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The US insurance market

A shared history

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WELCOME FROM:

Christian Mumenthaler

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J. Eric Smith

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Evolution of a global risk expert

Fundamentals of successSwiss Re’s early leaders established the sound principles of

reinsurance that have been followed by successive generations

of Swiss Re managers ever since. From the very start, Swiss

Re was to be an international reinsurance company that spread

its risks geographically, built strong client relationships, and

developed access to a diverse capital base.

The early years were difficult for Swiss Re—reinsurance

was a new concept that lacked the sophisticated risk

management tools of more recent times. The primary

insurance market was far from transparent. As a consequence,

client relationships rooted in trust and ‘upmost good faith’

rather than knowledge and facts.

In these first challenging years, Grossmann turned to

Giuseppe Besso, a member of the famous Besso family

associated with the Italian insurer Asscuriazoni Generali.

Besso accelerated Swiss Re’s international diversification, and

continued to build the company as a financially robust and

independent reinsurer.

Diversified form the startRight from the start, Swiss Re had an international outlook,

with only two of its 18 early contracts written with Swiss

insurers.

By the turn of the Twentieth Century, Swiss Re was already

reinsuring risks in Europe, the US, Latin America, Russia and

Asia. It was also beginning to establish a global network,

opening overseas offices and looking to underwrite directly in

key international markets.

The reinsurer also looked to spread risk across an

increasing number of lines of business, writing its first

accident and health contract in 1881, marine reinsurance in

1864, its first life reinsurance policies in 1865, and motor

reinsurance in 1901.

The form of reinsurance contracts also evolved around

this time—in 1890 Swiss Re underwrote its first excess of

loss contract, a type of reinsurance that pays claims above

an agreed level of losses, rather than a proportion of all an

insurer’s losses.

This change in approach would enable reinsurers to focus

on the less frequent catastrophic risks.

In a sense, the modern age of reinsurance had begun.

Catastrophe losses The first decades of the Twentieth Century were marked

by growth in both international exposures and single large

risks—demonstrated by the Spanish Flu epidemic in 1918,

which led to a CHF 1 million loss for Swiss Re, and the sinking

of the Titanic in 1912, also insured by Swiss Re.

However, it was the catastrophic 1906 San Francisco

earthquake that was to be the insurance and reinsurance

industry’s wake-up call. The earthquake and subsequent fire

that swept through San Francisco was a market changing

event. The extent of the damage made insurers rethink the

potential size of losses, as well as the importance of seeking

well-capitalised counterparties.

Within three years of the quake, San Francisco had been

largely rebuilt thanks to payments made by the insurance

and reinsurance industry. The majority of claims were paid

by foreign companies, demonstrating just how globalised the

industry had already become.

For Swiss Re, the earthquake generated the biggest single

loss as a percentage of net premiums in the company’s history,

but establish the Swiss Re brand in the US, bolstering its

reputation as a financially secure and reliable counterparty.

Just four years later, Swiss Re opened its branch in New

York and became an integral part of the US insurance market.

Global market accessAbove all else, the San Francisco earthquake highlighted the

need for further geographical and product diversification,

leading Swiss Re to make a number of acquisitions.

Acquisitions were to feature early on in Swiss Re’s history,

and continue well into modern times. In addition to helping

spread risk internationally, acquisitions give access to new

business, particularly where strong relationships between

local insurers and reinsurers make it difficult to grow.

Early acquisitions saw Swiss Re gain footholds in the

all-important London and German markets through stakes in

Scottish Mercantile and General Insurance Company (M&G)

SHOULDERING RISk— Swiss Re’s rise to become the global expert in taking and managing risks mirrors the dramatic social, economic and political development of the last 150 years

SWISS RE WAS ESTABLISHEd IN 1863 To MEET

demand for an independent reinsurer that would spread

risk in a rapidly changing world. The following 150 years—a

period of unprecedented change driven by a revolution in

science and technology, have seen Swiss Re become a leading

international provider of reinsurance capital and risk expertise.

Rising from the ashesRapid industrialisation and urbanisation throughout the

1800s were creating concentrations of risk, requiring insurers

to diversify their exposures. A clear role was emerging for

independent reinsurers that could shoulder and spread

insurers’ risks, develop expertise, provide capital and thus

contribute to secure the value generation to follow to the

present day .

The world’s first dedicated reinsurer, Cologne Re, was

established in the aftermath of the Hamburg fire of 1842.

Swiss Re was to be the world’s second.

Swiss Re’s beginnings date back to a devastating fire

that destroyed the thriving Swiss town of Glarus in May 1861.

The fire, which hit some local insurers with claims five times

their reserves, highlighted the threat of major catastrophes to

the Swiss insurance industry and demonstrated the need for

reinsurance protection to provide protection for events with a

low frequency but a yet unknown severity.

The country’s insurance industry responded swiftly,

and the head of Swiss insurer Helvetia’s fire and transport

business, Moritz Grossmann, proposed the creation of the first

dedicated Swiss reinsurer. The Swiss Reinsurance Company

first opened its doors in Zurich on december 19, 1863, with

CHF 6 million of share capital raised from a diverse group of

investors, including two Swiss banks.

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SWISS RE’S HISTORY

From its early settlement by Europeans in the 1500s and evolution into a leading world power by the late 1800, the United States has been a vibrant and attractive market for insurers and reinsurers.

With impressive economic expansion, a fast growing and increasingly affluent population, and an exposure to natural catastrophes, America’s needs for risk protection shaped the history of the insurance and reinsurance sector as we know it.

Today the US insurance market is the world’s largest—accounting for some 27% of total global insurance premiums. It is also one of the most sophisticated, being the originator of many innovative consumer and business insurance products and risk management practices.

But it was not always the case. It is hard to think that the United States, a global economic and political power, was, in a sense, the emerging market of its time 150 years ago. As it evolved, the US underwent many of the same processes that we still see happening in today’s emerging markets.

Like emerging markets today, the United States has proved to be an irresistible opportunity for many insurers, but it was not short on danger. Insurers and reinsurers exploring the early American market were operating in virgin territory, working with a complex and burdensome regulatory system, catastrophe exposures of epic proportions, and then later, a costly pro-consumer tort system.

More recently, the terrorist attacks of September 11, 2001, Hurricane katrina, and the financial crisis have highlighted the complexities of the reinsurance markets in a globalised world. Even today’s sophisticated models and past experience are unable to predict the future, and just as in the early days, every unexpected or record event puts into question the notion of insurability.

The history of the insurance market in America is as insightful as it is fascinating, offering a salutary reminder of the role that insurance and reinsurance performs in a successful society, as well as some of the challenges.

From the building of skyscrapers at the turn of the last century to the high tech industries of today, America has shown a willingness to take risk, as well as leading the world in the development of insurance and risk management.

US insurance

Genesis of the World’s Most Influential Market

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two, as the owner of the WTC had claimed.

The first decade of the 21st century put

into question the insurability of some large

risks. Hurricane Katrina, which produced the

highest damages of any natural disaster in

history, cost Swiss Re $1.2 billion. Although

it demonstrated the resilience of the industry

to absorb devastating losses, within six

years later the toll of the 2005 hurricane

season was equaled by a string of natural

catastrophe events in the Pacific region,

starting floods in Australia, a sequence of

earthquakes first in New Zealand and later in

Japan, followed by a tsunami and finishing

the year with yet another flood in Thailand.

The financial crisis of 2008 was also

tough on Swiss Re. The company made a loss

(CHF 864 million) in 2008, mainly the result

of investment losses and the performance of

two Credit default Swaps.

After de-risking its asset portfolio

and concentrating on its core reinsurance

business, the company emerged from

the crisis as a leading

participant in the

reinsurance market—

ratings agency

Standard & Poor’s

raised its ratings on

Swiss Re to ‘AA-‘

in october 2011, in

recognition of

the company’s handling

of the crisis.

Preparing for the futureIn 2011 Swiss Re

implemented a new legal structure to support

its strategic priorities and refine its business

model by creating three separate business

units, namely Swiss Re’s existing reinsurance

business, along with two new entities for

Corporate Solutions and Admin Re®.

The company also continues to invest

in the future. In 2003 Swiss Re opened

its award-winning St

Mary Axe building,

affectionately known

as the Gherkin, while

work began on a new

building at Swiss Re’s

headquarters in Zuruch

in 2012.

By staying true

to the fundamentals of

reinsurance championed

by Swiss Re’s early

leaders—the importance

of diversification and

long lasting client

relationships—Swiss Re has weather many

storms in its 150 year history, continuing to

provide its clients with a secure partner in

risk. The history of the company shows the

pivotal role reinsurance has played in the

management of risk. And with Swiss Re at

the forefront, it remains well-position to

carry on doing so.

in 1915 and Bayerische Rückversicherung of

Munich in 1924.

Financial crisisThe 1929 stock market crash in the US stock

and subsequent Great depression showed

insurers and reinsurers for the first time that

they were exposed to significant risks on the

asset side of the balance sheet.

The crash led to write downs of assets

at Swiss Re amounting to almost CHF 26

million, although the company was saved

by its accumulation of hidden reserves

–some CHF 30 million were taken from

these reserves in 1931 to cover record

losses. However, Swiss Re learnt valuable

lessons, and the crisis marked the birth of

asset liability management at Swiss Re,

an important risk management tool that

continues to be used by insurers today.

Redrawing the mapWhile German and Russian reinsurers were

expelled from international business

around the time of the two World

Wars, Swiss Re was able to

capture a market-leading

position in the US.

However, the radically

different world that

would emerge after

the Second World War

constrained reinsurers’

ability to spread risk.

A number of markets

were now off limits—with

those in Central and

Eastern Europe slipping

behind the Iron Curtain

while others, such as

Brazil and India, became

state owned. At the

same time, other markets were enjoying

a boom in consumer spending, leading to

higher concentrations of risk in markets like

the US and Europe.

Swiss Re continued to seek geographical

and product diversification, developing a

leading presence in new markets, including

Canada, Australia, South Africa and then

Asia, as well as rapidly growing industries like

energy and aviation.

Focus on core business In response to the growth in risk management

and the trend towards greater self-retention

in the 1980s, Swiss Re began expanding

its service offering, acquiring insurance

service companies, as well as increasing its

participation in the primary insurance market.

