Finance

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Kanye West has got into a fight with a handful of Lloyd's of London insurers. Somehow, the world has noticed. The rapper's ability to generate massive publicity has exposed a weak spot in the insurers' business model.

Very Good Touring Inc., the company behind the rapper's 2016 Saint Pablo tour, is suing a group of Lloyd's syndicates for at least $9.9 million because they haven't paid out for a handful of canceled gigs. It wants interest at 10 percent and punitive damages, too.

The litigation is already pretty ugly. Very Good's lawsuit claims the insurers have implied that Kanye's use of marijuana provides them with grounds to refuse the claim. For their part, the syndicates -- some linked to Lancashire Holdings, Allianz and XL -- have denied this is the sole basis for not paying.

Lloyd's of London companies "enjoy collecting bounteous premiums" but "don't enjoy paying claims, no matter how legitimate," the lawsuit says. This is the worst kind of publicity for any insurer. A reputation for being a prompt, no-quibbles payer is paramount in this industry. Small wonder Lloyd's quickly retorted that its standing has been built on "meeting our obligations quickly and effectively".

Now consider the economics of the insurance in question, so-called contingency cover. Pretty much anyone hosting a large event -- like a giant music festival -- takes out a policy. This is a great business for insurers as it is a must-have for the organizer. Yet most events proceed as planned, so the insurer rarely pays out.

This means the combined ratio, which measures costs as a proportion of premium income, is often well below 100 percent in most years -- but occasionally shoots up when there's a big claim. 

When Things Go Wrong...
Specialist Lancashire's expense ratio is lower but more volatile than broader based RSA's
Source: Bloomberg
Note: Annual combined ratio measuring costs and claims relative to income

Hence Lloyd's specialist Lancashire has had a combined ratio of between around 45 and 86 in the last decade. By contrast, RSA Plc, which has a broader business spanning individuals to large firms, has a combined ratio that has pretty consistently stuck in the mid nineties. A lower ratio means bigger profits for the insurer. 

Such dynamics ought to make contingency event insurers give claimants the benefit of the doubt. Refusing a claim risks getting a name for being a non-payer. And that may make potential customers think about going elsewhere. The savings from denying a claim may then be outweighed by the future loss of business.

To come out winning here, the insurers need the judge to find so resoundingly in their favor that rivals won't be able to use the episode to suggest the syndicates are flaky. No insurer wants to pay a claim it thinks it can swat away for fear of encouraging moral hazard. The snag is that when reputation is at stake, the pressure is on to pay up -- and move on.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net