The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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It's a human instinct to try and reach out for something positive from a shocking event, however hideous.

But for the (re)insurance industry this impulse was particularly difficult when faced with the carnage of 9/11.

Anger, shock and horror were the natural emotions the world over as word spread of the hijacked planes careering into the Twin Towers of the World Trade Center (WTC), laden with terrified passengers and deadly jet fuel.

But for some in the industry, these emotions were heightened by a fear for family, friends and colleagues caught up in the atrocities.

For example, both Marsh & McLennan Companies (MMC) and Aon occupied sizeable offices in the towers and lost 355 and 175 employees respectively. Beyond that, downtown Manhattan was a much more dominant financial district than it is now. Almost everyone in reinsurance knew someone who worked near Wall Street. Even now the area has strong industry connections. AIG's magnificent art-deco headquarters, for example, remain in Pine Street, a mere stroll from Ground Zero.

The attacks also coincided with the Monte Carlo Rendez-Vous, when more than 2,000 executives converge on the principality for the global reinsurance industry's annual gathering of the clans. News of the attacks more than overshadowed the event - they effectively closed it. But for many of the US and Bermuda-based delegates present 10 years ago, their shock was combined with impotence as they were trapped thousands of miles from home.

But while raw emotions were on display in Monte Carlo that day, there was also a palpable acknowledgement that the world would never be the same again. It had become a more dangerous place or - in industry speak - a riskier place.

Click to enlarge Despite the confusion and apparent chaos that followed the attacks, even in the immediate aftermath many delegates knew that some reinsurers would also not survive the atrocities. Indeed, there was a grim irony that Copenhagen Re hosted the traditional final party of the Rendez-Vous. They, like a number of other reinsurers, were forced to call time shortly after 9/11, as the scale of their WTC exposures tipped them over the precipice following the near-suicidal underwriting conditions of 1997-2000.

Since then, the industry has had much time to reflect on the events 10 years ago that led to the death of almost 3,000 people.

The question is whether it has learned from them?
The short answer, of course, is that it is too early to tell. The WTC attacks were a devastating financial loss and cost the industry some $20bn (with over half carried by reinsurers). At the time it was the largest-ever loss borne by the market and is only overtaken by Hurricane Andrew when indexed at 2010 levels.

But - in pure economic terms - the industry has since faced much worse. In 2005 Hurricane Katrina, most notably, dwarfed the WTC attacks with a bill to the industry of over $70bn when including the vast offshore energy/marine losses. But even the Japan earthquake earlier this year - which is widely expected to cost the industry up to $30bn - was a significantly more costly event (see table).

However, the difference is that the WTC loss came when the industry was already near-bankrupt due to its own underwriting follies. Indeed, 2001 had already seen a number of specialty (re)insurers forced to stop underwriting - including Reliance and Kemper in the US, Australia's HIH and the UK's Independent Insurance.

Obvious lessons include contract certainty. The WTC programme triggered a maelstrom of litigation between insurers and the property leaseholder Silverstein because of the variety of different wordings used by insurers, which meant the courts had to decide whether the attacks were "one event or two". In some cases, insurers paid twice, in others only once. It was a poor reflection on the industry and it is to its credit that it has not experienced a similar "wordings dispute" of that magnitude since then.

But perhaps a more profound lesson to come from the WTC attacks was for underwriters to go back to basics - to look at their aggregate exposures and to price on risk, not previous loss experience. Inevitably, it was the Sage of Omaha who most elegantly voiced this lesson.

In his 2001 letter to Berkshire Hathaway shareholders, Buffett pointed out: "In short, all of us in the industry made a fundamental underwriting mistake by focusing on experience, rather than exposure, thereby assuming a huge terrorism risk for which we received no premium".

Buffett continued:
(a) The probability of such mind-boggling disasters, though likely very low at present, is not zero.

(b) The probabilities are increasing, in an irregular and immeasurable manner, as knowledge and materials become available to those who wish us ill. Fear may recede with time, but the danger won't. The war against terrorism can never be won. The best the nation can achieve is a long succession of stalemates. There can be no checkmate against hydra-headed foes.

(c) Until now, insurers and reinsurers have blithely assumed the financial consequences from the incalculable risks I have described.

(d) Under a close-to-worst-case scenario, which could conceivably involve $1tn of damage, the insurance industry would be destroyed unless it manages in some manner to dramatically limit its assumption of terrorism risks. Only the US government has the resources to absorb such a blow. If it is unwilling to do so on a prospective basis, the general citizenry must bear its own risks and count on the Government to come to its rescue after a disaster occurs.

Click to enlarge In fact, the US government - like many others in the world - has acknowledged its role as the reinsurer of last resort in the event of another terrorist atrocity with the Terrorism Risk Insurance Act 2002, which is currently scheduled to run until 2014.

But the private terrorism insurance market has also blossomed since the attacks. In addition to the circa-$9bn of capacity government-backed terrorism pools, Guy Carpenter estimates there is currently some $6bn-$8bn of US terrorism capacity available, much of it emanating from the specialist wholesale markets in Bermuda and London.

And while there has been no shortage of global terrorist incidents in the past ten years - not least the horrifying lone gunman attack in Norway this summer - the US' success in ensuring no repeat atrocity within its borders has ensured that underwriters have reaped large profits from their terrorism books.

But - in a trend that appears to cock a snook at Buffett's principles - this benign loss experience has also led to a consistent downward slide in rates as fresh capacity has chased business. Will it continue?
"Much will depend on loss experience for the remainder of this year, but barring further significant capital depletion, the over-supply of terrorism reinsurance globally is expected to stifle price increases in terrorism even if other lines experience upward pressures," MMC's reinsurance arm noted in a recent report on the sector.

Does this mean the industry is beginning to forget the lessons of 10 years ago? Not necessarily, although it does remind us how fickle specialty (re)insurance rates can be.

The real concern will be when the industry forgets that "mind-boggling disasters" events can occur at all and, as with 9/11, fails to price for them at all. After all, the brutal roll-call of natural disasters in 2010-11 were a reminder that "one-in-a-hundred" year events seem to take place with surprising regularity. The world is a risky place - which is why, of course, companies buy (re)insurance in the first place...