However, although dependent upon each

other, Swiss Re discovered that the actual

management of a primary and a reinsurance

company had little in common. in 1994

a new management team refocused the

company’s operations back on reinsurance,

reinvesting the proceeds from the sale of its

primary insurance businesses in achieving its

strategic goal of becoming the world’s largest

reinsurer. Growing catastrophe exposures

and an increasingly complex and globalised

risk landscape were beginning to drive

demand for large, well rated expert managers

of capital and risk.

Swiss Re sought to grow its life

reinsurance business, develop its Insurance

Linked Securities offering and expand its

direct corporate insurance unit, as well as

further globalise its nonlife reinsurance

operations.

In the 1970s Swiss Re was one of

the first reinsurers to recognise

the importance of emerging

markets. In more recent years

it began opening offices in

key markets, seeking to

build strong relationships

and expertise through

a local presence. Most

recently Swiss Re

obtained licences in

Korea in 2002, China

in 2003 and Japan and

Taiwan in 2004.

during this period, Swiss

Re took on much of

its current corporate

form—it adopted a single

brand operating from

one global capital base, providing the highest

levels of financial strength, expertise and

tools to clients, whilst remaining attractive to

a wide range of capital providers.

New risk frontiersFollowing Hurricane Andrew in 1992,

which was the largest insurance industry

loss at that time, Swiss Re began working

with Swiss bank Credit Suisse to develop

alternative financial and risk transfer

solutions.

developments in actuarial modelling

and a growing interest in hedging risk in the

1980s, led Swiss Re to explore developments

in capital markets and bring new financial

products to existing and new clients. The

growth in Swiss Re’s financial products

business helped forge lasting relationships

between reinsurers and capital markets that

had not really existed before.

A new era was beginning, and capital

markets had been opened up as a source

of additional and complimentary capacity.

Innovative products were also been

developed, including some of the first

Insurance Linked Securities, Public Private

Partnerships and those that incorporate

derivatives and parametric triggers.

Market consolidation and expansionWith strategy firmly fixed on its core

reinsurance operations, Swiss Re

strengthened its position by buying

competitors in a number of markets during

the 1990s and 2000s.

The company made a series of

acquisitions in the US life reinsurance

market between 1995 and 2001, increasing

Swiss Re’s share of the US life reinsurance

market to 25%, a market leading position.

The acquisition of Life Re also brought

opportunities through AdminRe, an

operation specialising in the acquisition and

administration of run-off business.

Swiss Re’s largest acquisition was the

$7.6 billion deal in 2006 for GE Insurance

Solutions, the fifth largest reinsurer at

that time. The transaction reinforced

the reinsurers leading position in the US

reinsurance market.

Challenging timesThe opening decade of the Twenty-first

Century was challenging for global insurers

and reinsurers, including Swiss Re.

The terrorist attack on the World

Trade Center in 2001 not only cost three

thousand lives and billions of dollars in

property damage, it also changed insurers

thinking about the possible size of losses

and the interconnectivity or accumulation of

seemingly unrelated risks.

Swiss Re underwrote half of the $3.5

billion coverage for the WTC, and insurance

claims from the attack contributed to Swiss

Re’s first net loss since 1868.

It took five years before a New York Jury

ruled in favour of Swiss Re and other insurers

in the largest insurance litigation ever,

confirming the attack was one event and not

CONTINUED FROM LAST PAGE

Guiseppe Besso, General Manager of Swiss Re, 1865-1879

Moritz Ignaz Grossmann, Founding Father of Swiss Re,

Member of the Board (1863-1870)

SWISS RE’S HISTORY

PRODUCTS: The Value Of Reinsurance: Enable & FacilitateUNLIKE CoNSUMER BRANdS oR CAR MANUFACTURERS,

REINSURERS ARE LARGELY UNKNoWN To THE WIdER PUBLIC. THIS

doES NoT impair the vital function reinsurers perform in shouldering

extreme risks, as well as supporting and often enough facilitating

economic growth and development.

Few people give much thought as to who should compensate

them if they are injured at work or if a storm destroys their home –

that is until it happens to them. Governments and business have a

role, but usually it is insurance that pays the bills.

Living your life means taking risks, and insurance has become a

valuable tool to mitigate these risks. Whether it is cover against fire,

theft, the risk of being sued, an accident or a disease, insurance can

help manage the unexpected, reducing the impact by spreading the

risk among a wider population.

Reinsurance has a long tradition in enabling new technologies.

Beyond supporting insurers in providing cover to individuals, large or

specialized insurers and reinsurers perform an essential role as risk-

takers, and thereby facilitating the development of new products or

investments in infrastructure.

For instance, the launch of new consumer goods or a

pharmaceutical product would be impossible unless an insurer

assumed the casualty risk. Likewise, the proliferation of skyscrapers

could not have happened if investors were not certain that their

investment would be safe, even in case of a devastating fire or an

earthquake. From a societal point of view, ultimately insurance

protects progress, because it assures that values accumulated over

time will not be lost in case of a large catastrophe.

However, many providers of insurance are local and specialist.

This makes them vulnerable to very large or unexpected losses.

This is where reinsurers come in to play. They are the insurers of

reinsurers.

Reinsurance by definition is a global business. While insurers

often concentrate of the needs of their customers in a certain region

or risk categories, reinsurers are able to diversify and balance the

risks across geographies. Reinsurers stand behind insurers, making

sure that they can cope with very large losses or once in a life time

events that would threaten their ability to pay claims. Reinsurers

promote an efficient use of capital and help protect insurers’ earnings

by transferring concentrations of risk to financially secure partners

around the world.

one insurer could suffer crippling losses if hit by a storm or

a major fire loss, but through the mechanism of reinsurance, the

insurance industry can mutualise these catastrophic losses.

By spreading the risk into global reinsurance and capital markets,

reinsurers make it possible for insurers to provide affordable

protection for the most extreme and unexpected risks, providing the

funds to help a society and businesses rebuild and quickly get back

on its feet.

Reinsurance also supports the wider growth of the economy and

the development of a more sophisticated society.

As an economy grows and as businesses face ever more

challenging exposures, insurers can help manage the risks. They

can help identify emerging risks – such as nano technology or the

affects of climate change -, stimulate debate and invest in research

and development, as well as supporting business as they expand by

providing working capital and expertise.

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REGULATION: Where Liberty Has Its Costs

REGULATIoN HAS BEEN AN IMPoRTANT FACToR IN SHAPING THE

US insurance market, and a major challenge to foreign insurers.

despite heated debates on the role of federal government, most

recently after the 2008 Financial Crisis, insurance regulation has

largely been drawn along state lines, although federal statutes and

self-regulation do also play a part.

Competition between states and sensitivities around freedom,

liberty and central government power have long dominated US

politics, and are reflected in the state-based system of insurance

regulation.

After the War of Independence, US states were loosely joined in

a federation, but continued to operate their own legislature, a factor

that has resulted in differing rules and regulations across the US that

survive to this day. As a result the US insurance market has been

fragmented and expensive, for both domestic and foreign companies

alike.

State regulation encouraged many US insurers to remain focussed

on their local markets, and not seek diversification across borders. It

also led to a lack of diversification along product lines. For much of

the past 150 years, US insurers have tended to specialise in only one

line of business that is until after the Second World War when most

restrictions on multi-line underwriting were finally removed.

Historically, state regulators have focussed on solvency and

consumer protection, which has seen them oversee pricing,

availability of cover and claims. This has proved particularly relevant

in catastrophe-exposed states, especially those like California where

Insurance Commissioners are elected.

US insurance regulation has also historically had a political

dimension. Politics has also been a factor in the treatment of

foreign insurers, with regulators applying their own rules and capital

requirements for non-US companies.

To underwrite business in the United States, foreign companies

were forced to demonstrate their commitment and were required to

invest in US securities, a practice that would have particular relevance

during the 1927 Wall Street Crash and the two World Wars.

Harsh deposit requirements imposed by some states on foreign

insurers in the 1800s, dissuaded some from entering the market and

led many to participate only through reinsurance, rather than pay the

price of state regulation.

While state regulation encouraged the creation of state-based

local insurance markets, rather than a national one, insurance

supervisors have sometimes co-ordinated their efforts nationally.

In 1871 the National Association of Insurance Commissioners was

formed, which to this day continues to develop model laws and

provide a platform for regulators to discuss changes and communicate

with the wider insurance sector.

United States equalled that of the United

Kingdom, having been one-sixth of its

spend just thirty years earlier.

Although several associations

were established in the early 1700s to

provide care for widows and orphans of

their members, life insurance developed

at a much slower pace than property

casualty.

In 1812 the first real life insurance

company was formed in the United

States with The Pennsylvania Company

for Insurance on Lives and Granting

Annuities opened for business. Other

companies soon followed, and from

1870 to 1895, life insurance in force

increased nearly six-fold as companies

introduced industrial and whole life

policies.

Early foreign contributionForeign insurers gained a foothold in

the US market early on, so beginning a

lasting relationship—with all its ups and

downs—between the US market and

overseas insurers and reinsurers.

The United States was an important

market for some UK insurers in mid-

1800s, in particular for insurance

linked to the trade in cotton. However,

the period of Reunification after the

American Civil War, was to see many

more insurers from Canada, Germany,

Russia, Switzerland, as well as the United

Kingdom, attracted to the United States

by its growing population and expanding

economy.

Foreign insurers were soon writing

significant volumes of business in the

United States—by 1881, around 25% of

US fire premiums were underwritten by

foreign insurers—with some UK insurers

outgrowing their domestic US rivals.

Building reputationsBy 1913, a total of eighty-nine foreign

companies from fourteen nations, were

operating in the US. UK companies, in

particular, invested heavily in the United

States—according to some estimates US

THe FIRST dOmeSTIC FIRe And

mutual marine insurers were already well

established before the American War of

Independence (1775-1782), with at least

10 property companies created in the

two decades following the declaration

of Independence in 1776—including the

first US joint stock insurer The Insurance

Company of north America, InA,

founded in 1792.

more companies were to follow and

by the mid-1800s most US states had a

rich assortment of organisations writing

insurance.

The period following the American

Civil War (1861—1865), with the

opening of new territories in the

American West, saw the US enjoy one of

its most sustained periods of economic

growth, quickly becoming the world’s

largest economy by the end of the

century.

The non-life insurance market

also grew more quickly at this time. In

1880, per capita insurance spend in the

The US domestic insurance market pre-dates the founding of the nation itself, tracing its roots to Colonial trade with the United kingdom in the 1700s

[Right] dale Creek, Iron Viaduct,

Promontory, Utah:

Railroad expansion in the late 18th

century let the US economy develop

across the interior of the continent.

premiums accounted for 40% of British

premiums between 1870 and 1914.

