Time-Tested Lloyd’s Turns to Address U.S. Disaster Losses

Lloyd’s of London, the world’s oldest and most visible insurer, has set about dealing with the aftermath of the terrorist attacks of Sept. 11. Two weeks after the event, it released its projected net loss figures. Calculations from more than 100 syndicates revealed that its exposure will be around £1.3 billion ($1.91 billion), the largest single loss in Lloyd’s 300-plus year history.

Due to Lloyd’s unique structure, calculating the potential losses required extra time and energy. As an insurance market—not an insurance company—Lloyd’s is comprised of 108 separate underwriting syndicates in four major categories: Marine, Non-Marine, Motor (Auto Insurance) and Aviation; there are also “composite” syndicates that write policies in two or more areas.

“In fact the boundaries are increasingly blurred, and it’s becoming harder to analyze our business along these lines,” said Lloyd’s spokesman Adrian Beeby. He indicated that any syndicate, providing that it’s properly capitalized and adheres to the business plan it has submitted to Lloyd’s regulators, “can write anything it wants.” This includes both primary and reinsurance.

Syndicate 2791, which began operations in January with a capacity of $209.5 million, is a good example. It’s managed by Managing Agency Partners Ltd., and its lines of business include “property insurance and reinsurance—casualty insurance and reinsurance” (D&O, E&O, EPL and medical malpractice). It also writes policies in auto, accident and health, marine, political risks and space and entertainment risks. That’s more lines than a lot of companies have.

When a disaster of the magnitude that struck the U.S. occurs, it becomes very complicated to determine the extent of the exposures. “Not only are you dealing with 108 syndicates,” said Beeby, “but also with the solvency of 890 corporations and approximately 2,800 individuals.” Although he declined to break down the loss estimates into primary and secondary loss categories, nor would he state what the gross claims figures are, Beeby indicated that “reinsurance coverage was a major part of our analysis.” He’s fairly certain that having taken the time to properly calculate its exposure, “these [net loss estimates] are as definitive as we can come up with right now; they may well be changed over time, but only by small amounts, as more information becomes available.”

Some of Lloyd’s assumptions, however, have raised questions. A number of analysts, including Fitch’s rating service, have indicated that the gross losses may total as much as £7 billion ($10.1 billion), five times the net figure. This could significantly raise Lloyd’s net losses if it can’t collect on all its reinsurance policies. Preliminary figures from most disasters have also tended to increase as actual claims are made. In addition, there’s no real way to estimate what claims are on reinsurance policies, and what claims are on primary policies.

The exact percentage of Lloyd’s reinsurance business isn’t certain. According to its Glossary, it’s more than half of its total business. Beeby said it’s more like 40 percent. Whatever the actual figure, it’s a large portion of the risks that pass through Lloyd’s. Last year, net written reinsurance premiums totaled almost $4 billion.

Beeby pointed out that “according to Standard & Poor’s 2001 edition of Global Reinsurance Highlights, the top 5 reinsurers by net premium in 2000 were: 1) Munich Re, $10.6 billion; 2) Swiss Re, $5.2 billion; 3) Lloyd’s, $3.9 billion; 4) Allianz AG, $3.7 billion; and 5) General Re, $3.2 billion.” Different ratings may use different criteria. The Reinsurance Association of America ranks Lloyd’s seventh, using the same net written premium figure as S&P.

Ultimately, Lloyd’s syndicates cover risks, and those risks can be practically anything. The same syndicate may write primary coverage, surplus lines, treaty reinsurance, facultative reinsurance and retrocessional coverage in a number of areas, which explains why it took more time for Lloyd’s to calculate its loss exposures. Lloyd’s is addressing the problem. One of the goals of its market reform program is to have a single underwriter responsible for each risk.

Other insurance companies can neatly compartmentalize their business. Munich Re writes as much primary coverage as it does reinsurance, but it does it through carefully denominated subsidiaries like Ergo. Lloyd’s can’t do this.

Ironically, on the same day as the disasters, London’s Financial Times published a series of articles on the reinsurance industry, which generally contained some encouraging news. While warning that results were deteriorating, it noted that the decrease in capacity was putting upward pressure on rates. Lloyd’s, which hasn’t made an overall profit since 1996, was expected to benefit and to at least break even this year and return to profitability in 2002. Those predictions no longer have any validity after Sept. 11.

While some analysts were relieved that Lloyd’s estimates weren’t higher, paying the losses will put a heavy burden on the capital of Lloyd’s syndicates, and will require additional contributions to its Central Fund, and additional deposits from Lloyd’s members. Shortly after it released its loss figures, Lloyd’s announced that it was increasing the monthly levy paid by all syndicates from 1.1 percent to 2 percent of monthly premiums, effective in January, and continuing through 2003.

The move was aimed at strengthening the fund as it may be called upon to pay claims in the event a syndicate and its investors are unable to do so. It currently has around £323 million ($466 million) in liquid assets and constitutes the “third link in Lloyd’s chain of security.” It in turn is backed up by a policy Lloyd’s negotiated in 1999, which provides for £350 million ($505 million) of cover over five years with an aggregate limit of £500 million ($722 million). Swiss Re, Employers Re, The St. Paul, Hannover Re, XL and Chubb are the underwriters. They’re also some of the companies with the largest exposures from the Sept. 11 disasters.

Lloyd’s Chairman Sax Riley has continually assured the international community since the day of the attacks that, with $27 billion in assets, it can manage the loss exposures. He commented that, “While a figure of this size will have a significant impact on the Lloyd’s market, the market’s strong capital base will absorb this. The size of our asset base, the spread of the losses and the resilience of the reinsurance programmes in place are important in coming to this conclusion.”

