The Insurance Market subsequent to September 11th

The terrorist attack on the World Trade Centre (WTC) in September last year changed perception across most aspects of human life. As the full scale of the human horror and economic cost begins to unfold, the implications for the insurance industry are becoming clearer.

First, the hard facts; nearly 3,000 people died in the WTC attack. The insured cost of the loss is variously estimated between US$ 50,000m and US$ 70,000m. The previous most deadly terrorist attack was the bombing of the U.S. Marine Barracks and French Paratrooper Base in Beirut in October 1983 in which 300 people died. The final insurance cost will be between two and three times the size of the previous largest ever insured loss (hurricane Andrew in August 1992 cost approximately US$ 20,000m in today’s prices).

Following last September, industry figures have been quick to point out the exposed position of insurers to this type of loss, and in some cases, accept the blame for their own company’s losses. Warren Buffett of Berkshire Hathaway wrote to his shareholders in November 2001 claiming that there were three basic rules in running an insurance company: “Only accept risks you are able to properly evaluate… limit the business accepted in a manner that guarantees you will suffer no aggregation of losses from a single event or from related events that will threaten your solvency… avoid business involving moral risk: no matter what the rate, you can’t write good contracts with bad people“. Buffett went on to say that all of these rules were broken in his own company, General Re, during the last three years. Failure to observe the first and second of his basic rules resulted in enormous losses to the company.

In a different context, the Swiss Re listed the criteria for insurability of risks as assessability, randomness, mutuality, and economic feasibility. In their report “Natural catastrophies and man made disasters in 2001“, they commented “Terrorism risk does not readily satisfy all of these criteria. The data available from past events gives little indication of the future risk. Although terrorists do not act randomly, but strike by surprise and deliberately maximise effects, their attacks are fortuitous for their victims. Mutuality is difficult to achieve, given the major differences in terrorist hazard exposure between landmark risks and most other buildings. The tremendous loss potentials and the risk of co-ordinated terrorist actions throughout the world hampered diversification. And, finally, the evident uncertainties regarding risk qualification make the economic feasibility of the business extremely doubtful“.

The comments from two world leaders in the insurance market were a prelude to a number of changes in the market, two of which we shall expand upon: the definition and availability of terrorist cover, and the impact of the WTC attack on insurance pricing.

Terrorist Cover

The majority of fire insurance policies used historically to cover fire and explosion damage from any cause with certain exceptions such as war, civil war or civil commotions. As terrorism was not mentioned in most war exclusion clauses, loss or damage resulting from a terrorist act was covered. In some countries where the threat of terrorist risk was perceived to be particularly high, such as the UK, Pools regulated by the government were established to regulate the risk. However, the issue of terrorism cover was not clear, even in policies where terrorism itself was specifically excluded.

Any number of definitions of terrorism abounded. Some tried to define it in terms of the motivation of the people perpetrating the act while other definitions concentrated on the type of weapon used. Both routes are fraught with difficulty: how can you really ascertain the motives of a bomber (especially a suicide bomber)? The clauses defining weapons of war never envisaged the use of civilian airliners as flying bombs. The confusion after the WTC loss resulted in an attempt by many insurers to limit their cover either by quantum or by the addition of further exclusions. As the months have passed by, a greater degree of clarity has emerged and some common features can be seen across the entire insurance industry. These may be summarised as follows.

1) Greater clarity in terms of war and terrorism exclusion clauses.

2) Reduced capacity available in both the war and terrorist markets.

3) Greater attention being paid by insurers to risk and capital management in order not to over expose their balance sheet to this type of loss.

4) The emergence in the private insurance sector of specialists offering cover in niche areas.

Impact on pricing

An insured loss of the scale of the WTC disaster affects every atom of the world insurance industry. The scale and diverse nature of the loss across so many different classes of insurance ensures this. So in the short term, increased prices and tighter capacity are inevitable. However, the September loss served as a dramatic accelerator of a trend which was already underway. World non life insurance markets were in the doldrums in the late 90’s with only a few of the major players making money. The well publicised losses in the London market in 1999 and 2000 were typical of the majority of insurers’ experience.

It may not be very profound to predict rate increases after the WTC bombing and all the less so a year after the event. For buyers of insurance and investors in the stock of insurance companies, a view as to the length of this rating up-swing would be more interesting.

If we go back to Warren Buffett last November, he predicted that the hard market would be relatively brief as capital would flood into the market to take advantage of the newly attractive terms. It is certainly true that worldwide capacity for catastrophe risks has dramatically increased since 1 January. Investors in Bermuda have been leading the charge, as literally dozens of new companies have either been incorporated or substantially increased the amount of capital available to them. The London market may have consolidated in terms of its number of players, but overall capacity in Lloyd’s in 2002 will be at least 20% higher than the previous year. If the normal rules of supply and demand apply, one would expect this surplus to result in price increases gently easing over the next 18 months. This may not apply to certain specialist areas such as the insurance of terrorism itself, retrocessional reinsurance, or tough liability business (to give a few examples), but it will certainly be the case for the majority of business.

The scale of the WTC loss awoke many insurers from a world where inadequate pricing and lack of clarity were already leading them down a loss making path. A catastrophic loss of this size was bound to bring a commensurate reaction but it looks as if it may be short lived.

We are grateful to Xavier Villers of Miller Marine (the Club’s reinsurance brokers) for the above global review of the World insurance market subsequent to September 11th. Members of ITIC were fortunate to be shielded from the effects of September 11th, as the Club’s re-insurance contract was negotiated in the previous April and fixed for two years. Elsewhere in the insurance market it has been common for those renewing their professional indemnity cover to see premium increases of 30%. The forecast is for prices to continue to increase.