US domestic non-life insurers were

also flourishing around this time, with

a few –such as InA—even venturing

overseas. But with good growth

opportunities at home, diversification

into markets outside the United States

was to remain limited, even after the First

World War.

US life insurers—that had seen

business in force grow seventy-six times

over in the second half of the nineteenth

century—were more successful in their

overseas expansion. The top three US life

insurers—equitable, new York Life and

mutual—were all active overseas.

No easy rideConducting insurance business within

the United States was never easy.

For much of its history, the US

insurance market has been fragmented

and highly regulated. Unlike other

markets, US insurance regulation

was, and continues to be governed

by a complex set of state and federal

rules, self-regulation and international

standards. (See box).

In addition to the relatively high cost

of doing business in the United States,

catastrophe and other losses meant that

profits were hard to come by. Although

every state had licensed foreign insurers

in 1914, fifty-three foreign insurers exited

the United States between 1861 and

1914.

Reinsurance— a European affairdespite America’s exposure to large

hurricane and earthquake perils, the

reinsurance market started slowly and

largely remained an activity of foreign

US consumers were quick to adopt technology, buying domestic appliances and, of course, the car. Automobile insurance increased with the rapid growth in vehicle sales...

Chapter One

The ‘Philadelphia Contributionship for the Insurance of Houses from Loss by Fire’ was the oldest property insurance company in the United States. It was organized by US statesman Benjamin Franklin

11

United States of AmericaFrom Emerging Market to Global Power

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Piccap to go here

12

The earthquake, which is generally

regarded as a pivotal moment for the US

insurance market (see box), cost Swiss

Re around CHF 8.4 million, resulting in

the largest net property loss in Swiss Re’s

history as a percentage of annual net

earned non-life premiums.

For Swiss Re, the quake

demonstrated its fundamental

proposition to clients. By insuring the

insurer, Swiss Re could help them

withstand the losses of a ruinous

earthquake or fire.

Within four years of the earthquake,

Swiss Re opened its first branch in new

York and became an integral part of the

US insurance industry.

Rapid expansionSwiss Re’s decision to establish an

office on the 20th October 1919

proved to be good timing. The US

market economy was growing, and

the increasing awareness of potential

risks from disasters like the San

Francisco earthquake was a boon to the

reinsurance industry in the United States.

Opening a US branch signified

Swiss Re’s long term commitment to the

US insurance industry. It enabled Swiss

Re to position itself as a key player, allying

its fortunes to those of its US clients, a

factor that was to prove important in the

turbulent war years ahead.

The plan was to grow Swiss Re’s

fire treaty business and launch a new US

casualty reinsurer. Together with other

investors, Swiss Re launched the ground-

breaking european Accident Insurance

Co. Ltd.—in 1920, the first licensed

professional accident and casualty

insurer and reinsurer in the United States.

The outbreak of World War I in

europe in 1914 would lead to structural

changes in the US insurance market, as

well as transform Swiss Re’s position as

it helped fill the vacuum left by the rapid

decline of its competitors. The war would

see German insurers banned from the US

insurance and reinsurance markets, while

the Russian Revolution in november

1917 would see Russian insurers

withdraw from the market.

The US insurance market would

emerge from the War period in relatively

good shape, as domestic insurers

increased their market share. From

1910 to 1920, the four top domestic

companies. Overseas companies

accounted for 90% of reinsurance at the

end of the nineteenth century.

US insurers favoured other, often

less effective forms of spreading risk,

including co-insurance agreements

and insurance exchanges. US insurers

remained dangerously undiversified and

exposed to both man-made and natural

disasters, a fact reinforced by the losses

incurred in the Chicago and Boston fires

of 1871 and 1872, and later with the San

Francisco earthquake of 1906 (see box).

A place in the marketThe relevance of the US reinsurance

market was clear from an early stage in

Swiss Re’s development.

Its first foray into the country was

through reinsuring the US business of

its trusted partners, including Swiss

Re’s founding partner Helvetia in 1873

and German insurer Prussian national

Insurance Co. in 1880, which built a

substantial business in San Francisco,

regularly ceding business to Swiss Re.

Swiss Re’s focus on the fast

growing Californian market was to have

unfortunate implications for the company.

1929 CRASH: A Wake Up Call For InsurerTHE ExUBERANCE ANd oPTIMISM oF THE 1920S CAME To AN

abrupt end with the 1929 Wall Street Crash and the Great depression

of the 1930s.

The crash had huge implications for insurers, causing massive

losses from volatile investment markets and exchange rates, as well

as years of falling revenues. Longer term it also led to fundamental

changes in financial services regulation and had a profound affect on

the perceived role of the government and the private sector in social

welfare provision.

In the first decades of the twentieth century, US capital markets

came to lead the world. The country seemed to offer opportunities for

growth as well as a combination of stable exchange rates and a broad

range of securities to invest in.

Insurance companies benefited from a growing interest in equities,

with most fire companies enjoying double, and even triple, digit returns

on their investments. With 80% of fire insurers’ investments going to

financial markets, the bull market in insurance stocks became a self-

fulfilling prophecy.

during this time Swiss Re increased its weighting in equities,

buying stocks in railroad companies, as well as public utility bonds and

government and industrial debt. The reinsurer experienced significant

growth in its business during this period and was obliged by insurance

rules to invest a large share of its premiums in the US market.

When the music finally stopped in 1929, Swiss Re, like other

insurers, suffered losses as share prices plunged. The company

reported total write-downs of CHF 26 million between 1930 and 1938,

although the company was able to tap reserves held in Zurich– in 1931

some CHF 30 million was taken from the reserve pool to cover losses

on the asset side, almost wiping out the fund.

despite the losses, Swiss Re survived the financial crisis in good

shape, maintaining its high dividend and reporting profits throughout

the crisis.

[Above] Edwin Hürlimann, General Manager of Swiss Re between 1919 and 1930

14

days became a major problem for

insurers and resulted in off-putting higher

premiums.

The 1920s were to end with a crash,

signalled by the collapse of the US stock

market in 1929 (see box). The optimism

of the 1920s was soon replaced by the

Great depression of the 1930s, the worst

economic downturn of modern times.

From 1929 to 1933 US gross domestic

product halved from $104 to $56 billion.

Insurers were hit on two sides, with

investment losses from steep declines in

the stock market, and by falling demand

for insurance. As the economy slowed

and unemployment soared, casualty

insurance premiums fell 30% over the

same period. By 1934, fire insurance

premiums had fallen to the lowest level in

twenty years.

Like other sectors, US insurers

benefited from the interest in equities,

reporting double or triple digit earnings

on investments by the middle of the

1920s. Swiss Re’s expanding US

business meant it was also obliged

to invest more in US assets, and its

investment portfolio at the time included

a heavy weighting in railroad and public

utility bonds, as well as US state debt.

The length and severity of the

depression helped reshape American

attitudes to risks and insurance, setting

the stage for a blend of public and

private welfare provision. Poor economic

conditions and increasing regulation had

led many foreign insurers to leave the US

market.

Within a decade of the Wall Street

stock market crash, europe was again

plunged into war. Foreign insurers and

reinsurers, Swiss Re included, found it

increasingly difficult to communicate

with their overseas headquarters.

The political upheavals of World War

II had a dramatic effect on Swiss Re’s

business in the United States, where it

had become a well-established cog in

the insurance machinery. By 1941 the

Zurich-based company was the largest

fire reinsurer in the country, with net

premiums 50% greater than its nearest

rival.

The War made the transfer of

documents between Zurich as the

US subsidiaries impossible, and all

correspondence was carefully watched

under the terms of the 1917 espionage

Act. The crucial flow of cross-border

funds was also severely impeded by the

War, creating huge liquidity and foreign

exchange risks for international insurers

and reinsurers like Swiss Re.

One sign of Swiss Re’s commitment

to the US market can be seen in its plans

to transfer all US operations and assets

to a US entity, should the situation in

europe deteriorate. All shares in the US

operations were transferred to a holding

company held in trust by US citizens.

fire insurers collectively increased their

premiums by 150%. For Swiss Re, this

period would see it become established

as the leading professional reinsurer in

the US market.

In addition to the tragedy of

World War I, a catastrophic influenza

pandemic in 1918, later dubbed “the

Spanish flu”, was a reminder of the limits

of globalisation and the difficulty of

diversifying certain risks internationally.

Were such a pandemic to hit the US

economy today-where 30% of the

workforce became ill and 2.5% were to

die, the total cost would be around USd

700 billion.

US life insurers took a big hit,

although demand subsequently

increased, as did prices.

Roaring TwentiesThe 1920s witnessed the rise of a

particularly American phenomena,

the rise of the consumer culture and

the development of mass marketing.

This boosted demand for insurers, that

were already creating their own brand

of advertising, ensuring a period of

profitable growth for US carriers.

At this time Swiss Re was

reinforcing its leading position in the

US market, reinforcing marketing and

legal connections. As early as 1923 it

used north America in the name of its

operations.

US consumers were also quick

to adopt the latest technology, buying

radios, domestic appliances and, of

course, the motor car. Automobile

insurance increased with the rapid

growth in vehicle sales, although cars

proved easy to steal, which in the early

The 1920s witnessed the rise of a particularly American phenomena, the rise of the consumer culture. This boosted demand for insurers, that were already creating their own brand of advertising, ensuring a period of profitable growth for US carriers

99 YEARS: Disasters That Shook A Market

CATASTRoPHIC EVENTS, WHETHER natural

or manmade, have been a defining feature

of the US insurance market from its earliest

days.

From the fires that destroyed many US

cities in the 1800s, to the San Francisco

earthquake in 1906, Hurricanes Betsy in

1965 and Katrina in 2005, and the World

Trade Centre terrorist attack in 2001,

catastrophes have helped drive demand in

the world’s largest insurance and reinsurance

market.

These events, costly in both economic

terms and loss of life, highlight the potential

scale and concentration of catastrophe losses

in the United States, as well the need for

foreign capital and expertise.

The US is particularly exposed to natural

disasters—from the powerful hurricanes that

have hit the Gulf of Mexico states and the

East Coast to earthquakes that have rocked

California, Washington and Missouri, as well

as less quake prone cities like New York

and Boston.

