Update on Contract Certainty John Harvie Contract Certainty Sponsors and PMs 28 th September 2006

Market Reform Page 1 Contract Certainty – The headlines Market on target to achieve 2006 milestones. Currently ahead of schedule. FSA meetings held –Q3 review now complete –See FSA website for write-up – –FSA issues are still: Quality of data; exceptions; legacy policies; 2007 –This update provides an insight into the markets message to the FSA Market Reform Slip Mandated (for Lloyds) from 1 st Oct –Binder and line slip guidance to follow shortly

Market Reform Page 2 We have focussed on the areas highlighted by the FSA as requiring further work 1.More challenge and assurance over data 2.Focus on the key drivers which are likely to inhibit cultural change 3.Greater clarity over the extent of the legacy issue

Market Reform Page 3 The Market is making progress in line with expectations Contract Certainty Evidence of Cover 86% - Contract Certainty in June 06 June performance UP 1% from May 06 85% - Open Market Contracts in June 06 June performance UP 4% from May 06 88% - Certificates in June 06 June performance DOWN 3% from May 06 84% - Evidenced to client in 30 days in June 06 June performance UP 6% from May 06 77% - Open Market Contracts in June 06 June performance UP 3% from May 06 92% - Certificates in June 06 June performance UP 8% from May 06

Market Reform Page 4 Data from Managing Agents and Companies continues to support Broker data Managing Agent Contract Certainty 89% - Total Contract Certainty in Aug 06 Aug performance UP 1% from July 06 89% - Open Market in Aug 06 Aug performance UP 1% from July 06 90% - Binding Authority in Aug 06 Aug performance UP 1% from July 06 Company Contract Certainty 93% - Total Contract Certainty in July 06 July performance UP 2% from June 06 93% - Open Market in July 06 July performance UP 2% from June 06 91% - Binding Authority in July 06 July performance UP 15% from June 06

Market Reform Page 5 In response to the FSAs challenge, Lloyds, the MRPO and the Associations have undertaken an analysis of organisations self- assessed contract certainty performance The following methodology has been applied: Visits by LMBC to organisations scoring less than 75% Contract Certainty. Visits by Lloyds to organisations scoring in the top 5 and bottom 5 of Contract Certainty and where there is divergence between self- assessed and Slip audit scores. Visits to other volunteer firms to support market initiative, including the Company market. Findings reviewed by CCPB and MRG.

Market Reform Page 6 The key findings from this analysis are: Measurement regimes vary between firms, as they interpret the CC guidance in the context of their operational risk management strategies, as originally envisaged in the market guidance on measurement. The late placement guidance is not applied consistently by all firms, again in accordance with operational risk profiles. The precise timing of the CC checkpoint within measurement systems and the systems themselves can differ. Different classes of business and different geographies perform in different ways.

Market Reform Page 7 Late placement data has been collected for 3 months and to date it accounts for 5%-10% of the markets volume (broker data) Contract Certainty 6% - order completed after inception in July 06 9% - firm order completed post inception in July 06 Evidence of Cover 5% - order completed after inception in July 06 7% - firm order completed post inception in July 06 Findings on late placement position The late placement guidance introduced in March 2006 recognises that Late Placements can be contract certain. Most organisations have adopted the late placement guidance and are reporting late placements as passes where they comply with the guidance. However, some organisations (brokers and carriers) have taken the stance that the late placement guidance weakens the drive for contract certainty or is incompatible with their own assessment of operational risk and continue to mark late placements as a fail. This may have a material effect on the level of contract certainty being achieved by those organisations. Organisations are also interpreting the late placement guidance in a different way, for instance, contract certainty is being measured by some firms at the date the first line is bound and by others from the date the last line is bound.

Market Reform Page 8 The survey found that 74% of market participants regard their systems & controls for achieving Contract Certainty to be either embedded or very well established in their Business-as-usual operations* *Completed surveys represented the following % of contract volumes Broker – 90% Managing Agents – 100% Company Market – 84% **Calculated by aggregating survey responses to 6 questions covering: the use of the Contract Certainty Checklist, approach to measuring Contract Certainty, use of Contract Certainty data to drive improvements, analysis of the causes of Contract Certainty exceptions, approach to monitoring & reporting Contract Certainty progress and the level of Contract Certainty education.

