Lloyd's - Challenges for the global insurance industry in 2005

As we enter 2005, I am in no doubt about the critical role of insurance in supporting the economy, here in the United States and around the world. Indeed, I experienced at first hand in Malaysia only a few weeks a tragic reminder of the need for insurance in picking up the pieces after disaster, and I shall say more on that later. The start of a new year presents us with a golden opportunity to stop, and take stock. So, this morning I want to look back at three defining events of 2004 and the challenges which they present for our industry in 2005.

First, I would like to say a few words about the very special insurance relationship which Lloyd's and Massachusetts enjoy.

Lloyd's has been insuring risks in the Boston region since at least the 1770s when the area was still a colony of the old British Empire. I am pleased that the welcome you have given me this morning is somewhat warmer than Lloyd's might have received in 1773. Indeed, I can honestly say that 16th December of that year was a very sad day for us. And no, I am not harking back to the loss of our Empire - I'm referring to the fact that Lloyd's insured the 340 crates of tea that your forebears threw overboard on that fateful day 1 - and I noticed just the other day that one of the original crates was up for sale - maybe we should get it back!

Over 200 years on, Lloyd's relationship with the Boston region is as strong as ever, and relations between our two markets are considerably more cordial. Today Lloyd's is rightly known as a trusted international insurer and the global powerhouse for specialist risk. But although we operate in over 200 countries and territories around the world 2 , the United States is, by a considerable margin, our largest market, accounting for over a third of our worldwide business 3 . In 2004, Lloyd's underwrote over 8 billion dollars of direct and reinsurance business here 4 . The security of Lloyd's runs like a thread through the American economy, underlined by the fact that some 93% of companies listed on the Dow Jones are Lloyd's policyholders 5 .

Our relationship with you in Boston is a microcosm of that whole. In 2003, the Lloyd's market underwrote over 150 million dollars of surplus lines business in Massachusetts and the surrounding New England states 6 . Add to this the reinsurance business emanating from the region, and it makes for a very significant relationship between our two markets, crossing the widest spectrum of specialist risk - from property catastrophe to liability for the biotech industry.

As you might expect, Lloyd's also plays an important part in the underwriting of some risks unique to the Boston area. Take the Big Dig: we led the 500 million dollar airport contractors' liability insurance 7 and a major share of both the first and second 200 million dollar layers of excess liability coverage 8 . Like you, we perhaps did not appreciate quite how long the policy period would finally be, but we are nonetheless proud to have played our part in such an historic project. Of course, we realise that even if things take a little longer than expected, Boston will always get there in the end. I'm thinking of the Boston Red Sox finally reclaiming the World Series trophy and I am sure that you will not be surprised to hear that a number of their players are (or have been) insured - and reinsured - by the Lloyd's market too 9 . In fact, the Lloyd's market and the Boston sports scene are somewhat entwined - we have been a risk sharing partner for all of your major sports teams over the years, whether covering the players for personal accident risks, the games themselves for contingency risks, or insuring the promotions which surround them 10 .  

Three defining events and three key challenges for our industry
Although you could probably write a whole book about the relationship between Lloyd's and Boston, I want this morning to reflect more broadly on the year past and look forward to the year ahead for the insurance industry as a whole.

For me, there were three defining events for the insurance industry in 2004, which will have a major impact for us in 2005 and beyond. I wish I could report that they were triumphs, which had enhanced the standing and reputation of our industry in the eyes of consumers and business leaders - but that is not the case. Each defining event presents the insurance industry with a major challenge to get our house in order and improve our reputation.

The good news is that a new year provides us with a fresh start. And if each of these three defining events helps us to see the challenge more clearly, we will then be in a better position to respond. Let me take these events in chronological order:

• The Silverstein court case, which fuelled discussion on the need for contract certainty;
• The Spitzer investigation into insurance industry practices, which proves the need for greater transparency; and
• The Asian tsunami completing a year of record disasters, reminding us of the need to better prepare for, and price, risk better.

The Silverstein court case - contract certainty
Let me start with what was, for me, the first defining event for our industry in 2004. And it took place here, in the United States, in a New York courtroom.

I am talking about the Silverstein trial which followed the World Trade Center tragedy. I can hardly think of a more emotionally powerful subject to litigate in court, reminding us of that terrible day, of the 2,600 dead, and of the massive destruction in Manhattan.

