Good morning. Thank you for that kind welcome and the invitation to speak to you today. I am delighted to be back here in the capital.
We live in challenging times. Conflict in the Middle East. Drought in Africa. Terrorism threats to our major cities and airports. Global trade strains. Fifty-dollar barrels of oil. Like much of the policymaking establishment in Washington these days, insurers are paid to worry. And there is no shortage of issues to chew over. But in recent months I have begun to wonder whether these sizeable dilemmas will, in generation or two, prove minor in comparison to the threat posed by natural catastrophe trends.
If we fail now to prepare and adapt quickly and vigorously, I believe that we will take responsibility for putting society’s future in grave danger. At Lloyd’s, the world’s leading market for specialist insurance and reinsurance risk, understanding and anticipating major risk trends is what we do. And we have a particular responsibility to understand those trends in the US, our largest market, where we underwrote a record 12 billion dollars of insurance and reinsurance here last year, up over 2 billion on the previous year1.
Of course, we don’t pretend to have all the answers. But there are three key questions which we believe we need to tackle together, and I would like to discuss those today.
First, is the US a nation in denial? Today the insurance industry faces the prospect of a 100 billion dollar national disaster - that's twice the size of Katrina. We need to wake up to the truth about catastrophe trends and radically review our public policy.
Second, is the insurance industry strong enough to protect its policyholders against Mother Nature? Insurance has a vital role to play as a supporter and enabler of the economy – but it can only do that where free market forces prevail.
Third, what action can we take on climate change? We believe that International partnership which brings together governments and businesses is the only solution, and there are sound business reasons to change our behaviour.
Challenge one
So let’s start with the first question: is the US a nation in denial about catastrophe trends?
Right now, it is more tempting than ever to bury our heads in the sand. Despite apocalyptic predictions, the 2006 hurricane season came to an end six weeks ago, and it was officially a quiet one. Indeed, of the last 20 years, only two enjoyed insured losses lower than in 20062. So, have the forecasts been overblown and can we take it easy?
Weather-related catastrophes are costing the global insurance industry more than ever before. Between the 1960s and 1990s the number of natural catastrophes doubled. Insured losses increased nearly seven-fold, most of them weather-related. 2005 was the worst year ever, with total global insurance claims of 83 billion dollars, over 80 per cent from the US hurricanes3.
Based on natural cycles alone, we can expect the current trend to continue. It is widely agreed that the North Atlantic entered a new cycle of extreme activity in the 1990s, and as the cycles last around 30 years, severe activity can be expected for the next decade at least4.
We can only expect this to accelerate as climate change takes hold. Ten years ago, I was very much a climate change sceptic. Indeed, I think it’s fair to say that until very recently, world opinion on the subject was sharply divided. But the 10 warmest years on record have all been since 19955. Within the insurance industry, no-one seriously disputes climate change is happening any more.
The collective evidence says we can no longer remain in denial. We must stop relying on historical patterns, looking to the future instead. And we must also begin to factor in the increasingly accurate short-term predictions which are available for each season ahead.
Over the coming years, with warmer sea surface temperatures making windstorm landfall more likely, particularly destructive storms are a likely scenario. We can expect the “storm” season to lengthen, and we will be at risk over a wider geographical area than ever before.
Now square that up against the fact that the insured value of properties in US coastal areas has doubled over the last decade - to more than seven trillion dollars6. Florida and New York are way out ahead with a value of nearly two trillion dollars each. In New York’s case almost 1.4 trillion dollars relates to commercial property. Imagine the disruption to the economy if even 10 per cent of those businesses were forced to close down. And the trend is very definitely upwards.
So, two years after Katrina, and two years away from a national election, where’s the public debate on catastrophe trends? At Lloyd’s we do not subscribe to scare stories, but for all the reasons above, we believe that a 100 billion dollar US mega-catastrophe is getting closer for the insurance industry – and it could hit almost anywhere on the Atlantic coast.
At Lloyd’s, we are now actively planning for this kind of scenario. But I seriously question whether all policymakers, businesses, homeowners are doing so. Society must make some tough decisions and be prepared to change its behaviour. Here in Washington, does the will and the commitment exist to encourage that process?
