Money with Mia

Stuff happens. Risk is all around us. Some you can predict using past indicators or technology, and others are more capricious. When things become harder to foresee, many people choose to protect themselves. Most do this in the form of purchasing insurance.

I had the pleasure of sitting down with Richard Ward, the CEO of Lloyd’s, when he was on campus in the winter. After doing a case in Investment Management about the insurance industry, it was fascinating to hear about the current insurance marketplace. Lloyd’s bank is different from Lloyd’s the insurance market. Lloyd’s is the world’s leading specialist insurance market, home to more than 50 managing agents andÿmore thanÿ80 syndicates that offer specialist underwriting.

Lloyd’s is not an insurance company but rather a society of members, both corporate and individual, who underwrite in syndicates on whose behalf professional underwriters accept the risk. According to its website, the supporting capital is from investment institutions, specialist investors, international insurance companies and individuals. The brokers are responsible for creating business opportunities and presenting them to the market. The risks placed with the underwriters come from clients, other brokers and intermediaries, globally.

Here’s an inside peek of the conversation I had:

Mia: How has the risk appetite across the insurance industry evolved, and how will it play out in 2010?

Richard: Interesting question. When answering it, we need to look at the past. The insurance market, specifically Lloyd’s market, is in a strong position because of changes we’ve introduced within the market in the past 5 or 6 years. As we were hit by the economic crisis, we found ourselves in a far better situation than banks. Our risk appetite is reasonably strong and the sector is reasonably strong. Lloyd’s in particular is very strong. We’ve done a lot of work around improving the efficiency of our business model, extending our market reach. We are looking for opportunities now. We got to temper those opportunities with the current economic climate.

Mia: Given the fact that many companies looking to get insured were hit hard, how have you looked to serve these clients?

Richard: Insured values are falling, businesses are struggling and profits are hard to come [by]. Given this environment, businesses are looking to have a reduction in their insurance premiums to compensate them for the loss of earnings in other areas. The dilemma for us is that as we go through this economic crisis, the investment income isn’t there to be made as it was in the past. And underwriting profitability has been under question. The insurance business would like to see the rates increase, just as the insured would like to see the rates decrease. So it’s quite a difficult economic environment to operate in. Insurance is a very simple business. Claims must be less than premiums, otherwise you lose money generally. I’ll share an example with you. We’ve been looking to increase rates in the aviation sector for quite some time now. Of course, the aviation sector is absolutely hurting at the moment. I mean British Airways’ revenues are probably 25% down (at time of interview), and they recently reported the worst loss in history. Passenger numbers are down. So it’s difficult for them to say ‘yes, we are struggling and we are going to pay more for our insurance.’ This is, of course, what we want them to do. So we have to balance the two. The risk has to be priced appropriately. So given the environment, I think we’ll step back from a few risks instead of cover them. There’s no point in giving people insurance at the wrong price. Because if we don’t make money, ultimately we won’t be financially sound to pay out the claims. So the challenge for us is to price risk at the appropriate price, and if we can’t, then to walk away.

Mia: How do you oversee risk management on a day-to-day basis?

Richard: I think one thing that the crisis has done is to get people to focus on risk management. Two or three years ago, you wouldn’t have had risk managers on the boards of companies. Now, we are starting to see this. It’s a very important trend when you start to see boards take an active role in discussing risk management. The CFOs are having to get more involved in discussing risk management. So it is becoming an agenda item, but it doesn’t have the prominence that we want it to have. From our point of view, our whole business is about risk management. We need to ensure that Lloyd’s of London – the marketplace, that the risks we take on, are risks that are manageable in our capital structure and are handled well, and are risks that won’t cause damage if we get claims that fall upon us. We take a very active role in risk management.

Mia: Can you provide me an example of how you manage the risk?

