Insurance woes create billion-dollar bill

By Campbell McIlroy

Friday 28th September 2001

NEW YORK FALLOUT: The clean-up will mean increased insurance premiums

Global reinsurance markets were dealt a fatal blow on September 11 with many rendered insolvent and the likes of Lloyd's of London put in jeopardy. As a result, New Zealand business could face billions of dollars in increased insurance premiums.

Insurance Council chief executive Chris Ryan warned the business community could face premium increases of 100% or more.

Other industry heads gave similar warnings.

Crombie Lockwood chief executive Steve Lockwood estimated increases would be more in the order of 20-25%. Willis NZ chief executive Allan Morris said some industries would not be badly affected but others could face increases of up to 200%. He was not willing to comment on which industries would be the worst hit.

But the cost, whatever the scale, will be two-fold for the business community. As well as increased premiums, businesses will be faced with more exemptions on their policies.

"Business will need to begin carrying more of the risk itself," Mr Ryan said. "Companies will have to reserve more capital to cover themselves for the risks that are either unaffordable or simply no longer available,"

Morgan Stanley, whose head office was destroyed when the World Trade Center collapsed, released a report saying large swathes of the reinsurance market were likely to be insolvent.

Its special insurance industry overview described the attacks as the largest workers' compensation loss in history (by multiples), the most expensive aviation disaster in history (by multiples), one of the largest property losses in history, the most expensive business interruption in history (by multiples), the largest life insurance catastrophic loss in history (by multiples) and one of the largest potential liability claims in history.

"Yet every one of the 36 major companies, representing the vast majority of market exposures, say they are going to come out of it financially A-OK, with little more than a bad quarter or year."

The report said they could not all survive and some of the numbers being reported were likely to be significantly understated, mostly because they were net of reinsurance recoverables that in many cases would never be collected. The implied amount ceded to reinsurers was large enough to bankrupt many reinsurers.

"A $US25 billion loss to the reinsurance market would be fatal to more than a trivial segment of the reinsurance market," the report said.

And there is considerable precedent to support the claims.

Eight small US insurers were bankrupted by Hurricane Andrew and, closer to home, the entire Australian reinsurance market was rendered insolvent by a series of catastrophes in the late 1990s.

Estimates of the losses incurred now range from $US40-50 billion but Mr Morris said it was too early to tell if the amount would be greater.

"I don't want to be alarmist but business needs to be aware of the impacts this event could have," he said.

As the viability of some insurance companies causes jitters, there will be a flight to the blue-chip ones that are most likely to weather the storm. That in itself will create problems as there will be reduction in capacity.

The Morgan Stanley report estimated the capacity of the reinsurance market worldwide was about $US120 billion annually in premiums and this would shrink significantly, perhaps by one-third or even more.

Some companies have already stopped taking any new business while they assess their exposure. Others will be reluctant to take more risk in an uncertain and unstable market.

Mr Lockwood, who was in London when the attacks happened, said the day before, a Monday, one broker was able to accept a $250 million line on aviation. On Wednesday the amount available for that same line was just $5 million.

This lack of capacity will drive up the cost of cover. The flight to quality could also cause more second-tier reinsurers to collapse as their cashflows dry up.

The disaster comes just as the US is entering its hurricane season and there is also the possibility of a terrorist reaction to the US-led military retaliation in Afghanistan.

Many insurers have moved to exclude terrorist attacks from their policies, which in the UK and South Africa are covered by a voluntary government pool, similar to New Zealand's earthquake and war damage coverage.

Mr Morris said it would be prudent for the New Zealand government to at least examine the possibility of a similar pool in here.

On a small scale the effects are already beginning to manifest themselves. Malaysia Airlines announced effective from October 1 it would impose an insurance surcharge of $US1.25 a passenger for each flight sector to meet the hefty insurance surcharges being imposed by insurance underwriters.

The unknown factor is what effect the collapse of insurance companies will have on the equity markets. Large amounts of money from the insurance industry is invested in stocks. As claims are called up there could be large-scale selling on the world's stock markets to cover the losses.

Liquidity will become a major issue as it will not be possible to immediately realise all the assets necessary to meet the claims. The insurance industry has large property holdings that are not easy to dispose of in a short amount of time.

While the losses will cripple some insurers there is no doubt the industry itself will survive. Standard & Poor's, a credit rating agency, said the insurance industry was strongly capitalised and could withstand an enormous financial hit without threat to the stability of the system overall.

"The totals would have to exceed $US50 billion before we would begin to worry about the insurance system," S&P's managing director US insurance industry ratings Steve Dyer said.

Despite the grim outlook, Crobie Lockwood's Mr Lockwood said it would be unwise to be too sensationalist about what will happen because no one has been able to fully assess the damage.

His advice for New Zealand business was to consult with their brokers and adopt a wait and see attitude until more solid information was available.

He also said there was no suggestion anyone in New Zealand was badly exposed but there was no doubt business would suffer premium increases across the board.

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