There needs to be wide and open discussion now, in our view. We need to see much greater willingness to consider radical land use policies for affected areas. The relationship between government aid and unsound building and location decisions needs to be examined. And we need to raise public awareness of risk in a transparent way, improving the standards and consistency of building codes and other risk mitigation programmes. Research shows that if all properties in south Florida met the stronger building code requirements which apply in some counties, property damages from Hurricane Andrew today would be only half the 1992 levels7.
There are no easy answers and no simple decisions. This is a national issue which impacts everyone. But the stakes for our society have never been higher. As National Hurricane Center Director Max Mayfield highlighted when he left last week, the toll of casualties from the ‘next Katrina’ could be ten times greater8. At Lloyd’s we are playing our part. We are already investing in new scientific research in the UK, and we are currently in discussion with other US industry leaders to form a high-level task force examining the risk implications of climate change, to help all of us shape and lead the debate.
Challenge two
Let’s move on to the second question, then. Will the insurance industry remain strong enough to protect the economy against greater catastrophe losses?
The answer is both yes and no. Recent events – from 9/11 to Hurricane Katrina – have clearly proven the resilience and financial strength of the insurance mechanism in the United States. But it will only continue to prosper if free market forces are allowed to prevail.
We are now hearing calls from some in this city who want to impose windfall profit taxes, suppress rates and otherwise rein-in a so-called “greedy” industry.
Allow me to share some figures which underline the vital role of insurance as a supporter and enabler of the economy. In this country, insurance directly employs 2.3 million people. That’s more than one in every 50 of the US workforce9.
It contributes more than 2.3 percent of national GDP and is expected to raise a record 25 billion dollars in premium tax revenues to state governments for 200610.
And in 2005 the US industry paid out 1.3 billion dollars in claims each working day11. Strong balance sheets allowed it to settle over 95 percent of the record 1.7 million-plus Katrina claims filed by policyholders within a year – paying homeowners alone more than 16 billion dollars12.
For 2006, the claims total is expected to be lower. In fact, given the benign hurricane season, US insurance industry profits could be the best in a generation at upwards of 70 billion dollars.
Not a bad headline number. But even in 2006, its best year in almost six decades, the industry’s performance still trail the 14.5 per cent return on equity averaged by the Fortune 500 companies13.
The property and casualty insurance industry is a notoriously cyclical business. Peaks in profitability occur once approximately in every 10 years – 1997, 1987 and 1977 being previous high performers14. In practice, this peak has come to represent a restorative period during which insurers’ claim playing resources are rebuilt. Without them, the industry would be in a financial mess. Consider that just five years ago, in 2001, insurers sustained their worst ever financial performance, when the industry recorded an overall loss of seven billion dollars15. Or that, over the past 30 years, the US insurance industry has lost over 400 billion dollars on its underwriting16.
In that context, and with catastrophe losses soaring, we refute the idea that profitability should be a dirty word. As an industry we need to look policyholders in the eye and tell them that there will be sufficient funds to cover claims should disaster strike, that their insurer is still going to be around in ten years’ time to pay their claim.
Our clear view is that insurance markets operate most effectively and most efficiently when left to free market forces. Based on long experience, Lloyd’s believes that the vast majority of natural perils are currently insurable.
We are therefore very confident that the global insurance market is well equipped to respond to US catastrophe risks. We are able to model the impact of natural disasters with an increasing degree of accuracy, so that exposure can be managed and risk spread. This is unlike terrorism, which is much more difficult to predict and the economic costs of an attack could be more than the market is able to bear. Here, public-private partnership has been proven by most mature economies to be the best way to manage society’s risk.
But this holds true only as long as the insurance market is free to price risk adequately, in line with the risk it represents. Political interference in the pricing process or any sign of movement away from a risk-based approach - to prices which are not actuarially sound - especially in disaster-prone areas, can only lead to disaster later down the line. Not just for the industry but for policyholders who rely on our protection.
It is also important to remember that the insurance market is highly international in its operation. Take Lloyd’s for example. Over 80 per cent of Dow Jones companies have a Lloyd’s policy. Lloyd’s was the biggest single loss-maker from 9/11, rather than a US domestic insurance company. And Lloyd’s will pay out 6 billion dollars in respect of the 2005 hurricanes alone17. Indeed, 80 per cent of reinsurance purchased by US companies comes from foreign reinsurers18, a figure which has increased in recent years as the international market becomes ever more integrated.