There is also a history of costly manmade

disasters. Growing urbanisation in the

1700 and 1880s, and the preponderance

of wooden building, led to devastating fires

in many US cities, including New orleans

(1788 and 1794), New York (1776 and 1835),

detroit (1805) Pittsburgh (1845) Seattle

(1889). In more recent times,

The San Francisco earthquake was one of

the first natural disasters to have a deep and

lasting affect on the US insurance market.

The 7.9 magnitude earthquake that shook

San Francisco in 1906 was a turning point in

US insurance history. It caused around $10

billion of damage at current dollar value, with

two thirds of the damage being caused by

the fires that swept through the cities largely

wooden buildings.

Forty-three companies paid out $4.9

billion of claims at today’s values, equal to the

insurance market’s entire forty-seven years

of profit. Although most foreign insurers

weathered the catastrophe better than their

US counterparts, they were also hit by big

losses.

In addition to the financial consequences,

the quake also exposed a lack of insurance

and reinsurance standards in what was still a

localised US insurance market.

Although some 90% of houses in San

Francisco carried fire insurance, earthquake

risk was not considered insurable and

therefore not covered,

while many companies excluded fire

following an earthquake.

As a result, many insurers paid nothing

in claims, while others went bust or tried to

renegotiate contracts.

one of the most important lessons of the

quake was the need for diversification—those

countries with greater financial strength and

international diversification, showed more

resilience and ability to pay claims.

15

Hurricane Betsy of 1965 makes landfall in Florida

[Left] Charles Simon— General Manager of Swiss Re between 1900 and 1919

Panarama of the rebuilding of San Francisco three years

after the earthquake of 1906

16 17

cities, the space race and

satellite technology, as well

as giant strides in medical

sciences and the more

recent development of the

internet. Whole industries

were developed, including

the earliest commercial

airline companies,

energy firms, global

consumer brands and the

entertainment industry.

Insurers build on economic successOn the back of growing consumer

demand and the success of US business,

the domestic insurance market grew

from strength to strength.

As a percentage of disposable

income, Americans were spending 50%

Mature Market:Innovation, expansion, prosperity but also market distortions

THe exPAndInG US eCOnOmY

and developing consumer market

provided fertile ground for the US

insurance industry, which began to

take on a new sophistication, reflecting

developments in risk management and

actuarial sciences.

experiencing a boom in demand

for insurance, American insurers grew

from strength to strength, but increasing

prosperity brought about changing

social attitudes, market distortions and

some volatility.

Blinded by high investment returns

and over confidence, the US insurance

industry under-priced risk at a time of

rising claims inflation and unfavourable

developments in the legal system. The

resulting liability crisis hit US insurers

and their reinsurers with massive

unexpected losses, causing a ripple

effect that was felt by insurance markets

around the globe.

The rise of American technology and culture Post war America was to prove an

economic powerhouse, fuelling the

global economy and breaking new

ground in terms of technology and

culture.

The United States offered a strong,

liberal and stable market in the uncertain

Cold War era. While large parts of

the world had slipped behind the Iron

Curtain or were struggling to emerge

from colonial rule, America was buoyed

by new confidence.

After the set-back of the Great

depression, the United States was again

prospering, enjoying growth levels last

seen prior to the First World War. From

1950 to 1973, world trade saw exports

outpace economic growth by a factor

of two.

For the entire twentieth century

the US was to lead the world in

technological innovation, manufacturing

and consumer goods and services.

Industrialisation took on a new

form in the US with the likes of Henry

Ford introducing the concept of mass

production, while the growth in the

consumer market was unrivalled.

In the first decades of the twentieth

century, US consumers were keen to

own their own motor cars and were

quick to embrace new technologies,

whether they were the latest household

appliances, television or computers.

The post war years saw rapid

growth in transport, the rise in mega

The post war years saw rapid growth in transport through motor cars and aviation, the rise in mega cities, the space race and satellite technology, as well as giant strides in medical sciences

DEVELOPMENT: Liability crunch timeTHERE WAS A HEAVY PRICE To PAY FoR THE ECoNoMIC ExPANSIoN

in the US during the 1950s and 1960s, both in terms of the

environment and the runaway tort system.

A combination of new technologies and a huge increase in

compensation awards by the courts created a traumatic time for US

insurers.

The combination of tort and class actions favoured strong

consumer rights and made it easy and potentially also quite rewarding

to sue. Together with a broadening of evidential standards and

doctrines of culpability, the number of suits dramatically increased, as

did the size of awards. Strict liability and the need to only establish a

degree of guilt made US companies an easier source of compensation.

during the second half of the twentieth century, US tort costs rose

from 0.6% of GdP to 2.2%. In the early 1980s some US insurers were

spending as much as 25% of their premiums on legal expenses, up

from 5% in 1960.

Insurers had written business on completely different assumptions

of the likely frequency and cost of claims. The expanded concept of

liability and the long-tail nature of casualty insurance meant that US

insurers were hit with claims in the 1980s they had not anticipated

or priced for when the policies were underwritten in the 1960s and

1970s.

The largest losses were for environmental, pollution and health

hazards, with asbestos related claims being the largest single cause.

This mainly US phenomenon—of emerging liabilities and

huge increases in awards—was to have global ramifications, with

international insurers and reinsurers reporting losses and a reduced

appetite for casualty business.

The crisis in liability insurance came to a head in the 1980’s,

resulting in a number of insurers going bust while others withdrew

cover or stopped writing casualty lines altogether. The dramatic

reduction in the availability of casualty insurance and skyrocketing

of insurance prices that followed had serious consequences for US

businesses and consumers.

Medical malpractice and product liability were the first to

suffer but workers compensation, general liability and then later

professional liability and directors’ and officers’ insurance were hit

with overwhelming claims. The cost and lack of liability insurance,

especially in the US healthcare sector, became a political hot potato. It

eventually led to tort reform in the late 1980s, which was successful in

reducing the worst excesses, but a shortage in insurance capacity was

to remain for some time.

The experience of asbestos, in particular, alerted insurers to

the huge potential risks from emerging or unexpected liabilities and

shifting legal positions. To this day, foreign reinsurers remain mindful

of the cost of under-pricing casualty reinsurance and the importance of

keeping track of emerging risks like nano technology or biotechnology.

The liability crisis also had long term implications for commercial

insurance in the United States, encouraging insurers and companies

alike to look at new ways of managing and retaining risk. Increased

retention levels and consolidation among US insurers produced a long

term decline in demand for casualty reinsurance in the United States .

The liability crisis led many large US companies to retain more

risk and self-insure, and even as the casualty market showed signs

of improvement in the mid-1990s, risk retention mechanisms would

remain a viable alternative to US organisations.

Chapter Two

more on life, annuity and health

insurance in the twenty years after

the end of the war. By 1965, the

number of life insurance contracts

was almost three times higher than

in 1945.

motor insurance also grew

hugely, with premiums rising ten-

fold in the twenty-five year period

following 1945.

demand for commercial

insurance also increased with the

success of US business, but the scope

of challenging engineering projects,

from ever larger and more complex

factories, bridges and aircraft, were

increasingly beyond the capacity and

skills of a single insurer.

Such risks required a new level of

industry expertise and risk management

that most US insurers did not possess. A

few large and expert reinsurers like Swiss

Re were able to extend their capacity

to reinsure these single, large risks in

collaboration with insurers and large

corporate clients.

Home market opportunities In contrast to the pre-1914 expansion

overseas by US life insurance companies,

post war insurers remained firmly

focussed on opportunities at home. With

a strong domestic market, US insurers

generally lagged behind US companies in

other sectors, like automotive, that were

expanding overseas, growing increasingly

multinational.

There were a few exceptions, such

as American International Group (AIG),

American Foreign Insurance Association

(AFIA) and InA which continued to

build on their overseas ventures in the

[Right] Piccap to run here

The decades following the Second World War were to be a golden age of growth for the United States that saw a flowering of American culture, business and technology

18 19

entrants and high investment returns

stoking competition.

There were still opportunities for

reinsurers. Reinsurance accounted for

just 3.6% of total nonlife premiums in

the mid-1980s and US companies –

which faced increasingly complex risks

– sought the help of technically capable

global reinsurers like Swiss Re.

Swiss Re was also able to

increasingly benefit from economies

of scale, such as increased technical

sophistication and product development.

However, the reinsurance market

remained competitive and few

recognised that fundamentals needed

to change.

Counting the cost In 1979 only three of the top 13

reinsurance companies operating in

the United States had a combined ratio

below 100%. Unprofitable underwriting

was being supported by unsustainable

high investment returns, and in particular

stock market returns.

Insurers continued to compete

aggressively in the 1980s, cutting prices

and taking on more risk. Just as rates

were falling, demand for commercial

insurance exploded.

new inexperienced entrants were

attracted to the commercial insurance

market, fuelling competition and driving

down rates. And so called cash flow

underwriting – with its focus on volume

rather than profit – became popular.

At a time of double digit interest rates,

insurers believed that they could offset

underwriting losses with investment

returns.

But as the losses rolled in,

approximately half the reinsurers in

the market had left by the mid-1980s,

putting pressure on those that remained

to take on more risk and support their

clients.

Spiralling liability costs and

competitive pressure on pricing hit

reinsurers like Swiss Re hard in the

US. Its business was focussed on large

carriers, particularly foreign players that

were especially hit by asbestos liability

and pharmaceutical product liability

claims.

The Swiss reinsurer also typically

underwrote pro rata reinsurance, which

meant that it shared the losses of clients.

even excess reinsurance, which is only

triggered by very high losses, produced

unexpectedly large claims, some dating

back to the 1940s and 1950s.

The liability crisis also added new

administrative costs for reinsurers, as

disputes became bitter and involved

teams of lawyers. Litigation between

insurer and reinsurer, once a rarity, was

frequent and disputes became more

difficult to resolve as the focus moved to

a legal interpretation of contracts, rather

than one based on good will.

Staffing had to increase at Swiss Re

to deal with the increasingly complex

claims. A whole new department was

created to audit client data and the

claims unit grew from 12 in the late

1970s to 72 people by the mid-1990s.

A change of strategy - such as shift

to writing excess reinsurance, which

generates higher returns from fewer

expected losses – was difficult. excess

reinsurance generates less premium

volume, which was needed to help

smooth the loss ratios - Swiss Re spent

much of the 1980s writing just enough

new casualty business to keep pace with

its growing losses.

