The Global Risk Map in 2009

Good morning and thank you Phil for those kind words of welcome.

Well it’s great to be back in the US. As you may know, although Lloyd’s operates in over 200 countries and territories around the world, the United States is, by far our largest market, accounting for over a third of Lloyd’s worldwide business. That’s over 12 billion dollars of insurance and reinsurance business a year[1].

As a result, the strong financial security of Lloyd’s runs like a steel thread through the American economy. Today, some 93 percent of companies listed on the Dow Jones choose to underpin their risk management strategy with the reassurance of a Lloyd’s policy[2].

So it’s entirely appropriate that my first overseas visit of 2009 should be to the US. And I’m particularly pleased to be in Boston and to be able to catch up with a number of people I met during my last visit here. That visit now seems like a very long four years ago, and to underline the point I thought I’d share with you two comments made around that time.

Here’s quote number one. “Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately.” That was the then Chairman of the Federal Reserve Bank Alan Greenspan speaking in early 2005[3].

And here’s quote number two. "Britain is today experiencing the longest period of sustained economic growth since records began in the year 1701.”[4] So said our UK Prime Minister, then Chancellor, Gordon Brown around the same time.

How dramatically things have changed since then on both sides of the Atlantic – and it is interesting how history has since cast a different light on those particular statements. But of course, the last two years have—perhaps understandably—caught even the most knowledgeable experts by surprise.

What does 2009 hold? I’m in no position to give you a definitive assessment of what will or will not happen this year, however I would like to share our view at Lloyd’s of how the global risk map looks.

I will attempt to do that first by discussing the outlook for the insurance industry in the context of a difficult global economy.

But even with these global challenges dominating the headlines, we must not become so obsessed with today’s news that we forget that we also continue to face hurricanes, terrorist attacks and other disasters. These risks have not gone away. And in some ways, the current economic climate serves to exacerbate the problems. So I will conclude by making some remarks about some of the wider risk challenges which we believe business may face in 2009.

I’ll start then by talking about the outlook for the insurance industry.

Redundancies, cutbacks, insolvencies—this is hardly the finest hour for the financial services sector. And the dramatic bail-out of America’s largest insurer proves that it would be foolish to pretend that the insurance industry is insulated from what’s happening elsewhere.

We also need to contribute to the debate about the new architecture which we need for our markets.

Financial services must take stock and get back to basics. It exists to provide services to keep wider society and business moving. And there is a clear consensus for change. Over two thirds of global business leaders surveyed at the end of last year said that complex financial instruments required better regulation, more restrictions and greater disclosure.[5]

Regulation certainly needs to be more effective. We need to have more oversight over what we are doing. But I must sound a word of caution at this point: better regulation doesn’t simply equate to more regulation. It doesn’t mean knee-jerk reactions or equate to vast new rafts of legislation. We need change, but we definitely don’t need another “Sarbanes Oxley”. What the current crisis proves is that we are all part of a global market. What we therefore need—for insurance and reinsurance too – is closer co-operation across borders, more harmonisation of standards and greater mutual recognition between different territories.

We also have to identify the checks and balances that we need. Boards everywhere—the insurance industry included—need to demonstrate that they want to reward performance, not just risk taking.

Of course, not to reward our people fairly would be ludicrous. Those who perform well must be properly rewarded and we would simply lose them if we did not do so. But in order to retain public trust we must demonstrate that we are not part of a ‘culture of excess’ and that we do not reward failure.

Too many personal compensation structures have pushed people into taking bets on positions which, if they were thinking in the long term and in the true interests of the business, they may well not have done.

But at this point I also want to draw an important distinction between the insurance industry and wider finance.

Despite the high profile casualties, the overall impact of recent events on the general insurance industry overall has been limited.

Recent months have actually shown that the whole financial sector is not a house of cards destined to fall. Insurers and bankers are not joined together in an unholy matrimony.

First and foremost, insurance is an economic necessity, not a discretionary purchase. And although insurance is not immune from what’s going on elsewhere, this largely holds true even as recession bites.

