How Not to Make a Shilling in Insurance
A decade ago, it was perhaps the ultimate experience for an American Anglophile: What better way to indulge one's fascination for things English than to join one of that country's most storied, exclusive clubs?
To become a "Name" at Lloyd's of London--to become an investor in the 300-year-old insurance institution--gave hundreds of Americans not only a steady profit but also entree to a strata of British society few outsiders could attain.
American Names were told they had become a part of a British business institution which prided itself on honesty and good-faith dealing. And how could an investor feel differently when he took the requisite trip to London and was ushered into an antiquated chamber by liveried attendants for a rite of initiation? There, a panel of bewigged Lloyd's committeemen questioned the prospective Yank and then, with just the right touch of melodrama, a committeeman put his hand into a box and pulled out a piece of paper with the one word: "Yea."
Americans who negotiated this mostly ceremonial process found themselves suddenly welcome among an elite international jet set. They were part of an institution that had made its name first in marine insurance, underwriting centuries of empire-building, and later expanded into specialized markets of surplus insurance, where almost anything is insurable--even Betty Grable's famous legs, which were insured during World War II by Lloyd's for a reported $1 million.
In the postwar era, invitations to join Lloyd's as a Name--a province traditionally reserved for Britain's well-heeled and titled--was opened to the less affluent in Britain, and, later, to foreigners. During the 1970s and 1980s, Americans joined in droves, and enjoyed sizable profits year after year.
Only after a series of natural and manmade disasters struck Lloyd's did the realization begin to dawn that American and other international investors had fallen victim to what some say is the largest fraud in world history.
American Names, who had gladly accepted the prospect of unlimited liability as Lloyd's underwriters, faced losses many times their original investments. Names who had thought they were joining relatively safe and profitable insurance syndicates found out they had instead been exposed to the most extreme of risks: asbestos and pollution claims emerging from policies written decades earlier.
Losses among the 2,900 American Names alone have been estimated at more than a billion dollars--or about a half-million dollars each on original investments that averaged about $40,000.
And while Lloyd's itself has struggled to recover from years of losses, analyses by business and insurance experts have found several areas of blame, including antiquated underwriting practices and negligence.
But the most serious charge against Lloyd's has been leveled by Names who say they were the victims of outright fraud. Lloyd's insiders had known that the catastrophic losses were coming as early as the late '60s, the Americans claim, when the institution went looking for new members specifically to absorb those losses.
Despite compelling evidence which backs up these claims, no government entity appeared willing to prosecute the venerable insurance market. Not the British government, which by fiat has bestowed a kind of immunity on Lloyd's, nor American securities regulators, who proved reluctant to take on the insurance giant.
But then, last year, two government entities proclaimed that they could prove fraud and intended to punish Lloyd's on behalf of their citizens.
Those entities were the states of Arizona and Illinois.
Charles de Trenck looks as if he should be strolling the deck of a 1940s cruise liner rather than sitting in the unromantic clubhouse of a Scottsdale condominium complex.
The 75-year-old wears a double-breasted jacket, a silk handkerchief sticking prominently out of its pocket. He has a round face with vaguely Churchillian features, and he speaks with an accent that is hard to place.
Born of German parents in what is today the Czech Republic, de Trenck grew up in Italy and England. When he became a Name in the 1970s, he was running a bank in Switzerland.
"Lloyd's was a wonderful thing to belong to then. Not now, of course. Now it means you're a sad jerk," he says with a self-deprecating laugh.
De Trenck moved to Arizona in 1979--"What should I tell you? I love the cactus."--and was one of the founding members of Founders Bank. He had retired from a lifetime of successful banking only to find that his investments in Lloyd's were wiping out much of what he'd set aside.
"It was absolutely fraud," de Trenck says.
He says he was assured by Lloyd's agents that he would not be exposed to asbestos and pollutions claims, only to find out that he had been lied to.
De Trenck claims that Lloyd's agents exposed Names to unreasonable risk during the 1980s to produce illusory, short-term profits. But when a series of oil-rig explosions and hurricanes came in 1988 and 1989, that shortsightedness spelled disaster.