But despite the challenges, Swiss

Re’s nonlife net premiums grew in the

1980s from USd 4 billion to USd 7

just the wrong time.

US courts were strengthening the

concept of liability, making companies

and their insurers more culpable

for unforeseen mistakes, as well as

awarding greater levels of compensation

to consumers.

Reinsurers like Swiss Re were

to suffer losses far greater than any

expert would have forecast, leading to a

period of insurance market volatility not

previously seen in the United States.

Opportunities and challenges despite emerging problems in the liability

insurance market, the US insurance

market continued to grow overall

throughout the 1970s and 1980s. From

1960 to 1985, property and casualty

insurance premiums increased from

USd 15 billion to USd 144 billion. Life

insurance premiums grew at an even

more impressive rate over the same

period, up from USd 586 billion to USd

6 trillion.

The growth was good news for

reinsurers like Swiss Re, but it also

meant that life was about to get a lot

harder. Larger insurance companies and

corporations were able to retain more

business and self-insure through the

increasingly popular option of a captive

insurer. Competition was also heating

up for established reinsurers, with new

US life and nonlife premium revenues

increased six- and tenfold respectively.

The company’s US business accounted

for 27% of the group’s total premiums

revenue, almost twice that of the next

largest country, Germany, and as much

as France, Belgium, Switzerland and the

United Kingdom combined.

The turning tideAmerica’s post war economic boom was

both an opportunity and a threat to the

country’s insurers and reinsurers.

The expansion in the US economy

created opportunities to grow for

insurers. However, direct insurers

not only wrote more business, they

also broadened cover, often without

corresponding rate increases or a proper

understanding for the underlying risks.

Concerns over the quality of

business being written was to become

a big issue for reinsurers like Swiss Re,

that were keen to support insurers in

expanding their portfolios, but were wary

of the potential risks.

Commercial insurance premiums

doubled in the 1970s, with general

liability and malpractice premiums

increasing by some 150%. Reinsurance

premiums also tripled at this time.

However the 1970s was to be

a turning point for the US insurance

market. The favourable claims and

investment experiences of the 1950s

and 1960s left the insurance market over

confident and ill prepared for the losses

and inflation turmoil that followed.

The 1960s saw a breakdown of

international monetary agreements

reached in the immediate aftermath

of the war under the Bretton Woods

System. The country was entering a

long period of economic and business

uncertainty, marked by rising inflation

and volatile exchange rates, a major

problem for liability insurers that accept

premiums at a point in time, but may not

pay claims for many years after.

Naïve capacityThe strong profitability of the 1950s and

1960s gave way to a turbulent period

for insurers in the 1970s and 1980s.

Fierce competition and high investment

returns had helped drive down premium

rates and blinkered insurers to long term

technical profitability of the business

being underwritten.

Insurers took their eyes of the ball at

interwar period. AIG, in particular, grew

into the world’s largest non-life insurer,

becoming the byword for international

diversification and innovation, until its

near-collapse in the 2008 financial crisis.

However, despite improving access

to newly liberalised foreign markets,

there was just one US insurer in the ten

largest multinational insurers in 2003,

compared with three Swiss and two

German.

As US insurers grew stronger

in the post war economic boom, the

participation of foreign insurance

companies reduced. Although some

UK insurers were still among the top

twenty US insurers, foreign companies

represented just 170 out of 4,800 US

insurers in the 1970s.

Foreign reinsurers, however,

continued to play an important role in

the US reinsurance market. By 1977

US insurers ceded over USd 1.4 billion

to foreign reinsurers and assumed USd

1 billion, a threefold increase in seven

years.

Swiss Re reinforces its core position Swiss Re emerged from the Second

World War in a strong competitive

position in the United States. The

company maintained its wartime

trust holding structure, reinforcing its

American branding, and raised the level

of the US company’s capital.

during the 1950s and 1960s Swiss

Re rationalised its US business, spinning

off its Canadian business into a new unit

and opening offices in Atlanta, Chicago

and San Francisco.

With a new geo-political landscape,

Swiss Re sought to further diversify,

opening offices in Australia, South Africa

and across Asia. The development of

the global network benefited US clients

as Swiss Re was better able to further

diversify US natural catastrophe risks

by writing exposures like Japanese

earthquake, risks that had a low

correlation to those in the United States.

By the end of the 1960s Swiss

Re was able to look back at a very

successful 15 years. After virtually no

growth during the war years, Swiss Re’s

Piccap to go here

Piccap to go here

20 21

billion, as it differentiated itself from other reinsurers by its financial strength

and by offering access to its global expert underwriting and claims.

Storm of the centuryUp until Hurricane Katrina in 2005, the most expensive natural disaster in US

history was Hurricane Andrew in 1994, which caused some USd 22 billion in

damage. With winds in excess of 200 mph, Andrew produced over 700,000

claims across thousands of square miles.

Just two years after Hurricane Andrew, a strong earthquake hit the

California community of northridge, just 20 miles north of Los Angeles,

causing some USd 20 billion in damage.

The storm, one of the most powerful to hit Florida in

the second half of the twentieth century, and the quake

were a wakeup call for insurers. They highlighted the

underappreciated risks of increasing concentrations of

property values in catastrophe exposed parts of America,

notably the hurricane prone Gulf of mexico and quake prone

California.

The insurance industry’s response to Hurricane Andrew

was swift and its effects long lasting. A number of smaller

insurers became insolvent and local subsidiaries of national

carriers required capital injections to keep them afloat. The

market for residential and commercial property coverage in

Florida all but dried up, and catastrophe reinsurance prices

soared and available limits greatly reduced .

Insurers realised they had underestimated the likelihood

and potential costs of a large natural disaster hitting a

populated area. Future hurricanes and earthquakes would

require insurers to significantly improve their understanding of

exposures and the potential impact on their portfolios, as well

as look at new ways to transfer the risk.

In particular, Andrew was a boost to the nascent

catastrophe modelling industry, and led Swiss Re to increase

its investment in its own models and in-house expertise – the

reinsurer now employs modellers, climatologists and other

scientists to better understand what drives hurricanes and the damage they

cause.

Hurricane Andrew was also to kick start a new property catastrophe

insurance and reinsurance market in Bermuda – Swiss Re helped form

Partner Re, one of several pure catastrophe reinsurers established in Bermuda

in the years following Andrew.

Significantly, Andrew ushered in the age of capital markets in insurance

risk. The hurricane encouraged insurers and reinsurers to turn to new capital

market products like catastrophe bonds, an area that Swiss Re has built

considerable expertise in the intervening years.

Investing in the US marketIn the mid-1990s Swiss Re sold its holdings in primary insurance and service

companies in order to reinvest and focus on its core reinsurance business, as

well as develop capital market solutions like cat bonds.

The goal was to become the number one global reinsurer, and the US

market was key to achieving this goal.

divestments freed up CHF 5 billion, which Swiss Re reinvested into

further growth of the life business, increasing the global non-life operations

and the development of allied financial services. The trend towards more

costly catastrophes and opportunities in alternative risk transfer solutions

made these attractive areas for investment.

At the same time the US operations became more integrated with the

group as Swiss Re began to operate more as a global business, under as

single brand and a single capital base. US senior managers became a familiar

part of Swiss Re in europe as their talent and experience was shared by the

rest of the business.

The 1990s saw Swiss Re invest further in its US operations, boosting

capital, rationalising legal structures, as well as investing in staff, IT and data

collection. Around this time Swiss Re moved its US head office from Park

Avenue in new York to larger modern premises in Armonk Westchester,

which were designed to promote a more collaborative work environment.

As the twentieth century came to a close Swiss Re’s US operations

accounted for 30% of the reinsurer’s global business, with expectations that

this would grow to 60% over time.

DEVELOPMENT: Risk ManagementTHE REVoLUTIoN IN RISK MANAGEMENT

THAT GoT UNdERWAY IN the United States

in the 1960s and 1970s went hand-in-hand

with developments in technology. Almost all

new theory on pricing risk in the latter part

of the twentieth century emanated from the

United States, with lasting implications for

risk management and insurance around the

world.

The growing size and complexity of

US business and technology required a

new approach to risk, and the role of the

risk manager was created. US business

culture, with its emphasis on education

and technical development, encouraged a

professional approach to understanding risk,

its identification, mitigation and potential

transfer to third parties like insurers.

The United States is now home to one

of the world’s most developed communities

of risk managers, represented by the Risk

and Insurance Management Society (RIMS).

Established in 1950, RIMS serves more

than 10,000 risk management professionals

around the world through 81 chapters across

the United States, Canada, Mexico and Japan.

Working alongside their brokers and

insurers, US risk managers have been

pioneers in risk management and the transfer

of risk to third parties. US companies are

among the biggest users of captive insurers

and are often the first to embrace new

insurance products, such as directors’ and

officers’ insurance, environmental impairment

liability and more recently cyber insurances.

US companies were also early

beneficiaries of globalisation, with motor

manufacturers being among the first to start

operating overseas. The increasing size and

complexity of risk, as well as the expansion

into foreign territories was to lead to many

innovations in commercial insurance, such

as multinational insurance programs and

eventually the use of bespoke structured

solutions.

DEVELOPMENT: Embracing Capital MarketsIN THE WAY THAT CAPTIVE INSURANCE CoMPANIES BECAME A

viable concept with the development of actuarial practices, advances

in statistical modelling and innovations in financial products allowed

insurers and reinsurers to explore alternative risk transfer products in

the 1980s and 1990s.

Insurers began to develop potential new commercial insurance

products that ranged from multi-line multi-year insurance policies to

those that incorporated financial products like derivatives or swaps. For

example, an insurer could offer cover for a combination of insurance

and financial market risks. Such a contract that could cover potential

catastrophe losses and a fall in equity markets.

Some of these experimental products were more successful than

others. But the most enduring has been the catastrophe bond, which

has grown into a market in its own right, attracting investors and

insurers with the potential to transfer nonlife and life insurance risks

between the two largely uncorrelated markets.

The first catastrophe bond was issued for a life insurer in the

1980s, but it took Hurricane Andrew in 1992 and the resulting shortage

of reinsurance capacity to really get the insurance linked securitisation

market going. The catastrophe made insurers and reinsurers look at

new ways to protect their balance sheets against major catastrophes

like a hurricane or earthquake.

US companies used their risk management and financing skills

to package insurance risk and transfer it to capital markets. The first

catastrophe future contracts were launched by the Chicago Board of

Trade in 1992, and while the venture was ultimately unsuccessful,

it was one of the first of many innovations to trade cat risk in capital

markets.