The Lloyd's market is rightly proud of the fact that it promptly paid in full the limit it underwrote - about 680 million dollars - as soon as the expert valuations were in. But, given the high stakes involved and the sheer complexities of this huge and tragic loss, it was always likely that this would end up in the courtroom.

However, as I followed the case, it became clear that this particular litigation was complicated by one fact: namely that the participants in the many placements that made up the 3.5 billion in limits had not reached a common, final policy wording before 9/11.

To any outsider, it must seem highly unusual that this single agreement should not be in place. In fact, I am surprised that more of the media did not focus on this issue in their commentary. In what other industry would sophisticated parties find this acceptable?

Eventually, the New York courts ruled that the 9/11 attack met the definition of one occurrence under the prevailing WilProp form, and 10 of the 13 insurers who claimed that they bound coverage on this form prevailed at trial 11 .

A more recent, second trial involving nine insurers not bound under the WilProp form then followed. Here, the jury concluded that two distinct occurrences had taken place according to the language of the policy wording on which they had bound.

But as the story continued to roll, it made me wonder what avoidable harm such high-profile and complicated litigation must do to the public image of the insurance sector. Why, I wondered, is it that participants so often fail to agree final policy wordings for commercial insurance contracts prior to inception - or even, as here, prior to the loss?

When this happens, the customer does not get the policy they deserve, and the insurer does not get the finality they expect. A survey this Fall found that only 23% of risk managers received their final policies in a timely fashion, error-free. It seems almost comical to conclude that this was a big improvement on the year before, when only 8% of risk managers responded positively 12 .

The truth is that final policies for many commercial risks are simply not produced on time. Mistakes are too frequent. And as last year's court cases showed, the stakes can be huge.

Improved contract certainty, including fully-agreed final policy wordings, is critical to the future of the insurance industry. We have to end what John Tiner, CEO of the UK regulator (the FSA), called in a recent New York speech the 'deal-now, detail-later' culture 13 .

In my view, as a newcomer to the industry, I found the reluctance to change traditional practices totally unacceptable. But within the Lloyd's market we have now reached some important milestones in driving change forward.

First, last year, we mandated a standard form of slip for recording deals done in the London market, for the first time in over three centuries. Used properly, it helps ensure that important features of the contract are documented in a more uniform way and are clear from the start. Use of this slip is now improving month by month 14 .

Second, we recognise that brokers and underwriters must also exchange reliable data and agree contract details in a secure and transparent way. Lloyd's is therefore sponsoring the Kinnect electronic platform to drive this change using efficient modern technology.

The insurance industry owes it to its customers as well as to itself to ensure that cover is fully agreed and clearly documented right from the start. It is a core objective at Lloyd's. In fact, back in the UK, after we had discussed with them the importance of these initiatives, the FSA called a meeting of leading market figures to kick the process off just before Christmas, and we committed Lloyd's full support in taking the agenda forward over the coming months.

There is more to be done, but we must get there. 2004 confirmed that the standards which the commercial insurance industry has inherited are no longer acceptable, and that everyone has an interest in seeing that change comes fast. But, as with any change, it will only succeed if every individual is committed to making it happen. And that means collaboration, not lip service, from everyone throughout the commercial insurance chain, from risk manager to retail broker; from wholesale broker to underwriter.

The Spitzer investigation - need for transparency
The second defining event for the insurance industry in 2004 came in October. And it was even less pretty.

With his investigation into insurance business practices, Eliot Spitzer seems determined to drive a fundamental overhaul of how commercial insurance and reinsurance markets work.

The investigation sparked Senate hearings and more than a dozen state-level probes. Corporate leadership changed within weeks; executives at three companies pleaded guilty to criminal charges; and the four largest brokers announced complete overhauls of their business models 15 .

In fact, what recent events have clearly highlighted is the lack of transparency in our industry's workings. It demonstrates that the antiquated practices of the insurance sector lag behind what an open, transparent 21st century business environment expects. It shows, once again, that serious overhaul is needed.

The first challenge for the industry is to clarify and re-define our inter-relationships.

The world's largest brokers have already taken decisive action and abandoned contingent commissions, and I am in no doubt that all intermediaries face a challenging time ahead.

But there is a wider imperative for the insurance industry as a whole: we need to take careful stock of our inter-relationships and workings. So far, the investigation has highlighted a considerable deal of ambiguity in these relationships. But today's businesses want to understand exactly what they are getting when they buy insurance, and why. So we need to be clear and unambiguous on who is doing what exactly, for whom, and at precisely what cost.

