“Why take the risk?” some ask, “let’s take the risk.” The magic word insurance spread like a flash among those who had some assets in the 19th century, and once there, insurance became a constant in the thinking and actions of a large part of the population. Closely linked to the concept of insurance is, of course, the insurance company, i.e. the company with which you sign an insurance contract, to which you pay a premium and, if something happens that you have insured against, you get paid the agreed insurance premium. This insurance premium is, in fact, nothing more than an instrument, or rather the daughter of the insured capital.
The word capital and its insurance can be immediately linked to the Industrial Revolution in Britain and the rise of its maritime power, which is marked by the year 1588. It was then that the English defeated the ‘invincible armada’ of King Philip II of Spain off their shores. From that moment on, the flags of English warships and merchant ships flew on almost every sea in the world. But the year 1688 was a turning point, a hundred years after Britain became the world’s first naval power.
At that time, a Welshman called Edward Lloyd ran a café in the City of London where merchants, shipwrights and bankers regularly gathered. It was also a time when there was a growing need for the type of insurance for which Lloyd’s is still world famous today: marine insurance. At that time, marine insurance was still relatively unknown in the UK, but it had been known in Mediterranean countries since ancient times. In the early days, even English insurance terminology had its roots in the insurance texts of the Italian maritime republics of the time, among which Genoa played a particularly strong role. The earliest insurance policy issued in London in 1547 is even written in Italian.
The then Lloyd’s Coffee House, which stood not far from the company’s present headquarters on Lime Street, soon became the most famous meeting place for those businessmen who were willing to invest money to cover the risk of shipping for a reasonable premium. The decisive and important point was that these private individuals had to bear the unlimited risk of insurance and be liable with all their assets. Lloyd’s News was also published from 1696 onwards and in 1702 published for the first time an annual list of ships that had sunk or disappeared. This was so important that from 1740 onwards the paper was even published weekly.
Some of that tradition can still be seen today: in the middle of the futuristic main space of the Lloyd Building stands the ship’s bell, the iconic “Lutine Bell” from the frigate that sank in the North Sea in 1799. The frigate was left underwater, but the bell was pulled out to dry land. It is said to have had a double symbolic meaning. Firstly, it is a reminder that insurance evolved from marine insurance and that this was Lloyd’s flagship business for two centuries. And its fatal ringing reminds us that the insurance business is a high-risk business. One strike of the bell of the “Lutine Belle” means good news, two bad, or rather the loss of a ship.
Eventually, Lloyd’s began to write contracts and pay premiums that had little to do with insurance itself and were more like betting. This led some Lloyd’s members to set up New Lloyd’s Coffee House in Lombard Street in 1769, where they underwrote marine insurance only.
For centuries, membership of Lloyd’s was restricted exclusively to individual natural persons or “names”, i.e. people who had a suitable position in British society and could take on the financial risks associated with insurance, risks that few could afford. It was not until 1994 that Lloyd’s was also able to attract so-called “corporate members”, who had invested a limited amount of their capital in Lloyd’s and were not liable for the loss with all their assets.
There have long been two categories of “names”, which were limited to 32,000 members in 1989. “External members are limited by their capital function. The second category is the “working members”, which are no more than 500 and invest their own capital in the company and decide which risks the company will take and for what premium. It is also extremely important that the “names” must provide a bank certificate that their assets are not less than £250,000.
Interestingly, until the 20th century, fire insurance, which played a very important role in insurance companies in other countries, did not attract much interest at Lloyd’s. In the 20th century, however, this view was radically changed and diversification of the insurance business became an important part of the management’s plans. Thus, in the same year as the sinking of the Titanic, Lloyd’s was the first to underwrite a civil aviation insurance contract.
But the years have only done their work. Lloyd’s members have slowly fallen asleep, living in the firm conviction that their investment in the insurance industry is not only profitable, but also impervious to any risk. So in 1988 – the 300th anniversary year of its foundation – it came as a bolt from the blue that the accounts showed a loss of £500 million. By 1992, it had risen to £8 billion.
