Why Lloyd's Blueprint One is doomed to fail...but how it could succeed

The proposals set out in the Future of Lloyd's Prospectus - recently formally launched as Blueprint One - coupled with changes to improve the market's profitability, have been met with much fanfare and optimism. With good reason. After decades of inaction and studied complacency, any effort to drag the market into the modern world is to be celebrated. However, while welcome, Blueprint One is perhaps as notable for what it doesn't address as what it does. Further, the market faces an existential crisis that now, more than any time in its history, threatens its long term survival in the form we know it today. The question, therefore, is whether the proposals go even nearly far enough. In the words of Lenin, "You cannot make a revolution in white gloves."

Let's start with the positives. A spirit of reforming zeal is abroad in the market, the like of which has not been seen since the R&R crisis of the mid 90s. In this, credit must be given to Bruce Carnegie-Brown and John Neal, the Lloyd's Chairman and CEO respectively, who have sought to confront longstanding issues head-on and move the market from talking, to action.

In this, they have no doubt been helped by the cumulative effect of two consecutive heavily loss-making years that can only have focussed the market's mind on the need for reform. One of Lloyd's greatest Achilles heels is surely its tendency to kick the can down the road unless and until, things start to go seriously awry. Never have ￡3bn of losses been so timely!

The short-term response was a crackdown on poor performance, with Lloyd's ordering syndicates with three consecutive years of losses to come up with a remediation plan and ordering all syndicates to fix or exit the worst-performing 10% of their books – the so-called "Decile 10". Eight syndicates stopped trading at the end of 2018. Others have cut their capacity or exited in 2019.

The most surprising thing, is that people have been surprised! Any normal industry would never have allowed things to get that bad in the first place. A legacy, perhaps, of focusing the Franchise Board's scrutiny on whether syndicates had enough capital - as has arguably been the case previously - as opposed to whether they are making an adequate return on that capital. 

The longer-term response has been Blueprint One, which to Lloyd’s great credit has been rooted in a genuinely consultatative approach that has actively sought input from key stakeholders through an exhaustive (and no doubt exhausting) series of interviews, focus groups, seminars, presentations, conferences and all points on the compass in-between.

Unsurprisingly, the response has been almost uniformly positive. And to to give Lloyd's its due, achieving a shared vision and broad-based support for what amount to a bold and exciting set of proposals after years of floundering, is certainly a big step forward. But then - without wanting to seem overly cynical - how else would you expect people to react when presented with a vision of a beautifully baked cake lying just over the horizon and then being asked if they would like a slice? The challenge, as ever, is one of execution. Especially in a market of (modestly) rising prices, which carries the extra risk that some might believe that they can maintain the status quo for just a bit longer. This is after all a market littered with failed big ideas. We have been here before…

Viewed through a more critical lens, it is also worth noting that Blueprint One carries some inherent risks and implied consequences within it, not all of which are necessarily positive: 

Firstly, there is a significant focus – some might say far too much – on growth. This may seem somewhat counter-intuitive, as growth is clearly important if the market is to flourish – like a shark, if it stops swimming, it dies. But having destroyed over ￡3bn of capital over the past two years Lloyd’s priority, surely, must be to fix the cost, operational and structural issues that have contributed to the current state of affairs. In a sense, growth would be better seen as an outcome of the successful implementation of other objectives, rather than an objective in of itself. 

Secondly an unintended consequence of the proposals contained in Blueprint One, may well be to push the smaller players out of the market. Simply put, do they have the resources and capabilities to survive the scale of change that is being proposed and that is yet to come? Do they have a distinctive role, if their traditional ability to innovate and take risks in new and unfamiliar niche markets, is constrained? Can they realistically be expected to compete over the longer term with larger, better branded, better resourced players, especially those spanning both Lloyd's and the company markets? It isn't written down anywhere in Blueprint One, but the Lloyd's of tomorrow will necessarily have less players in it and the likely winners will be today's bigger syndicates. 

