COMMENT: LMX spiral – back to the future?

COMMENT: LMX spiral – back to the future?

I’ve been looking through the last 30 years of Reactions as we prepare to mark its birthday in April with a special issue of the magazine. It has meant being reminded of some of the industry’s low and highpoints, of which there seem to be more of the former than the latter. Maybe that’s a journalist’s view.

But the catalogue of human suffering through the years, even when seen through the filter of “industry losses” is deeply moving, especially at a time when the extent of the catastrophe in northern Japan is just beginning to unfold.

When the world suffers, the industry usually suffers with it. That’s a seemingly trite observation, but the fact is that the industry is unique because it has a direct line to every sort of catastrophe, from windstorms to earthquakes all around the world. That includes manmade catastrophes as well.

Anyway, back to the future.

I recently attended the Association of Run-Off Companies’ annual meeting in London and heard some interesting papers on the state of the so-called legacy sector: a funny niche business because its future depends on events creating insurer carrion.

One conference paper that stood out, because it chimed with what I had been reading about in Reactions’ archive, was to do with the potential for an LMX-type spiral to re-occur. Speaker John LaBarbera of the US law firm Cozen O’Connor voiced the opinion that looking back at the original phenomenon, the conditions could be right for a second coming of the spiral.

The term LMX spiral refers to the concentration of risk that occurred within the London market prior to the mid-1990s when, by writing retrocession business, re/insurers unwittingly ended up reinsuring themselves. The spiral unravelled when the industry was hit by big claims from the energy industry following the Exxon Valdez oil spill in Alaska (1989) and the Piper Alpha North Sea offshore platform disaster (1988).

LaBarbera argued that the Deepwater Horizon catastrophe and climate change could be the environmental double whammy that creates a new spiral. He believes that among the drivers of a potential XL spiral today are that insurers are facing risks across multiple lines of coverage (D&O and first party liability) relating to environmental impairment, sudden and gradual. Meanwhile third-party liability claims are building outside the Gulf Coast Claims Facility.

These claims are building against a background of consolidation of the reinsurance market and there’s a risk of insolvencies creating a break in XL layers, he said.

On the potential for climate change related claims, citing an article in Nature magazine, LaBarbera said that severe worldwide weather events could be proved to be causally related to global warming and climate change issues. Several lawsuits have already been brought in the US seeking recovery for injuries allegedly caused by carbon emissions, notably around Hurricane Katrina.

“There’s simply insufficient risk dispersal and claims could circulate among a small number of reinsurers,” LaBarbera reckons, quoting recent research that said 92.6% of US reinsurance premiums in 2008 were written by only 10% of reinsurers.

He thinks it is still too early to know if a spiral is in the making and he expects it to take five years for liability claims around Deepwater to emerge and threaten companies with insolvency. He also added the important caveat that reinsurers may have improved their risk management controls since the original LMX spiral.

It would be nice to think re/insurers have learned from experience. But who knows how the Gulf oil spill will play out in the courts? Who could have foreseen litigation related to climate change only five years ago? As Marty McFly famously said in the movie Back To The Future: “History can change.”

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