Such poor performance, which was already on the brink of survival, had its causes, of course, because during those years there were a series of major natural disasters, mainly fires and pollution tragedies, such as the one when the Exxon Valdez spilled a huge amount of oil into the sea. Seven years after the Exxon Valdez ran aground near Alaska and caused the world’s biggest environmental disaster with its oil spill, an agreement was reached with insurance companies to pay out USD 480 million. Exxon Corporation was reimbursed a total of $780 million, although it claimed to have incurred as much as $2.5 billion in costs.
Eugene Anderson, whose law firm represents all major corporations in disputes with insurance companies, said: ‘Insurance companies deliberately deny all large claims from the outset. In the end, it all comes down to a compromise and an insurance payout that is much smaller than the claim.”
Lloyd’s was involved in the insurance of all these disasters. It was also during this time that some tragic events occurred for them. They were suitably hyped up by the press, so that Lloyd’s reputation was thoroughly tarnished. One such event was the case of a widow who mortgaged her house to join Lloyd’s and, after a profitable first year, had to sell the house the following year to cover the debts of a poorly performing company. After that, she lived on social assistance.
The plane crashed
There are hundreds of thousands of registered aircraft in the world, including tens of thousands of passenger aircraft. For insurers, aviation is a relatively modest insurance market, quite complex and fraught with risk given the potential for aviation catastrophes, but very profitable nonetheless. Claims are dominated by those resulting from coffee spilt on clothes during a turbulent flight or lost luggage. Such cases are of no concern to insurers. But they do become concerned when a plane crashes, because such accidents are never without human casualties. It is a well-known fact that, in terms of passengers and kilometres flown, aircraft are still the most reliable means of transport. Nevertheless, a good number of people have a panicky fear of flying, because sometimes planes really do fall out of the sky, and the images shown in the media of these accidents are not very pleasant for sensitive stomachs.
In 1995, a small Embraer 120 crashed west of Atlanta, USA. Five passengers lost their lives and the total insured loss was estimated at 82 million dollars. In the same year, a Boeing 737 owned by a Cameroonian airline crashed into an African swamp. 74 passengers were killed. In this case, the insured damage was estimated at only seven million dollars. It is easy to calculate how much more the life of each passenger on the American plane was worth than that of the Cameroonian one.
Careful readers might wonder how it is possible that in such accidents the compensation for a single passenger can run into millions of dollars, when the airline ticket says, in English only, that the carrier is liable under the Warsaw Convention for death, personal injury or other damage to health up to a maximum of $75,000, including legal costs. However, there is no mention in this text that the compensation in the event of negligence or carelessness on the part of the carrier is recalculated.
The Warsaw Convention was adopted in 1929, when aviation was still in its infancy, and the level of financial compensation was never in question. Those who wanted to win more had to accept from the outset that they would lose. Structural defects and poor maintenance could not be successfully proven at that time. The public also had a different view of passenger aircraft flights than today. Those who boarded had to be aware that they were taking a risk, and if they lost their lives in the process, they were joining the ranks of the victims of the new age of human mobility.
Over the years, however, some of the provisions of the Warsaw Convention became obsolete and were therefore supplemented by the Hague Protocol in 1955, while the Montreal Convention, adopted in 1999, brought even more changes to the compensation of victims of air accidents.
World War II already saw an explosion in aviation and aeronautical technology. But the real boom for passenger transport began in the 1950s, when insurance companies reorganised themselves accordingly and aircraft reinsurance became almost the norm. In 1952, for the first time, an insurance company had to pay out more than the amount written on the airline ticket. The case attracted a lot of attention not only in the insurance industry but also in the public.
A widow whose husband lost his life along with 34 passengers when a plane crashed on a flight from Miami to New York sued National Airlines. Her lawyer succeeded in proving that the DC-6 had been poorly maintained and the court awarded the widow $165 000 in damages. As a result, the relatives of the other victims of the crash also came forward and demanded more compensation than the original amount. A so-called “aircraft business” developed. The law firm that first started this business is still in existence today and still handles claims in aircraft accidents.
