Earlier this year, a London insurance market industry
group published London Market looks ahead: Preparing for the next big insurance event, a White
Paper describing a stress test of the market when faced with a
never-before-seen catastrophic loss event.
London passed the test.
This “dry run” simulation analyzed the impact of two
fictional CAT events taking place in quick succession: a major cyber attack on power infrastructure
in the U.S. (“Halloween Blackout”), and a Category 5 hurricane hitting Miami
(“Hurricane Guy Fawkes”). To make
matters worse, these two CATs were followed by a stock market crash, with a 16%
drop in global stocks, and the default of a major reinsurer, causing delays in
claims payments.
This nightmare scenario resulted in global insurance
losses of USD 200 billion, dwarfing other recent major catastrophes like Hurricane Katrina (insured losses of approximately USD 80 billion) and September 11
(USD 44 billion).
The market test was conducted over several months by a
group of 28 organizations, including London Market insurers, brokers, industry
groups, Lloyd’s, and rating agencies, with the support of regulators. Two working groups were established, led by
Hiscox and Aon. The actual simulation
took place over a two-week period in November 2016.
The genesis of this project was the realization that it
had been over 15 years since 9/11, the last “market-turning event” for London
insurers, and that it was necessary for the London Market to prepare itself for
the next major CAT loss event, particularly in light of the significant changes
in market dynamics since 2001. In
addition to testing the industry’s preparedness, the dry run also sought to
identify how the London Market could improve its resilience to these events,
and maintain its leading position in the global insurance market.
As Robert Childs, Chairman of Hiscox Group and leader of the project stated, many of
the people making key decisions in the London Market “haven’t yet experienced
anything like [9/11]. I hope they never
do, but we need to be prepared for the worst.”
The stress test showed that the London Market has access
to sufficient resources, both practical and financial, to cope with these
extraordinary losses, and that the industry would be able to pay the resulting
claims fairly and, at the same time, ensure that cover can continue to be
priced after a worst-case scenario catastrophe.
This conclusion relied on the strength of the London
Market’s reinsurance and recapitalization arrangements, and insurers’ ability
to implement these arrangements during a turbulent period. The White Paper also found that, in order to
achieve a successful outcome, it was critical for the London Market to maintain
its deep underwriting and industry expertise, and for regulators to respond
quickly as the crisis unfolds.
In order to improve the London Market’s ability to
withstand a major CAT, the White Paper made three broad recommendations:
(i) put in place internal processes to respond effectively to
market-turning events, such as crisis management training programs and clear
plans for raising additional capital; (ii) maintain the London Market’s
leading position and expertise in the global marketplace, by strengthening
Lloyd’s position and involving a broad set of key stakeholders; and (iii) collaborate
with the insurance regulator, the Prudential Regulation Authority, to clarify mutual expectations and ensure an
effective post-catastrophe response.
In sum, the industry-led dry run showed that the
London Market is sufficiently robust to survive huge CAT losses. Other insurance markets may consider conducting
similar studies to assess how they would respond if the worst happens.
Published by José Umbert
