms of management control and discipline, that will ensure we do not repeat the mistakes Ed Muhl described earlier.

I do not believe in the currently fashionable view that once Lloyd's has been "bought up" by these trade investors, that will represent the end of traditional entrepreneurism in the Lloyd's market as we know it. We are only just seeing the beginning of an endless wave of transactions and changes of ownership. Actually, I believe that out of the competitive strengths of Lloyd's in the future will be a hothouse of investing activity, and I believe that the introduction of trade capital in particular will encourage younger underwriters and their teams to set up independent businesses. So there are some major issues that we are going to have to tackle with our capital base that actually get to, in many ways, the whole identity of Lloyd's as a marketplace and an institution.

Now for another perhaps less glamorous issue: our cost base. When we published our business plan in 1993, we said that Lloyd's had become an increasingly high cost market in which to do business. You can see from this chart (see appended chart entitled Lloyd's Cost Base), by looking at the escalation of the bottom section of each bar, which is the ongoing cost of the market, that through the second half of the '90s we built up a cost base which made us uncompetitive in the market. Now you also can see from the rather gratifying decline in the bottom section of each bar that we have taken some steps to reduce out ongoing cost base. But again, I do not think that we can afford to be complacent. We need to take some pretty radical steps to ensure that Lloyd's is a cost-competitive market in which to operate.

I should say as an aside that I am not a fan of the argument that says you have to be low cost in the insurance or reinsurance business to deliver superior levels of profitability. I can discern absolutely no relationship between low cost and high profitability in any analysis of profitability in the insurance industry. But nonetheless, if you compare the cost of doing business in Lloyd's with the cost across the international arena, whether it in the U.S. insurance industry or in the U.K., Lloyd's has a high expense ratio. We have to do something to reduce the level of cost that we have in the marketplace.

While the market has itself been doing a pretty good job of reducing the level of cost there is more to do. I have talked about the attrition in a number of syndicates in the marketplace, there were about 400 in the early 1990s and that figure has come down to between 150 and 160 syndicates at the moment. There has been a considerable weeding out of poor performers and consolidation of superior performers. The average capacity of syndicates has gone up significantly as a result, and for those disciples of economies of scale the costs at a syndicate level are gratifyingly down in percentage terms. Now, in the same way that there is a question mark about the impact of the changing nature of our capital base for the entrepreneurship and the culture of Lloyd's businesses, there is also a question mark about the impact of that consolidation. There are going to be big management challenges to make sure we preserve entrepreneurship and the small team mentality, while at the same time instilling the disciplines of management control.

Aside from cutting costs, there is also the small matter of growing the business. I alluded earlier to the fact that we had not lost as much business as you might have expected us to, through our recent period of criticism, scrutiny, and difficulty. But equally I cannot pretend that we have demonstrated the performance of a growing business. We need to do many things to develop our business going forward, in terms of our strategy for geography, products and distribution. Traditionally, we have focused on U.S. and other North American markets, but now Europe and other markets around the world count for nearly a third of our premium base. If you compare that with the world insurance market, you would see that we are over-represented in our traditional markets and under-represented elsewhere. We need to put a lot of creativity and effort into thinking about the ways we can develop, particularly in the growing markets in Asia. We also need to address the fact that our American business has not been growing. Part of that is due to our well-publicized difficulties, and extremely capable and aggressive competitors in the U.S. and Bermuda who have taken business away from us.

As far as products are concerned, it may be something of a revelation to some of you that Lloyd's is much more than a marine, aviation and transport business or even a specialty reinsurance business. We are for instance the largest-motor insurer collectively in the U.K.. Lloyd's is about a lot more than some of the products for which it is best known, and we need to think carefully about tailoring our business system within Lloyd's so that each of those types of business can grow profitably. Further we need to think more widely about the challenges produced by some of the trends in the industry which I spoke about earlier, such as the move from traditional insurance products to alternative insurance products in response to changing client demand. So there are some very complicated issues there too. In terms of distribution, it is quite obvious to me that as technology changes, the role of the intermediary will change as clients look for different added value both from their brokers and from their insurers. We are going to have to think very creatively about how we can maintain our very strong partnership and relationship with our broking network, but at the same time move forward to address changing client needs in the future.

There is also a question about regulation. We are thinking about regulation in a review of our regulatory system over the next six months which we announced recently. We need to think very carefully about the different functions of regulation as they have been exercised by Lloyd's historically. There are the functions of policyholder protection which are the ultimate preserve of prudential regulators like the DTI and the New York Insurance Department.