Then, we need to communicate these workings better to those outside our industry. The business community at large does not differentiate between one segment of the industry and another. The reputation of the entire market is tarnished and collectively we need to rebuild trust with buyers, politicians and leaders.

Last year I saw the results of research Lloyd's had undertaken in the UK 16 , and it said that amongst captains of British industry, only the tobacco industry came off worse than general insurance! Even the legal profession came out ahead of us. And that was all before Spitzer! The rating agency Fitch sums up the latest position well, saying: "these matters have created another public relations setback for the insurance industry, which remains an industry that is not generally well-trusted nor held dear by its customer base." 17

2005 now provides us with the opportunity to improve that position by delivering transparency. And if we do not grasp the challenge now, our public image will continue to deteriorate further. Even worse, if we do not correct things now we could find ourselves on the sidelines with a shrinking influence on other important areas of debate which impact us, such as terrorism legislation and tort reform.

The Asian tsunami - a new look at risk
The third defining event of 2004 took place only 18 days ago. I was in Malaysia, with my family on the beach, when the tsunami struck. About noon local time, we were on the beach under a clear blue sky and bright sunshine. Suddenly in a sea where there is usually barely a ripple there was a large wave the whole width of the beach with a roaring sound and the high water mark advanced about 50 feet. Lulled into a false sense of security, we stayed on the beach but about three or four minutes later a bigger wave came and we had to rush to pick up all we could carry and all the children and ran from the beach. As we were retreating fast, a still bigger wave came but by this time we were heading well inland. I heard later that there was a shock felt in the nearest town about 9 a.m. local time. Within an hour, things were pretty well back to normal, but to give you an idea of the force of the waves, 80 of the sun beds that were on the beach were smashed like matchwood.

We were very lucky. So many tens of thousands of others were not. In fact, the sheer scale of human tragedy from this disaster is barely comprehensible.

Yet this was not the only natural catastrophe of 2004. Far from it, it was a year of improbable disasters. Sticking with Asia for a moment, Japan was devastated in 2004 by the worst typhoon season on record. Ten typhoons made landfall this year, causing billions of dollars worth of damage. The General Insurance Association of Japan says its member companies will receive 2.4 billion dollars of claims from Songda, plus over a billion dollars of claims from three other major typhoons 18 .

Here in the US, 4 of the 10 biggest-ever US hurricane losses ripped through the south-east in as many weeks. In fact, it was the first time since 1886 that more than three hurricanes made landfall in one US state 19 . The effect on Florida homeowners was devastating, and insurers will pay almost 7 billion as a result of Hurricane Charley, 6 billion for Ivan, over 4 billion for Frances, and over 3 billion for Jeanne 20 .

That all adds up to a likely bill for global insurance losses of around 50 billion dollars 21 . It also makes 2004 a record year for losses, probably ranking ahead even of 1992, 1999 and 2001 22 . And it is now forcing us to rethink exactly how we look at risk.

2004 only reinforces the trend, which I have been talking about for some time, towards higher losses. Rising population densities, and growing concentrations of people and businesses in catastrophe prone areas are the drivers. And it suggests the way in which we prepare for disasters risk may not be quite right. Frankly, although we at Lloyd's rigorously plan for various earthquake and storm scenarios, the unprecedented series of storms this year is not something for which any of us in the insurance industry had bargained. And it is not only the insurance industry and corporate boards that need to address risk management. The world needs to prepare for the most unthinkable disasters. Risk management should be addressed by everyone. Events in recent years - from the string of storms to the huge corporate scandals - show that even where the risk itself is slight, the consequences may well be great enough to warrant better preventative measures. And whatever the risk, we need to improve our early warning systems.

Last year's events will intensify the debate on global warming, as the rate of natural disasters continues to grow as temperatures rise. In fact, the 10 hottest years on record have now all occurred since 1990 23 , and while scientists say it is not yet possible to link the recent storm season directly to global warming, the World Health Organisation calculates that 150,000 people die each year as a result of climate change 24 . This is undoubtedly a debate where - as an industry - we need to get more involved.