Swiss Re was an early explorer of capital markets and innovative

risk transfer techniques. In the 1980s it founded New York-based Atrium

to look at new ways of assessing and transferring risk and in 1993

Swiss Re established a new division – called Alternative Risk Transfer –

to tap into new markets for handling risk.

The reinsurer established a relationship with the Zurich-based

investment and retail bank Credit Suisse to develop new products

and meet the insurance and financing needs of financial markets and

Fortune 500 companies.

The lines between banking and insurance were beginning to

blur and it was becoming possible to transfer exposures like natural

catastrophes, life risk and even motor to capital markets, as well as to

combine insurance and capital market products into new solutions for

large companies and public sector organisations.

Many leading insurers and reinsurers have embraced ILS as a

way to access capital market protection on a multi-year basis and at a

secure price. This has proved particularly relevant for peak risks like US

Hurricane and Earthquake, Europe Windstorm and Japan Earthquake,

where availability and price of cover can be subject to volatility

following a large loss event.

ILS have also proved popular with investors, the numbers and

diversity of which has been increasing over the years as the sector has

matured. Investors have found ILS an attractive prospect offering higher

yields and an asset class uncorrelated to other financial market risks.

In addition to finding solutions for its clients, Swiss Re has also

diversified in portfolio by issuing billions of dollars of exposure to capital

markets through catastrophe bonds, including pioneering mortality and

longevity insurance linked securities.

22 23

Interior of a lobby at the Swiss Re North American corporate headquarters in Armonk, New York State

Piccap to go here

during the second half of the last century it became increasingly important to advertise directly to the consumer. Swiss Re at it’s 75th anniversary emphasised it’s longevity and olf-fashioned values.

[Left] during picture research, in the Swiss Re graphics library, for the production of this history found this press advert for the 75th anniversary celebrations of North America Re. Closer inspection of the artwork revealed a mistake in the photography that was chosen. To illustrate the year1984, a photograph of the 100m final from the olympic Games was used, but unfortunately it was an image of the wrong Games instead being the finish of the 1980 100m in Moscow...

COMMUNICATION: Advertising

24 25

HURRICANES: Testing The Foundations of Insurability

THE dEVASTATING RUN oF HURRICANES BETWEEN 2004 ANd 2008

were a reminder of US vulnerability to powerful storms.

The past 150 years has been marked by a number of destructive

and fatal storms along the US East and Southern coasts.

The period of intense hurricane activity in the first decade of the

twenty-first century was unparalleled in modern times, raising serious

questions over the affects of climate change, the potential for even

greater losses caused by natural catastrophes and ultimately their

insurability in the future.

Storm losses have also risen in more recent times as the

concentrations of valuable property in hurricane exposed states like

Florida and Texas has increased along with the population shift toward

warmer coastal areas. Where once there was little but swamp lands,

major cities like Miami have grown in the past 150 years.

The power of Hurricane Katrina in 2005 shocked US insurers,

reinforcing some of the lessons of September 11 and reminding

insurers and reinsurers of the importance of identifying correlated

losses and in controlling their accumulated exposures.

As with the San Francisco earthquake almost 100 years before,

there was much uncertainty over what damage was covered by

insurance and what was not. Hurricane Katrina generated a swell of

litigation, much of it centred on whether damage had been caused

by the storm winds, which are covered under standard homeowners

insurance policies, or the flood, which is not.

As well as making insurers refocus their underwriting analytics on

their accumulated exposures, the string of hurricanes between 2005

and 2008 was a boon to the growing market for catastrophe bonds. In

2007 the catastrophe bond market enjoyed its best ever year, issuing

some $8.5 billion of protection, much of which was for US hurricane

and earthquake perils.

The insurance and reinsurance market in Bermuda was also to

benefit from the major losses in the first decade of the twenty-first

century. The Atlantic island began to attract insurers and reinsurers

of US risk in the liability crisis of the 1980s, and following Hurricane

Andrew in 1992, when some of today’s mid-sized reinsurers were

founded, some with partial funding from Swiss Re investments.

As insurance and reinsurance capacity became constrained

after the attack on the World Trade Centre, and again after Hurricane

Katrina, Bermuda became the focal point for start-up companies

and new capacity entering the market through so called side-car

arrangements.

The increased cost and frequency of Atlantic hurricanes, against

the backdrop of global climate change, caused many US companies to

reassess their approach to weather related catastrophes, implementing

risk reduction measures and purchasing greater levels of insurance.

Reinsurers called for the principle of risk based pricing to be

maintained, so those that choose to build along hurricane exposed

coastal areas are expected to pay higher premiums.

Hurricane Katrina also accelerated developments in the

catastrophe modelling arena, which was created in the wake

of Hurricane Andrew. With each storm, catastrophe modellers

incorporated new learning, such as the potential damage of storm

surge following Hurricane Katrina and the greater than previously

realised potential damage inland following a major hurricane.

26 27

the true value of insurance as a

mechanism for society and individuals to

manage risk and cope with unexpected

disasters.

Connectivity in a globalized worldIn many ways the start of twenty-

first century was a time of optimism.

The benefits of globalisation and

technological progress were having a

dramatic effect on the lives of millions

around the globe, and international trade

meant that the world’s economy was

growing.

Unfortunately the optimism proved

a false sense of certainty and was soon

overshadowed by fear and uncertainty.

The terrorist attack on the United

States of September 11, 2001, claimed

the lives of almost three thousand people,

many of whom worked for US insurance

and broking firms. In addition to the tragic

loss of life, the events of September 11

heralded a period of political volatility that

has lasted until the present day.

As well as sharing in the emotional

trauma of the destruction of the World

Trade Center, the insurance industry

shouldered much of the economic

burden. Insurers paid an estimated USd

23.8 billion, the most costly insured man-

made disaster ever and, at the time, the

second most expensive insured loss after

Hurricane Andrew.

The collapse of the World Trade

Centre was to show insurers and their

clients just how much the world had

changed. It highlighted a growing

global dimension to risk with more

interconnectivity than had been seen

previously—or in insurance terms,

demonstrating risk accumulation and

correlations previously unseen.

Interconnected risks The loss itself was highly complex,

leading to large claims for a number

of seemingly unrelated risks, including

aviation, property, liability lines, business

interruption and life insurance. In

addition, losses and potential exposures

were not confined to new York—airlines

were grounded, restrictive security

measures put in place and events were

cancelled throughout the US and around

the world.

The size and complexity of losses

were to make companies think differently

about risk going forward. Insurers had

suffered losses across different lines of

business and geographies, experiencing

unexpected correlations of risk. Also,

although the stock markets remained

reasonably robust in the aftermath of

9/11, the terrorist attack brought the

global economy to a grinding halt,

creating uncertainty for global equity

markets.

Insurers quickly realised that they

could no longer offer terrorism insurance

on the same terms as in the past. Once

offered as a blanket cover with property

insurance—and with little consideration

for price and accumulation of exposure—

terrorism cover was withdrawn by all but

a handful of specialist insurers.

The aviation and property insurance

The world at the turn of the twenty-first century was very different to that of 150 years ago, but many of the challenges remained

THe FIRST deCAde OF THe TWenTY-

first century played host to a series of

natural and man-made catastrophes.

It included two of the most costly

catastrophes ever, the terrorist attack

of September 11 and Hurricane Katrina

2011—events that raised many questions

also for insurer, highlighting the

magnitude of potential of losses and the

limits of insurability, the accumulation and

correlation of risks in a globalized world

and also the vulnerability of modern

society to large risks and its changing risk

perception.

The string of natural and manmade

catastrophes in the United States in the

first part of the twenty-first century had

global repercussions. It was a wake-up

call for the potential size and unexpected

nature of such exposures, as well as the

complexity and interconnectivity of risk in

the modern day world.

Risks on a truly global scale were

beginning to crystallise, with concerns

growing for the implications of climate

change, availability of resources and

the world’s aging population. The world

seemed to be more interconnected,

an issue resonating through all large

catastrophe events in the early twenty-

first century—starting with 9/11, followed

by the bust of the dotcom bubble, and

most apparent with the financial crisis of

2007/08.

The US insurance industry proved

relatively robust and financially strong

through all these crises—with some

isolated yet partially high profile

exceptions. Yet again, as had been the

case in 1906, the industry demonstrated

Interior of a lobby at the Swiss Re North American corporate headquarters in Armonk, New York State

Twenty-First CenturyThe Limits of Insurability

Modern Times

Catastrophes test limits of insurabilityThe world at the turn of the twenty-first century was very different to that of 150 years ago, but many of the challenges remained.

The first decade of the twenty-first century played host to a series of natural and man-made catastrophes. It included two of the most costly catastrophes ever, the terrorist attack of September 11 and Hurricane katrina 2011 – events that raised many questions also for insurer, highlighting the magnitude of potential of losses and the limits of insurability, the accumulation and correlation of risks in a globalized world and also the vulnerability of modern society to large risks and its changing risk perception.

The string of natural and manmade catastrophes in the United States in the first part of the twenty-first century had global repercussions. It was a wake-up call for the potential size and unexpected nature of such exposures, as well as the complexity and interconnectivity of risk in the modern day world.

Risks on a truly global scale were beginning to crystallise, with concerns growing for the implications of climate change, availability of resources and the world’s aging population. The world seemed to be more interconnected, an issue brought sharply into focus by the financial crisis of 2007/08.

Until the financial crisis, the US industry proved robust and financially strong through all these crises. Yet again, as had been the case in 1906, the industry demonstrated the true value of insurance as a mechanism for society and individuals to manage risk and cope with unexpected disasters.

Chapter Three

Insurers realised that they could no longer offer terrorism insurance on the same terms as in the past. Once offered as a blanket cover with property insurance—and with little consideration for price and accumulation of exposure—terrorism cover was withdrawn by all but a handful of specialist insurers

The 21st century

28 29

WORLD FINANCIAL CRISIS: Credit ContagionFoR THE GLoBAL BANKING SECToR THE FINANCIAL CRISIS oF

2008 was a catastrophe, and for the real economy it proved to be

the most severe decline experienced since the end of the 1920s

and 1930’s. Insurers, however, were better prepared.

They benefited from the measures introduced as a

consequence of dotcom bubble, which had made their asset

portfolios more robust against stock market volatility.