But there are also issues concerning investor protection which have been a major focus for the Lloyd's regulators over the past years, and will continue to be as we make the difficult transition in our capital base. Further, there is a set of, if you like, "commercial rules of the club" which actually defines Lloyd's and makes Lloyd's a rigorously defined commercial proposition. These rules encompass levels of security, management standards, and the levels of control that we need in order to define Lloyd's as an excellent place in which insurance business is conducted. It seems to me that whenever we talk about regulation we need to think about all these functions rather than thinking about regulation as one set of activities.

Then there are the issues about technology. There is a considerable pace of change in this area. The challenges for the insurance business in general, and for Lloyd's in particular, is to keep up with that pace of change in a way that is not too stop-and-start. We need to embrace technological solutions that allow flexibility rather than be misguided in attempting to come up with solutions that are designed to be there for all time. The latter seems to me to be a misguided and expensive objective.

Finally, we have done a lot to improve the level of professional standards in our market, consistent with the objective in our Business Plan. We have been employing more graduates. We now have individual accreditation for underwriters and participants in the market. We have done a lot to encourage and force a raising of professional standards, but there is a lot more that we need to do. At the same time we need to create the mechanisms to regenerate the underwriting talent which is the thing that makes Lloyd's a unique place to do business.

So to conclude, I think we have an industry environment that is characterized by great change. We have in Lloyd's a set of competitive assets that can allow us to take advantage of that period of change. But I will not pretend that we do not have some significant issues and some significant challenges to address before we can confidently say that we can take advantage of those competitive assets I have listed. I think we have achieved a great deal in the past. Clearly we have achieved the Reconstruction. But I think almost unnoticed while the Reconstruction has been going on, the Lloyd's market has transformed itself from an institution that did not know the difference between 1700 and 1990, into a modern, professional, rigorous and competitive marketplace. I think we do have some significant challenges to address. I am confident that we can address them and have the commitment to do so. And as a result of that, I believe we have a uniquely competitive proposition to offer in the world insurance and reinsurance market. Thank you.

SPEAKER: I am going to take advantage of your position as Head of Strategy to ask what might be a question that is impossible for you to answer. There are several things that you said and that came through in your projections that raise a question for me. How does Lloyd's intend to pursue and maintain its excess of loss reinsurance, which from your pie chart is the largest segment of its business at seventeen point eight percent? The capital markets have been looking for ways to provide alternatives to traditional reinsurance to insurer, such as catastrophe bonds, for example. That is a direct threat, it seems, to any reinsurer that has a substantial excessive loss segment of its business. You also mentioned the difficulties associated with funding research and development at Lloyd's. Given the challenges and the problems with coming up with money to find solutions, assuming money is the answer, as Head of Strategy, what do you see happening in the next five to ten years to address that problem?

MR. PRETTEJOHN: I think you have raised a fundamental issue for the industry, not just for Lloyd's. Better brains than I have spent a lot of time in discussing this issue in the recent past. I do not see the capital markets supplanting the role of traditional reinsurance, I see ultimately the role as a complementary one. I do think it will mean that there is a greater focus on what value the reinsurance program is bringing. I think as far as Lloyd's is concerned, the one thing that you cannot accuse Lloyd's underwriters of is an inability to think creatively about how to meet competitive demands. And talking to the excess of loss underwriters, they are alive to this issue. They are certainly not squeamish about the notion of moving away from their traditional role as providers of financial capacity and towards a more advisory role-if that is the right way for them to go and if they can make money by doing that. But I think we have actually a long way to go before anybody will know the answer to whether financial products are going to supplant traditional reinsurance products. I hope that we actually have a role to play in shaping some of that answer to that, rather than simply being victims of a trend.

MR. SUNG: My name is Chan Moon Sung, member of the class of 1993 from this school. The question I have is a general one pertaining to Lloyd's, specifically in strategy, in developing a new market in the newly developing countries of southeast Asia and Asia. Although many other countries are closed, it seems inevitable that these markets will be opening in the future. How do you foresee Lloyd's role in that?