De Trenck says he's already paid Lloyd's 250,000 pounds, and Lloyd's says he owes another 525,000 pounds (about $800,000). Lloyd's controls an additional 87,000-pound letter of credit that de Trenck expects will be drawn down soon, he says.
"That money was my retirement money," he says with a shrug.
"It's partly my fault, too. Let me say that. But that's 20-20 hindsight."
De Trenck says that after a scandal involving crooked insiders rocked Lloyd's in 1982, "I should have resigned then. It should have been a warning sign to me that the ethics were no good."
Recently, he says, when the full extent of the Lloyd's catastrophe was known, de Trenck sent a letter to his agents in London, complaining of their stupidity in underwriting matters. "Two 5-year-olds with a colored pencil could have done better than you did," he wrote.
Like other Arizona Names, de Trenck was encouraged when Arizona regulators set out to prove that Lloyd's had defrauded its Names. And although that effort would ultimately be futile, many Names are satisfied that Lloyd's offered a settlement to stanch the flow of the Names' losses.
In the offer, Lloyd's agreed to ask de Trenck for only 157,000 pounds of the 525,000 it says he owes.
De Trenck refused to take the deal.
About 45 Names live in Arizona, and almost all have accepted Lloyd's settlement offer. Documents on file at the Corporation Commission name only a handful of the Arizona Names, including agribusinessman and former deputy secretary of the U.S. Department of Agriculture John R. Norton III, and American Fence Company owner John VanDenBurgh. Others listed in the files were William Clardy, Morris Himmel, Will Pearson and Albert Rider. The Corporation Commission refused to name any of the other Lloyd's investors, citing confidentiality rules.
But New Times obtained a confidential list of Arizona Names and contacted some of the members. Of those, only Charles de Trenck was willing to talk on the record.
The rest say they're embarrassed to be connected to the Lloyd's debacle; others say they can't let business colleagues know that they have been involved in bad investments.
Nearly all, however, were eager to talk about the involvement of the state government in their years-long battle with Lloyd's of London.
With few exceptions, the Names praised the state's Corporation Commission as well as the head of its securities division, Dee Harris, for the way the state defended Arizona's Names when other governments would not.
"I was so tremendously impressed with the integrity and seriousness of this endeavor, it made me proud to be an American," says one Name who faces losses of nearly $1 million.
Karen Silver, assistant director of the Corporation Commission's securities division, says the state was prepared to take action against Lloyd's on several fronts. Investigators had found that by the standards of Arizona law, Lloyd's had sold unregistered securities, that its agents who sold those securities were themselves unregistered, and that fraud had been perpetrated against Arizona citizens. On September 21, 1995, the Corporation Commission filed a notice to this effect, allowing Lloyd's an opportunity to request a hearing on the charges.
"The notice alleged that as early as 1979, Lloyd's knew about the potential flood of asbestos litigation and asbestos claims coming. And Names were put into these risky syndicates without their knowledge," Silver explains.
What the state intended to do about it, she says, was to obtain a cease-and-desist order which would prevent Lloyd's from doing further business in Arizona and--more to the point from the perspective of Names--prevent Lloyd's from collecting on the debts of its Arizona members.
After Arizona and Illinois announced their willingness to prosecute Lloyd's, other states followed. Within months, 30 states had joined the effort in a nationwide task force of state regulators.
Not everyone was encouraged by the upstart movement of U.S. state regulators. Business leaders, insurance regulators and even some Names were sympathetic to entreaties by Lloyd's managers who predicted dire circumstances if the insurer were prosecuted.
State regulators were told that they could upset a delicate global balance which could mean the end of Lloyd's as well as a host of other insurance giants. Adam Raphael, a British Name who wrote a book on Lloyd's troubles, complained that American litigiousness was partly to blame for the Lloyd's predicament in the first place, and couldn't solve Lloyd's present problems.
The Yanks wanted to get to the bottom of the mess at Lloyd's.
That mess began with a hurricane named Betsy.
