If everything had gone to plan, the New York Insurance Exchange would have celebrated its 30th birthday at the end of March this year. The exchange opened in downtown Manhattan amid high hopes on March 31 1980. It was set up in response to demand for more flexible insurance cover following a capacity crisis in the US property/casualty industry in the mid 1970s.
It was originally conceived as a reinsurance exchange and was set up at the same time as the New York Free Trade Zone, which allowed licensed insurers to write hard to place risks free from rate and form restrictions.
Under legislation enacted at the end of the 1970s, syndicates on the exchange could write reinsurance, direct insurance on risks outside the US, surplus lines on business from outside of New York and risks rejected by New York’s Free Trade Zone insurers.
“The legislation that was enacted, which I remember very clearly because I was practicing in New York at the time, I thought was sound legislation and created the basis for a sound platform,” says Nick Pearson, partner in the insurance and reinsurance department at Edwards Angell Palmer & Dodge in New York.
But, from the start, the exchange had a number of things going against it. The biggest problem was the timing, which stunk. By the time the exchange was up and running a severe soft market had taken hold.
“Unfortunately the timing was horrible because the market was incredibly soft and the New York insurance exchange in trying to put business on its books took business that in retrospect it never should have written,” says Pearson.
Don Kramer, chairman of Bermudian reinsurer Ariel Re, recalls just how hairy the losses got in the 1980s. “I had what a called a 5, 4, 3, 2, 1 ratio,” he said at a Reactions US business club in January. “I said if you wrote business in 1980, then you are going to have a 500% loss ratio – or you were lying – 400% in 1981, 300% in 1982 and so on. By 1986 it went just the opposite way. I remember in 1986 we put up about a 65% target loss ratio. With 20 years hindsight it never developed past 28%.”
The exchange never got the chance to benefit from the resulting hard market.
It overwhelmingly wrote reinsurance. Peter Bickford, who was vice-president, general counsel and secretary of the original exchange and is now a consultant, says a study commissioned by the exchange’s board in 1982 predicted that the exchange would become an important reinsurance player with projected premiums of $1.2bn by 1986 and $5bn by 1991.
Business did grow quickly the first few years, with the $346m of premiums written in 1984 making it the eighth largest reinsurer in the US by premiums. The number of syndicates grew to 35 active syndicates by the end of 1984 from 16 when the exchange opened.
But in 1985 volume dropped to $310m from $345m, while loss ratios increased rapidly. In November 1987 the writing of new business on the exchange was suspended. A total of 50 syndicates wrote more than $1bn on the exchange.
Aside from bad timing, the exchange had calamitous structural issues. One problem was that syndicates were backed by US insurers who had little need for the exchange.
“At the time we didn’t have a non-traditional insurance industry that we have today,” said Kramer. “In those days you had the big admitted companies and you had very few offshore companies. Bermuda hadn’t yet flowered and Lloyd’s was going through its time of difficulties as well. So the people that joined the insurance exchange were all the fully licensed companies that had access to the market – it was Travelers, it was AIG, it was INA, it was Reliance. It was all these companies and they didn’t need the exchange. They were licensed everywhere and the exchange had no value to them.”
He adds: “My own syndicate was a Machiavellian scheme on my part to emulate Lloyd’s. I created a corporation that was taxed as a partnership so the underwriting losses could be against ordinary income, which in those days was at a higher rate. So I was trying to arbitrage the tax advantages. None of which worked. We got clobbered.”
Andrew Barile, a reinsurance consultant who worked as a broker at the exchange, said syndicates were competing with their own companies.
“You had a lot of friction,” he recalls. “As a broker I would bring business into that room or I could bring it out to the street and have a competing firm that was owned by the same parent. For instance, the AIG syndicates would compete with AIG. You’d go to 70 Pine Street and work with them or you would go into the exchange and you would get a different quote from the AIG syndicates.”
Barile worked at Lloyd’s before the exchange. He says Americans never got their head around the concept of following markets.
“They had a lot to learn, it was a big learning curve for Americans to understand the whole philosophy, especially the ones that had never worked in London,” he says. “We still had a lot of problems in those days with following markets. They would think that the lead is their competitor so they are not going to follow him and don’t like him. They didn’t have any of that kind of culture that Lloyd’s had.”
The market came to be seen as a dumping ground for bad business.
“The board members at the exchange were all the top persons in each of these entities and they all had syndicates on the exchange,” says Bickford. “That was considered part of the problem eventually because it was viewed by many people outside the exchange as these big players were just using the exchange for the risks that they couldn’t place anywhere else. And that contributed to the undermining of the exchange as a facility. I don’t buy into that theory totally but there are elements of it.”
Bickford charted the rise of the fall of the exchange in a white paper he put together in 2004 called What Ever Happened to the New York Insurance Exchange (And Why Do We Care?).