Sure, buyers will seek to cut costs during difficult times, and fraud may rise. Yet general homes, automobiles and businesses all need to be insured irrespective of the state of the economy. A decline in construction and automobile manufacture will hurt growth prospects—but this will impact mainly at the margins because so much growth of insurance exposure is linked to renewal business.

I should also say a few words about the Lloyd’s market at this point. Lloyd’s has had considerable and painful experience of dealing with its own ‘toxic liabilities’ in the past from which it has learnt some important lessons. Indeed, since the transfer of approximately 20 billion dollars of liabilities to Equitas in the 1990s, a business since bought by Berkshire Hathaway, we have changed almost every aspect of the Lloyd’s business. The creation of a new franchise structure in particular has led to fundamental changes in our business model—and one which has helped to keep us on course despite record insurance losses in recent years.

Another key reason why Lloyd’s in particular has not been greatly impacted by the current crisis is that we have stuck firmly to what we know—and that’s the business of underwriting. A few years ago, our rejection of complicated financial products must have appeared highly unadventurous, while in the middle of the bull market, our conservative investment strategy must have seemed full of missed opportunity.

In hindsight, however, it appears to be the right strategy. At Lloyd’s, the impact of recent events has therefore not been nearly as pronounced as it has been elsewhere.

However, insurers cannot be complacent. No business is immune from the effects of the current economic situation. In addition, we also face the pressures of our own market cycle right now – the insurance market cycle. There is no clear evidence yet of where the cycle is going to end up this year – although we remain optimistic.

For too long the financial sector has operated within a bubble of unreality. By contrast, we need underwriting decisions built on economic reality. At Lloyd’s we are therefore entirely supportive when we hear our underwriters say that they will not underwrite unprofitable business or chase market share. This is the only prudent approach right now.

For the second part of my remarks today I would like to comment more widely on the outlook for the commercial risk environment in 2009.

If we have learnt one thing from the financial crisis it is that poor risk management was a big part of the problem.

Let me clear. Risk is not and should not be a dirty word. However, we need to work to understand risk. Only once we understand it, can we start to manage it, something which we know from over 320 years experience at Lloyd’s.

Today there are three particular risk issues which business and society perhaps need to work to understand better. These are liability risk, climate risk and political risk and would like to run through each of these briefly.

The first is liability risk.

Liability is a concept which I think it is fair to say you have learnt to manage—or should I say to perfect—here in the US.

But one of our concerns is that a credit crunch, followed by a deep recession, creates the perfect breeding ground for a new increase in litigation activity.

There is typically a delay before claims tend to materialise from an economic downturn. Economic activity fell sharply in 1990 to 1991 while a raft of new claims arrived between 1992 and 1993[6].

Our own research at Lloyd’s last year with global business leaders shows that boards are once again spending an increasing amount of time discussing litigation and liability risk.

There are also particular concerns in Europe right now. One is that as globalisation takes hold, companies outside the US are growing more disposed to litigate generally. The other is a perception that US courts are increasingly being asked to rule on rule on cases that might have once been considered extraterritorial[7].

In these testing times, more than ever, it is important that we do not allow litigation and the fear of it to stifle the innovation that business needs to survive and succeed.

Insurers and intermediaries are well placed to help boards focus on these important areas. It is vital that companies carefully consider whether they have the right processes in place to manage liability risk.

Most global business leaders admit they have not yet adopted formal policies and procedures to respond to liability risk, although they have done so for other types of risk. Others need to focus on encouraging the right culture—only education can improve staff awareness of the issues.

As I mentioned at the outset, another area of concern right now is climate change.

When I last came to Boston, I reported that 2004 had been a particularly bad year for insurers, with record sums paid out.

Certainly, here in Boston, change is happening. The region's winters are warming by 0.8 degrees Fahrenheit every decade[8]—despite what you might feel this morning. Boston is not alone in this phenomenon—and many characteristics of the climate are changing, with greater extremes and more intense storms increasingly expected.

The economics of climate change are not yet entirely clear, but the indications are extremely worrying. We know that weather-related catastrophes are costing the insurance industry more than ever before.

