Changes in the US market over the course of 2001.

A year ago, one would have been hard put to find an average American who knew what the word ‘reinsurance' meant. However, in the wake of the World Trade Center terrorist attack, that word has moved into the vernacular of the common man. The reason, of course, is that primary insurers are pulling back from certain markets in anticipation of at least a year of higher rates and restricted conditions to be imposed by reinsurers in the US and all over the world.

Reinsurers in the US have said flatly that, without help from the federal government, they will have to exclude coverage for terrorism risks in their contracts with primary companies. Primary insurers, therefore, are faced with the choices of either continuing to offer terrorism coverage and bearing the risk themselves or withdrawing completely from commercial risks.

Previous fears
Steven Dreyer, head of insurance ratings at Standard & Poor's, sums up the situation this way: “Two years ago, fears over potential Y2K-bug havoc loomed over America. Traffic lights were to fail, air traffic control was to go haywire, and ATMs would refuse to dispense cash. Those fears proved grossly overblown. There was plenty of time to anticipate and deal with the problem by relatively simple programming corrections. Now, corporate America is faced with a sort of Y2K+2 bug – expiring insurance coverage for terrorism risk on workers' compensation, factories, plants, office buildings and business interruption – and this one may pack more wallop. Unlike the years of advance warning before Y2K, however, there is not much time to find a solution to this issue, temporary or long term.”

There is little fear that the reinsurance industry will be crippled because of September 11. Donald S Watson, an analyst with S&P, says that the global reinsurance industry is well positioned to shoulder the unprecedented insurance costs of the World Trade Center attack, while remaining on a secure financial footing. “Contrary to some analysts' predictions that the industry will be hard put to pay claims, S&P believes reinsurers not only will provide the critical financial backing for payouts resulting from the tragedy, but will also rebuild a fortified position with strong earnings in coming years.”

Two of the major players in the global reinsurance industry, General Re and Employers Re, are, says Watson, in ‘robust' condition with their AAA-rated status. General Re's net loss exposure from the World Trade Center disaster is estimated at $1.5bn and Employers Re's at $0.6bn. But their capital and surplus comes in at $40.1bn and $6bn, respectively. Smaller reinsurers rated by S&P are also in secure condition, according to Watson, with BBB ratings or higher.

Nevertheless, the fact that reinsurers will be able to withstand their losses from the World Trade Center attacks does not mean that they are not facing crunch times, according to Watson. “There remains a large discrepancy between estimates for the insurance industry as a whole, which in some cases exceed $70bn for property and casualty payouts, and the sum of loss exposures reported by companies, which amounted to about $20bn as of 1 October 2001,” he says. “The latter will continue climbing. Loss exposures incurred by business interruption and liability claims are the hardest to pin down at this early stage. Difference of opinions about levels of reinsurance coverage may also emerge as a significant variable. Investment losses, particularly for reinsurers with large equity portfolios, pose a secondary but potentially significant problem for reinsurers. The bulk of property and life insurance claims are likely to be settled over the next six to 18 months, requiring the sale of investments, some of which may have lose 15% to 25% of their value since purchase, exacerbating the decline in capital.

“Moreover,” continues Watson, “as reinsurers begin to rebuild portfolios from future premium inflows, any investments in fixed-income instruments will earn significantly lower rates of return. In general, most reinsurers manage conservative investment portfolios, but for some newly formed companies, market volatility could create liquidity concerns.”

For all these reasons, US brokers and primary insurers are wondering how much of their incurred losses reinsurers will pass down the ladder to them. That concern became apparent at the recent annual meeting of the National Association of Independent Insurers (NAII) in New Orleans. Reports indicated that attendants at the meeting – reinsurers, brokers and primary company representatives – were paying less attention to their programmed schedule and, instead, meeting over breakfast coffee, lunchtime cocktails and in the hallways to talk about reinsurance renewals. One reinsurance executive was reported to have commented: “We started at 100% more than last year on some lines and a lot of people took us up. Then we went to 200% and they still kept coming. I think it's just going to keep going up.” A broker at the meeting was reported to have needed $100m in coverage for a West Coast insurer specializing in workers' compensation. Last year, according to the story, the cost was $400,000. This year, the bidding started at $2.5m and ran to $6m.

For reinsurers, it's not just the known losses that they are seeking to recoup, but unknown losses as well. Recently, Swiss Re, the biggest insurer of the World Trade Center, announced that it was suing to limit how much it will pay to the buildings' managers. Larry Silverstein, the real estate executive whose companies hold a 99-year lease on the World Trade Center – a lease taken over just weeks before the attacks – is asking $7bn from insurers, of which Swiss Re holds the largest stake. He argues that each of the two hijacked airlines that crashed into the towers constituted a separate attack, each covered by $3.5bn in insurance. Swiss Re has asked the Federal District Court in Manhattan to determine that it and other insurers would be liable for only $3.5bn because both crashes amounted to a single insurable incident. At press time, no decision by the courts had been reached.