This ushered in a new era in the insurance industry, as insurers had to rework their policies and premium calculations to cover not only passengers’ claims in the event of an accident, but also the cost of acquiring new, increasingly expensive aircraft. Today, a new wide-body aircraft costs more than $200 million. Airlines are therefore asking insurers to cover the risk with appropriately high policy limits. It is therefore not unusual for an insurance company and an airline to agree on a $250 million or more casco policy.
Unlike other types of insurance, aviation premiums are not set on the basis of statistical data on aircraft accidents, but on the basis of supply and demand. The insurance risk assessment for a particular airline includes several elements; the type of aircraft used by the airline, their age, the routes they fly, how experienced their pilots are, how well the aircraft are maintained and the claims cover required by the airline. In the case of casco insurance, the insurer usually requires a certain percentage of the value of the company’s entire fleet, taking into account the number of kilometres flown. This premium can be more than $100 million for a large airline.
In the case of compulsory insurance, the extent of the damage can only be determined years later, making it a very slippery slope for insurers. The liability for damages is therefore sometimes even greater than the financial capacity of the insurer. Over the last 20 years, the claims on aviation insurance have ranged between $350 million and $1.9 billion. In assessing their liabilities, insurers have always taken two principles into account: domestic flights are subject to the laws of the individual country, while international flights are subject to the aforementioned Warsaw Convention and its subsequent amendments.
But the real panic settled among the insurance companies when, on 27 March 1977, two planes, a Panam and a KLM Boeing 747, collided at Los Rodeos airport on the island of Tenerife, killing 637 passengers in the world’s worst civil aviation disaster. The accident occurred when the captain of the KLM aircraft prematurely taxied down the runway, without having yet received clearance from air traffic control. He did not do this deliberately, but his decision was the result of a misunderstanding between his crew and air traffic control.
The KLM plane had taken off while the Panam plane was still on the runway. A collision between the two planes on the ground was imminent. This was the proximate cause of the accident, while the indirect cause had occurred a few hours before. A bomb exploded at Gran Canaria airport, followed by a second bomb threat, and air traffic control had to divert all planes to Tenerife airport. Here, air traffic control was now overloaded and there was not enough space to park the planes, so they had to park on part of the runway. Among them was a Panam plane.
Fortunately for the insurers, the incident and the related liability could not be explained in detail, as it was a combination of unfortunate circumstances. Thus, the liability for damages was spread over several parties. This meant that, despite the high cost of the accident, the amount of compensation was below the limits of the individual insurance policies. As many of the passengers were Americans, their lawyers decided to pursue larger claims through lawsuits. However, such lawsuits are not successful in most cases. For example, in one case in Bangladesh, the maximum insurance payout for the death of a passenger on a domestic flight was £913, which is the legal limit in that country.
In the US and Japan, there is no such limit, as consumer protection legislation provides for unlimited airline liability. However, such high liability is also intended to be punitive. The amount of compensation depends both on the personal circumstances of the injured party and on the route on which the aircraft was flown. It is the determination of these circumstances that has become a sport among American lawyers, in which the fairness of the judgment has taken a back seat and the skill of the lawyer has taken centre stage. The side that feels stronger – usually the airline, backed by the insurance company – therefore tries to delay the litigation. This increases the legal costs, which are already high, and in the end the weaker party gives up, while the relatives, at best, agree to a settlement, which, of course, is not in their favour.
Everyone still remembers the crash of a Panam plane on a flight from Frankfurt to Detroit, which crashed over the Scottish village of Lockerbie on 21 December 1988. Panam was found to have been negligent in accepting on board an unidentified piece of luggage containing a bomb. After this information was disclosed, the relatives, of course, did not want to hear anything about the limit of USD 75 000 in damages provided for by the Warsaw Convention. There were 270 victims of the plane crash, and the lawsuits rained down with astronomical compensation awards of up to USD 19 million.