Thirdly, will the focus on underwriting profitability and portfolio remediation stifle Lloyd's of what has always been one of its key sources of distinctiveness: its ability to innovate and take risks that other insurance markets won't. This is particularly important when you consider the huge ongoing shift in corporate balance sheets from tangible to intangible assets such as brand and IP and customer lists. This should be a big opportunity for Lloyd's. But in most cases still, there is no reliable data upon which to base a risk decision. How then to make it past the newly sharpened quills of the Lloyd's bean counters? You can't help but think that were he active in the market today, Cutherbert Heath would never get his idea for an excess of loss treaty off the ground.

Fourthly, I somewhat question the wisdom of making it easier for even more capital to enter the market when there is already far too much of it around. Global third party capital has grown from $5bn in 2002 to $18bn in 2018. A conservative estimate would be that the aviation market has 300% more capital than needed. Lloyd's needs to be careful what it wishes for!

However, perhaps even more interesting than what is in Blueprint One, is what it doesn’t address:

1. What is the plan as regards Lloyd’s expensive network of foreign offices, established under the previous regime under a (in my view misguided – isn’t that what brokers are for?) – strategy to place themselves on the ground “at source”. Singapore, given Asia, and Brussels given Brexit are understandable. US & Canada are half the market - Lloyd's has to be there. Even Dubai sort of makes sense. But Namibia? Cyprus? Mexico? Zimbabwe? I don’t know what the average cost of a Lloyd’s representative office is, but if I had to guess, I would say around ￡500k a pop. There remains a big disconnect between where Lloyd’s earns, and is likely to continue to earn its revenues, and its current footprint. Meanwhile the syndicates continue to pick up the tab. The market of the future will have to retrench back to its core - smaller, but more profitable.
2. When is someone going to tackle the elephant in the room that is the Lloyd’s broker? Many add huge value to their clients in terms of helping them manage and place their risks. But in too many cases, they add no value at all, charging a fee for the "privilege" of market access and doing little beyond directing traffic, forwarding emails and filling out whatever forms Lloyd’s sends their way. This surely has to change – clients and brokers have got to be able to access the market quickly and cheaply and brokers should only expect a fee where they add real value. The market of the future will have to collapse the existing, unsustainable, value chain.
3. Where is the radical thinking to really attack the cost base? Everyone knows that Lloyd's has a massive cost issue - John Neil is on record as saying that it is 9% more expensive than its competitors. Anyone who has worked in the market would recognise that as a very conservative estimate. And yet despite this, there is, in truth, a large dose of “motherhood and apple pie” to the Prospectus. If the various proposals appear to make broad sense, then that is largely because they are so blindingly obvious that the real question is why they weren’t tackled twenty years ago? Isn’t it all a little … timid?

The core cost issue in the market – despite what the syndicates would have you believe – is not broker remuneration. Yes it has crept up, but I believe a recent study by EY has shown that the core driver for this has been a change in mix - specifically the growing proportion of delegated authority business. The real cost issue is duplication.

One of the market’s great strengths is its syndicated model. However, currently, under the lead / follow approach, work is endlessly repeated by everyone involved. Take AML – the broker will do their checks, the lead underwriter will do their checks and then every other syndicate on the slip will do their own checks as well. Then everyone's auditors will check their checks. And Lloyd’s. And their auditors. And then perhaps the FCA or PRA for good measure. To what possible end or benefit? And then multiply that across sanctions or Solvency II or TCF. Not to mention the 750 Lloyd's minimum standards that all syndicates are expected to adhere to. Take the claims process too, where every single syndicate will individually consider each case. Appoint their own lawyers. Dispatch their own team of loss adjusters. Often, even if one or more syndicates are prepared to pay out, they will wait to see what the others do, leaving the poor policy holder hanging. It is a hall-of-mirrors of delay, needless bureaucracy and paperwork. 

It is this that perhaps accounts for the fact that at Lloyd’s, somewhat curiously, the larger syndicates largely have the same operational ratios as the smaller ones. In other words, there are no economies of scale – as you grow, you simply have to keep adding more and more resource to keep the compliance carousel spinning. If you really want to cut costs at Lloyd’s, you have to cut heads b, not try and digitise unnecessary work and processes.