Because of September 11, many primary insurance underwriters are facing a tight reinsurance market not seen since the mid-1980s and probably few of them are old enough to remember that market. It is feared that many primary insurers will just not be able to afford the coverages they need or be able to live with the high retentions being demanded.

One solution that is being looked at in the US is for the federal government to move into the reinsurance business. However, at press time, what role the federal government will play is open to debate.

The Risk and Insurance Management Society (RIMS) has issued a ‘statement of principles' on terrorism reinsurance capacity, which calls for federal involvement in reinsurance. “The US economy, in all its sectors, including real estate, construction, manufacturing, financial and transportation, is dependent on adequate insurance coverage,” says RIMS. “Insurers, in turn, must be able to spread the risk that they assume on behalf of individuals and businesses by purchasing reinsurance. Due to the financial uncertainties of predicting terrorism activities, most reinsurers refuse to include terrorism coverage in 2002, leaving the insurance industry without the financial backstop that reinsurance provides. It is imperative that Congress and the Bush Administration take prompt action to maintain a robust insurance industry, which is crucial to assuring the continued strength of the US economy.” For those reasons, RIMS said its supports federal intervention to “guarantee a viable property and casualty reinsurance source for US policyholders.”

RIMS has set down the following principles for a federal role in reinsurance:

  • All insurers of US policyholders, with domestic and international properties, should have access to an industry-driven reinsurance mechanism. This mechanism would guarantee a viable property and casualty reinsurance source, stability for policyholders and a healthy insurance and reinsurance market. A voluntary reinsurance pool would allow the industry to build reserves in case of future terrorism.

  • ‘Acts of terrorism' and ‘acts of war' need to be clearly defined. Precise definitions are required to meet our new reality. The definition of both ‘acts of war' and ‘acts of terrorism' should include a state law pre-emption to eliminate conflicting interpretations.

  • Federal support for the insurance industry should be limited to five to six years. Involvement by the federal government should be simple, clear and limited. As the world faces an unprecedented situation, the federal government should assume a temporary role to assist the insurance industry in the event that future terrorist acts deplete the industry's resources. However, the length of time should be long enough for the private markets to recover and become viable again.

  • Lines of coverage should not exclude business interruption or workers' compensation. While property coverage is certainly required, business interruption and workers' compensation insurance are two of the most essential coverages in an organization's risk management program, and should be included in any federal reinsurance mechanism.

    The NAII has also adopted a set of principles, which the association's president, Jack Ramirez, listed at the annual meeting in New Orleans. Similar to RIMS, the NAII is calling for a federal role in reinsurance, which would be temporary. He said the NAII believes also that retention levels should be credible and based on individual company standard, rather than an industry aggregate. The NAII's view is that the program should be fair with respect to the retention with no cross-subsidies and be broad enough to include other uninsurable events. “In short, NAII's objective has been to enact a short-term solution to prevent massive market dislocation, allowing Congress the time to fully consider a more detailed plan to address the terrorism reinsurance issue over the next year or two,” said Ramirez.

    There are other proposals on the drawing board for a federal role in reinsurance. The American Insurance Association has offered a plan modeled after the Pool Reinsurance program in place in the UK. And the Treasury Department has come up with a plan that would require industry retention of the first $10bn in losses and a quota share above that level.

    It is not yet clear whether Congress and the Bush Administration will accept any of these efforts, but industry representatives are convinced that a federal role is essential if severe market dislocations are to be avoided.

    Meanwhile, not all reinsurers are jumping ship in these difficult times. In fact, some see favourable opportunities because of the tight market. Recently, American International Group, The Chubb Corp and GS Capital Partners 2000 and investment banking firm managed by Goldman Sachs, announced that they were forming Allied World Assurance Holdings, Ltd and its wholly-owned subsidiary, Allied World Assurance Company. AWAC, to be based in Bermuda, will underwrite worldwide commercial property and casualty insurance and reinsurance, property catastrophe reinsurance, and certain specialty lines.

    Undoubtedly, these participants in the new venture recognize that forming a new company, with no claims history to worry about, at a time when market conditions dictate higher rates than in the past would be beneficial.

    AIG has also expressed confidence in the Lloyd's market with the commencement of an AIG backed syndicate at Lloyd's to underwrite general insurance.

    It is obvious that the World Trade Center terrorist attacks have eclipsed ‘business as usual' in the US reinsurance industry. Certainly, there is concern over asbestos exposures. The large, multinational firms that dealt with asbestos have already been sued and, by and large, settlements have been reached. Now plaintiffs' attorneys appear to be looking at the lower end of the market – small and medium-sized firms with only an indirect link to asbestos products – to determine whether lawsuits may be filed there and dip once more into insurers' and reinsurers' pockets. But the main focus in the current environment is the impact of September 11.

    On the regulatory front, the NAIC appears more concerned about achieving uniformity of regulation at the basic levels than about making major changes in the reinsurance sector. The spectre of Gramm-Leach-Bliley, the law that threatens the possibility of the federal government taking over the regulation of insurance, has the NAIC scurrying over issues such as agents' licensing and models for nationalization of insurance companies. And, so far, any and all merger and acquisition has been put on hold until September 11 can be sorted out.