Panam – which later went bankrupt – delayed the proceedings, challenged the evidence and reached out-of-court settlements. Nevertheless, there was never any fear that the $750 million insurance policy was in jeopardy. Two Libyan nationals were accused of the Panama plane crash and had to be extradited to a court in the Netherlands by Moammar Gaddafi due to international pressure. One of them was sentenced to life imprisonment, but was released in 2009 due to ill health and died a few years later, still claiming his innocence.
In 2003, Gaddafi acknowledged Libya’s involvement in the downing of the plane and offered $2.7 billion in compensation to the families of the survivors, i.e. $10 million to each family. However, Gaddafi made it a condition that the UN and the US lift sanctions against Libya and remove it from the list of countries that support terrorism.
The second major insurance disaster occurred on 12 August 1985, when a Japanese JAL aircraft crashed into Mount Osutaka after a half-hour of unsuccessful manoeuvring. It was insured for 450 million dollars. In Japan, as in America, relatives can recover not only the ‘true value’ of the victims, but also a whole range of other claims. They can also sue the airline for the lost profits of businessmen and for the hypothetical income of the students who were injured when they started their jobs. Then there can be claims for the psychological pain of the victims, who knew what was going to happen to them on the Japanese plane thirty minutes before it hit. Rescuers have even discovered among the wreckage farewell letters written by the unfortunate passengers before the plane hit the mountain.
Today, insurance companies, in calculating the potential risks of air accidents, are themselves already drawing up possible scenarios, such as this one … Two wide-body aircraft (each worth more than 200 million dollars), carrying businessmen (each valued at between 5 and 30 million dollars) and students (each valued at between 1 and 5 million dollars), crash into each other during a landing manoeuvre over Manhattan during a landing over the city of Manhattan.
If the plaintiffs had succeeded in proving that the disaster was caused by the negligence of the two airlines, it would not have been possible to calculate the damages claims at all, as the sum would have been astronomical. It is precisely to avoid these catastrophic costs that the insurance companies have agreed among themselves to increase the limit of compensation from 75 000 dollars to 200 000 dollars. In any case, the news that an overcrowded Antonov plane from an African company crashed into a crowded football pitch is far less panic-inducing for the insurance companies than the news that two American businessmen lost their lives when a Learjet business plane was landing.
The recent case of a German Wings plane flying from Barcelona to Dusseldoff crashing into a mountain in the French Alps on 24 March 2015 shows that compensation negotiations in such cases are lengthy and complex. Proving whether the airline knew or should have known that co-pilot Lubitz was suicidal and that he was being treated for it will be complicated. German Wings immediately offered an initial cash payment of €50,000 to the victims’ relatives, while the Montreal Convention on Airline Liability itself already provides for compensation of €143,000 in similar cases.
German Wings is expected to have to pay damages of around €30 million for its negligence, and the insurance company with which the airline is insured is already counting on paying out €300 million for the purchase of a new plane and compensation to the victims’ families.
It must be every pilot’s dream to have an unknown hacker take control of the cockpit instruments. But are modern passenger planes really immune to hacking? Today, modern aircraft already offer their passengers a wireless internet connection. For hackers, this is like opening the cockpit door, as they can enter their malicious programmes into the aircraft’s computer systems from the ground. The hacker does not have to be sitting in the plane, he can be in the vicinity of the airport or in an airport restaurant and smuggle a malicious program into the computer of one of the passengers in the plane, who then decides to turn on his computer at an altitude of 11 kilometres to infect the plane’s electronics. 11 kilometres away from the airport, the hacker is able to infect the plane’s electronics by using the ground.
An FBI agent made an experiment and got on a plane as a passenger, tapping into the electronic systems of different planes 19 times. Once, he even managed to change the direction of the flight. In May 2015, on a flight from Denver to Chicago, he tweeted a request to the plane’s computer system from his seat to drop his oxygen masks, and they did drop out of their bunks. Passengers panicked and the agent was arrested after landing and accused of trying to hijack the plane.