Barile says brokers tried to get their bad risks written on the exchange, and often succeeded. “Every underwriter knows when they open the doors on a new operation they are going to be inundated with stuff that could never get placed in the first place,” he says. “That’s the heart of a great broker, to say: ‘Let’s go in the bottom drawer first, take the garbage out and see if they write it.’”
Bickford says the exchange needed more stringent oversight. In August 1986 five syndicates were declared insolvent. Five more insolvencies followed.
“You had a situation where the reaction to syndicates overwriting their capital ability didn’t occur,” says Bickford. “It became clear to a lot of people that there were syndicates that were overwriting their capital ability and if steps had been taken to stop that from happening, by shutting syndicates down or imposing what today would be risk based capital requirements – those didn’t exist then – that the insolvencies would not have gotten to the point they got to.”
The exchange may have turned out differently if it had written a broader range of business. New York’s insurance department is hoping that a revived exchange will write surplus lines business as well as reinsurance. This approach may have helped the original exchange, which didn’t get the full authority to write surplus lines until the end of 1982.
“By the time the exchange started getting the approval as a recognised surplus lines carrier the tide had started to turn so that side of it never really got going,” says Bickford. “Whether it would have made a difference or not, who knows? I tend to think it would have because the problem with the reinsurance business was it wrote a lot of these high end excess treaties for nothing on the idea that those layers will never be hit. And of course we all know what happened to those high layers. It even happened to Lloyd’s.
“The surplus lines direct business is a much lower dollar exposure per risk. So if it had ever got traction on the surplus lines side it might have made a difference.”
“If they had run the exchange as efficiently as they closed it down, it never would have failed."
Peter Bickford, who was vice-president, general counsel and secretary of the original exchange and is now a consultant
Once things started going wrong, the exchange was quickly shut down. Management was quick to throw in the towel. But Bickford says not all syndicates were dong badly.
“There was a core group of syndicates that actually were doing very well on the exchange,” he says. “It is just that when they had their problems of the insolvent syndicates they basically folded their tent. They didn’t try to fight for it. Those that wanted to continue were a minority voice and didn’t have the ability to force the board to continue the exchange.”
Bickford says the syndicates that wanted to continue were not the big name companies. They were more the entrepreneurs and a few foreign companies that gave independence to their managing company on the exchange.
“They were doing it he right way but there weren’t enough of them,” says Bickford. “And in the end it was the big guys who said: ‘Well, this didn’t work. Let’s shut it down.’”
Once the exchange was closed to new business, its liabilities were swiftly dealt with. Seven of the 10 insolvent firms were liquidated, while three were rehabilitated under court-approved plans. The other syndicates withdrew from the exchange with their liabilities being moved elsewhere.
“If they had run the exchange as efficiently as they closed it down, it never would have failed,” says Bickford. “Once they decided to close the facility at the end of 1987 they managed to get all the facilities to withdraw having their risk assumed by other entities, either upstreamed or by some other entities, by about the end of 1989.”
The exchange management was quick to shut operations down and they were quick to rid itself of troubled entities. Syndicates tried to negotiate commutations and other arrangements with cedants to avoid liquidation, to no avail. One idea that appeared in similar form a few years later was also mooted.
“There was a proposal put forth to the court in a couple of the insolvencies suggesting a Syndicate 101 to wall off the old liabilities of the insolvent syndicates so that the good ones could continue in the market, with contributions from the security funds and so on, which in fact with variations was what Equitas ended up being at Lloyd’s,” says Bickford. “But that was rejected by the exchange. They simply turned everything over to the department for liquidation.”
Given the short and messy life of the original exchange it is easy to see why some are wary of moves to revive an exchange in New York. Some may question the need to return the New York market to a time when Michael Douglas was declaring ‘Greed is good’ as Gordon Gecko in Wall Street.
However, just as Douglas is reprising that role this summer in Wall Street 2, it seems another comeback after many years may be possible. The result could be the rebirth of the New York insurance market as a hub for business.
In the 1980s New York’s financial district was populated by many insurance firms. But since the exchange shut down most left, either through acquisitions or moving to neighbouring states and even further afield.
“When I first started to practice in the late 1970s, downtown New York still had a fair number of insurance companies headquartered there,” says Pearson, “which is why I think it would be really interesting if the exchange did function from a single building and had underwriters available and the brokers could go around and get their risks signed up. I think it would be a great thing.”
Ken LeStrange, chairman of Bermudian insurance and reinsurance firm Endurance, also worked in New York then.
“When I started working in New York in 1980 down on William Street, it was an insurance neighborhood, similar to what we see in Hamilton in Bermuda and the City in London,” he told Reactions. “Within a few blocks there were dozens of insurers and reinsurers. While it wasn’t a market per se, it functioned as a marketplace because there was a lot of talent and a lot of capital in a tight geography. So if one were to replicate that in downtown or midtown New York City, it certainly would be good economically for the city as it would draw people back that have been dispersed into the three states around it.
“So for certain types of risk that are really talent intensive, an insurance exchange would be good economically for New York.”
By Michael Loney - firstname.lastname@example.org
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