The surge in catastrophic events also reminds us of the importance of pricing risk correctly. The critical role of insurance is to pay claims, to assist the process of rebuilding. But the industry can only do that if its balance sheet is strong. The insurance industry's long overdue profits in recent years have been delivered in the context of a very hard market and the overriding pressure on prices is now a downwards one. Prices are unlikely to rise again anytime soon. To put it in the recent words of one analyst recently, "If four hurricanes hitting Florida for some 20 billion dollars does not do it, we'd prefer not to find out what would." 25

With the volatility in coverage and pricing over the last decade, it isn't surprising that insurance buyers feel hard done by and are unable to plan their finances effectively. But 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 means they can rest in the knowledge that their insurer is still going to be around in ten years' time to pay their claim. Critically, we can only cover claims if there are sufficient funds to do so and that means that every insurer, every underwriter, must ground their underwriting decisions on economic reality.

At Lloyd's, we entirely support our underwriters when they tell us that they are not prepared to underwrite unprofitable business or chase market share. In the face of increasing catastrophe losses and downward pressure on pricing, they are basing their underwriting decisions on economic reality. That is very good news. And proof is seen in the fact that the Lloyd's market's overall capacity for 2005 - that is, the amount of business it plans to write - is down 9% to 13.7 billion pounds or just over 26 billion dollars in this increasingly competitive environment.

Conclusion
In conclusion, as we enter 2005, it seems that the industry has never faced such a challenge to its reputation. In Shakespeare's Othello, Cassio cried: "O, I have lost my reputation! I have lost the immortal part of myself, and what remains is bestial." He knew that image is everything and it is an extremely difficult thing to recover.

But 2005 is the year in which we can rebuild what we have lost. And it is up to all of us in this room, whether underwriter, broker or buyer, to take on board the lessons we have learnt from 2004.

• The Silverstein case shows that achieving contract certainty is in everyone's interests;
• The New York Attorney General's actions have proven that the insurance industry needs to become more transparent;
• And the catastrophic events of 2004 prove that as an industry we need to prepare for and price risk better, in order to meet the future obligations which will be put upon us.

Each of us has an important role to play in making change happen, in communicating these changes, and delivering what our customers deserve.

Difficult though it is to rebuild a reputation, it is possible. Lloyd's is testimony to that: an organisation which emerged, phoenix-like, from an extremely difficult period to become a successful and highly respected institution once again. The Red Sox too have proven it through claiming the World Series again after an 86 year absence - and we knew that they were always contenders.

And so we must press on with confidence and say, as Queen Victoria once did, that "We are not interested in the possibilities of defeat. They do not exist."

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

Footnotes

1 Various sources suggest a link between Lloyd's and the Transatlantic tea-trade at the time, including The Blackheath Connection by Dan Byrnes 1996; Alan James, US reporter inter alia
2 Lloyd's Worldwide Markets, January 2005.
3 Lloyd's Market Reporting, April 2004.
4 XChanging Report LEG 720. Gross premium. December 2004.
5 Lloyd's customer statistics provided by XChanging and Dow Jones, February 2004
6 XChanging data, Calendar year 2003
7 Lloyd's Market Association, January 2005
8 Insurance Times, 17 September 2002, Vol XXI No. 19, The Big Dig's Insurance Plan by Mark Hollmer
9 Various Lloyd's underwriters, January 2005
10 ASU International, January 2005
11 National Underwriter, 13 December 2004
12 This paragraph: National Underwriter, 13 December 2004
13 John Tiner, Speech to 2004 Life and Property/Casualty Industry Symposium, New York, December 2004
14 Lloyd's slip audits, as quoted by Head of Business Process Reform, Lloyd's, October 2004
15 BestWire, 27 December, 2004
16 Lloyd's/ MORI Captains of Industry Survey, 2003
17 Fitch, December 2004
18 This paragraph: General Insurance Association of Japan, 2004
19 Benfield, Hurricanes Hardly Ever Happen, November 2004
20 This paragraph: Insurance Information Institute, November 2004
21 Based on Swiss Re's estimate of $42 billion insured losses for 2004 (16 December, 2004) plus losses from the Tsunami
22 Based on Swiss Re's estimate of $42 billion insured losses for 2004 (16 December, 2004)
23 2004: The Year of Living Dangerously - The Independent, 27 December, 2004
24 2004: The Year of Living Dangerously - The Independent, 27 December, 2004
25 Morgan Stanley 'Insurance - Property & Casualty' - December 30, 2004. William Wilt