Tuesday, April 11, 2017

Stressed about CATs? The London Market Is Ready

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