If New York’s Insurance Exchange was such a failure in the 1980s, why would regulators want to recreate a similar one today? Ronald Gift Mullins discovers that many people think the time is now right to establish a “Lloyd’s” in NYC.
It took Lloyd’s of London some 320 bumpy years to finally make a steady profit, so the second attempt to create an insurance exchange in New York, modelled loosely on Lloyd’s, seems like a notion that holds promise. Yet its success will require meticulous planning, adequate capital, the latest technological know-how and astute management.
The idea for the revival of the New York Insurance Exchange came from Eric Dinallo, the dynamic NY superintendent of insurance. “I’m very excited about the new New York Insurance Exchange,” he said during a meeting earlier this year hosted by Crain’s New York Business. He said the statute (NY Insurance Law Article 62) is still on the books for creating such an exchange, and that the risk culture and insurance market now make the time ripe to at least consider reinvigorating the exchange.
The concept for the first NY Insurance Exchange emerged in 1979. At that time, capacity was tight which intensified calls for more open competition. During this tight market, reinsurers had benefitted greatly from higher rates and favourable terms. These twin developments led to passage of legislation in New York to create a “Free Trade Zone” and an insurance exchange.
The intention of the legislation was to develop a reinsurance exchange where large or hard-to-place commercial risks could be underwritten by exchange syndicates, without having to abide by burdensome rate and form restrictions. On 31 March 1980, the exchange began operating. “It opened to great fanfare,” Dinallo said, “and crashed with great fanfare in the 1980s.”
The exchange was set up to operate similarly to Lloyd’s as a centralised marketplace for the broking and underwriting of insurable risks. Its two categories of members were the underwriting members (or syndicates) and the broker members. Only brokers approved by the exchange as members or associates could place business with the syndicates, and all business was to be processed through the exchange’s facility. The number of syndicates in the exchange grew from 16 on opening day to 35 active syndicates by 31 December 1984. The number of participating brokers exceeded 100, including most of the major national brokers and reinsurance intermediaries.
Launching of the exchange was publicly touted as the US answer to Lloyd’s, according to Peter Bickford, who was vice president, general counsel and secretary of the NY Insurance Exchange from 1980 to 1985. After all, Lloyd’s of London had thrived in the US domestic market, building a reputation as the “insurer of the world” on the inability of the US insurance industry to provide the unusual, but necessary, coverage American businesses sought. After a slow start, the exchange blossomed in the next few years, with over $300m in gross written premiums in 1983. As premium volume rose, unfortunately so did the loss ratio.
Exchange a “dumping ground”
The tight market that helped launch the exchange’s rapid growth in premium volume of the early 1980s helped spark a growing impression in the industry that the exchange was really the market-of-last-resort, the “dumping ground” for “submissions from the bottom drawer that could not be placed anywhere else,” Bickford explains. This acceptance of the worst risks eventually led the exchange to request certain syndicates to stop underwriting new and renewal business, but these actions proved to be too little, too late. Bickford is now a New York-based attorney who is an independent insurance consultant and a certified reinsurance arbitrator.
“Many of the exchange syndicates were well over their guideline capacity even before they were asked to cease writing,” Bickford says. “The syndicates also had written large volumes of business at a time of overcapacity and extremely soft pricing, with no ‘good times’ to fall back on. Thus the seeds of financial trouble were present in the first few years of the exchange, and by the end of 1985 the decline was in full swing.”
In 1985, GWP volume on the exchange dropped from $345.6m in 1984 to $309.5m. During the next year, several syndicates ceased writing business or sought to withdraw from the exchange. Capital contributions were used to bolster sagging surplus rather than fund new syndicates; and several syndicates were placed under joint control with the exchange to allow even closer monitoring of their financial activity. “These actions were still inadequate,” explains Bickford, who has written a book describing the birth, troubled life and demise of the exchange.
In August 1986, five syndicates were declared insolvent by the exchange board of governors and the New York superintendent of insurance was petitioned to liquidate four of them. By September 1987, three more syndicates were liquidated, and many of the remaining syndicates, fearing the worst, petitioned for withdrawal from the exchange by year-end 1987.
Although plagued by the adverse publicity of these insolvencies and the withdrawal of many of its major industry participants, as well as by a back-office operation that had not kept pace with its growth, the final blow was yet to come. According to Bickford, this appears to have been an action by the separate board of directors of the exchange’s security fund.