Reinsurance consultant Paul Walther, who heads Florida-based Reinsurance Directions, agreed that reinsurance would be a key element in managing the losses, but expressed two concerns. “[Lloyd’s] may not have enough cover. Size matters, and some of the smaller and more moderate sized syndicates may not have enough, especially the ones with multi-lines of business.” He also worried that the “spiral effect” will reconcentrate losses in syndicates that had ceded coverage.

Whether the reinsurance cover of Lloyd’s syndicates is adequate or not remains to be seen, but Beeby doesn’t think Lloyd’s will suffer from the spiral effect. “We had a problem in 1988-92 when asbestos hit—large losses were concentrated in small spirals—but we learned a big lesson.” Lloyd’s adopted new regulations to eliminate the problem of its syndicates ceding coverage to other syndicates, and ultimately getting the same loss exposure ceded back to them.

“By regulation a certain amount of risks must be reinsured outside of the Lloyd’s market,” Beeby said. “In addition, Lloyd’s Regulatory Directorate monitors [reinsurance placement] individually on a transaction-by-transaction basis.” He estimated that more than “ninety percent of our reinsurance risks are placed outside Lloyd’s with reinsurance companies rated ‘A’ or better.”

Following the catastrophe, the rating services have been reviewing the financial condition of literally hundreds of insurers. It was almost inevitable, given its large exposures, that Lloyd’s would be one of the first to be downgraded, and it was. S&P announced on Sept. 20 that it had lowered Lloyd’s financial strength rating from “A+” to “A,” its sixth highest grade. On Sept. 24, A.M. Best reduced the Lloyd’s market rating from “A” to “A-.” Lloyd’s gives both agencies preferential access to its accounts.

Best made some revealing comments. It anticipates that there will have to be “significant voluntary contributions from trade investors, many of whom are also very exposed to this event from their non-Lloyd’s exposures.” It also expects a higher “risk of unrecoverable reinsurance,” and is worried about the discrepancy between the public assessment of overall losses, and the amounts insurers have said they are exposed to.

“Moreover,” Best’s report continued, “the Lloyd’s market is a specialist in several of the lines of business most impacted. This includes Business Interruption, where losses are currently particularly hard to quantify but where the loss potential is clearly significant.”

On Oct. 16, Lloyd’s told its Names that most of them would receive cash calls from the syndicates they are invested in, which would average around £42,000 ($61,000). Beeby explained that Lloyd’s was seeking to raise £780,000 ($1.13 billion), but that this “wasn’t the biggest cash call ever,” and included provisions for losses in 1999 and 2000. “It would have happened anyway,” he said, “but it was certainly boosted by the World Trade Center Disaster.”

By Nov.1, individual Names will be asked to deposit a total of £246 million ($356 million), and corporate capital providers, mainly insurance companies who account for about 85 percent of Lloyd’s capacity, will supply the rest. “This doesn’t mean they necessarily have to write a check,” Beeby said. “They can instruct us to draw it from the Members’ reserves [funds already on deposit at Lloyd’s].”

One of the reasons for the cash calls is to augment the reinsurance trust fund held in the U.S., and administered by The New York Insurance Department on behalf of the National Association of Insurance Commissioners (NAIC). All “foreign” insurers maintain such funds. Lloyd’s has two—a surplus lines fund of around £1.2 billion ($1.74 billion) and the reinsurance fund of about £4.1 billion ($5.94 billion). This fund is normally kept equal to 100 percent of estimated gross claims, but the NAIC has agreed to relax its rules for at least the next quarter. The adjustment payment due Nov. 15 will require that only 60 percent of estimated gross claims relating to the WTC disaster be deposited.

The fund isn’t actually used to pay claims. “It’s like a security deposit,” Beeby explained, “While it could in theory be used to pay claims, it isn’t in practice. All claims are paid out of London.”

The NAIC has been examining all the funds following the events of Sept. 11, and in conjunction with the payment reduction, announced that it will conduct an in-depth audit of Lloyd’s financial condition, focusing on its gross exposures and the reinsurance provisions it has in place to cover them. It’s concerned both that the amount of the claims may be so large that in some cases companies won’t be able to pay them, and that the spiral effect may have skewed loss estimates.

Beeby also explained a further complication with reinsurance coverage. While Lloyd’s insures and reinsures a number of U.S. risks, it also reinsures European companies, who cover U.S. risks, but the operations are treated differently. The coverage placed in the U.S. affects the trust funds, but the European reinsurance doesn’t. “There’s a fundamental difference between the two, and so how the reinsurance is structured is a vital factor,” Beeby said.

The NAIC will also accept letters of credit for the amounts owed which are attributable to Sept. 11 losses, but, as this doesn’t apply to other claims, Lloyd’s will still be making a substantial increase in the reinsurance trust fund. It is nonetheless welcome news at Lloyd’s as it will decrease liquidity pressures on the syndicates.

Whatever amounts Lloyd’s eventually pays out, its real need in the coming months, and probably years, will be to rebuild its capital. As Riley stated, with $27 billion in assets, it’s hard to believe that the U.S. disaster will be the end of Lloyd’s, but its future activities could be significantly curtailed by a lack of capacity. Even if that reduction results in higher premiums, neither Lloyd’s nor any other insurer can profit if they don’t have sufficient capital to underwrite policies.

Reinsurance Directions’ Walther said he is “fearful for Lloyds’ future.” He thinks that a lot of the corporate capital which has flowed into Lloyd’s over the last five or six years may leave. Insurers need to replace their own capital reserves first before increasing any commitments they may make to Lloyd’s syndicates. In addition, they may look for higher returns elsewhere than Lloyd’s or the reinsurance market. Surviving this crisis will severely test not only Lloyd’s, but the entire industry.

Topics USA Carriers Profit Loss Legislation Claims Excess Surplus Reinsurance London Lloyd's