The radical approach would be to rip up the current model and start again, as is presumably being considered. Each risk would have a lead underwriter. They would do the underwriting and compliance and claims settling work and be paid more as a consequence. The follow markets on that risk would simply accept their analysis / compliance / loss decision and a lower fee to reflect their lower effort. Effectively allocating capital. And by eliminating a huge amount of duplicated work and refocusing on a smaller number of areas of deep expertise, the market would finally be able to radically reset its cost base. The Lloyd’s of tomorrow will have to have far less people in it, probably paid far less too. And syndicates will have to be far more trusting of other syndicates behaving professionally and "doing the right thing" - surely a foundational pillar of the entire market's past success and any sustainable future. A pillar which seems to have been badly eroded over time.

The challenge with this approach – beyond the regrettable trauma of further job losses – is that smaller syndicates in particular could struggle to establish clear areas of market leadership and find themselves reduced to a portfolio management role, allocating capital according to a defined risk appetite to those lead markets where they felt confident in the underwriters' ability to understand and manage the risk. They will therefore presumably fight this tooth and nail. But for private Names, such a reform could be quite positive and might even strengthen their role, as effectively they already operate as a form of alternative capital, allocating capacity to those underwriters they trust.

What all the above really exposes, however, is the existential question that is facing Lloyd's right now. Unless it reforms, Lloyd's is essentially condemning itself to becoming a market of last resort, attractive only to those risks unable to be placed elsewhere and therefore willing to accept the extra cost and bureaucracy. But if Lloyd's reforms as it needs to, the whole market has to accept that it will end up looking quite different from what it is today: smaller and more profitable, less and larger players, fewer and lower paid people, fewer steps in the chain, smaller geographic footprint, more automation and analytics, more intangible / less physical risks, more trusting, visits to the box restricted to tourists on a guided museum tour. And turkeys, as we know, have a very poor voting record when it comes to Christmas.

This isn't easy. But it is quite a straightforward choice: brokers and insurers are simple and for the most part economically rational creatures. If you make Lloyd's the cheapest and the most efficient and the simplest market to deal with, brokers will place risks there and insurers will write risks there. The market will prosper. That is what I meant about growth being an outcome, not an objective.

Another way of answering Lloyd's existential question is to ask another: "If Lloyd's didn't exist would you invent it?" It is a measure of just how far things have drifted that the answer today is likely to be far more equivocal than it would have been just a few years ago. At best, the answer is likely to be that you would invent it - after all the opportunities it faces to grow in Europe or Asia or even within its core markets remains enormous. The advantages offered by its brand, licenses and Central Fund equally attractive - but that it would look very different. And that implies a far more radical change than the one currently envisaged by Blueprint One.

Of course the challenge is any change programme is taking people with you. The change consultants - and God knows there have been enough of those around the market of late - will tell you that you have to take people with you, go for the "quick wins", plant acorns and not try uproot and move entire oaks. Blueprint One reads very much in that light: get people on board around some bold ideas we can all agree on, get a few "scores on the doors", build a track record - then (presumably) slowly "turn up the dial" on the more difficult stuff that will really "move the needle."

In any normal business - let alone one built around a syndicated model - that would be exactly the right approach. Evolution, not revolution. Consensus not diktat. But Lloyd's is not a normal business. In fact it's not a business at all! I can't help but think that Lloyd's has tried evolution before and that is part of the reason we now are where we are. It has tried laying out bold ideas and empowering the market to drive the change "from below", but has found its agenda repeatedly hijacked and delayed by the market's myriad competing (self) interests. It has tried to be consultative but has suffered from seasoned players' knowledge of how to play the system to delay and defer just long enough for another change of leadership and strategic reset. It turns out the speed of the slowest is no speed at all.

To quote Fidel Castro, another famous revolutionary: "A revolution is a fight to the death between the future and the past."

What is Lloyd's if not caught in the teeth of this same struggle? If not us, who? If not now, when?

? James Twining, 2019

James Twining is the Group Chief Executive of the Kingsbridge Group. He was formerly the Group Commercial Director and a main board Director of the JLT Group plc.

Please read James' other posts on the long term threats to Lloyd's future, the likely outcome of the Marsh / JLT merger, the end of the London wholesale market, whether we need insurers anymore, the enduring mystery that is the insurance broker, moving on from the concept of an annual policy, and the real InsurTech opportunity.