The Lehman crisis affected insurers quite differently to

investment banks. Insurers greatly differ from banks in terms

of their business model and regulation, and this helped them

weather the financial storm unleashed by the crisis in the US

subprime mortgage market and failure of Lehman Brothers in

2008.

The 2008 crisis demonstrated that insurers did not pose a

systemic risk and that they were not exposed to the same liquidity

issues as banks. Confidence in the insurance business model was

bolstered, but there were lessons for the sector, namely in the

areas of regulation and risk management.

The insurers caught in the financial storm of 2008 fell into

two camps – financial guarantee insurers and those that had

participated in banking-like activities, such as credit default swaps

and derivatives. However, the vast majority of insurers in the

United States and elsewhere, experienced few issues beyond the

impact of volatile investment markets.

Insurance regulation and industry practices require insurers

to hold capital in excess of their liabilities, often at a subsidiary

or local level. The industry business model, which sees premiums

paid upfront in return for a promise to pay valid claims, is not

exposed to the same liquidity risk of banks. While a bank can face

a run on deposits, policyholders are not so easily able to demand

a return of premium from an insurer.

However, the crisis had implications for insurers. It

alerted policymakers and regulators around the world to the

need for regulatory standards and increased cooperation

between supervisors. It also reinforced the need for better risk

management and governance, reflected in insurance regulatory

reform in both Europe and the United States.

The main regulatory response to the crisis in the United

States, The dodd–Frank Wall Street Reform and Consumer

Protection Act, bought about sweeping reform of banking, as

well as establishing a Federal Insurance office to collect data on

insurers and recommend changes to state regulation of insurance.

despite a tightening of regulatory oversight, the crisis

highlighted strengths in the insurer business model and showed

that insurers posed little systemic threat to the financial markets,

nor are they exposed to the same liquidity issues as the banks.

It also reaffirmed some of the fundamentals of reinsurance:

understand the underlying risks; challenge models that suggest

the future will follow the past and give due respect to improbable

‘black swan’ events.

markets, however, were quick to respond

with alternative solutions, and the

standalone terrorism market was borne.

Over time the standalone terrorism

market was to grow into a broader

product for terrorism and political

violence with a number of insurers

providing significant capacity. But in

2001 the world looked very different, and

very little cover was available, and what

limited insurance there was came at a

very high price.

In the immediate aftermath of

September 11, the threat of further

terrorist attacks was very real, but risk

was almost impossible to quantify. Swiss

Re and other US insurers emphasised the

need for terrorism exposures to be limited

and matched by adequate premiums if

the risk was to be transferred.

Insurers called on the government

to limit their exposures, enabling them to

offer more meaningful levels of terrorism

cover. The solution, the Terrorism Risk

Insurance Act (TRIA) was signed into US

federal law in 2002, providing a state

funded reinsurance backstop. Initially

TRIA was a temporary measure to allow

insurers to develop a long term solution,

but the Act has since been extended

twice and will next expire in 2014.

Confluence of lossesWhile the magnitude of the loss was

unexpected, so was the way insurance

contracts responded.

Claims made for the events of

September 11, 2001 highlighted

weaknesses in commercial insurance

contracts in the US and international

markets. The World Trade Center loss was

to lead to one of the biggest insurance

disputes of all time, forcing the industry to

change practices and contract wording

that had created such uncertainty of

cover (see box).

The destruction of the World Trade

Center was not the only issue for US

insurers and their reinsurers in the first

few years of the twenty-first century–

financial market volatility and the US tort

system were also causing immediate

concerns, while the ever present risk

of Atlantic hurricanes was also soon to

come into play.

At the close of the twentieth century

the US insurance industry was still reeling

from the liability crisis, which had caused

many carriers to increase their reserves.

Asbestos claims had yet to hit their

peak, and the US tort system and a

THE WTC LITIGATION: The Industry’s Largest DisputeTHE dESTRUCTIoN oF THE WoRLd TRAdE CENTER SPARKEd A MoRE THAN FIVE YEAR

coverage dispute, the largest single insurance dispute in history, between the building’s

leaseholder, Larry Silverstein and its insurers.

The collapse of the World Trade Center led to a number of disputes, with differing

results.

A risk as large as the World Trade Center required a number of insurers and reinsurers

to provide the huge sums insured. In fact, the WTC was leased by the New York real estate

developer Larry Silverstein in July 2001 and insured for $3.5 billion with 22 insurers.

However, when the terrorist attack of 9/11 happened, the contract wording for the

insurance policy had not yet been finalized and the various insurers, which were already on

the risk, used differing policy wordings, some of which provided more clarity than others.

Contract wording around whether the terrorist attack on the twin towers of the World

Trade Center constituted a single insured event, or two separate events, would prove crucial

to how much insurers would eventually pay.

The leaseholder, Larry Silverstein, claimed that insurers owed $7 billion, although in

2004 two federal juries said Mr Silverstein was entitled to a maximum of $4.68 billion in

insurance payments.

Led by Swiss Re, which had written a quarter of the $3.5 billion of insurance property

cover for the World Trade Center, a group of insurers finally won their case when a New York

jury confirmed the attack was one, and not two events, as the building’s owners claimed.

In separate trials a further nine insurers that had used different policy language, were

found to owe double their policy limits.

The dispute rumbled on for a further two more years as the two sides debated the value

of the WTC buildings at the time of its destruction.

In 2007, Swiss Re and six other insurers reached a settlement that finally concluded

the dispute. Insurers were to pay $4.5 billion towards the cost of rebuilding the World Trade

Center site.

one of the issues highlighted by the dispute was the differing contract wording used by

insurers, as well as practices that meant that insurance policy documents were often issued

sometime after contract inception.

In the case of insurance for the WTC, which Mr Silverstein had leased just weeks before

the attack, terms were still being finalised with some insurers at the time the loss.

The disputes surrounding the WTC loss led to an insurance industry initiative,

encouraged by regulators such as the UK’s Financial Services Authority, to improve contract

certainty.

Insurers pledged to ensure that all wordings and terms were agreed before policy

inception and that policy documentation must be issued within 30 days.

30 31

MERGERS & ACQUISITIONS: Larger Insurers, But Often Still Fragmented Market

IN 2006 SWISS RE ACqUIREd GE INSURANCE SoLUTIoNS FoR

$7.4 billion, the largest reinsurance deal of all time. The transaction

propelled Swiss Re to the number one position, making it the world’s

largest and most diversified reinsurer at the time.

The acquisition of Kansas City-based GEIS added new clients

and products to Swiss Re’s offering, reinforcing its leading position in

the US reinsurance market. The acquisition was one of the last of the

mega-acquisitions that had marked three decades of consolidation

among the country’s reinsurers and commercial insurers.

Today the US market remains relatively fragmented, but it has had

several periods of consolidation, most recently in the 1990s.

The late 1980s saw the start of a period of heightened mergers

and acquisitions, a trend that would also see many US mutual

companies revert to stock companies or succumb to acquisitions. The

flurry of activity saw one of the largest US insurers, Travelers Group

Inc., merge with US bank Citicorp in a deal worth some $72 billion in

1998. In 2001, American International Group, Inc. purchased American

General Corp for $23 billion.

Foreign insurers were also part of the consolidation, with

companies like Germany’s Allianz buying Fireman’s Fund and North

American Life and Casualty, and Switzerland’s Zurich Financial

Services acquiring Farmers Management Services, Universal

Underwriters Insurance Group and Kemper Corp.

The US reinsurance market underwent consolidation as the sector

became more global. US reinsurers acquired European companies

while European companies made purchases in the United States.

Between 1995 and 1998, some 50 reinsurance deals were

completed in the United States, including the acquisition of American

Re by Germany’s Munich Re. Swiss Re played its part too in the

consolidation, completing 18 deals between 1990 and 2007 valued at

a total of $16.5 billion.

Acquisitions have long played an important role in Swiss Re’s

journey to the top. In the 1990s Swiss Re struck a number of deals,

mostly acquiring life reinsurance companies in the United States.

Between 1995 and 2001 it purchased four major US life reinsurers,

increasing its market share to over 25%.

In 1996 Swiss Re acquired Mercantile & General for CHF 3.2

billion, a London-based reinsurer with 80% of its business in life and

health reinsurance, mostly in America, the United Kingdom and Asia.

Two years later it acquired Life Re, making Swiss Re the largest life

reinsurer in the United States –, followed by the Fort Wayne, Indiana-

based reinsurance arm of Lincoln National Corp, further extending its

market share to 30%.

Swiss Re also made a number of acquisitions to build its property/

casualty and financial services businesses. In 1999 it acquired

Fox-Pitt Kelton, which gave Swiss Re experience and capabilities of

investment banking at a time when capital markets were converging

with reinsurance. In the same year Swiss Re completed the purchase

of Underwriters Re, a subsidiary of Alleghany Corp., which also had a

strong position in alternative risk transfer products and the brokered

reinsurance market.

These, acquisitions, including the purchase of asset manager

Conning Corp in 2001 and the deal to buy GEIS in 2006, made Swiss

Re a much more American company, both in terms of its geographical

spread and the influence of the US business and personal throughout

the group.

3 billion.

The double whammy of 9/11 followed by

the burst of the dotcom bubble made some

insurers, and european reinsurers in particular,

embark on an accelerated program to bolster

their risk management, governance and asset

management. Systems to manage accumulations

of risk and manage asset liabilities were

enhanced, and the first economic models were

developed.

The massive losses of September 11, 2001,

and the bursting of the dotcom bubble came

at the end of a so-called soft market. A period

of low rates and increasing liability claims had

started to eat into the profits of US insurers, and

rates for commercial lines had started to increase.

The losses of September 11 accelerated this

trend, and almost overnight the cost of insurance

increased significantly.

The hardening market for insurance helped

restore profitability for US insurers, but within four

years the market was to face its second major

catastrophe.

Hurricane Katrina first made landfall as a

Category 1 hurricane in Florida on 25 August

before again making landfall on 29 August in

Louisiana, 110 km south east of new Orleans,

as a strong category 4 hurricane. Katrina caused

massive damage to new Orleans, the 24th

biggest city in the US at the time, before moving

inland to cause vast devastation in mississippi,

Alabama and Tennessee.

Winds of up to 240 km/h followed by heavy

rainfall left behind a trail of destruction. The storm

and tidal surge overwhelmed new Orleans flood

defences. Some 1,800 people were to lose their

lives and the industry absorbed massive losses

from damage to commercial and private property

as well as infrastructure and offshore oil rigs in the

Gulf of mexico.