He later said that he had repeatedly abused the very systems on the plane that allow every passenger to watch films, listen to music or play games. Such systems are installed under passengers’ seats and can be secretly connected to the cable of their own laptops. When the agent was investigated, he was also seen to be carrying blueprints of the electronic systems of different types of aircraft. Insurance companies are, of course, powerless against such attempts, as they cannot prohibit the use of computer equipment.
Fire insurance
In the history of mankind, there have always been catastrophes, with many victims and huge damage, which were not compensated because the insurance company did not insure the event. For example, the London fire of 1666 and the Hamburg earthquake of 1842, and the San Francisco earthquake of 1906 are unforgettable in the historical memory, although some disasters have been even greater and more tragic.
At 2am on the night of 1 and 2 September 1666, a bakery near the Tower of London caught fire. The fire spread at lightning speed, burning the adjacent timber-framed houses and then the warehouses of oil, shipping cargo and grain. The Thames water mains were destroyed and the keys to the earthen pipes leading to the New River were not found, so buckets of water were used to extinguish the fire. The city authorities could not decide whether to isolate the fire and demolish the houses to contain the fire. The fire raged for four whole days, almost reaching the Royal Palace before slowly dying down, but almost all of London was destroyed.
But people learn little from history. After the earthquake that hit the Japanese city of Kobe on 17 January 1995, people could not help but wonder at the indifference of the city authorities, who had neither set up a safety warning system nor prepared the most essential supplies in case of such an eventuality. Systemic failures, jurisdictional confusion and technical failures have deeply shaken Japanese confidence in their own capabilities. But the London fire had already helped to slowly establish the idea of fire insurance. Thus, in 1680, Dr Nicholas Barbon, a London physician, opened the first office dedicated to insuring buildings against fire. A fire insurance policy from 1682, signed by the founder of this insurance, can still be seen.
Following the example of London, the Hamburg Fire Insurance (Feuerkasse) was set up in 1686, bringing together under a common roof some of the existing fire insurance contracts. The City Council was the initiator of this insurance and the Feuerkasse became the first public insurance company. However, the documents show that Hamburg never expected to be hit by a fire of similar proportions to the one in London.
In 1794, the entrepreneur Georg E. Bieber drew up a plan for the establishment of a fire insurance company, which stated that a major fire in Hamburg was completely impossible. But on 5 May 1842, at one in the morning, a fire broke out in a multi-storey tobacco warehouse in Hamburg. The fire, which the dry spring and the large warehouses in the harbour had allowed to spread, soon engulfed almost the whole city. The city’s firefighters were no match for it, nor were sprinklers from nearby ships. The wind, which was blowing steadily, only fanned the blaze. It was only after 79 hours that the rain and the wind, which had reversed direction, allowed the fire to be extinguished.
In contrast to the London fire, the damage in Hamburg was largely reimbursed by the insurance company through a loan. The city’s fire insurance (Feuerkasse) helped to rebuild the damaged buildings, while German, French and English companies provided funds for other damages. However, the Hamburg Residents’ Association against Fire Danger, founded by Georg E. Biebler, ceased to function, as it could only cover 25 % of all insured claims.
It was only the catastrophic fire in Hamburg that made people realise the importance of fire insurance. Not only did insurance companies increase their capital base to cope with such catastrophes, but they also adopted a number of regulations governing fire-safe construction. Volunteer fire brigades were set up in many German cities and in Berlin in 1851 the first professional fire brigade was established. More importantly, reinsurance companies began to emerge. Insurance companies now realised that in the event of large-scale catastrophes, they alone would not be able to pay for the losses incurred. In 1846, the Cologne Reinsurance Company was founded as the first professional company of its kind.
