Lloyd's had its roots in Mr Edward Lloyd's coffee shop in 17th century London. The market was incorporated by Act of Parliament in 1871. It was part of the old City establishment - a blue-blooded sort of place where the underwriters came from a common background and knew each other and each other's families. The market functioned to a huge extent on trust - and, by and large, the system worked. The most distinctive feature of the market was that it drew its capital from external sleeping partners - the Names - who put up some of their assets for investment at the price of accepting unlimited liability for any losses. This is the "ultimate risk" of the book's title. This quirky arrangement functioned well for nearly all of the Names nearly all of the time. There were occasional losses and scandals, but the surprising thing was not that such events occurred but rather how uncommon they were.
The first danger signs surfaced in the 1960s. A series of misfortunes - notably Hurricane Betsy, which hit the United States in 1965 - led to uncomfortable losses. New members began to stop signing up, and existing Names resigned. In 1969, a report was commissioned from Lord Cromer, a former Governor of the Bank of England. Cromer pointed to the conflicts of interest inherent in the system and stated frankly that the market was in need of major reform. This wasn't what the old guard wanted to hear, and the report was largely shelved. Its contents didn't become public knowledge for another 20 years.
In one respect, however, Cromer's recommendations were implemented - it become a lot easier to invest in Lloyd's. Before Cromer, a Name had to have assets of £75,000, and a deposit of £35,000 would allow him to underwrite business worth £180,000. After Cromer, a Name had to have assets of only £50,000, and a deposit of £35,000 would allow him to take on business worth £350,000. A separate class of 'mini-Names' was also created: these needed assets of only £37,500. You couldn't include your house in your asset figure, but you could put forward a bank guarantee secured against it. Moreover, any assets deposited with Lloyd's would carry on earning money: shares, for example, would continue (hopefully) to rise in value and to pay dividends. It should also be said that the tax regime maintained by the Labour governments of the 1970s created unwitting incentives to invest in the insurance market.
The size of the market increased considerably in the 1970s and 1980s, and the old ways started to break down. The bonds of trust and honour began to fray. There was a series of embarrassing scandals, including the Sasse affair (1976-1980), in which, for the first time in Lloyd's history, some Names refused to pay claims on the grounds that they had been the victims of fraud. There were unfortunate misunderstandings with the Inland Revenue. Underwriters allotted their friends and family to low-risk "baby" syndicates, a practice that was widely regarded as fair game until it was banned in the 80s. A couple of duets of colourful characters - Ian Postgate and Ken Grob, Peter Cameron-Webb and Peter Dixon - ended up making the headlines for all the wrong reasons, and a former chairman, Sir Peter Green, was censured for "discreditable conduct". Some attempts were made to get Lloyd's house in order. Two important reports were commissioned in 1979 and 1986, and a chief executive was brought in from outside the market (only to leave a couple of years later). However, Lloyd's was still granted valuable legal immunities in the Lloyd's Act 1982 and the landmark Financial Services Act 1986.
If all that had been wrong with Lloyd's was a few rogue underwriters, the market could probably have survived, no doubt with some of its problems being lessened by the general wave of modernisation and professionalisation that broke through the gentlemanly world of the City in the Thatcher years. Unfortunately, this was not the end of the story. Unbeknown to the tens of thousands of people who had pledged their life savings to the insurance market, something almost unimaginably devastating was about to hit.
People had always known that there was something dodgy about asbestos. The substance had had a bad reputation as far back as Roman times. By the early decades of the 20th century, the health risks associated with it were documented and known to members of the medical and insurance communities. After the Second World War, the evidence continued to mount up, and by the 1960s the asbestos industry had begun to panic. At the same time, a change in American law enabled private individuals to sue asbestos companies, and in 1971 a test case produced a landmark verdict in favour of the plaintiff (or rather, the plaintiff's widow). The floodgates had swung open. It will be a long time before they close again: as of 2005, the total cost of asbestos-related litigation in the US alone was estimated at over $250bn, and the bill is continuing to mount up.
None of this would have mattered very much to the staid world of the British insurance industry, had not Lloyd's spent the previous three decades insuring and reinsuring liability risks for American companies using very broadly worded policies (some American insurers, by contrast, wouldn't touch asbestos manufacturers). The colossal risks arising out of asbestos litigation began working their way inexorably along the insurance chain, and claims were starting to hit the London market by the mid-1970s. Some insiders realised where things might be headed and sought to dispose of their liabilities while they still could. Others were less worried, and indeed some of them - most famously, an underwriter called Richard Outhwaite, whose Names numbered in the thousands - willingly took over their colleagues' risks.
By the early 1980s, an Asbestos Working Party had been set up and Lloyd's auditors were beginning to make worried noises. Not much of this penetrated to the outside world, however. There were a few danger signs. In the mid-80s, some syndicates started to leave past trading years open - the significance of an open year being that the Names who had been on the syndicate for that year would continue to be saddled indefinitely with the entirety of its past liabilities unless someone else could be found to take them off their hands. Another red flag appeared in 1986, when Richard Outhwaite began making cash calls on his Names. Most Names, however, were oblivious to what was afoot, and new recruits continued to stream in. Lloyd's membership peaked in 1988 at 32,433, up from 18,552 in 1980, 6,001 in 1970 and less than 2,000 at the end of World War II. This continued growth in the number of Names later gave fuel to a conspiracy theory that Lloyd's had followed a deliberate policy of "recruit to dilute" in order to soak up the looming losses, an allegation that was rejected by the courts in the case of Jaffray v Lloyd's.