Market Reform Page 9 The FSA asked the market to test whether there was a strong correlation between value and lack of contract certainty. Broker dataCorrelation varies from firm to firm but there does not appear to be a strong correlation. Managing agent dataIf the average value of premium for all risks was £100, the average value of contract certainty passes would be £85, the average value of failures would be £122. This implies that 81% of contracts by value are contract certain. Survey30% of organisations analyse the contract value/certainty relationship. Of this set, over 90% of organisations concluded that the average value of their exceptions was either approximately the same or less than the value of their certain contracts. – Market set out to test whether there was a strong correlation between value of contract and lack of contract certainty. Analysis based on data from managing agents supported by individual brokers performance and output from the survey. – Analysis concluded:

Market Reform Page 10 The results of the market survey support the view that there is not a strong bias towards uncertain contracts being of a higher value. *Value = average premium The survey found that currently 30% of organisations analyse the contract value/certainty relationship. Of this set, over 90% of organisations concluded that the average value* of their exceptions was either approximately the same or less than the value of their certain contracts.

Market Reform Page 11 A number of actions have been undertaken on legacy since the last meeting. The plan going forward is to continue monitoring legacy reduction. Actions taken Legacy contact list made public XIS purging facility now available Market session in September Changes to Unsigned Policy Report defined and agreed Plan Devise and implement a coherent plan and monitoring regime to demonstrate progress and eradication to the FSA.

Market Reform Page 12 The survey found that 50% of organisations have made some or significant progress in reducing their Legacy backlog

Market Reform Page 13 Summary of current Contract Certainty position The markets performance remains ahead of published market targets. Variations in reported performance exist because organisations are dealing with contract certainty within the context of their particular operational risk frameworks. The guidance that the market has issued is substantially embedded in firms business-as-usual processes. The analysis of value is sufficient to demonstrate that there is not a strong bias towards high value contracts and lack of contract certainty. However, it is acknowledged that there is further work to do in: –Continuing to support the market in the interpretation and use of existing guidance. –Consolidating, simplifying and incorporating lessons learnt into the guidance. –Supporting the market in the elimination of contract certainty exceptions. –Addressing the issue of Legacy and being able to demonstrate tangible progress.

Market Reform Page 14 Current position for the remainder of 2006 and 2007 FSA Liaison –Continue existing information flow for 2007 –Build on existing levels of CC performance Guidance –Revision of guidance into a consolidated set in order to simplify, remove inconsistencies and ambiguity, improve clarity - strictly retaining the principles-based guidance approach (Q1 2007). Measurement –Continue to reduce exceptions and demonstrate reduction to a set target (by volume of contracts) (end of Q2 2007) Late placements –Continue to reduce late placements and demonstrate reduction (end of Q2 2007) Stamp conditions and subjectivities –Continue to drive through agreed approach Signed lines and Signing provisions –Review in the light of practical experience Legacy –Work for the remainder of 2006 and into 2007 will be to devise and implement a coherent plan and monitoring regime to demonstrate progress and eradication to the FSA.

Market Reform Page 15 Ongoing support required from the FSA Provide support to the market by: –Continuing to feedback findings from market analysis and visits. –Continuing to address oversees regulators and markets. –Maintaining a principle rather than policy based approach.

Market Reform Page 16 The FSAs message to the market Good progress, carry on the quality of data – all firms need to be able to demonstrate that they are achieving contract certainty so should have in place appropriate systems and controls to challenge and support the data reported to the market legacy issues - work on scoping and addressing the backlog of policies across the Subscription Market needs to result in quantifiable progress by the year end; and exceptions - work to assess the value and complexity of those policies that do not achieve contract certainty must continue to enable lessons to be learnt and improvements made. Contract certainty will continue to be a supervisory priority in Any firms that fall behind the rest of the market will be subject to the full range of regulatory tools, including where necessary consideration of enforcement action.