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When the ground shakes
Unlike previous catastrophes, the insurance industry faced a new challenge in the aftermath of the catastrophic San Francisco earthquake of 18 April 1906. At 5.13 a.m., the city’s inhabitants were woken by a strong shaking. Houses began to sway and chimneys to collapse. Ten minutes later, the tremor turned into a massive earthquake. Roads broke up and houses collapsed, with residents fleeing the city in panic. At 8.15 a.m., an even stronger earthquake jolt shook the city, causing numerous fires. Gas pipes began to burst and the fire, fanned by strong winds, engulfed the whole town.
A newspaper wanted to hire the famous writer Jack London, who was born in the town, to write a report on the fire. He could not refuse the offer of 25 cents a word, and his report appeared in Collier’s Weekly on 5 May 1906. It began as follows: “An earthquake in San Francisco has shattered walls and chimneys worth several hundred thousand dollars. But the fire that followed the quake destroyed property worth several hundred million dollars. The true damage cannot even be estimated. Never in recent history has such a large and glittering city been so completely destroyed. San Francisco is no more.”
Jack London was, of course, a much better writer than reporter, and his coldly written report did not attract much interest.
Singer Enrico Caruso, who was in San Francisco on 17 April for Bizet’s Carmen, staying on the sixth floor of an elegant hotel, was skinned by the earthquake and fire, but was very scared. Insurance claims from the earthquake fires amounted to $250 million, a huge sum of money for the time, and $235 million in insurance claims were paid out. Lloyd’s of London announced that it had paid all the claims, totalling $50 million, in full.
After the San Francisco earthquake, 200 insurance and reinsurance companies were involved in the recovery efforts. They paid out compensation of three quarters of the insured sums. However, a number of insurance companies – seventeen of them – collapsed and had to close their doors as a result.
It then became clear to insurers that they needed to assess the likelihood of an earthquake more seriously and differently from other insurance business. Requirements for safer earthquake-proof construction emerged, dangerous buildings were excluded from insurance, earthquake insurance premiums increased, and monitoring of clients’ compliance with required building regulations was tightened. There have also been growing calls to exclude fires caused by earthquakes from insurance policies altogether. But in 1909, the California Senate prescribed the contents of a fire insurance policy that did not contain any earthquake clauses. This meant that insurers had to indemnify for fires even if they occurred as a result of an earthquake.
Historical and media-hyped disasters have undoubtedly been more etched in our memories than the usual, albeit perhaps more tragic and serious, disasters. One of these was the sinking of the Titanic in 1912, a ship that was thought to be unsinkable. Recently, the original insurance policy for the Titanic was auctioned off with a bid of £15,000. The policy was taken out just 15 days before the ship sank.
It is precisely because of the allegations of Titanic’s unsinkability that insurance companies charged a lower premium than usual to insure her. Those who signed the policy, which covered “all loss” of the ship to the tune of $5 million, believed it was just an unnecessary formality. They were more concerned about what might happen during the delivery of the ship from Belfast to Southampton, so they handwrote at the bottom of the policy that the insurance also applied to that voyage.
The ship’s owners were paid just a month after the ship sank, but the victims’ relatives had to wait four years for their insurance payout. In total, only $663,000 was paid out for all victims, despite claims from the families of the deceased for £1.6 million (now £1.7 billion). The largest award, $50,000, was made to the widow of John Trayer, an American businessman from Philadelphia. Strangely, the widow died 32 years later on 15 April 1944, the very day the Titanic sank.
In those days, wireless telegraphy for communicating with ships at sea was still in its infancy. Ironically, however, it was Lloyd who was one of the most ardent supporters of this innovation, setting up signal stations from Cornwall to Canada with the inventor Marconi – to help ships as they crossed the Atlantic and warn them of the danger of icebergs. Lloyd’s signal station in Halifax was also the first to receive the message that the Titanic was sinking. Other signal stations sent conflicting messages, so that some newspapers were convinced that the Titanic had survived the collision with the iceberg and that, although damaged, it was on its way to Halifax.