Betsy hit the Carolina coast September 4, 1965, with a furious intensity which killed hundreds of people, then took a bizarre, backward path through Florida into the Gulf of Mexico. Betsy also took out a dozen expensive offshore oil platforms.
The platforms were insured by Lloyd's. This disaster and others in 1965 caused a rare occurrence for the venerable insurance institution: a loss year. To the typical Name, it meant that rather than receiving a check for profits at the end of the year, he or she had to send in a check for about 10,000 pounds, which would be the equivalent of about $100,000 today.
Alarmed over flaws in its underwriting practices, Lloyd's commissioned an internal investigation in 1968. The result, known as the Cromer Report, indicated that much needed reforming at Lloyd's. The report was kept secret even from Names until 1986. Specifically, the report asserted that Names were particularly at risk in Lloyd's way of doing business.
That way of doing business had begun over cups of coffee in a London shop 300 years earlier.
Edward Lloyd's coffee house, established around 1680, was popular not so much for its penny cups of coffee, but for the latest shipping information from the nearby docks. Gradually, Lloyd's evolved into a marketplace for shipping insurance, where investors eager to take risks on Britain's commercial fleet could write policies and keep up on news. Those early policies were written on elaborate documents, sometimes reaching four feet in length, to contain lists of conditions as well as the signatures of risk-takers who were willing to back the policy.
The documents were then fan-folded so the signatures could be seen--and the names backing the policy known. Hence, regular underwriters at Lloyd's came to be called Names.
Today, Lloyd's retains something of its original form, insisting that it is not a corporation but a marketplace, akin to a stock exchange, where syndicates of underwriters--for the most part, agents who represent the Names--take risks by writing myriad insurance policies. The corporation of Lloyd's, meanwhile, is simply the firm that maintains the premises and provides support services where that business is transacted.
Collectively, the underwriters, their agents, and the premises where underwriting occurs are known as "Lloyd's of London."
From its humble beginnings as a coffee house to its elevation as a quasi-governmental agency, Lloyd's became a giant in marine insurance. In 1900, half of all the world's shipping policies were underwritten by Lloyd's.
To this day, ship captains maintain the tradition, when passing British-held Gibraltar at the entrance of the Mediterranean, of signaling with the message, "Report me to Lloyd's."
Names provided the capital on which this business empire was built. And when enough ships made it safely to port so that losses did not exceed premiums on a particular syndicate's policies, Names who had invested in that syndicate profited. But when disaster struck, Names knew that they had to make good on the policies they backed at Lloyd's--even if it meant paying far more than their initial capital investment. Throughout the world, it was known that a Name was "liable to his last shirt-button."
Much of Lloyd's success was due to the trust placed in this principle. Lloyd's commitment to its policyholders was legendary. Never was that clearer than when news of the 1906 San Francisco earthquake reached London. After the scope of the devastation was communicated to Cuthbert Heath, who is to insurance underwriters what Thomas Edison is to inventors, the Lloyd's underwriter telegraphed his San Francisco agent a simple message: "Pay all our policyholders in full irrespective of the terms of their policies."
The public's trust, combined with prudent underwriting, ensured substantial profits for Names.
The losses of 1965, however, indicated that over time, Lloyd's syndicates had strayed off course.
And the Cromer Report detailed how misguided they had been. It pointed out that the majority of Names had no real contact with underwriting activities. "Managing agents," paid on commission, handled the actual day-to-day transactions of underwriting, while "members' agents," also on commission, represented Names and their interests to these underwriting agents.
Some Names, called Working Names, did participate in the actual underwriting at Lloyd's and were more familiar with the risks syndicates were taking, but they were vastly outnumbered by so-called external Names who relied on the facility and honesty of various agents.
And in that network, conflicts of interest ran rampant.
The Cromer Report made several recommendations for reform at Lloyd's, but the institution's leaders ignored all but the last: to create a larger safety net for the market by expanding its capital base.
The next year, Lloyd's went to America in search of new Names.
