Twenty years ago – in the immediate aftermath of the horrors of 9/11 – Lloyd’s was subsumed in a liquidity crisis and potentially teetering on the edge of insolvency. 

Lloyds building

The true extent of the losses caused by the terrorist attacks would not be known for some time but already cash-strapped Lloyd’s syndicates were facing demands from US regulators to replenish their 100 percent collateral limits requirements, as per the terms of Lloyd’s US trading licences.

As stocks and other assets spiralled downwards in response to the post-loss global shockwaves, the Bank of England was demanding reassurances from the executives and Council members on the 12th floor of Lloyd’s headquarters that the more than 300-year-old insurance market was solvent. 

But coming on the back of the brutally soft casualty market of 1997-2000, which had recently claimed the lives of the US’ Reliance, the UK’s Independent and Australia’s HIH, not everyone involved in the Lloyd’s inner sanctum was convinced the market was – or indeed that it could survive. 

But survive it did – just. 

It was an extraordinary collective enterprise of resolve in the face of looming disaster. Well-respected market emissaries were dispatched to New York to negotiate a temporary reprieve on timings for collateral restoration, which created invaluable breathing space for stretched syndicates. 

“Not everyone involved in the Lloyd’s inner sanctum was convinced the market was [solvent] – or indeed that it could survive…”

Rumours of hushed conversations between Downing Street, Lloyd’s heavyweights and the Bank of England may have led to UK regulators not testing the market’s initial loss assumptions too aggressively. A flurry of Lloyd’s syndicates went to the wall but the main ones traded through – in some cases aided by judicious reserving. Rates rocketed and an exceptionally benign claims period followed, enabling insurers around the globe to rebuild including, of course, Lloyd’s. It was close but Lloyd’s made it through and enjoyed the rewards of its most profitable ever decade in the 10 years that followed.

But during those dark months of late 2001, a key contributor to Lloyd’s survival was a canny decision made by the market’s then CEO Nick Prettejohn two years earlier to buy a £500mn reinsurance/retro policy to protect the Lloyd’s Central Fund – the market’s final, mutualised chain of security.

Nick Prettejohn

The pioneering policy – it was the first time that the Central Fund had bought reinsurance cover – cost Lloyd’s a handsome £78mn premium but it provided five years of cover with £350mn for any one loss/year and a maximum of £500mn.

And in the aftermath of 9/11, the treaty enabled Lloyd’s to book a maximum loss as a reinsurance recoverable on its balance sheet. Without this £350mn, Lloyd’s ability to pass solvency would likely have been extremely stretched. The Insurer has always suspected it may just have been the final straw to break the Lime Street camel.

Fortunately, it is a moot point but industry historians will recall that years later, the £500mn Central Fund reinsurance policy proved to be a chimera. 

Swiss Re – which led the reinsurance – together with General Electric, Hannover Re, St Paul Travelers, Chubb Corp and XL Capital Ltd declined to pay. It went to arbitration and the reinsurers won. The claim was invalid. If Lloyd’s auditors had known that three years earlier, would the market have been able to persuade regulators it was solvent?

“Years later, the £500mn Central Fund reinsurance policy proved to be a chimera”

What is the point of this 20-year trip down memory lane? Well, the lead article of this week’s #ReinsuranceMonth edition focuses on the continuing Mexican stand-off between insurers and their cat XoL reinsurers over Covid-19 BI claims. 

It is an intriguing dilemma. At 1 January, the industry collectively decided to kick the can down the road on this issue. The assumption was that it would be resolved this year. There is, however, little sign of progress. And this leaves carriers – such as Hiscox – heavily leveraged to their reinsurers and the assumption they will be able to collect at 100 percent. But as we note, reinsurers are resisting. Indeed, Guy Carpenter recently produced invaluable research examining the six principal objections made by cat XoL reinsurers on the issue of Covid-19 business interruption claims. 

For some carriers – not least Hiscox – it puts them in a potentially vulnerable position. As we note in this week’s edition, the Lloyd’s insurer has net tangible assets of ~$2.2bn and reinsurance recoverables of $4.4bn. A 10 percent adverse movement in the latter would be the equivalent of a 20 percent hit to its book value – a devastating blow.

Hiscox has highest reinsurance leverage among peers…

But just like Lloyd’s 20 years ago, as long as the reinsurance boat isn’t rocked and it maintains liquidity then Hiscox can continue to benefit from 100 percent relief by booking the recoverable as an asset and continuing to trade in the hard/hardening market conditions (this also applies to other insurers, of course).

This might partly explain why there has been only modest progress this year on resolving the issue of Covid-19 XoL reinsurance claims. It is not in insurers’ interests to accelerate certainty if there is a chance of having to write down assumed recoveries; nor might it be in reinsurers’ interests to pay now when their peers aren’t and there is a chance of a reduced settlement in the future.

“At some point, something has to give but it’s not necessarily in anyone’s interests for it to happen anytime soon…”

This uneasy status quo could therefore continue for some time yet. However, it also depends on the impasse not being challenged by events. A series of heavy cat losses could push insurers to attempt to accelerate recoveries for liquidity purposes or perhaps an inquisitive regulator may decide to examine just why insurers’ reinsurance recoverables are ballooning (to put in context, Hiscox’s reinsurance leverage is now at a record 1.99x). 

At some point, something has to give but it’s not necessarily in anyone’s interests for it to happen anytime soon…