Immediately after the disaster, rumours emerged that Titanic’s owner, the White Star Line, had sunk Titanic on purpose in order to collect insurance money. This was based on the fact that three months after the Titanic’s maiden voyage, the Titanic’s sister ship Olympic collided with a British warship off the Isle of Wight. A dispute ensued with the insurer, which was able to prove that the Olympic was at fault for the collision. This was a major financial blow for the White Star Line, which had to be made up somehow.
This conspiracy theory is also supported by the fact that a few days before the voyage, 50 passengers cancelled their participation in the voyage, including the owner of the White Star Line, the well-known millionaire J.P. Morgan, and some of his friends, as well as the inventor Marconi. Morgan’s three biggest business rivals, J. Astor, B. Guggenheim and I. Strauss, were on board and went down with him. A suitable way to remove unwanted competition?
The extent of the insurance industry became apparent after the sinking of the luxury Italian ship Andrea Doria on 26 July 1956. The reinsurance of the ship, which was also considered unsinkable, was spread over several hundred reinsurance companies; for all of them, the sinking of the ship came as a complete surprise. Most of them had decided to participate in the reinsurance without knowing which object would be insured. Nevertheless, they paid out $11 million just ten days after the disaster.
It is difficult to estimate how much the accident of the Costa Concordia, the luxury cruise ship that ran aground off the Italian coast on 13 January 2012 off the island of Giglio, will cost insurers. The ship itself was insured for €405 million and the costs, including the cost of raising the ship, have already risen to €1 billion. This does not yet include the cost of future lawsuits by passengers and relatives of the victims. Insurance companies reckon that the final cost will be somewhere in the region of two billion euros.
Natural disasters
But even the greatest damage to technical installations is not as great as the devastation left behind by natural disasters, especially weather-related ones; tropical storms, hurricanes that batter the Atlantic and North Pacific coasts, known as hurricanes. Cyclones form in Australia and the Indian Ocean and typhoons in the Western Pacific.
The first hurricane in the history of the international insurance industry to result in more than a billion dollars in claims was named Betsy, a woman, and devastated the USA between 6 and 12 September 1965. The name itself caused a wave of indignation among American women’s organisations, and the World Meteorological Organisation, under pressure from this, decided that hurricanes would henceforth also bear male names. Thus, in 1979 it was Frederick, ten years later in 1989 it was Hugo and in 2002 it was Andrew. Only Europe still allowed names such as Diana, Herta, Judith and Vivian.
So insurance companies have had a rather bad night’s sleep in this area since the 1960s. Statistics show that the number of natural catastrophes, namely those involving more than a billion dollars in insured losses, is constantly increasing. And the bills that insurance companies have to pay are also increasing. The United States has been hit the hardest by such disasters in the meantime. Although their frequency has not changed, they have become more devastating year by year. In the case of Hurricane Andrew alone, which raged in 1992, insurance claims were paid out for more than $15 billion. For the 1994 earthquake in California, insurers paid out $7 billion, and for the 1993 blizzards in the US, only a “modest” $1.8 billion.
However, Hurricane Katrina, which struck New Orleans in August 2005 and wreaked havoc in the US states of Louisiana, Florida, Texas and Mississippi, was the costliest catastrophe in the history of the insurance industry. New Orleans was a particularly hard-hit city. Numerous levees and river embankments were breached, 80% of the city was flooded and some parts of the city were 4.6 metres under water. Eighty per cent of the population had been evacuated before Katrina arrived, but many remained because they did not want to leave their homes, had no means of transport or were old and alone. The death toll was 1 500.
As soon as Katrina began to lose its destructive power, the looting of shops, violence, shootings of rescue workers, murders and rapes began. And for the insurance companies, it was a nightmare period. They paid out 45 billion in claims and insurance agents had to fight their way through 1.7 million claims. Nevertheless, many property owners were disappointed and angry, as some were reimbursed only a fraction of what they expected or had their claims rejected altogether.