MR. PRETTEJOHN: They are certainly some of the markets in which Lloyd's is underrepresented. I do not know how you would classify the Japanese market in relation to some of those more rapidly developing markets, but there for instance, in response to the deregulation of that market, we are setting up a business in Japan, to have a direct license in Japan. That is a model we may seek to replicate across different parts of southeast Asia and elsewhere, but there may well be other ways in which we need to develop our presence. Each individual market obviously has its own regulatory environment, and that clearly is the starting point for thinking about any entry or development strategy. Certainly, judging from the prolonged absences that some of the underwriters I know have had from London recently, most of them seem to be on trips to southeast Asia. So there is a considerable degree of development activity going on.

The starting point is to successfully develop the relationships and trust with the local intermediaries and local companies to enable a credible business base to be developed. But it is a very important area for us going forward. Very important indeed.

SPEAKER: This is a follow-up question to the question asked of the superintendent. Can you say how the reserves for Equitas were established and whether or not they were reviewed by anybody outside, and whether there is any truth to something that was circulating a few months ago that if you added up all the reinsurance recoverable in the United States that far exceeded the reserves being set up in Equitas?

MR. PRETTEJOHN: The latter part of your question is not something that I would want to get into in this forum, but I was intimately involved in the reserving exercise for Equitas, so I can talk to you about the process that we went through. Essentially, we divided the liabilities that were faced by Equitas into a number of different categories. About half of the balance sheet is accounted for by asbestos, pollution and health hazard liabilities. There we did extensive exposure-based analyses of those liabilities, looking, if you like, from the bottom up, looking at reinsurance programs, assessing the likelihood of legal judgments and so on and so forth, in order to come up with a bottom-up evaluation of those liabilities. I certainly believe that the work that we did there was state-of-the-art evaluation of that type of liability. I think it was Malthus who described economics as the dismal science. I have to say after my experience with the health hazard evaluation that actuarial science is more worthy of the description. We evaluated an almost endless number of different potential health hazards that might create liability for the Lloyd's market.

We then looked at the rest of the balance sheet and we again subdivided the rest of the balance sheet into a number of different areas. We looked separately at major catastrophe liabilities, for instance, those associated with Piper Alpha. We also had a separate project looking at some issues associated with professional indemnity. And then as far as the remaining liabilities were concerned, we subjected those liabilities to the most extensive actuarial review in the history of the Lloyd's market, with over 200 individual syndicate level reports assessing about three-quarters of the remaining liabilities by independent firms of actuaries. I have no qualms about standing up here and saying we went through a thorough and proper exercise. It was an exercise that Ed Muhl's team was involved in and was shown the results of. They had every opportunity to ask questions about any angle they cared to. It was a process that our U.K. Department of Trade and Industry sat through; they even had a room in the building where they had access to documentation throughout the process. So I believe we went through a thorough and proper reserving exercise, scrutinized by others that resulted in a company that has a well-reserved balance sheet.

SPEAKER: You mentioned at the beginning the goal of added efficiency to claims handling to come through Equitas. I wonder if you can comment where you see the successes in that and particularly comment on the fact that a high percentage of the claims are a number of years old and they have already been handled to a great extent in the past, and are changes really being made in the way that claims that initially came in ten years ago are is now being handled?

MR. PRETTEJOHN: The CEO of Equitas, would be better placed to talk about that than I am, but I suppose the primary feature of the establishment of Equitas from a claims-handling standpoint is the creation of centers of excellence and those particularly dealing with asbestos and pollution and health hazard claims. The idea that those sort of claims, which present huge technical difficulties, could be handled in a commercially sensible and responsible way by a fragmented collection of over 700 businesses was, I think, a little difficult to imagine. So the creation of centers of excellence to think about those claims and to deal with them in a consistent and expert way seems to me a good thing from the every standpoint, not least that of the policyholder.

MR. CONE: When this symposium was in the planning stage, it seemed to me that we should have a speaker who could put these problems into a social context if we can call it that or political context or overall economic context; some general context, and I was talking with Superintendent Ed Muhl about this and he said, "Well, I have just the man for you." He said, "His name is Sean Mooney." Sean very graciously saw me in his office and we talked about this, and now he is here with us and so he will be talking principally about mass torts but about other things, as well. I am delighted that the Superintendent made the suggestion and at least equally delighted that Sean agreed to follow up and be with us.