At the time Hurricane Katrina was the most

expensive catastrophe ever recorded, with total

damages of USd135 billion. It has since been

surpassed by the 2011 Japanese earthquake

which caused USd 210 billion in damages,

although Katrina remains the most expensive

insured loss at USd 74.7 billion.

Swiss Re’ losses from Hurricane Katrina

alone were USd 1.2 billion, again demonstrating

the reinsurer’s ability to absorb the impact of

exceptionally large catastrophes, a core function

of a leading reinsurer.

In what was to prove an exceptional year for

US insurers, Hurricanes Wilma and Rita caused

that was to burst in 2001.

The subsequent turmoil, prolonged

by September 11 and the ensuing

political uncertainty of wars in

Afghanistan and Iraq, hit the investments

of insurers and reinsurers, causing many

to write-down the value of assets and

reduce their exposure to equities.

The bursting of the dotcom bubble

also made insurers and reinsurers

re-evaluate their asset portfolio mix in

favour of less risky investments such as

government bonds. In the run-up to the

stock market boom, some insurers had

become overweight in equities—as high

as 30% of portfolios in some cases—but

after the bubble burst, many insurers

reduced their equity investments to

below 5%, while some ceased investing

in stocks completely.

Just as insurers were digesting the

billions of dollars in claims associated

with September 11, 2001, investment

returns turned to investment losses.

Double whammyFor Swiss Re the tragedy of the World

Trade Center led to its largest loss in its

138 year history and contributed to its

first net loss (CHF 165 million) since

1868. Like other reinsurers it suffered

from the accumulated losses from

different lines of business, including

property, aviation, liability, accident

and life—all leading to combined losses

related to 9/11 in the magnitude of CHF

competitive insurance market were now

also causing problems for other liability

lines. While still paying millions of dollars

for asbestos claims, many insurers

were now also finding that class action

lawsuits and securities actions were

generating an unexpected volume of

claims for professional lines like directors

and officers insurance.

Bursting of the dotcom bubbleFinancial markets were the other big

issue for insurers to contend with in the

volatile first decade of the twenty-first

century. The promise of huge efficiencies

and new business models from the

Internet caused a stock market bubble

THE CAPTIVE CoNCEPT HAS BEEN

ARoUNd FoR A LoNG TIME, and is not

too distant from the collective efforts of

Europe’s marine underwriters of the 1500s

and the mutual insurance companies

formed by particular industries to provide

insurance coverage in the 1700s.

A captive insurer is a company formed

to insurer the assets and liabilities of

an entity, however captives can also be

used to insurer the risks of associations

of organisations or groups of companies

that share similar risks. Specific captive

legislation can differentiate captive insurers

from commercial carriers, often simplifying

rules and regulations.

The term ‘captive’ was first coined in

the 1950s by Frederic M. Reiss, a property

engineer turned insurance broker in ohio.

Mr Reiss, who is generally regarded as

the father of captive insurance, began

assisting corporations in setting up captives

in 1958, mainly in offshore jurisdictions

like Bermuda, although Cayman Islands,

Barbados and Guernsey are now also

popular captive domiciles, with many

countries in Europe, Asia and the Middle

East joining the list in recent years.

US regulations made it prohibitively

expensive to form a captive in the United

States up until the 1970s, when US onshore

captives started to become a viable option.

Bermuda has traditionally been the

domicile of choice for US companies,

although changes in tax and insurance laws

in the 1970s and 1980s have kick-started

the on-shore captive industry.

In the 1970s, the first laws were

passed to encourage captive formation in

Colorado, and then Tennessee and Vermont.

According to the National Association of

Insurance Commissioners, the number of

captives has nearly doubled in recent years

as an increasing number of states have

passed, or modified, captive legislation.

With close to 500 captives, Vermont, is

the largest onshore captive domicile in the

United States, followed by Utah and Hawaii.

Initially captives were slow to take off,

but the liability crunch of the 1980s and the

hard market following the terrorist attacks

in the US in 2001 were major catalysts in

their development. Captives are typically

used to retain risks, covering high frequency

and low severity exposures such as property

and motor. However the can be used to

retain risks for which insurers have limited

appetite, or when pricing levels spike after a

major event.

Today captives are held by the vast

majority of Fortune 500 companies,

particularly in the finance, real estate,

construction and manufacturing sectors,

and more recently there has been growth in

the use of captives by health care, property

companies and life insurers.

There are now more than 5,000

captives globally compared with

approximately 1,000 in 1980. More

than 1,000 captives are domiciled in the

United States, with a further 3,000 in the

Caribbean and 1,200 in Europe and Asia.

(Source NAIC January 2012 http://

www.naic.org/cipr_newsletter_archive/

vol2_captive.htm)

The move towards higher retention

levels in the liability crisis had important

long-term implications for US and foreign

insurers.

Although lacking in the diversification

benefits the insurance industry as a whole

can bring, captives and other retention

vehicles have proved an attractive and

effective way to manage high frequency

and low severity risks, particularly in

combination with loss prevention and risk

management measures. They are also

used by high risk industries like energy and

pharmaceuticals to fund infrequent but

potentially high-cost events like a major

pollution event or a product recall.

Reinsurers were particularly active

in helping companies self-insure by

transferring unwanted risks as well as

providing protection against the potentially

most damaging catastrophe losses.

DEVELOPMENT: Captives

32

AND FINALLY: Still The Place To BeTHE US INSURANCE MARKET REMAINS THE LARGEST ANd MoST

influential in the world, reflecting the dominance of the country’s

economy, its prosperity and affluence, its innovativeness, but also aits

exposure to large risks and contagion.

The market is also one of the most sophisticated, being the home

to, and the source of the majority of insurance and risk management

innovations of the past 150 years. Whatever events affect the US, they

carry a larger weight and reverberate around the world, potentially

altering cost, processes and products.

In itself, the United States remains a challenging market,

characterised by its exposure to natural hazards, a still fragmented

state based-regulatory regime, and a legal system that favours

consumers to the huge cost to business and their insurers.

Throughout the history of the US market, foreign insurers and

reinsurers have played a crucial role in supporting US business and

society. The country’s exposure to natural hazards – including some

of the world’s largest potential hurricane and earthquake losses –

requires the capacity and expertise of global reinsurers like Swiss Re.

From the San Francisco earthquake of 1906 to Hurricane Katrina

in 2005, reinsurers have been central to helping the US absorb the

shock of such disasters, helping the country bounce back and continue

to thrive. However, the catastrophe threat remains a major challenge

for the US insurance market, as an increasing number of people are

drawn to hurricane and earthquake-prone states. In addition to the

value accumulation in these regions, climate change further aggravates

the risk by potentially increasing the frequency and severity of natural

catastrophes.

The US tort system, while having undergone some reform in

recent years, also poses an on-going challenge to the insurance

industry, as does the potential for government and the courts to

reinterpret established industry rules and practices. Following 9/11

the US government moved to limit the liability of airline carriers, while

following Hurricane Katrina insurers were encouraged to settle claims

for flood damage.

While proving to be a testing market for reinsurers, the US

insurance sector has been instrumental for the growth of Swiss Re,

and likewise Swiss Re become an intrinsic part of the US market,

having taking part in all the major events of the past 150 years.

For almost all of its history Swiss Re has been close to the heart

of the US insurance and reinsurance market, supporting property/

casualty and life insurers through both good times and bad. over this

time Swiss Re has itself become a more international company, and

grown into the leading provider of reinsurance capacity and expertise

for the US market.

a further USd 35.6 billion of insured damage,

and followed on from the USd 25 billion bill for

Hurricanes Ivan, Jeanie, Francis and Charley in

2004.

Hurricane landfall activity after 2008 abated,

but a new storm was about to break in the form of

the US and european banking system.

Financial crisisThe banking crisis of 2007 and 2008 started in

the US sub-prime mortgage market but quickly

spread to major banks in the United States and

europe. Culminating in the collapse of investment

bank Lehman Brothers in September 2008, the

crisis spilled over into the broader economy as

the worst recession in decades.

One of the major features of the crisis was

to be the damage caused by trading in Credit

default Swaps, credit insurance that took the

form of derivatives contracts. The CdS market

had grown astronomically in the years leading up

to the crisis, with many banks and some insurers

holding significant exposures.

American International Group (AIG) was a

big player in the CdS market and counterparty

to Lehman. The bankruptcy of the investment

bank threatened to drag AIG down with it, but a

last minute bailout saved the then world’s largest

nonlife insurance company.

most US insurers managed to successfully

navigate the financial crisis, although six life

insurers –Hartford Financial, Lincoln Life, Principal

Financial, Allstate and Prudential Financial sought

assistance from the US governments Troubled

Asset Relief Program.

While insurers did suffer from the extreme

financial market volatility following the collapse of

Lehman, insurers more conservative investment

strategy and lessons learnt from past stock

market turmoil meant that most US carriers came

through the crisis unscathed.

US insurers also escaped the same liquidity

issues that paralysed the banks—insurance

premiums are typically paid upfront and are not

subject to the demands of policyholders, other

than to pay claims.

Overall losses were only one-sixth of those

suffered by the banking sector. And while a

handful of insurers received state aid, some 592

banks were to require federal funds.

Swiss Re refocuses

Swiss Re was also caught in the financial

storm. Beyond the fall in share price and assets

classes experienced by most other insurance

players, Swiss Re had to report losses related to

two credit default swaps. The company reported

a CHF 11.4 billion reduction in in shareholder

equity on investment losses and a loss of CHF

864 million for 2008.

despite challenges, Swiss Re emerged from

the crisis as a leading reinsurer, a tribute to the

strength of Swiss Re’s core reinsurance business

and its solid client base. The company benefited

from a USd 3 billion investment provided by US

investor Warren Buffet’s Berkshire Hathaway. The

investment was seen as a sign of confidence in

Swiss Re and its actions taken during the crisis.

The company moved to de-risk its investment

portfolio and refocused its business on its core

property/casualty reinsurance, life reinsurance

and corporate solutions. The Financial Services

Business was disbanded and split into asset

management and legacy business.

Swiss Re was back reporting profits in 2009,

and in november 2010 the company repaid

the loan from Berkshire Hathaway in full. It was

finally able to put the financial crisis behind when

Standard & Poor’s acknowledged the progress

made by the company and upgraded the financial

strength ratings to AA+.