Richard: To give you an example, our marketplace consists of about 50 businesses writing insurance policies. They are their own business in their own right. They are often listed on the London Stock Exchange, headquartered in Bermuda, etc. When the Lloyd’s business is writing the risk, it’s issuing effectively a Lloyd’s policy. Let us say hypothetically, Ace, inside of Lloyd’s, is writing the aviation risk for Air India. When they issue Air India the policy, it’ll actually be a Lloyd’s policy. And what that means is that you’ll have Ace’s balance sheet inside Lloyd’s, behind the policy. If Ace fails, then you have Lloyd’s the corporation’s balance sheet behind the policy. So you have a chain of security. It enables us to give the client, the insured, the confidence that we’ll be there to pay the claim since it’s issued in Lloyd’s name. If Ace outside Lloyd’s writes a claim – and Ace does write business outside Lloyd’s – you only have the Ace balance sheet behind it. So if Ace fails, that’s it. We are a mutual support for people in the market. This is why an Ace or a similar company would come inside of Lloyd’s. It’s to benefit from the mutual structure, our credit rating, and to benefit from our capital structure. What that means for us is that we need to ensure that the risks they write are risks that are manageable in our overall market structure. And that Ace, in writing Air India risk, doesn’t overexpose the whole market, and doesn’t cause issues for other players in the market. We don’t want Ace to be writing business that is damaging to the rest of the marketplace. Lloyd’s oversees all of the market and the risks that are taking place within our marketplace to insure those risks are manageable at an individual business level and also at the corporate and market levels. We have to make sure the market is not overexposed and that we have sufficient capital.

Mia: How do you decide which 50 companies you work with?

Richard: They have changed dramatically over 351 years and have gone through many changes and revolutions. Today we have 50 businesses. Ten years ago we had 150 businesses. At one point we had as many as 300. There’s a lot of consolidation in the industry. The key for businesses that are writing business in Lloyd’s market is that in order for them to participate they have to submit a business plan to us. We have to approve this plan. This is quite a new phenomenon that we started doing in 2003 because we nearly went bankrupt in 2001 because of the World Trade Center and then again also in the mid 90s due to asbestos issues and other problems that are well-documented. Because of all these problems, we went through a major restructuring, including asking for business plans.

Mia: How do you evaluate the business plans?

Richard: My team will look at the plans. Put them through stress tests, i.e. what would the loss be if we had a California earthquake or if we had a terrorist attack? What would the loss be if we had a $120 billion loss in the Gulf of Mexico, etc. All these various stresses, we apply to the business plan, to make sure the individual business can withstand those types of events. And we do contingent events also. The second thing we do is to take all the business plans for the whole market together and look at the exposure to ensure that we are not overexposed as a market to too many businesses writing the same risk. Risk diversification is absolutely key. We are happy to provide coverage for a World Trade Center type of event, but what we don’t want to find is that every single business in the Lloyd’s market is providing coverage for World Trade Center types of events. Insurance relies on diversification.

Mia: How many businesses are successful at going through your selection process?

Well, we ultimately modify all of them. We end up writing $33 billion of premium every year in the market. We end up paying claims of between $10-15 billion a year. So, if the company doesn’t get its business plan approved, then it’s out of business because it can’t write, so they all will modify their business plans and work with us. It’s a commercial partnership. It’s also a matter of getting the capital right for that business plan. Capital, though, is no substitute for a poor business plan.

Focus on 2 things: 1) the business you want to write is profitable, and 2) You have capital to support it if you have a loss. And that you are making a return on that capital. The problem, in the past, is that insurance companies have allowed the two to contaminate each other. In this day and age, focus on your core business, because when you don’t, you lose sight of what you’re trying to do. And in insurance people have lost the fact that (AIG, Swiss Re) their business is insurance, which is about pricing the risk, taking the premium and paying the claim. It is not trying to make a lot of money from investments, from assets, and using that to subsidize poor underwriting decisions. Up until 2007, when investment returns were quite spectacular, let’s not worry about underwriting. Once you start doing that, you are in a very difficult game that ends in tears.

Mia: How has Lloyd’s reacted to different insurance companies dropping product lines due to the economic environment?

Richard: Swiss Re went through a difficult patch, and it wasn’t on the insurance side – it was on the financial product side. They got involved in a lot of instruments that they had to write down significantly. The result of that is they have new management. Swiss Re has to get back to its basics of being an insurer. Lloyd’s went off the rails in the mid 90s. We haven’t had to change our business model. When looking at how our competitors are doing, yes, we have seen more business come to Lloyd’s. People like our business model. We write a policy with Lloyd’s central fund behind it. The other reason, when you place business inside the Lloyd’s market, you spread the risk.

Mia Saini is a born and raised California girl. She is currently on a voluntarily leave of absence from HBS and is working in NYC as a reporter/anchor for TV. She graduated from MIT and went straight to the sales floor at Goldman Sachs. She honed her journalism skills at CNN, WB, CNBC and as a TV reporter at Jim Cramer’s www, She is the founder of HBS TV and is a video host for MBA PodTV on Each week she writes a “Money with Mia” column about money, business and personal finance, so email HBS’s Money Honey your questions, story ideas and feedback.