It is recommended that managing agents should have a clear policy on what, if any, downgrade clauses and their component parts are acceptable to them.
When considering what downgrade clauses might be acceptable, managing agents should consider and assess the potential risks to their members and Lloyd’s as a whole which may arise as a result of their use.
As a minimum, any policy should provide that, as a rule, the managing agent:
- Will not accept provisions in clauses that, when triggered, require that the syndicate provides collateral for liabilities. It should of course be noted that in a number of territories Lloyd's syndicates already have in place funding or collateralisation arrangements, including through Lloyd's trust funds, to meet local regulations;
- Will not agree to provisions that lead to the returning of earned premium. Premium will not always be deemed to be earned on a proportionate basis. LMA 5140 is an example of a clause that may be used where premium is earned disproportionately, for example on seasonal catastrophe business. Managing agents should also consider their policy on returning premium where a loss has been paid.
- Will only agree to clauses that have a minimum trigger that is considered appropriate by the managing agent. One approach is to require that the clause is triggered only if the rating falls below a minimum rating (such as A-).
Any downgrade clauses used on inwards business should be clear and contract certain.
Lloyd’s recognises that there will be cases where a managing agent will not be able to achieve its requirements for special termination/downgrade clauses. A record, however, should be kept of all exceptions.
Managing agents are encouraged to develop more detailed policies as appropriate for their syndicates. The above points Lloyd’s believes reflect an appropriate and prudent minimum requirement.
Managing agents may wish to consider using the LMA model downgrade clauses (LMA 5139 and LMA 5140). Where managing agents choose to use other clauses, they should give careful consideration to the operation of the clause selected to ensure that the prudential risk is properly managed and that, where relevant, it addresses the same issues as those addressed by LMA 5139 and LMA 5140.
The Lloyd’s Market Association has also produced additional information and guidance for its members on the use of these clauses.
Performance Management – Supplemental Requirements and Guidance, pages 25-26