DR. MOONEY: Thank you, Terry. I am very pleased to be here. The topic under discussion is mass torts. We are talking about substances that cause injuries to people. By mass we mean causing injuries to large groups of people, such as, asbestos, Agent Orange, lead paint, silicon breast implants. Why are we talking about this in the context of Lloyd's? Well, in the United States if you look at estimates of insured losses from asbestos, the latest figures from A.M. Best last year put insured losses from asbestos at $40 billion, $16 billion of which has been paid, and $24 billion is yet to be paid. One-third is to come from reinsurance and that is about $13 billion. And of course, a large percentage of reinsurance payments come from Lloyd's. So obviously mass torts are of very great importance to Lloyd's in its recovery.

I am not going to deal with Superfund; it is another major area of mass torts, but Superfund basically deals with physical damage, not with bodily injury. There was a study group, 301E, that was set up under the Superfund Legislation in 1980 to look at the bodily injury side. They made a report in July of 1982 and recommended a system of recovery, part of which would be compensation system, the other part would call for recovery in state courts. That report really never went anywhere because there were so many problems on the cleanup side, the physical damage side of Superfund, that I do not think anybody really wanted to enter into the bodily injury side.

From the insurance perspective there are two major messages from our experience with mass torts. There should be clearer language in terms of definitions of occurrence and pollution. There is also the issue that we need better underwriting. This is a difficult issue. In hindsight, one can ask what should have happened, say, with asbestos? Companies did insure a lot of the Johns Manvilles of this world for asbestos. Did they not know that there was a danger out there? When you look at the record it is difficult to know what was going on. Of course, there has been much litigation about what was going on, but you definitely knew that asbestos was a dangerous product. Mr. Johns of Johns-Manvilles died in 1898. When they did an autopsy on his lungs, they said he died from dust on his lungs. So that would give you some indication that a person dealing with asbestos products faced a health hazard. Also, the manufacturers of asbestos did know that there was a problem for the workers in the asbestos factories. In fact, they had gone so far as to have plenty of precautions for the workers, including masks for workers in the factories. The manufacturers also moved to have asbestos related diseases covered under workers' compensation statutes. The manufacturers did not want to be sued in tort by their own workers. They decided to have diseases that caused asbestos covered under the workers' compensation system, where the levels of compensation are not as high as they are in the tort system. So I am not sure what lessons you can draw from the asbestos experience in terms of underwriting. It appears that there was enough information to make companies wary of insuring asbestos manufacturers. Yet, they did insure them. Insurance companies today are a lot more careful about insuring products when they believe there is a danger of prolonged disease. As a society, how have we dealt with mass torts, with areas of mass injury? I think there is been three basic approaches. One is what I would call the safety net or the unknown risk, or ignorance is bliss approach. Many people die of different diseases every year. There are 450,000 cancer deaths a year. Many people get heart diseases, pneumonia and so on. We do not know what causes all of these diseases, but we treat the people within the social net. This net includes their own health insurance, the workers' compensation system, disability benefits, and Medicare/Medicaid.

The second system that we have used in these areas is the tort system. If someone can prove legally that the disease resulted from a product and that the product was unreasonably dangerous or that there were not sufficient warnings on the product, that person may recover in the tort system. The main complaints about the tort system are that it is duplicative - and that in many cases people are recovering from their own health insurance and that the transaction costs are very high. When you add in the legal costs of the plaintiff's lawyer and the defense, plus all the expert witnesses and other court expenses, you are talking about over 50 percent of the dollars not going to the plaintiff. It is being used up in transaction costs.

The tort system leads to insurance availability problems, which in turn leads to economic problems. Because insurers are scared away from products that have the potential to cause disease, they are not going to insure those products. So frequently those products may not be produced, and that is an economic loss to society.

You also have inequities in the system. If you were filing suit, it is better to be in Alabama or South Texas than to be in Maine or somewhere else where there is a lot less litigiousness. The third system that has been used to deal with many injuries - and I know it might have seemed natural in the 1980s, when you look at all the major problems that were caused in the tort system - is the compensation system. In the 1980s it was believed that if you move to a compensation system you would eliminate the transaction costs associated with tort. You would also have the belief that you were "solving the problem." If there were a group of people that were injured, we could marshal the resources and get compensation to the injured. It would be all very straightforward and very simple. In general, our experience with compensation systems is that they have not worked very well. The main reason that they have not worked very well is because there has been an expansion eligibility. There are three elements of the compensation system. Who is eligible for the system? What are the benefit levels when the people are injured? Also, where does the money come from? Where is the funding? The usual problem with the compensation system is eligibility; eligibility gets expanded for a number of different factors, and the system explodes. The funding is not sufficient to cover the resources that are needed because of the expansion in eligibility.

