The absence of a proper audit is worrying for investors as Lloyd's continues to be in breach of several statutory regulatory bodies, says Sir William Jaffray
After racking up £7bn of losses between 1997 and 2001, Lloyd's is desperate to prove it still has a place in the 21st century.
To justify its existence, Lloyd's points to profits of £834m in 2002, the introduction of a franchise system and replacement of its three-year accounting system with annual accounting. And perhaps Lloyd's chairman Lord Levene's plans to utilise the record £14.4bn of capacity to expand into European and Chinese markets will excite those tempted to place capital at Lloyd's.
But, down years in insurance cycles prove to be far longer and deeper than profitable years, making it impossible for anyone to obtain a viable investment return, let alone preserve capital.
More worryingly, until Lloyd's is prepared to introduce even basic auditing controls, it is unlikely to make a convincing case for market solvency. If, as I believe, it is insolvent, then investors are throwing their money into a bottomless pit. It is quite extraordinary that a financial institution with £14.4bn of capacity is allowed to trade without having to provide audited accounts.
Only last year the Court of Appeal ruled that Lloyd's syndicates were not audited. Lloyd's syndicates and global results remain improperly audited, in ongoing breach of the Insurance Companies Act 1982 and in breach of UK supervisory regulation (DTI, Treasury and the FSA).
Lloyd's must pass a three-part solvency test each year: syndicate solvency, Names solvency and market solvency. Lloyd's admits that the market solvency test does not conform with UK and EU insurance law on audit requirements - witness its 2002 global results. These were signed off by Ernst and Young, which said its review "excludes audit procedures such as tests of controls and verification of assets, liabilities and transactions as stated in the global results. It is substantially less in scope than an audit performed in accordance with auditing standards and therefore provides a lower level of assurance than an audit".
Enron and Worldcom are harsh reminders for investors tempted to park money in enterprises whose accounts are opaque, unreliable and improperly audited. Lloyd's solvency or insolvency turns not on the gloss of public relations , but on mundane facts and figures.
Where Lloyd's has shown immense adaptability to adverse circumstances is in transferring market insolvency to membership insolvency. The £8.5bn losses racked up in 1988-1992 were largely for undisclosed asbestosis claims, which ruined the 27,000 Names recruited into the market between 1975 and the peak year of 1989. Lloyd's survived by bankrupting the membership.
The inescapable conclusion is that corporate capital represents an Achilles' heel for the insurance market because, once margins were called to the limit of funds lodged at Lloyd's, £508m in unpaid claims had to be met by the Central Fund. It will not be surprising if Lloyd's reverts to traditional Names within five years and most of them happen to be Chinese.