Michael Skay considers the possible changes to the re/insurance sector following the events of 11 September.

The tragic events of 11 September will have repercussions that will reverberate through the insurance and reinsurance industry for years to come. Losses of this magnitude will neither be settled quickly nor will the questions and contract interpretations likely be resolved expeditiously. One thing is for certain, however; the available funds generated by the insurance recoveries, as reported by The New York Times on 15 October, will provide a greater stimulus to the New York economy than Federal Aid and will help to shape the future of the city.

As has been reported extensively, the primary insurance companies are hard at work sorting out their obligations and making payments to their insureds. Preliminary estimates of industry exposure run from $35bn-50bn, making it the worst catastrophe and most heavily insured event ever, but the uninsured losses may well be incalculable. How, for example, can one calculate the ripple effect of lost businesses by retail establishments in midtown Manhattan? These economic conditions have the potential to dwarf the insured losses.

Coverage issues
Insurance claims will run across all lines of business covering property, casualty, workers' compensation, life and accident & health policies. There is also a report that several prominent plaintiffs' firms have been engaged to consider the issue of possible airline culpability. There will undoubtedly be interesting and complex questions involving millions of dollars in claim indemnity arising from these events. For example, one currently debated issue is whether or not the 11 September tragedy at the World Trade Center was a single or multiple occurrence under both direct policies and reinsurance contracts. The answers to this question and others can and will have an enormous impact upon the insurance and reinsurance community now and well into the future.

Before 11 September, reinsurance rates had already started firming following many years of intense price competition. It might not be unusual for some lines of business to now see 50%-80% reinsurance rate increases. One should consider whether, given the dramatic upturn in reinsurance rates, the primary companies will be able to pass the entire increase in the cost of their reinsurance along to their insureds, or will they be forced to absorb some of these increased costs. The industry is certainly in a difficult position since investment returns are down at the present time; therefore the rate at which the industry's asset base can be rebuilt has been slowed. This situation would only be exacerbated if the primary companies were unable, for whatever reason, to pass the entire rate increase along or if the Federal Reserve continues to cut rates in its continuing efforts to stimulate the economy.

Capacity shortage?
This leads us to consider whether or not the industry will commit its capacity to only those lines where it feels it can charge an adequate rate and consequently obtain a better return. This strategy could result in a capacity shortage similar to that of the 1980s. Primary companies might not be inclined to write certain lines of business without adequate reinsurance protection. Or, if they would be willing to do so, it would be very expensive and under very strict conditions with high insured participations and capped exposures. As a result of a loss of this magnitude, it would not be inconceivable also to see some shrinkage and/or significant rate increases in the personal lines market as insurers and reinsurers go through the process of realigning their portfolio and clients. The so-called ‘flight to quality' by both insureds and insurers, already underway, would only accelerate under these conditions.

Commentators have indicated that the World Trade Center collapse will result in large amounts of reinsurance being uncollectible because of reinsurer insolvencies. While this is speculative at this point in time, the next five to ten years should be extremely interesting and tense as insurers and their reinsurers discuss, argue and possibly arbitrate or litigate the interpretations of clauses in their policies and reinsurance contracts. At the least, there may be a slowdown or halt in reinsurance payments to insurers while such questions are being resolved. This situation would not give the insurer any relief from its obligation to its insured. If an insured is slow to receive claims payments under its policy while the insurer and reinsurer determine their obligations, it could ultimately imperil the insured's financial security. This in turn would give rise to various policyholder actions against their insurers which might be struggling to meet all of their obligations. At worst, reinsurance obligations would be determined to be uncollectible by primary insurers which could result in their impairment or insolvency. The same logic would also apply to reinsurers and their retrocessionaires, hence it would not be at all surprising to see the failure of several smaller insurers or reinsurers. While the larger well-capitalised insurers and reinsurers will survive, there may very well be some companies disappearing from the ranks of the second and third tiers. The flight to quality could result in the big getting bigger and the smaller surviving companies becoming niche players.

Future hazard
This situation could come closer to reality if within the next several months there is a major storm, earthquake or other natural catastrophe which would further tax the resources of the industry. While the industry can and will survive the WTC catastrophe, subsequent major events could wipe out those companies whose balance sheets have been seriously depleted as a consequence of the 11 September events. The ensuing strain on the industry, state insurance department staffs and budgets could be tremendous.

Some coverages will cease to become available as insurers and reinsurers adjust to the new realities of the risk business. US insurers will find that terrorism and other similar risks will now likely be excluded by their reinsurers. These risks will, in turn, be excluded upon renewal of primary policies. Given the fact that a large number of reinsurance treaties renew on 1 January, some insurers may be scrambling to fill the gaps in the coverage that they have outstanding as a result of their treaty renewals. The upcoming treaty renewal season is likely to be one of the most difficult and expensive in recent memory. This then raises the issue of whether or not the US Federal Government will enter into the business as an insurer (or reinsurer) of last resort. The Bush administration has expressed interest in participating in various ways, among which is the establishment of a reinsurance vehicle with a certain lifespan to reinsure coverages such as terrorism, which may become otherwise unavailable.

Federal aid to the insurance business will have a ‘flow through' effect to other economic activity in the US. This would explain the Bush administration's desire to assist the industry. For example, the presence of the Federal Government as a safety net will have a calming effect on the commercial property lending market. Lenders depend upon the borrowers obtaining adequate insurance coverage; with this cover available, the commercial real estate market would be able to continue functioning in an orderly manner.

The modification of personal lines coverages to provide for exclusions which reflect this new world reality will take some time, as most states require the insurance department pre-approval of certain personal loss policy terms and forms before they can be used in the mainstream. In the interim, a reduction in coverage by reinsurers could place insurers at risk until such time as the appropriate policy amendments have been approved and added to the issuing company's outstanding policies.

Range of solutions
Historically, events of such a magnitude resulted in a vacuum when the markets have shrunk. Necessity being the mother of invention, new solutions have surfaced which lead to a continuing metamorphosis of the insurance and reinsurance markets. There will be no one solution to these problems but rather a number of tailored solutions. This was evident after Hurricane Andrew in 1992. Whether or not the capital markets will step to the fore remains to be seen. It would not be unreasonable to see financial coverages written for certain types of exposures on both a primary and reinsurance basis as well as relatively small amounts of limits put out for these covers, if at all.

While no one can predict what the future will hold for the industry, there can be no doubt that it will be subject to profound change.