On 2 September 1987, the security fund’s board of directors called down the $500,000 deposits of each of the underwriting members on the exchange – a total of $25m – to meet the potential claims against the security fund resulting from the declared syndicate insolvencies. “This action, which was totally unexpected by the underwriting members,” Bickford says, “sent a shockwave through the exchange market resulting in all but ten of the syndicates petitioning to withdraw. On 23 November 1987, the remaining exchange members, on the recommendation of the board of governors, voted to temporarily suspend the writing of new and renewal business. The exchange never opened its doors again.” It took 18 years for the exchange’s security fund to pay out about $82m, or about 74 cents for every $1 due in claims.
“The seeds of financial trouble were present in the first few years of the exchange, and by the end of 1985 the decline was in full swing
Reinventing the exchange
Dinallo, describing the formation of the new exchange, says: “I am very excited about the possibility that permits us to form syndicates to reinsure large property and exposures of any kind. It is a great opportunity for the city and the state to become a leader in reinsurance and potentially to take some business from Bermuda, Ireland and Lloyd’s.”
He suggests that there may be some tax advantages that could be legislated for business placed in the exchange, and thought placing its physical operations on Governors Island would produce a “certain poetic symbolism”. Governors Island is located in Upper New York Bay, approximately half a mile from Battery Park in Lower Manhattan and a quarter of a mile from Brooklyn. A ferry service provides the only transportation to the island from Manhattan.
He thinks the first NY exchange failed because of the soft market and also “it was a little ahead of its time”. “There was nothing like the private equity and hedge funds and the boldness to invest in insurance that is available today. Creating an exchange is very consistent with my idea of globalisation of capital with insurance and securities and it is an inevitability that securitisation of insurance is coming in the future. We have to manage very carefully, however, when we look at what has happened with over securitisation in mortgage-backed areas. I think it is even more important in insurance. When the ultimate risk taker gets completely removed from the risk and fails to do due diligence, such a situation can lead to disaster.” He stressed the formation of the exchange “is something we want to do in 2008”.
Remember the Titanic
Dinallo notes that since the 1980s, strong advances in communication technology have occurred. “This would allow an exchange to operate efficiently without a lot of administrative overhead, which dragged down the old exchange.”
Frank Nutter, president of the Reinsurance Association of America (RAA), says his organisation had offered to share its thoughts for creating a new insurance exchange. “We are willing to participate in a working group to explore the idea further. In particular, the superintendent wants to address regulatory questions and how to encourage new capital to invest in the insurance industry,” he explains.
“Eric Dinallo is looking at a Lloyd’s model, with self-regulation except for oversight by the Insurance Department, just as the FSA does in the UK,” Nutter adds. “We are happy to explore this. We are very open.” He cautions that creating and operating such a new enterprise during a soft market would be a challenge, but he compliments Dinallo for “having a positive idea as to how to make New York a positive environment for insurers and reinsurers.”
Some observers have suggested that if Dinallo wants to encourage additional capital to be invested in the reinsurance industry in New York, he would be better advised to remove some of the regulatory barriers now limiting such investments from US interests. A reinsurance executive says: “It seems unfair to allow foreign investment entities free rein by entering the NY Insurance Exchange while tethering domestic reinsurance and insurance companies operating in the state with strict enforcement of stringent rules.”
Bickford asks why they would consider opening an insurance exchange if the first one was such a failure in the 1980s. “My short answer is another question,” he says. “Is Lloyd’s still a relevant market today? Given the renewed vibrancy of Lloyd’s over the past decade after its own financial tribulations (eg Equitas), a Lloyd’s-type facility not only can work, it can thrive, if its creation and rules of operations are done right.”
At a meeting of the Association of Insurance & Reinsurance Run-Off Companies in London in February, Art Coleman from Citadel Re, referring to the attempt to create a Lloyd’s in New York, said: “Don’t you remember the Titanic?"
Ronald Gift Mullins is an insurance journalist based in New York City.
Timeline of the New York Insurance Exchange 1980-87
March 1980 The exchange opens with 16 syndicates.
December 1983 The exchange reaches a milestone writing $300m in gross written premiums.
December 1984 35 syndicates are operating, along with more than 100 brokers.
December 1984 $345.6m in GWP are written, but rapid growth creates an impression of the exchange as a market-of-last-resort and the decline begins.
December 1985 GWP falls to $309.
August 1986 Five syndicates are declared insolvent by the exchange.
September 1987 After a further three syndicates are liquidated, the exchange board of governors calls in $500,000 deposits from its remaining underwriting members to cover claims against insolvent members.
November 1987 Many other members become fearful of the economic consequences and petition for withdrawal.
November 1987 The remaining members vote to suspend business and the exchange closes.