We are, however, concerned that the US insurance sector is in danger of being left behind the rest of the financial services industry. Why? Because of a tendency to cling on to national and sometimes state barriers. Insurance – and reinsurance in particular – relies on the international sharing of risk and cannot work effectively if constrained in this way.
In the US until now, overseas or so-called “alien” reinsurers operate under discriminatory rules that require them to post collateral equal to 100 percent of their gross liabilities – that is over 8 billion dollars in Lloyd’s case alone19. Domestic reinsurers have had no such obligation – even if they are financially weak. We have long argued for this discrimination to be dropped, however these efforts have been countered by a blast of opposition from some sectors of the US industry - even though both the consumer and the market alike can only benefit from more open international markets.
With mega-catastrophes a growing threat, it is more important than ever that the entire insurance industry is free to underwrite and to share risk across all its boundaries. The US must ensure that it does not become bogged down in a plethora of rules that inhibit efficient global markets, real competition, and fair and transparent prices for policyholders.
We are encouraged by the recent announcement by the National Association of Insurance Commissioners that they are now considering real change on the collateral question. But there is a great deal to be done and we urge the regulators to move swiftly to put real change into effect.
Challenge three
That brings me to the last of the three questions I wish to explore today: what action can we take on climate change?
In July, Lloyd’s held a conference on the subject in London attended by 200 business leaders from insurance and other industries. A key conclusion was that we can only make progress if we have commitment from every major country on the planet.
Now while there is much discussion on Washington’s refusal to sign the Kyoto accord and submit to mandatory limits on man-made greenhouse-gases, it is positive to see important momentum for change taking place at other levels.
Many US state and local governments are working to cut carbon dioxide or CO2 emissions by Kyoto levels. And there’s a groundswell of opinion which suggests action will become an increasing priority for business too.
In our research last summer, 79 per cent of UK executives agreed that the benefits to a company of climate-friendly behaviour outweigh the costs20.
And let’s not forget that climate change can provide plenty of new opportunities for business too. 90 per cent told us that companies which take climate change seriously have competitive advantage over their peers. And some of corporate America’s leaders are also beginning to figure out that ‘going green’ can be good business.
DuPont has slashed emissions by 72 per cent since 1990 and says production is up 30 per cent, energy costs are down 7 per cent and savings so far total 2 billion dollars21.
At a local level, a new chiller and related improvements at a Kraft ice-cream plant saved 33 per cent of its electricity and 2,500 tons of carbon emissions a year. Productivity rose ten per cent and the plant turned from a money-loser into one of the most competitive.
For financial, reputational and pure risk management reasons, we expect this trend to continue and to gather momentum. In our research, 92 per cent of attendees agreed that climate-friendly behaviour makes good risk management sense.
The Lloyd’s market is therefore determined to help businesses become more energy-efficient. We provide a major share of the world’s insurance of new technology that cut carbon emissions. That includes about a third of insurance for ‘waste to energy’ plants, which burn household and industrial waste to give off gas and generate electricity. Lloyd’s also covers about a quarter of the world’s wind farms, which are proving a major source of renewable energy22. And as the global renewable energy market grows and diversifies in the years ahead, the Lloyd’s market remains poised to respond.
Conclusion
In conclusion, ladies and gentlemen, there is much to be done if we are to leave this planet in tolerable shape for our children and grandchildren.
• We cannot risk being in denial on catastrophe trends. We can expect to see US mega-catastrophes with100 billion dollars insured losses soon. We urgently need a radical rethink of public policy, and to build the facts into our future planning.
• The insurance industry will continue to play a vital role as enabler and rebuilder of the US economy. We must therefore ensure it is allowed to remain financially strong, and free to operate under market forces.
• And we need to take co-ordinated action on climate change. The good news is that there is an important role which business can play, and there is commercial benefit to be gained from doing so.
Mega-catastrophes and climate change are two powerful forces here to stay. We don’t yet know exactly what the future will bring. And there is little or nothing that could be done now to turn back the clock. Even if we stop all man-made CO2 emissions now, we would still endure 30 years of warming before the effects take hold.
But we must not use that as an excuse not to act. History, and future generations will surely not forgive us if we do.
Thank you for listening.
