Legal fight looms over '20 years of regulatory failure at Lloyd's'

Successive British governments failed to supervise and regulate the Lloyd's of London insurance market properly for at least 20 years, according to a probe by the European Commission.

Successive British governments failed to supervise and regulate the Lloyd's of London insurance market properly for at least 20 years, according to a probe by the European Commission.

Documents relating to a two- year-long EC investigation into Lloyd's, which was dropped 18 months ago after intense lobbing by the Treasury, have been obtained by The Independent on Sunday. They show serious weaknesses in how Lloyd's was run and supervised.

Frits Bolkestein, then the European Commissioner for the single market, said the new regime brought in at the start of 2002 - under which the Financial Services Authority (FSA) took over regulation of Lloyd's - meant that the major concerns raised by the EC had been dealt with. He therefore dropped plans to take action against the UK Government. The European Parliament is now pressing for the matter to be reopened (see the article on page 7).

The EC sent two enforcement letters to the Government in December 2001 and January 2003, saying it believed that the European Directives on non-life insurance were being breached by poor regulation at Lloyd's.

The EC limited its probe to the running of Lloyd's from 1982, when the then Conservative government passed an Act formalising the self-regulatory struc- ture of the insurance market.

It found that "the delegated authorities at Lloyd's appear not to have been obliged (nor did they see it as their duty) to convey intelligence of any financial problems to their competent authorities".

It added that in 2001 "the flaws in the regulatory/supervisory system would appear substantially to remain". This was despite huge reforms at Lloyd's, notably the "Reconstruction and Renewal" initiative in 1996 that hived off much of the liabilities which had dogged the market into a new vehicle, Equitas.

The EC found pressure had been placed on auditors within Lloyd's to the point where there was a "lack of a material, independent audit" -a situation it said was still continuing in 2001.

It cited a 1982 letter from one of the Lloyd's auditors, Neville Russell, saying that asbestosis claims were so high, it was impossible to determine them - a view that challenged the solvency of the entire market.

The EC found that Lloyd's had not disclosed this letter to the Department of Trade and Industry - at that time in charge of insurance regulation - until 1993 at the earliest.

Asked about this delay, a Lloyd's spokeswoman said: "We have nothing new to say on this matter."

The EC also raised questions about how Lloyd's is run today. It pointed to the high percentage of policies reinsured within Lloyd's - one syndicate taking on the risk from another. In the 1980s about 80 per cent of risks were reinsured within the market, though this fell to 17 per cent in 2003.

The EC stated that "reinsurance placed within the market is mere self-reinsurance", adding that "there is no risk transfer" and this has a bearing on the calculations of how well the market is able to pay claims.

Both Lloyd's and the FSA reject this claim. "An agreement by one member (or group of members in a syndicate) to reinsure another member or another syndicate entails a substantive transfer of risk," said the City regulator.

Both the FSA and the Treasury, which took over responsibility for insurance regulation in the late 1990s, say the fact that the EC ultimately decided to take no action against the Government meant they consider the issues closed. "The Commission has investigated UK compliance with EC directive 73/239/EEC and has concluded that the UK is fully compliant," said a Treasury spokeswoman.