How Lloyd's is dealing with the aftermath of the US terrorist attacks.

As the US constitutes the Lloyd's largest single market, it should perhaps come as no surprise that it should be the source of Lloyd's largest ever claim. September's appalling attack on the World Trade Center presents a net loss to Lloyd's of £1.3bn – roughly £400m more than the market's previous highest claim, Hurricane Hugo in 1989.

At a time like this, one cannot help but hark back to the San Francisco fire of 1906, when Lloyd's reputation in the US was founded by Cuthbert Heath's famous instruction to ‘pay all claims'. It was Heath's insistence on dealing with the situation speedily and fairly that created the atmosphere in which Lloyd's has grown to become the US's major surplus lines carrier and a significant player in the country's reinsurance market. Clearly, it is our aim to deal with the WTC in the same exemplary manner.

The 11 September losses also present an extraordinarily complex claim for insurers. One Lloyd's underwriter, Elvin Patrick, broke down the constituent parts of the global damages as follows:

Workman's comp $3bn-$5bn
Property $10bn-$12bn
Life $4bn-$6bn
Business interruption $3bn-$7bn
Event cancellation $1bn-$2bn
Aviation hull $130m
Aviation liability $6bn
Other liabilities $5bn-$20bn

Many underwriters have already commented that they never expected to see many of their risks aggregating in this fashion. No one had ever conceived of a scenario in which aviation hull and aviation liabilities came together with so much property damage, business interruption and life cover in one of the most densely populated and business-packed areas of the planet. The disaster has triggered an industry-wide reappraisal of insurers' books of business with very specific focus on the element of North American terrorism cover – a risk that many insurers had taken onto their books through property coverages but had never formally rated. The risk of a major terrorist incident in the US had, until 11 September, seemed like the stuff of Hollywood. Now it has become a terrifying reality that underwriters, at Lloyd's and elsewhere, must adapt to.

For Lloyd's, the disaster has presented a series of major challenges:

  • firstly, the urgent need to understand the nature and level of the market's exposure at a time when the vast majority of facts were unclear or unknown;
  • secondly, to come to terms with what this exposure meant to our US funding requirements for the fourth quarter;
  • thirdly, to deal with an incredibly volatile insurance landscape in the wake of the tragedy; and
  • fourthly, to communicate all of the above to a global network of brokers – but especially to brokers in the US.

    Dealing with the first of those points – understanding our exposure – was a complex process which effectively took two weeks to complete. That length of time was needed for two reasons; to take account of the complexities of the Lloyd's market's structure, and to ensure that the final figure would be as robust as possible. Two questionnaires were circulated to all Lloyd's syndicates during that time: the response rate was 100%. The information provided was then subjected to rigorous stress testing and review by a panel of regulators, financial analysts and underwriters. The estimate at this time showed that our net exposure was approximately £1.3bn.

    While there has been much speculation that Lloyd's will at some point revise this figure, this is unlikely to happen in the short term. But dwelling on the number is short-sighted. In order to fully understand the impact on the Lloyd's market, one must take into account the totality of our current trading position – and that means premium rates. Premium rates have risen across the market as a whole by 20%-40% since the disaster; in some specific areas underwriters have seen 1,000% increases. If your view of Lloyd's is shaped only by the losses, you are not seeing the whole picture.

    The second point I want to touch on is our requirement to fund two major US trust funds – one for our surplus lines business, the other for reinsurance. It's important to recognise that it's not just Lloyd's which is required by the US regulators to operate these funds: all alien reinsurers are in the same position.

    The trust funds are maintained within the US and effectively act as a guarantee of payment. They provide US regulators with a sizeable pot of capital within their own jurisdiction which they can secure should something untoward happen to that insurer. The funds are maintained at 30% of gross liabilities for surplus lines and 100% gross liabilities for reinsurance. An adjustment is made on a quarterly basis to account for new gross liabilities. This means the value of the funds can rise or fall four times a year. At the time of writing, the total value of the two Lloyd's funds is £5.3bn.

    NAIC discussions
    Following 11 September, Lloyd's entered into discussions with the National Association of Insurance Commissioners (NAIC) in the US about the situation regarding our trust funds. As part of the outcome of these meetings, the NAIC will conduct a review of Lloyd's liquidity and the security of its own reinsurance programme. Some reports have tried to characterise this as an unprecedented investigation into Lloyd's ability to cope with the losses. That is a wilful misrepresentation. The NAIC's John Oxendine has already gone on the record saying this is a “liquidity issue, not a solvency issue for Lloyd's”. And visits from US regulators to Lloyd's are hardly unprecedented. At least one such audit has taken place for the last three years.

    In terms of adjusting to the new insurance landscape post-WTC, that remains an ongoing process. The reaction in rates was the first sign of the changes; now we're seeing underwriters coming to terms with what could be a scarcity of reinsurance going forward, or reinsurance that is dramatically more expensive. Chairman of the Lloyd's Market Association, Stephen Catlin, has already spoken about the need for underwriters to move towards making gross underwriting profits over the next few years. Clarity of position for most underwriters is still some way off as they wait to see what happens within the reinsurance market and what their capacity will be going forward. These factors are unlikely to be understood fully until late November.

    My fourth point related to communication. When major disasters strike, most organisations' attention is, of necessity, directed inwards. For Lloyd's that was the need to quantify our exposure and to deal with a variety of other short-term issues. But when information is not forthcoming, rumour and misinterpretation thrive in the vacuum. For us at Lloyd's, the greatest challenge going forward is to ensure that brokers in the US and worldwide understand the situation as it impacts on our market. It's all too easy for the dramatic upward correction in rates to be seen as profiteering. We need to explain the market forces and increased risk profiles which are driving them. It's also easy to compare our £1.3bn net loss against the size of the Lloyd's Central Fund and say ‘How can they possibly pay?' But that is a total misunderstanding of Lloyd's capital structure – its chain of security – and fails to recognise that Lloyd's has over £18bn in capital available to it.

    In the coming months, it will be our aim to provide as much information as possible to the thousands of brokers who represent our distribution system. We are the first to admit that Lloyd's is a complex organisation. For a broker living and working in the American mid-west, it can seem like an organisation that inhabits an entirely different world. Our job now is to close that perception gap and ensure that all necessary information is available.

    History lessons
    History has shown us that by handing major disasters well, an insurer's reputation can be enhanced. Lloyd's proved that with the San Francisco fire almost a century ago; it is our aim to demonstrate it again now. Indeed, some claims have already been met, and new mechanisms have been put in place to ensure additional claims are paid quickly and efficiently. What has really changed is the need for communication. In today's world of almost instantaneous reporting and proliferation of media, the scope for messages to flourish – both correct and incorrect – has grown almost beyond comprehension. An insurer which recognises that fact is an insurer which is already well on the way to dealing with it.