If Lloyd's agents who came to the United States after 1970 weren't discussing the conflicts of interest cited in the Cromer Report, they also weren't telling American Names about other unsettling developments in London.
Certain policies, written primarily in America decades before, threatened to produce a devastating burst of claims. Many of them concerned the widespread use of a cheap, useful mineral that provided excellent insulation and fireproofing in buildings.
The mineral was asbestos, and as early as 1924, doctors reported that it was a killer. But many companies ignored or suppressed evidence about the dangers their workers faced and continued to use asbestos for decades afterward.
Workers who had handled asbestos and were dying from its effects began to sue those companies. By the early 1980s, lawsuits brought by those workers and their families had exploded. In 1982, American manufacturer Johns-Mansville filed for bankruptcy protection in the face of 16,000 lawsuits; 6,000 new suits were being filed against Johns-Mansville every year.
Lloyd's found itself in a nightmare position. Most American insurance companies wrote liability policies requiring claims to be filed during the period of the policy. But Lloyd's had written "occurrence"-based policies, meaning that the cause of a loss had to have occurred during the policy's period, but the claim based on that loss could be filed anytime--even 20 or 30 years after a worker had breathed asbestos fibers.
The liabilities of such "long-tail" policies could remain unquantifiable for decades.
One Lloyd's agent said of the deluge of claims: "The main reason for these huge losses is that the asbestos manufacturers went on manufacturing asbestos for decades after its harmful effects were known; and, above all, because some insurers were naive enough to insure them."
Lloyd's was no longer naive, however. It stepped up efforts to recruit Americans after 1980.
"The scale of asbestos claims was foreseeable by the late 1970s," writes Adam Raphael, the British Name and author. "By 1982, it was clear that the market was facing a very serious problem. But little or none of this was disclosed to the thousands of Names who were recruited by commission agents and persuaded to join long-tail syndicates in the mid-1980s."
Americans traveling to face the initiation ritual in London knew they were taking a risk; but they had no idea they would shortly be expected to pay the losses on bad policies written decades earlier.
Lloyd's denies that American Names were defrauded. William Pitt, a Lloyd's spokesman in New York, says that Americans applying for membership were fully informed of the implications of being "liable down to one's last shirt-button."
But revelations following the asbestos calamity showed a striking disproportion of the asbestos burden was placed on the backs of American and other external Names.
One computer analysis showed that 90 percent of the losses from the hardest-hit syndicates were borne by external Names--the Working Names, or insiders, had not invested in them.
"The Working Names," Raphael writes, "appeared to have an uncanny knack of getting access to the most profitable syndicates."
The correlation of external Names to bad debt and Working Names to profit was too coincidental for Americans who faced ruinous losses.
Jeffrey Peterson of the American Names Association tells New Times that his members joke that a Name's losses are directly proportional to how far he lives from London.
"Well, except it's not really a joke," he says, pointing out that of all Americans, Californians were on average hit hardest.
An Arizona Name who joined Lloyd's in 1983 says that after investing less than $100,000, he and his wife owe Lloyd's 850,000 pounds, or about $1.3 million.
"And that's just a guess," he says, "because I don't really want to know."
Even after the asbestos calamity became obvious, American Names charge, Lloyd's assured new members that they would not be put on the asbestos-exposed syndicates--which turned out not to be true.
Says the Name facing a debt of $1.3 million: "What kills me is that I talked my wife into joining in 1987. I told her, 'Don't worry, you know with Sedgwick [a Lloyd's members' agency] you will never ever have a cash call on your syndicates. And you will never have an open year [when accounts cannot be closed because losses cannot be calculated]. And finally, you will never have a loss year.' So she joined. And then the opposite happened. She had nothing but cash calls, losses and open years. This Lloyd's is just like quicksand. Once you get into it, you can't get out of it. You just sink further and further."
When an oil rig blew up in 1988, killing 165 workers, Lloyd's discovered that it had turned much of the rig's catastrophic-loss policies back on itself. Rather than spreading the risk of such an extreme disaster among dozens of companies, underwriters hungry for the high profits of excess-loss policies had concentrated the damage onto Lloyd's.
