The 1990s have probably been the most eventful decade in the history of reinsurance. Stacy Shapiro and Lee Coppack look back.
To parody Charles Dickens, it was the worst of times and the worst of times for the reinsurance industry back in September 1990 when Global Reinsurance launched its first issue at the Rendez-Vous de Septembre in Monte Carlo.
In fact, it was so bad, particularly for the London market, that no one knew just how bad it was. The love affair with LMX - London market excess of loss reinsurance - and North American liability business was about to come to an explosive end. And the terrible crunch would change the world's insurance and reinsurance markets forever.
In 1990, all the commercial markets - marine, non-marine and aviation - were awash with heavy losses. The marine market was still coming to terms with the 1988 explosion of the Piper Alpha oil platform in the North Sea which produced more than $1.4 billion in losses. The aviation market was suffering with the terrorist explosion of a Pan American World Airways jumbo jet over the Scottish town of Lockerbie which eventually became one of the largest aviation losses ever.
Property catastrophe underwriters were still taking the brunt of Hurricane Hugo, which in 1989 had blown through Puerto Rico, the Virgin Islands and North and South Carolina costing insurers $4 billion. Meanwhile, brokers were questioning the ability of the companies backing London's leading US casualty underwriting agency, H.S. Weavers, to pay future claims. The answer to their questions was, ultimately, no, and the total liabilities have been estimated in excess of $10 billion. There was also growing evidence that excess liability insurers and reinsurers, particularly Lloyd's syndicates, had dramatically under-estimated potential future asbestos and pollution related claims in the US.
So the beginning of the decade was bad enough for underwriters when hurricane-force winds ravaged many parts of Europe in January and February, costing another $8 billion and Typhoon Mireille hit Japan in 1991, costing $6.4 billion. The climax came in August 1992 when Hurricane Andrew cost insurers an historic $18 billion, resulting in the demise of many smaller companies in the United States and the final collapse of the LMX spiral.
The scenario led to the demise of Lloyd's as it had been known for more than 300 years, the near-collapse of the entire London market and heavy losses among reinsurers worldwide. In fact, Lloyd's reported five straight years of losses between 1988 and 1992 of £8 billion, the full extent of which did not finally emerge until 1995 under Lloyd's three-year accounting.
In 1991, David Rowland (now Sir David), then chairman of Sedgwick, was invited by Lloyd's Council to set up a task force to consider ways to modernise Lloyd's. Though the task force realised things were serious, it did not know just how bad the future would be.
By the time Sir David became Lloyd's first full time chairman in 1993, the market was wracked by catastrophic losses and thousands of angry, litigating Names who refused to pay their cash calls. For the first time in history, there was fear that Lloyd's might not be able to pay every legitimate claim in full.
It took Sir David and his team - including chief executives Peter Middleton and his successor Ron Sandler - three years and eight months to cajole regulators and convince the vast majority of Lloyd's membership to sign Lloyd's 1997 Reconstruction & Renewal (R&R) plan. The R&R plan reinsures about 740 pre-1993 syndicate years into run-off company Equitas Ltd and leaves the current market with an almost clean slate to continue underwriting. In other words, at the moment the old Lloyd's is in run-off and the new Lloyd's is going forward with corporate capital offering a larger and stronger capital base. Today, nearly three-quarters of the market's £9.9 billion capacity comes from corporate members, admitted for the first time in 1994, and individual members or Names, who numbered 32,722 in 1988, were down to 4503 at the start of 1999.
Soaring catastrophe rates
What has changed? Size and strength, technology and globalisation.
In 1990, there were many small reinsurers with less than $50 million in capital. Many of these underwriters sat in London, though others were spread in other parts of the world. Their reputations, and sometimes their egos, were much larger than their balance sheets.
The success of R&R meant Lloyd's has continued to pay legitimate claims in full. Not so a host of other reinsurers, some of them well known names, who are today in insolvent run-off. Their demise taught insurers the world over that when it comes to reinsurers, small is not beautiful. Security and the flight to quality became the words on everyone's lips.
Thus, began a process of consolidation and concentration which has completely changed the shape of the reinsurance industry. First, however, the attraction of high rates for property catastrophe risks in the wake of Hurricane Andrew allowed new players to attract big blocks of capital. ACE and XL had already been established in Bermuda in the mid-1980s to fill a gap in high level liability coverage for major US industries. As a regime where earnings could be held tax free as a cushion against future catastrophes, the island became the home to eight new property-catastrophe reinsurers between 1992 and 1993.
In 1995, the giants began to move. General Re acquired Cologne Re and ERC bid for Munich based Frankona at the end of the year. The next year Munich Re bought American Re and Swiss Re acquired the UK owned professional reinsurer, Mercantile & General, from the Prudential and Unione Italiana.
