In the 1980s, the seeds were sown of what became a decades-long scandal at Lloyd’s of London – one that threatened not just the insurer’s 300-year status as a bastion of the City, but its very survival. As ICAEW member Edmund Lester recounts in his gripping new book ‘Lloyd’s in Crisis: The Insurance Scandal of the Twentieth Century’, troubles stemmed from three key sources.

“Largely as a result of US legislative shifts, Lloyd’s saw a rapid rise in claims around asbestosis, pollution and exposure to the synthetic hormone diethylstilbestrol,” he explains. “Those so-called ‘long-tail,’ non-marine claims were pouring in and weren’t being properly assessed. Often, they were either ignored, or their scale was unappreciated.”

Compounding that issue was inadequate accounting and auditing. While internal reviews had called for a major boost in the firm’s usage of audits and actuarial reporting, some of its syndicates had failed to take appropriate action. As such, Lloyd’s ‘Names’ – the term for the thousands of investors who comprise the insurer’s syndicates – did not know whether the numbers underpinning their reinsurance decisions were correct.

What followed was a destructive game of financial pass the parcel. In the typical Lloyd’s workflow, Lester notes, one syndicate would reinsure with another and take commission, then that second syndicate would reinsure with a third and take commission, and so on. “It became a spiral,” he says. “Underwriters drew out so many commissions that the process left a set of ‘dump syndicates’ holding vast losses.”

Chief among them was Syndicate 418, which was reinsuring 334 – the one Lester, a former Lloyd’s Name, was on. “Some 30% of Names held 80% of the losses,” he says. That pressure forced cracks – and Lloyd’s syndicates soon collapsed into bitter, prolonged litigation. Out of 33,000 Names, Lester says, around half were either engaged in, or considering, legal action against their peers.

Market liabilities

As the infighting raged, Lester himself was encumbered with huge losses, inflicting family trauma. In his view, those woes had stemmed not from ‘business as usual’ practices, but “severe incompetence and mismanagement”, as old policies from the 1940s, 50s and 60s were suddenly interpreted in “unintended or unexpected ways” following the legal changes.

In recent years, armed with 14 lever-arch files of original documents from the time, Lester began to write his book – partly as therapy, but also to produce “an accurate, trustworthy, definitive” account of a “traumatic and evolutionary period in the history of Lloyd’s”. With his book now complete, Lester has a very clear idea about which governance failings led the firm into litigious chaos. 

Failure to provide disclosure

“First was a failure among syndicates to provide sufficient disclosure – and reserve sufficient funds – for asbestosis and pollution claims, once they were apparent in the market,” he says. “That issue was exacerbated by the withdrawal of mandatory Errors and Omissions (E&O) insurance for syndicates, against the recommendations of a 1968 report by former Bank of England Governor Lord Cromer. The cost of E&O insurance would have risen as claims mounted, forcing a greater appreciation of market liabilities.”

Accounting failures

Second – and with significant resonance for the profession – is the failure of accountants in some syndicates to have at their fingertips qualified audit reports, at points when claims were unquantified. Furthermore, Lester points out: “Required actuarial reports, relevant to the firm’s long-tail business, were omitted from syndicates’ financial statements.”

Optimism bias

Third, Lester notes, was the spectre of optimism bias. “Senior working Names with vested interests appeared generally satisfied with their own results,” he says, “Indeed, in some cases they steered very profitable business to their syndicates. That led the firm to overlook the factors that were spawning the dump syndicates and leaving them with huge claims to be paid by unsuspecting Names.”

Fresh perspectives

Lester is equally clear on the lessons that those failings present for the accounting profession. Most importantly, he notes, firms must balance meritocracy and diversity according to the needs of the task.

In Lester’s assessment, Lloyd’s of the 1980s was neither a meritocracy, nor particularly diverse. But he had direct experience of how academic competence can blend with diverse points of view. 

“I had a small training office where I trained chartered accountants,” he says. “I found it very helpful to work with people at different stages of their training. If I’d needed some up-to-date information, I could talk to someone who was on the relevant part of the course. We also had a questioning approach, whereby we didn’t want to do things this year the same way we did them last year. That meant we always had fresh perspectives.”

Next, Lester urges firms to implement recognised quality standards – such as ISO 9001 and 14001 – which promote effective governance and efficiency. “Putting 9001 into my own practice ensured that everyone in the office knew our structure and how it should work.”

Third, for an organisation to maintain independence of thought and action, it should diversify its client base. “The profession should aim for high-quality standards on all tasks,” Lester notes. “That may mean refusing some business.”

ICAEW recommends that the fees from any one client should not exceed a particular percentage of a firm’s total income. “In addition, I would encourage firms to conduct a thorough risk analysis of their client base. That should include an appraisal of vested interests.”

Finally, Lester says: “Some of the situations that accountants come across in their work are very stressful. So, it’s important for professionals to manage their time – whether that means days away on leave to regenerate, or working from home.”

Get your copy

‘Lloyd’s in Crisis: The Insurance Scandal of the Twentieth Century’ is published on Thursday 23 January by Whitefox Publishing Ltd and Edmund Lester, and is available to order from Amazon.