It proved to be the single biggest hit Lloyd's had taken since Hurricane Betsy. Lloyd's net loss, a staggering $900 million, only became obvious as the rig's spiral of 43,000 separate policies was uncoiled.
This and other catastrophes compounded the asbestos disaster for Lloyd's members. American long-tail claims involving EPA Superfund sites have also hit Lloyd's hard, as did a series of other natural disasters in the late '80s, such as 1989's Hurricane Hugo.
By 1992, the crisis at Lloyd's reached a head. After years of modest gains, thousands of Names were hit with enormous cash calls. Several in Britain committed suicide--which didn't relieve the obligations from the families they left behind. American Names learned the precariousness of their position when Lloyd's agents finally told them that they had been put in the syndicates most exposed to long-tail and excess-loss catastrophes. And there was nothing they could do, they were told, but pay up.
British officials, meanwhile, refused to take action on the Names' charge that they had been swindled. In 1982--at precisely the time it became clear asbestos claims were inundating Lloyd's--the British government had proclaimed by fiat that Lloyd's would be immune from criminal prosecution by the British government.
Furthermore, when they had become members, American Names had agreed to argue any grievances in British courts and under British law, where it is much more difficult to bring a civil fraud lawsuit than in the United States.
And in American courts, Names have been unable to enter evidence of Lloyd's fraudulent behavior. American judges have so far held that Names must, as their contracts stipulate, take their fight to Britain.
The Names counter that U.S. and state laws were violated by Lloyd's agents, regardless of what their contracts say.
These legal setbacks did not go unnoticed by the task force of state regulators who were planning to prosecute Lloyd's. Lloyd's could, after all, ask that any action brought by the State of Arizona, for example, be moved to the federal courts, which had proved so friendly.
"What we saw were a number of very recent cases where federal and state courts were showing that they were not overly sympathetic to Names trying to get out of their obligations with Lloyd's," says assistant attorney general Robert Zumoff, who served as the Corporation Commission's legal adviser in the case.
That success in mostly federal courts has led some of the Names to suggest the possibility of an international conspiracy. Some believe a deal was struck during a 1992 meeting between then-president George Bush and Prime Minister John Major, but they know there's little real proof of U.S.-British collusion.
"Around the country, the cases were losing in courts and I can't help think there's something behind it," says one Arizona name. "Lloyd's is incredibly important to England and to the world, and if they didn't settle this, they couldn't continue."
Throughout 1996, as Lloyd's continued to find success in American federal courts, the 30-member coalition of state regulators began to crumble. One by one, state securities regulators dropped out of the case. They did so not only because of unfavorable court rulings, but because Lloyd's had in the meantime offered a settlement agreement to Names, and many of them were taking it.
Other pressures were felt by the task force of states. "As the investigation proceeded," says Karen Silver of the Corporation Commission's securities division, "particularly at the level of the task force, there were a number of allegations tossed back and forth, such as, 'If you orchestrate the downfall of Lloyd's, the world as we know it today will cease to exist.'"
Securities director Dee Harris says those pressures were primarily coming from out-of-state insurance regulators who predicted many American insurance companies would face insolvency in the event Lloyd's failed.
Still, a few states remained determined to prosecute Lloyd's. In a letter, Colorado's attorney general let it be known she was glad that her Names were getting some kind of settlement, but it didn't deter her determination to make Lloyd's pay for its deceptions.
Arizona, too, remained resolute. While most of the states in the original task force dropped their cases and endorsed Lloyd's settlement offer, Arizona did not. In July, Arizona's Corporation Commission agreed to continue with its effort.
Within a few months, however, even the most stalwart states could see that the effort was failing. Finally, by October, there was only one state left standing.
Arizona had been among the first, and now it was the last.
On October 4, Arizona's Corporation Commissioners voted to endorse Lloyd's settlement offer and withdraw its complaint.
"Ultimately, Lloyd's gave up and the states gave up. Lloyd's gave up a tremendous amount of liability and settled for a certain amount, severing relationships with Names," Silver says.