I think one of the simplest ways to review the issue is to consider what happened with one major compensation system, black lung. Black lung is known as coal miner's pneumoconiosis. This condition basically means that you have a scarring of the lung occurring because the person is inhaling the coal dust. It was recognized at least as far back as 1822 when it was referred to in the literature as miner's asthma. In the United States it began to be recognized as a serious problem in the 1960s. There are two forms of it. There is the simple form where somebody has a little scarring of the lung, not much trouble breathing and really no major symptoms. And then the complicated form, where they have lot of trouble breathing and ultimately can die of the disease from either heart failure or some other disease, pneumonia, that is caused by the disease. There was major concern about this in the 1960s, so a special program was put in place by the Federal Government in 1969 under the Coal Mining Health Safety Act. For eligibility under the 1969 act you had to be employed for ten years in a coal mine. In addition, you had to show just on an X-ray that you had the lesions caused by the coal dust. If you could prove those two parts, you were eligible for the benefits. The benefits basically were about fifty percent of the total disability benefit that a federal employee at the GS2 level would receive. Then if you had dependents, the compensation was increased.

The initial cost of the system over its entire life was estimated at a total of $2.7 billion dollars. That is what they estimated it would cost the Federal Government to run the whole system. By 1985 the system had already cost $16 billion dollars a year and was running at a cost of a billion dollars a year. What happened? It is a long story, but basically the eligibility was expanded in 1972 and in 1977 and the increasing eligibility led to increasing payments. That is how the system exploded. In 1981 they moved to curtail the system, and now it is beginning to tail off. The mines are a lot safer on the East Coast and there is more surface mining on the West Coast, where you do not have as much exposure to coal dust.

So as we look at those three different systems, first of all, let us take the viewpoint of insured of insurance companies. What system would insurers prefer for mass torts? I would argue that in general we have seen a bias in insurers towards the social net system. If people are injured, they should be covered by first-party insurance, by their own health insurance, by workers' compensation, and so on. There is a little bit of sympathy among insurers for the tort system but a general bias against compensation systems. The general bias against the compensation systems is because we have had the experience with systems like black lung. The major problems are the expansion of eligibility and the expansion of benefits, which are driven by political forces. There are two factors which cause this result. One, you are talking about the special interest group, the injured parties. This group can get organized and no counter group is organized on the other side. The special interest group is typically seeking compensation from federal government revenues or from insurance companies, so the costs are borne by the general public, rather than a specific interest group.

Also, in an era of budget deficits, politicians like to look to regulation to redistribute income. So compensation systems where insurance companies, employers and so on are the funding level, become very attractive to politicians. That is why there is a general bias in the insurance business against the compensation approach. Well, you would say, why do we not favor a compensation approach, at least over a tort solution? After all, the insurance industry argued for no-fault systems, first-party systems, like no-fault auto insurance or like workers' compensation. Why do we not argue for some kind of first-party system, non-litigious system in this area?

Many insurers are less fearful of the tort system than they were in the 1970s and 1980s. Many of the problems that we have had in toxic torts happened because of decisions by the courts. We have had some bad science from our courts. Lots of junk science winds up in the courts. However, in recent years we are seeing better judgment on the part of judges in term of scientific knowledge. A recent study concluded, as of now, there is no evidence of danger from electromagnetic fields. Increasingly, if we get that kind of science in the courts, we will do a lot better in terms of the tort system. Also the industry can look for better results in terms of judicial education. In terms of junk science, the Supreme Court decision in Daubert vs. Merrill Dow Pharmaceuticals Inc., did change the rules of evidence and said that the judges should be making the decisions on what is admissible and not admissible.

Also, when you look at compensation systems, you do not find that they are without litigation. In fact, many compensation systems are overrun with litigation. For instance, with the black lung disease, the black lung program itself had much litigation in terms of just the administration of the system itself. It also had a lot of litigation associated with who was eligible and how could you prove you were eligible. So we do not necessarily get away from litigation when you go through a compensation system.

So if our bias is against compensation and torts, is the social safety net solution to these areas of injury, combined to some extent with the tort system, good public policy? From a public policy point of view, how would we as a society want to deal in mass injuries?