It was in 1991 that the shit started to hit the fan, when Lloyd's made the landmark announcement that it had lost half a billion pounds in the 1988 trading year - its first loss-making year in a generation. The annual loss figure jumped to £2bn in 1992 and then to nearly £3bn in 1993. By this time, over 90% of active Names, along with thousands of others who had tried to get out of the market, were trapped on an open year on at least one of their syndicates. The misery was not equally spread. For the 1990 accounting year, for example, the average loss per Name was £100,000, but 2% of Names lost over £250,000 and nearly 20% lost between £100,000 and £250,000. Overall, it was reported that 70% of the losses fell on 30% of the Names. The result was that different Names' interests were divergent, and they formed into camps of moderates and militants. By the time the crisis ended, there had been 500 bankruptcies and at least 15 suicides, to say nothing of the countless Names who were reduced to destitution and who lost their homes or marriages.
Inevitably, everyone ended up in court. Richard Outhwaite's investors took the lead in going to the High Court in 1989, with their case eventually settling in 1992. Within a year, more than 15,000 other Names had either issued writs or were actively considering doing so; there followed the biggest torrent of litigation in British legal history. A case management conference held by Mr Justice Saville in an attempt to impose some kind of order on the various sets of proceedings is said to have cost £2 million in legal fees by itself. A number of the cases were successful, but they didn't provide a panacaea for the Names, not least because the people obliged to pay the damages - i.e. the insurers of the Lloyd's agents who were the defendants - were ultimately other Names, or even the very Names who were bringing the cases.
It wasn't just asbestos that the Names had to grapple with. There were also long-term pollution claims, as well as claims from a series of natural and man-made disasters that took place in the late 1980s - Piper Alpha, Hurricane Hugo, Hurricane Gilbert, the Exxon Valdez and others. Plus, something else had developed that served to amplify further the problems facing Lloyd's - the infamous 'LMX spiral'. This phenomenon was connected to the growth of the reinsurance market in the 1980s. As thousands of new Names came on board, the general demand for insurance cover did not expand to meet the extra capacity, so it was filled up instead with reinsurance business - that is, syndicates insuring each other's risks. The reinsurance market at Lloyd's developed in a dangerously incestuous way. What ended up happening was that large-scale liabilities were concentrated within a limited number of reinsurance syndicates and sold and re-sold within those syndicates. According to classic insurance principles, the risks should have been spread widely and thinly.
The LMX spiral was not a new development - it had made an appearance at the time of Hurricane Betsy in the 1960s, and it has been sighted more recently since - but its effects in the late 80s were uniquely destructive. Again, when the losses came, they fell out in a disproportionate way. Because the spiral liabilities were concentrated in quite small numbers of syndicates - with cryptic names like Feltrim 540 and Gooda Walker 164 - a few thousand unfortunate individuals were faced with immense losses. The losses of the Names represented by one members' agency, Lime Street, were said to have averaged £2 million each. An odd quirk of Lime Street is that it targeted London tennis clubs for recruitment, so the ruined Names included the likes of Buster Mottram and Virginia Wade.
It was noted that the worst hit syndicates were disproportionately composed of external Names rather than market professionals. This led inevitably to allegations of conspiracy and fraud, but such allegations were dismissed by an independent inquiry chaired by the Deputy Governor of the Bank of England. Market professionals had a better idea than lay investors of which syndicates to avoid, but some of them still got badly burned, and in any event no-one had deliberately been dumping external Names into the spiral. Here as elsewhere, the Lloyd's saga owed less to conspiracy than it did to cock-up.
The Names didn't receive universal public sympathy. There was a feeling in many quarters that a bunch of greedy millionaires had taken a foolish risk and had got their come-uppance. But this rather facile view was based on a deep ignorance of who the Names actually were. There was a time when the membership of Lloyd's had represented an exclusive club of British high society, but those days had gone by the time of the crash. True, there were still some judges and minor royals, along with Jeffrey Archer and Ted Heath. But many of the Names who had been recruited in the 70s and 80s were middle-income professionals and retired people trying to supplement their pensions. The truly rich tend not to sign up to unlimited liability for the sake of a few thousand pounds extra a year, but a provincial dentist with school fees to pay just might.
The Names didn't have much protection against the risks they were taking on. Lloyd's agents were far from generous with information, and most investors who came on board in the 70s and 80s had no idea what they were getting into. New Names were supposed to be alerted to the risks of unlimited liability at their "Rota interview", but in practice this doesn't seem to have deterred anyone. Former Names say that the interview didn't make the risks clear to them; Lloyd's officers reply that prospective Names tended to be bent on joining and weren't interested in listening to warnings. If Names wanted to limit their exposure, they could buy a "stop-loss" policy, but this would cut out above a certain level of losses - and, because stop-loss policies were underwritten within the market, losses covered by the policies would end up being paid for by other Names.
We now know enough to extend the story beyond the end of the book (which was published in 1994). Lloyd's today is a very different beast from the Lloyd's of the 1980s. In 1996, all pre-1993 business of the market was compulsorily transferred to a specially created corporate group called Equitas. The vast majority of the individual Names have now gone, being replaced by corporate investors with limited liability. The market is now regulated by the FSA, and it would be impossible for the events of the 80s and 90s to recur again. All the same, the story of the Lloyd's collapse stands as a sobering tale of human error, and one which has been explicitly likened to the financial crisis of our own times.