NEWS STORY
Why Lloyd's can't 'sleep easy'
Famous insurance syndicates unprepared for Sept. 11
James Moore Vancouver Sun
Saturday, September 29, 2001
In a dimly lit room at Lloyd's, carefully worked models called "realistic disaster scenarios" -- a mainstay of claims management for years -- are being ripped up.
Lloyd's regulations require its 108 syndicates to report what the effect of various ''scenario" events would be to them and to the capital providers that enable them to write business.
None of the scenarios, with the possible exception of the 1988 Piper Alpha oil-platform collapse in the North Sea, has taken place. Even Hurricane Andrew, the biggest single-event loss in history of the insurance industry, fell far short of the market's worst predictions, at $20 billion US paid out over-all and $1 billion US by Lloyd's syndicates.
Then on Sept. 11 fanatics crashed two aircraft into the World Trade Center, an attack that made the ''realistic disaster scenarios" models obsolete. The events included in the Lloyd's plans include an American storm costing the global insurance industry $50 billion US and Lloyd's almost 11.8 per cent of its 2001 capacity; a Los Angeles earthquake, $50 billion and 10.8 per cent; and the loss of a North Sea oil rig, three per cent. The estimated insured loss from the terrorism attacks could reach $57 billion, actuary Tillinghast-Towers Perrin reports. Lloyd's says its estimated exposure of almost $2 billion US amounts to 12 per cent of its 2001 capacity, outside the "worst case scenario" disaster models.
Says Michael Dawson, chief executive of Cox, a Lloyd's insurer: "Every syndicate has been carefully going through its exposure, but there is bound to be a certain amount of guesswork. Our estimate does not include any possible U.S. government funds or recoveries from other insurers. At some point everyone is going to have to get around a table and work it all out."
Insiders at the market say privately: "It is a nightmare. We are ripping up our business plans." Lloyd's syndicates have exposure to nearly every part of the disaster, with the possible exception of the life coverage some of the 6,000 deceased may have taken out privately.
That includes the aircraft hulls, the property, business interruption cover, workers compensation cover and various legal liability claims that are almost certain to be lodged.
It is also one of the world's biggest reinsurance centres, hence the doubts that have been expressed over how accurate its estimated loss is.
Reinsurers can only ascertain how much they will have to pay out when they have received claims information from primary insurers.
The way the World Trade Center was insured provides a challenge in itself. Typically, a consortium of insurers will accept the risk, laying a proportion off with one or more reinsurers. If a claim is made, they pay in proportion to the percentage they subscribe to.
The WTC is nowhere near as simple and this explains some of the difficulty insurers, and particularly reinsurers, have had in estimating their exposures. Its coverage is "layered.'' One or more insurer has responsibility for the first $100 million or so of damage. For the next $400 million or so another group will come in and so on up the chain. At the very top is what is known as a "sleep easy" policy. This covers the building in an absolute worst-case scenario, one outside conventional insurance modelling. It is extremely rare for these policies to pay out. Many buildings do not even have them.
In the late 1980s a number of insurance companies set up in Bermuda, including ACE and XL Capital. They specialized in writing this type of high level cover and made huge amounts of money from the premiums. This is because they looked like a sure thing. A similar delusion was held by many Lloyd's names until the late 1980s, when the losses it was piling up ran into the billions of dollars.
The "sleep easy" for the WTC is understood to have been underwritten at Lloyd's with reinsurance provided by Swiss Re, which helps to explain the high exposures estimated by these two insurers. Swiss Re's involvement is significant. While insurers such as Royal & SunAlliance, AXA and AIG have insisted the attacks are terrorism and will therefore not trigger war exemptions, Swiss Re has not been so clear. True, it has said: "Swiss Re's estimates are based on the assumptions that claims will be paid in full." But it added: "Given the complex circumstances surrounding the event, the outcome of ongoing substantial debate over liability and other issues will affect the ultimate amount paid by the industry."
One senior insurance executive, whose company is also treating the matter as terrorism, told The Times: "Property cover usually carries war exclusions but not, in the U.S., terrorism exclusions. The thing is, every war exclusion is written differently, so it is difficult to say whether and how they would be applied."
Including the "sleep easy," the WTC property insurance involved a consortium of 22 property insurers, with Lloyd's and Swiss Re, unsurprisingly, having the biggest exposures at $684 million and $742 million respectively.
Other leading participants include Allianz, the German group, ACE and Chubb Corp. A further 19 insurers underwrote a separate liability program, with ACE and Zurich Financial Services having the biggest exposures.
Industry insiders say that even with the "sleep easy" in place, the full value of the building's two towers is unlikely to have been covered. However, they say: "Because there were two aircraft to hit the building, the incident could be considered to be two events.
"That would mean there would be two hits on the total amount of cover, meaning you could recoup the full costs of rebuilding. You can be sure that the claim will be filed in the best interests of the insured."
In addition to the WTC, there is also the collateral damage to buildings around it from the falling rubble. Tillinghast-Towers Perrin has estimated the total property damage at between $10 billion and $12 billion.
The U.S. government is considering responding by becoming the reinsurer of last resort for U.S. buildings in a future terrorist attack. The same situation has been operating in the U.K. since the beginning of 1993 through Pool Re, a government-backed terrorism insurer.
The aircraft cover is simpler. Hulls are usually covered for about $200 million with an extra $1.5 billion of liability cover attached. Of that, $500 million covers those travelling on the aircraft, while $1 billion covers property damage.
This means those exposed to the WTC may not have to pay out the full amount of their exposure. The hotel that was damaged when Air France's Concorde crashed last year, for example, was covered by the liability policy attached to the aircraft.
Many countries, in fact, demand this liability cover to enable aircraft to land. This type of insurance is usually written by syndicates of insurers, but has been unprofitable for several years. That is changing.
Premium levels are going up by 400 per cent or more and governments have been forced to step in to provide emergency terrorism cover. This usually has to be bought separately to the main policy and is on a seven-day cancellation notice.
The real imponderable, however, is in the field of liability. The U.S. government has already issued veiled warnings against those lawyers who are rubbing their hands together in glee at the prospect of 10 years of litigation. One company has suggested some form of tribunal should be set up to rule on claims, and has received backing from a number of rivals.
Tillinghast says it believes legal liability could account for claims from anything between $5 billion and $20 billion. Other variable costs include business interruption; life; and workers compensation.
Tillinghast believes that at worst the total loss could reach $57 billion, breaching the level at which Standard & Poor's, the credit ratings agency, suggests the global insurance industry will find itself under grave pressure.
Analysts believe the big reinsurers will ultimately be able to trade through the loss. But smaller reinsurers could find themselves under pressure, while certain Lloyd's syndicates may find themselves close to collapse.
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