I think our major concern would be that sick people are taken care of. If they have cancers or if they have a heart disease, society wants them to be properly treated. And that would suggest that we should stay in the social safety net, and if anything, we should expand the social safety net so that it covers everybody in the system. We would also want, from a public policy viewpoint, that where egregious wrongdoing has occurred, it is punished by the full force of the law. And you probably would also want to keep the tort system to punish egregious wrongdoing. So actually you see the convergence of public policy viewpoint and the insurance viewpoint in that area. So bottom line, I would say the insurer's interest in the bias and preference towards social safety net, plus the proper use of the tort system is also in line with sound public policy. Thank you.

PROF. CONE: We now are privileged to have as our speaker Christian Milton, AIG. He is here to talk about corporate capital in Lloyd's. I am delighted that he has taken the time because he is an extremely busy man as Vice-President of Insurance at AIG.

MR. MILTON: Thank you, Terry. Good afternoon, ladies and gentlemen. AIG has obviously been very keyed to what is been happening in Lloyd's. They are both our competitor and our reinsurer. I do not think anybody here today has stated the sort of praise that should deservedly go to David Rowland, Chairman of Lloyd's, who has worked extremely hard with regulators in numerous different markets, clients, underwriters, and actuarial departments, all with a view to restructuring and creating the business environment that will allow Lloyd's to continue trading in the future. As you know, on September 4, 1996, the approval of R&R went through with the Department of Trade approving Equitas.

There are many questions vis-à-vis Equitas in terms of can Equitas fulfill its purpose? In fact, in the short term, it is estimated twenty to thirty percent of its actual value will decrease and that should be natural in many respects. I can tell you as a reinsured, many things within the Lloyd's marketplace, particularly on tort liabilities, such as asbestos, and on environmental liabilities have been held up because of the amount of time and attention paid to Equitas and its set-up. Until that was completed, other things were left on the back burner. Now, however, we have begun see claim settlements moving at a speed for which we are gratified. Over the last two, I have been asked by two different sets of management consultants about what I think Lloyd's should do. I am not sure how these management consultants got to me, but from their questions I quickly understood that they had both been employed by Lloyd's to find out how Lloyd's could service its clientele more effectively. On the catastrophe side of the house, Lloyd's has always been a very prompt payer of its claims. In fact, with Hurricanes Hugo and Andrew and with the Northridge Quake, it not only paid its claims, but it paid them within seven days.

The same cannot be said for Lloyd's casualty claims. This is particularly true in cases involving complex tort claims that have occurred within the United States. A number of different law firms representing Lloyd's argued about what was covered and what was not covered. The policy wording was not exactly the best written policy wording and therefore it could have been interpreted in a number of different ways. This problem coupled with the reinsurance wording superimposed on the original coverage made it an even more difficult task. Furthermore, the segmentation of the London market made the task nearly impossible in terms of trying to reach an agreement in a timely and efficient manner.

What we have seen in Equitas is that Lloyds now has a central body of claims expertise and experts. Many of them are out of individual companies and/or syndicates in the London market base. We know them well and we know their biases and prejudices. We know who they like and who they dislike. But at the same time we know who they are, and they are a very unique body of individuals. In fact, I was reminded by Dean Wellington at lunch today that part of the asbestos problem in the United states (reinsurance and insurance) was the Wellington Agreement which was developed by some of these same individuals. The Wellington Agreement addressed many asbestos settlement questions and did a lot to get at least some settlements to claimants who were certainly in need of reimbursement in some shape or form.

Equitas should fulfill its purpose at least for a number of years. If anybody were to say that it is going to run short of funds or that it is going to be overfunded, we believe that this it is too early to call at this point in time. I am sure that the New York State Insurance Commissioner did whatever he felt was appropriate to protect the policyholders' interest within the United States and to ensure that they get full impact as far as that is concerned. We have no doubts after having dinner the other night with the Chairman of Swiss Re North America, who was the actuary concerned in doing most of those calculations, and a lady of the highest integrity, who I would not like to second-guess on any dealings. I do a lot of business with Heidi Hunter, a very remarkable lady.

We have no doubt that Lloyd's is evolving its capital structure with its decision to introduce corporate capital, which really started as part of its business plan back in 1993. Now, we just have to distinguish the Names from the corporate capital. We should expect to see the diminishing role of the Names, which we believe is going to happen more and more, with an ever increasing role for corporate capital. But we have to be careful with corporate capital. If we were to look at the press over the last couple of weeks, corporate capital according to recent Lloyd's numbers represents only about thirty percent of the total capital.