By then, the new Bermuda market was already changing. ACE bought property-catastrophe reinsurer, Tempest, followed by CAT Ltd. For its part, XL added the property-catastrophe reinsurer, Global Capital Re, to its portfolio, and later took control of the first post-Andrew reinsurer, Mid Ocean Re.
In 1997 and 1998, the process continued. The largest of the Bermuda property-catastrophe reinsurers, PartnerRe bought France's SAFR, and another Bermudian, Terra Nova, bought Corifrance. Munich Re acquired Reale Ri in Italy. Berkshire Hathaway acquired General + Cologne Re, and ERC bought the US companies, Industrial Risk Insurers and Kemper Re, plus the UK's Eagle Star Re. Further moves have followed in 1999, perhaps not surprisingly at a slower pace: XL, now XL Capital, took over the US company NAC Re. More recently US insurer Markel agreed to buy Bermuda's Terra Nova.
These were just some of the largest of the many mergers and acquisitions that have taken place during the 1990s. The effect has been a reduction in the numbers of reinsurance companies and substantial increase in the concentration of business. Between 1990 and 1996 the number of US professional reinsurers fell from 130 to 41. In 1990, the five largest reinsurers were estimated to control 21% of the world non-life reinsurance market estimated at $90 billion a year; by the end of 1998, the five largest controlled 38% of a market estimated at $125 billion a year.
Bermuda companies, such as ACE, XL Capital and Terra Nova, have become major investors in Lloyd's. Indeed, ACE now controls at least 10% of Lloyd's capacity.
Reinsurance brokers have gone through a similar transformation with the two outright leaders, Aon and Marsh's Guy Carpenter, sweeping up and consolidating the reinsurance broking operations of groups they have acquired. In London, leading specialist reinsurance brokers, Benfield and Greig Fester, merged in 1997 to become Benfield Greig.
The rise of ART
Soaring excess of loss rates and a new emphasis on monitoring aggregate exposures combined with an increasing awareness of the potential size of a massive catastrophe turned eyes toward the enormous cash flows of the capital markets. Along came alternative risk transfer (ART) ideas, such as catastrophe options, bonds and equity options as a way of raising additional capital in case of major losses.
A few deals were planned, but not consummated before 1995, but in September that year, the Chicago Board of Trade (CBOT) launched a new insurance derivative option series based on indexed loss estimates. Despite huge initial interest, large volumes of trading have never built up, perhaps because of a continuing fall in conventional property-catastrophe reinsurance rates.
Indeed, the largest ever proposed catastrophe bond, the California Earthquake Authority (CEA) deal, was withdrawn in late 1996 after months of planning when Berkshire Hathaway stepped in with a conventional excess of loss reinsurance contract to provide the cover. Finally in December 1996, St Paul Re completed a 10 year securitised transaction, using a special purpose vehicle in the Cayman Islands, George Town Re, to allow it to write additional catastrophe risks in the US and Caribbean. Winterthur and Hannover Re were the first European companies to announce ART transactions.
The high financial and time expense involved in such deals has kept them as headline items, but finite risk transactions, such as loss portfolio transfers, have become mainstream products. The first finite risk writers were established in the mid-1980s taking advantage of Bermuda's regulatory environment, infrastructure, location and history of alternative insurance solutions. Initially, they mainly provided retrospective covers and timing risk until new, US accounting principles in 1993 meant that finite risk solutions needed also to include a material element of underwriting risk. Since then, finite risk techniques have been disseminated throughout the (re)insurance world.
In the final years of the 1990s, a blurring and blending of insurance and banking techniques has also seen (re)insurance used in new ways, for instance to improve credit risks, a trend which is expected to continue.
In this past decade, the iterative pattern of mergers and acquisitions followed by consolidation among corporate policyholders aiming for global presence has set off a chain reaction among insurers and reinsurers. Regional and factional rivalries are falling to twin necessities of global thinking and exploitation of technology. The end of the decade has seen the merger of the marine and non-marine company market associations in London to form the International Underwriting Association (IUA) and much closer links between the IUA and Lloyd's.
In mid-1999, the markets finally succeeded in sinking their differences and merging three separate electronic networks to form WISe (WorldWide Insurance e-commerce), which supporters believe will bring about a significant reduction in international barriers to electronic trading.
Already, insurers and reinsurers have set up websites to exploit the internet. While some of these sites are organised by household names in the underwriting world, others are start-ups with little to lose. Perhaps they are the Munich Re's of the future. Only time and the internet will tell.
Stacy Shapiro is a freelance journalist and former London bureau chief of Business Insurance. Lee Coppack is co-editor of Global Reinsurance.