There are also concerns right now that our focus on the economic crisis could all too easily become an excuse for inaction on climate change.

But despite the economic challenges we face, it would be an environmental and a business disaster to lose our strategic vision on climate change now.

With a new administration entering the White House, we can expect the US Government’s attitude to change too. Of course, Mr Obama’s choice of a Boston-educated scientific adviser can only help with that process!

The climate also needs to be a factor within every corporate risk management strategy and the insurance industry has a key role to play in helping to change attitudes. We also need debate on important issues like flood defence, how we can best adapt buildings and infrastructure, and development in high-risk zones. These are complex issues and we can’t just put them in the ‘too difficult’ box and walk away.

And let’s get one thing straight. As well as significant challenges, climate change also presents us with real opportunities. Ultimately, society will adapt to the climate. It has no choice. And new technologies will be developed which will create huge opportunities for business—and indeed for insurers too.

It is clear enough to us back in the UK that consumers will expect to see much more in the way of climate-friendly behaviour from their brands. And as a result, how we respond to climate change will start to have a tangible impact on corporate reputation and brand image for companies all around the world.

Now I’d like to touch on terrorism and political risk. Our work at Lloyd’s has highlighted the emergence of a new brand of home-grown terrorism. And the UK government agrees with us: home-grown terrorism is probably the greatest security threat we now face.

Yet our research in the UK and US suggests that only one-in-three business professionals think we have learnt enough from events like 9/11 in the US and 7/7 in the UK to be better prepared next time[9].

A gap has emerged between our heightened awareness of the risk and a lack of understanding as to how to tackle it. We need to close this gap urgently. This will only become more urgent and more important as the impact of recession begins to bite. In the US and the UK, rising unemployment and economic hardship mean that the number of vulnerable young people susceptible to extremist doctrines could increase.

Looking farther afield, we should be concerned too. I had been relatively optimistic up until now about the economic prospects for the emerging markets despite what has been happening here. However, on my last visit to China a few weeks ago it became clear to me that the economy there is beginning to suffer too. Should the downturn in emerging markets be sustained, there is little doubt that it could result in greater tensions and instabilities in some regions.

The director general of the security service in the UK confirmed just last week[10] that he thinks the global economic crisis will increase the security threat to Britain, and I suspect the same logic can be applied elsewhere.

Against this background, the insurance industry can help in at least two ways. Insurers and intermediaries can work with their clients to improve their information gathering and planning.

Getting the right information from the right sources is critical. Today, too many business leaders rely on media reports for their knowledge on terrorism and political violence, and not enough use other sources. Companies must also make sure they have in place an up to date business continuity plan which reflects the reality of the risks as they change.

What’s more, given its global impact and influence, the insurance and wider financial sector has a responsibility to lead by example. Until now, the business community has tended to keep a low profile when it comes to engaging in debates on terrorism and related issues, for fear of becoming caught up in politics.

But in the UK, we are coming to accept that the struggle with home-grown terrorism represents a struggle to engage with a lost generation. Society will only conquer the threat if we start thinking and investing ‘long-term’, and business can make an important contribution to that process. A growing body of opinion now suggests that closer engagement—both at home and abroad—can make a lot of sense for both the business and the local community. Our global risk map is clearly changing. And it is impossible right now to say exactly what this week might bring, let alone this year.

As we enter 2009, more than ever we need to expect the unexpected. But there are also some risks that we know about, and that we at Lloyd’s believe society can begin to plan and prepare for.

And as business faces one of its most difficult years in memory, a strong and stable insurance industry has a unique opportunity to help develop risk solutions that the struggling economy needs.

For Lloyd’s part, we do not believe risk is a dirty word. And we will continue to work closely with intermediaries, insurers and indeed the wider business community here in the US to help you manage it. We are particularly proud of our long association with you here in new England. Lloyd’s insured the 340 crates of tea that your forebears threw overboard on the day of the Boston Tea Party[11] and over 200 years on, Lloyd’s relationship with the region is stronger as ever, worth over 500 million dollars last year[12].

Thank you for listening. I look forward very much to your comments and to your questions on these and any other areas you wish to discuss.