What is more interesting is the agencies that are actually owned by corporate capital and the infrastructure through which they have evolved. These are the takeovers of Lloyd's member agencies which took place during the 1990s. Ace took over what used to be known as the Okham Agency, previously known as the Sturge Agency as well as the Methuen Agency. Aon strategic partners have taken over a number of syndicates. Chartwell has just taken over Archer and this week, Mid-Ocean in addition to its purchase of Brockbank, purchased another Lloyds agency. Terra Nova took control of Octavian and the Trident Partnership secured the agency run by Venton. As well a couple of other syndicates are setting up.

When I was in London a week or so ago, the information in Lloyd's was that there is an estimated forty new capital syndicates scheduled to be set up for 1997. The number is actually overstated and it is probably about half of that. This will actually increase the number of syndicates from about 167 to close to 200. But the average stamp capacity is estimated to be thirty million pounds. That adds another billion-pound stamp capacity to the Lloyd's writing. That is where it is right now as far as stamp capacity averages per syndicate. Interestingly, for a number of years we felt that the average individual syndicate with its stamp capacity was too small. Therefore, we believed that the average individual syndicate was unable to invest money into its own infrastructure. Furthermore, we believed that the need to create larger capital vehicles was an absolute necessity for Lloyd's to continue in the future.

The future for Lloyd's is always changing. It changes insofar as syndicates going forward. If we look at the mega-syndicates, the ability to write mega amounts in risk in today's environment is an absolute necessity. Marsh & McClennan announced, on behalf of Lloyd's, a new Political Risk Lineslip written in the marketplace which will take up to $250 million dollars in new markets for confiscation, expropriation and nationalization risks. AIG will probably only have about $120 million since Lloyd's competes very heavily where its capital is concerned.

The other part of Lloyd's that required more capital and more continuous capital is its capital base. In fact, Lloyd's recreates its capital base every year. This gives the market a tremendous amount of (a) volatility and (b) lack of continuity as far as Llody's insurance clients are concerned. It is very frustrating when as a client in Lloyd's, and I have placed most of my business in Lloyd's for several years, I go to renew a set of contracts, and Lloyd's underwriters say, "Well, Chris, it is like this, I am not too sure that I have got the stamp capacity for next year. In fact, I am not too sure I am going to be in business next year at this point in time." I have a continuing history of profit with that particular syndicate and yet, the renewal and everything have been built up over the years, goes down in one easy swoop. It happened in 1985, it happened in 1996, and certainly our program has seen the loss of a number of syndicates. We used to place seventy percent of our catastrophe covers within the Lloyd's marketplace, but today that percentage has dropped to thirty percent. We have not taken business away from Lloyd's. What actually happened was as a result of Lloyd's lack of continuity and capital base. It has been replaced by Bermuda capacity and it has been replaced by other American capacities. It is this loss of a business trading relationship that basically Lloyd's has to get back.

Another problem is that Lloyd's in the past, has over traded. Because of the small capital bases per syndicate and because of the need to demonstrate underwriting at an operating profit, Lloyd's underwriters have bought reinsurance at levels which quite frankly in today's age makes no sense. Several years ago our former reinsurance department wrote what was traditionally known as London Market Excess of Loss Business. We insured syndicates in excess of $250,000. In today's mindset, you have to really wonder about the quality of security. Capital and the quality of security is paramount. In fact, I know that in the Equitas project, a lot of security was eliminated, in terms of what was going to be necessary to support the future situation of Lloyd's.

The other thing that has really concerned us is the link between Equitas, the funds of Lloyd's, and Lloyd's security chain. In fact, we actually spoke to about ten people from Lloyd's about this issue because we felt that they could know what they are talking about. The central fund of Lloyd's actually still exists, but a substantial amount of it actually has been used by Lloyd's to fund Equitas. It is not as large as it used to be, and actually it does not need to be as large as it used to be. Part of the reason that it does not need to be as large as it used to be is essentially because the liabilities representing nearly 100 years of runoff are now separated out from the old Lloyd's system. I think the average point in time right now is that all members will contribute to the fund, corporate members will contribute at a rate that is two and a half times that of an individual member. And that is partly because they have limited liability. All this forms part of the concerns that we have.

