The View From London

Insurers Can Weather Global Financial Crisis

Buyers that aren’t buying; houses that aren’t selling, banks that aren’t lending — sound familiar? But in this case it’s the United Kingdom that we’re talking about, not the United States. However, one thing you don’t hear about the economic meltdown roiling both sides of the Atlantic is: “Insurers not insuring.”

This is not to say that insurance leaders in the City of London are ignoring the crisis, far from it, but they aren’t panicked. “The insurance market depends upon the economy,” said Sue Langley, Lloyd’s director of market operations and North America. “However, Lloyd’s is in a good position,” she continued. “Our business model is strong and we concentrate on spreading the risks.” By doing so Lloyd’s avoids being too vulnerable in any one area, such as natural catastrophes. Solid financial management backs up that formula.

“Since the ’90s we’ve taken a very conservative position when it comes to investments,” said Richard Ward, Lloyd’s CEO. “As a result of the World Trade Center attacks, Enron, WorldCom, etcetera, we changed our management structure in 2003 [when Lloyd’s adopted a franchise model]. We avoid aggregating underwriting risks, so we aren’t over exposed in any given area.”

As an example he pointed out that, although Lloyd’s has some directors and officers liability exposure, an area where claims are expected to rise during the financial crisis, it is not overly concentrated.

Lloyd’s has historically been very cautious about where it puts its money; somewhat “stodgy,” Ward suggested. “We want the funds available to pay claims; therefore only about 5 percent of our investments are in equities; the rest is in cash, government bonds and highly rated [i.e. non-derivative] corporate debt.” That strategy is now paying off, as Lloyd’s remains very solid financially. Capital, however, is only one element for London’s insurers.

Fear Factor

It’s impossible to ignore the daily drum roll of failed and imperiled companies, government bailouts and tax reduction plans without being somewhat concerned. Langley aptly called it the “fear factor,” adding that it’s “become a cultural issue.” She cited a number of concerns — not all of them economic — that have contributed to an ongoing “crisis of confidence.” Terrorism, job losses, foreclosures, riots in Greece (and in China, although they’re largely unreported), AIG’s demise, plunging stock markets and many more have created a “negative feedback loop.”

Although they all, to a greater or lesser extent, affect the insurance industry, there isn’t much it can do to change matters. “We must get our confidence back,” Langley said, “before things will begin to improve.”

Neither she, nor anyone else in London, is expecting that to happen in the near term. “The spring or summer of 2009 may see a change,” Langley said. She indicated that Swiss Re’s economists were probably correct in their assessment that a “severe recession,” will continue, “until mid-2009 in industrialized economies, including the United States and Europe.” [See Insurance Journal’s Web site: www.insurancejournal.com/ news/international/2008/12/10/96176.htm].

In that report Kurt Karl, Swiss Re’s chief U.S. economist, stated: “Due to the worst financial crisis since the 1930s, the world will see a severe recession. A rebound of the economy cannot be expected before mid-2009 and market uncertainty will continue well into 2010.” He added: “Insurers are not immune to the crisis.”

However, Thomas Hess, Swiss Re’s chief economist, explained: “The insurance industry came into the crisis with very healthy balance sheets. Despite the asset meltdown, the insurance industry is able to weather the financial turbulence. There can be no ‘run’ on an insurance company because pay-outs are triggered by hazardous events, not by policyholders’ will.”

Those are encouraging words, but they don’t tell the full story. “The financial crisis, single risk losses such as [Hurricane] Ike and the meltdown of AIG have taken between $100 [billion] and $150 billion in capital out of the industry,” said Paul Jardine, the Catlin Group’s chief operating officer. “However,” he continued,” the situation’s not the same as it was in 2001, or even 2005.” From his accounting background, Jardine explained that the task of “reloading” that lost capital is going to be difficult. “The cost of capital has gone up, because its availability has gone down.”

Finding that capital will be difficult. The usual providers — investment banks, hedge funds and private equity sources — have some problems. Jardine remains confident. Although, as he said, “the world has changed,” most of the insurance industry will come out of the crisis in good shape. In some respects it may be in a position to profit from the crisis, as its capital base is not highly leveraged, and a harder market may see raises in premiums.

“Banks and insurance companies have a different view of risk,” Jardine explained. “Can you imagine an insurer that’s leveraged* at 30 percent?” By contrast he pointed out that the failed investment bank Lehman Brothers had around $50 billion to $60 billion in “hard” assets, but financial commitments, which, before it failed, totaled over $600 billion — that’s 90 percent leverage. Nothing like that exists, or ever has existed, in the insurance industry.

“There’s a fundamental difference between underwriting and investing,” said Ward, “consequently we [the insurance industry] are far less leveraged than the banks, or even most of the business sector.”

He’s concerned, however, that cultural influences may have a negative effect.

“The current generation never expected anything like this. The generations that grew up in the ’40s and ’50s worried about debt, “but now there’s a cultural acceptance of debt.” He listed the progression from student loans to credit cards to property, all of which encourage people to borrow.

In addition, Ward said, “the world is very different than it was in the ’30s.” The computer and Internet revolution has enabled capital to become highly mobile. It flows freely around the globe where returns are highest.

As a result, Ward is skeptical about how successful the current measures governments in the United States, the United Kingdom and elsewhere are taking to encourage people to spend more in order to stimulate economies out of the recession. “Policies that worked then, may not work now,” he said, although he also admitted that no one seems to have come up with any credible alternatives.

Many of the lessons the insurance industry has learned over the years — at great expense — now seem particularly applicable to measures the world’s economy needs to revive. Foremost among them would be a real calculation of risks and the need to preserve capital for the day you might really need it.

*In the financial sense leverage, from the Latin levere — to lift or raise — defines the use of a small initial investment, credit, or borrowed funds to gain a very high return in relation to one’s investment, to control a much larger investment, or to reduce one’s own liability for any loss. AIG Financial Products — trading on AIG’s ‘AA’ ratings — was able to borrow enormous amounts to make investments. When those investments fail to pay, however, the leveraged enterprise is nonetheless required to repay the lenders and the counterparties involved the amounts they’ve advanced.

Topics USA Carriers Excess Surplus Market London Lloyd's AIG