Arizona Names tell New Times that they are generally ambivalent about terms of the settlement offered by Lloyd's. It will cut down on their indebtedness: a typical Arizona Name will have to pay about $200,000 rather than the $800,000 Lloyd's says he or she owes. But as part of the offer, the Names must give up any attempt to sue Lloyd's for fraud.
Also, the Names disagree with Silver's assessment that their relationship with Lloyd's will be severed: Despite the deal, the Names could continue to be exposed to asbestos and pollution liabilities which may not surface for years, or even decades.
"Obviously, we would have preferred a better settlement than we were able to achieve, but there were countervailing circumstances that we normally don't encounter," says securities division director Dee Harris. "The British government really made it obvious that they didn't want Lloyd's to fail."
Some Names still refuse to take Lloyd's offer. But even though Arizona has given up its attempt to prosecute the insurance behemoth, few complain about the state's decision.
"We were the last state, which was a tribute to the state's workers," says one nearly destitute Name.
Outside of the United States, Lloyd's spokesman William Pitt says, almost all Names--94 percent--have accepted the settlement offer. But considerably fewer Americans--78 percent of the 2,900 members in the U.S.--have taken the deal.
Some 600 American Names, such as Scottsdale's Charles de Trenck, defiantly refuse to agree to Lloyd's terms.
"Do you think they're going to sue me for it? Come on," de Trenck says of the risk he faces by refusing the Lloyd's settlement offer. "They would have to file a writ and then come here after me. But they'd never risk what could come out in discovery."
De Trenck says that unlike other Names whose assets would be in danger, he has no "visible means." He drives a 10-year-old car, he points out. He figures he's not worth Lloyd's trouble. But he insists there's a greater reason he resists the institution's overtures.
"You see, I'm not settling on principle," he emphasizes.
He's asked how the losses have affected his life in retirement.
"Stupid, simple, idiotic things. My style has been quite circumscribed," he says, as if he were talking about something no more noteworthy than a late notice from the utility company. "I didn't take a vacation this year. Things like that, you cramp your style."
"A lot of other people," he points out, "are totally ruined."
Although the state of Arizona has dropped its attempt to punish Lloyd's, members such as de Trenck say they are pleased with the state's efforts.
"I thought they did an excellent job," he says. "Dee Harris did an absolute triple-A job."
And Jeff Peterson of the American Names Association says that despite Arizona's capitulation, its effort will not have gone to waste.
If Lloyd's does come after de Trenck and the other Names who refuse to accept the settlement, Peterson explains, the work done by the Arizona Corporation Commission's securities investigators will prove an invaluable resource to attorneys fighting defensively for Arizona Names.
Peterson isn't surprised that Arizona Names, both those who have accepted the settlement and those who haven't, admire the work done by the state.
"I'm glad to hear it, because they did an amazing amount of work and put their necks on the line for the Names. And in hindsight, I can say that this was not a winnable battle. I mean, we're not fighting a Merrill Lynch here. This is really a business with the backing of its government," Peterson tells New Times from his San Diego office.
"If this company was Lloyd's of Phoenix, the directors and officers would be in jail and we would have had our money refunded."
Peterson and many Names are still fighting to enter evidence about Lloyd's fraud in an American court. Currently, they await a decision from the Ninth U.S. Circuit Court of Appeals, which is considering whether to overturn a lower court ruling that the Names had to bring their complaints to British courts. If the American federal court finally allows the Names to argue that Lloyd's broke American securities laws, Peterson says, then Lloyd's will be in for the fight of its life. "This isn't over," he predicts.
Names who have accepted Lloyd's settlement agreement hope that the market's attempts to contain the runaway losses will hold up. They're nervous, they say, when Lloyd's makes assurances that their nightmare is over.
One Name says he's been duped one too many times already. He says he'll never forget his initiation ritual in that stuffy London meeting room. "One of the guys in the wigs says to me: 'I'm sure you understand that there's unlimited liability.' And the guy at the end of the table winks at me. They had this thing all staged.
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