I should not even say concerns. Part of the issue that revolves around Lloyd's and its changed capital is how we get to give it a credit rating and how we measure that from a security standpoint? I know that Ed Muhl has significant issues with the role of credit agencies like S&P and A.M. Best. In this day and age, one of the things that we have to do for the New York State Insurance Department is to give them actuarial assessment of what we think our reinsurance looks like and what our creditworthiness looks like at some point in time. In some respects we use the S&P and the A.M. Best credit agents to do that. We cannot do that with Lloyd's. Partly what we need to be able to see over an extended period of time is how its security funds look and how its overall statements work towards giving us financial assessment and transparency. I am suggesting this idea to a number of syndicates. We need them to start thinking about seriously producing the equivalent of the United States Convention Statement given the amount of business that they have within the United States so that we can measure them on the same basis as we measure American companies.

The other part of this chain of security that causes me some concern is that with the introduction of corporate capital into Lloyd's, I have to deal with both a reinsurance buyer and with risk management within AIG in terms of understanding risk, financing risk, and reinsuring corporate vehicles into other related companies. One of the things that worried me to some extent is that reinsurance is really an indirect form of financing a company. You can, in fact, transfer money from one place to another. What has to be addressed is the regulations that deal with the questions raised, such as, if Ace Limited were to own a syndicate of Lloyd's and provided it with corporate capital, is it moving money from one vehicle to another vehicle? What regulations are in place to ensure that there is at least some oversight responsibility? The same is true with any company, with the exception of limit, everybody else is an insurance company. They can move money around. We do not want to be facing the same problem ten years down the road. It is one of the major issues that we think needs to be addressed from the Lloyd's system. In fact, unfortunately, I have to file a request with the insurance department every time I want to do piece of reinsurance for a related company. I do not see that within the Lloyd's system at this point in time. This is an issue which perhaps our Lloyd's representative would like to address.

AIG has some conclusions as far as where Lloyd's is heading and what corporate capital is going to do for it. First, we think that the corporate membership's impact on Lloyd's future is that it will eventually eliminate the unlimited Names. In that respect we think that will be a great loss, but we think that is going to be a move that eventually will go forth. There will be fewer but even larger syndicates, and in fact they are going to become much more like insurance companies as opposed to syndicates as we have known them in the past. Certainly there will be a more permanent, less volatile capital base, which will allow Lloyd's to grow and also to diminish their conflicts of interest. Second, one of the real problems Lloyd's has had in the past is that the person who has been managing the business (the managing general agent), and the person who has been providing the capital resources for it to write that business, have not been the same person. With the advent of corporate capital, basically corporate capital buying the underwriting agency and having control of the underwriter, you now have a different set of interests where economic processes are combined at that point in time.

If you go back and look at some of the issues of over-trading in terms of under reserving and profit commission statements, a tremendous amount of this activity is very similar to what we have in the United States. For instance, in the United States, managing general agents are commission-orientated while having the reserving capability, and therefore they are able to calculate their enumeration by virtue of remuneration. It is a formula for fraud and I think the underwriting agency being owned by the capital that is providing it makes a lot of sense. It means, you can fire the underwriter, and you can do things you would not be able to do ordinarily. We think more discipline and less tolerance for poor results have certainly resulted in some rather interesting results. For example, a Lloyd's underwriter said to me, "This corporate capital stuff, are really benign investors when all is said and done." I said, "They are only benign while the rate of return is positive. Wait until it's negative and you'll find out how benign they are then." I thought that was a very naive comment that he made at that point in time.

Third, we think at the same time as Lloyd's regenerates itself with larger capital bases, there may in fact be a redundancy of a need for the central fund after all, particularly as the unlimited Name disappears from the equation. Lastly, we think that there will be an end to self-regulation. I think that is already on the table as far as there is already some pretty serious discussion about a House of Parliament selectively being set up to have oversight for Lloyd's transactions at this point in time. Thank you.

SPEAKER: Why do you think that the elimination of unlimited liability Names is going to be useful? Will it not have the effect of doing precisely what you wanted, make it more transparent in terms of the credit rating of the other side of the transaction and not have any ambiguity about that?

MR. MILTON: I think what is really going to happen is that the unlimited Name is essentially going to incorporate itself as limited capital. I think you will see that there is an advantage to it. Why take on an unlimited risk when you can limit that risk by turning it into a corporate capital vehicle? You do not need a lot on the Lloyd's system. On the Lloyd's system you can create a corporate capital vehicle very inexpensively at this point in time. Thank you.