Ms Cassin, a local artist, was thus convinced that her insurance policy was more than enough to compensate her for the damage, which she estimated at USD 100 000. Two years after Katrina, she was still homeless, and her insurance company was offering only $41,000 in compensation. Even those who wanted to renew their flood insurance after Katrina were disappointed, with premiums quadrupling.
Some insurers refused to hear anything about paying compensation and avoided paying out with various excuses: ‘Floods are not covered by insurance. If it turns out that the water ingress is caused by wind or wind-driven rain, then we will accept such damage. But if the damage is caused by flooding or flood waves, this is not covered by the insurance policy. Only those who have flood insurance are entitled to compensation.” Thousands of property owners have therefore decided to sue the insurer.
No scientific theory explains very convincingly why the number of devastating natural disasters is rising. Take hurricanes, for example. Some meteorologists link them to the weather conditions in the Sahel, an extremely dry and hot climate zone in central Africa, but close to the Atlantic, the breeding ground of hurricanes. Others argue that the strength of hurricanes is increasing as sea temperatures rise and the earth’s surface warms globally. At least one of these explanations is shared by insurance companies.
But something else has fundamentally changed the insurance “industry”. People and businesses are increasingly taking out insurance against natural disasters. It is estimated that the insurance value in the US coastal belt, which is most frequently visited by hurricanes, has already risen to billions, possibly even more than five billion dollars. The insurance industry is also facing the problem that its costs are rising faster than anticipated. Many insurers have therefore significantly increased their premiums for certain types of natural catastrophes, while others have simply reduced the range of their offerings. Others no longer insure some events at all, saying they are impossible to insure.
But people generally like to take out insurance. When faced with the choice of paying a relatively small premium and a 10% probability of losing a lot or even all of their assets, customers usually opt for the former. Insurance companies, of course, operate on the principle of spreading risk among policyholders. They also want to insure as many risks as possible, independent of each other. It would be unwise for an insurance company to collect only insurance on houses in an earthquake zone. An insured event, if it were to occur, would financially ruin it in the short term.
Insure against terrorism?
The financial risk for insurers became even more acute when terrorist attacks started to occur. The year 1992 was a turning point, when the terrorist attack in the City of London caused $527 million in damages. After this attack, many reinsurance companies no longer wanted to include terrorism in their commercial insurance cover. As a result, insurers failed to cover this risk and threatened to remove terrorism from their insurance offer. To avoid a crisis of confidence in insurers, the British government set up a special ‘pool’, of which the insurers were members, as well as Lloyd’s, which also accepted insurance against terrorist attacks.
Why has there been such a panic in reinsurance companies? Terrorism has “broken” a few of the rules under which reinsurance companies operate. The probability of a terrorist attack cannot be calculated. Moreover, only larger companies and companies in big cities want to insure against this risk, which means that the spread of risk for insurers is very small. As a result, some insurance businesses have turned to “self-insurance”.
So Daimler Benz embarked on an uncharacteristic venture for its field of work: it set up its own insurance company, which it hoped would eventually move beyond insuring Daimler’s business to the open market. Of course, it was questionable what the point of such a company operating on the open market was, since there were already more than enough other insurance companies there. Nevertheless, some estimate that several thousand companies, half of them in the US, had such divisions in the early days. The big companies simply got fed up with the traditional insurance companies, which kept raising premiums. Some of the companies that took up self-insurance were themselves financially stronger than the insurers.
Unfortunate circumstances
Insurance companies complain that they often encounter negligence, indifference and a lack of a sense of responsibility when it comes to claims. Some of the biggest catastrophes reinforce these claims. For example, on 6 July 1988, a series of explosions ripped apart the oil rig Piper Alpha, which was moored off the Scottish coast. As many as 167 oil rig workers lost their lives. Only those who risked a 25-metre plunge into the ice-cold North Sea escaped.
Insurance companies had to dig deep into their pockets and pay out $1.5 billion in compensation. But the investigation found a series of irregularities. Poor maintenance of the pumps led to over-pressurisation of the rig’s pipes, ruptures and oil spills and ignition. At this point, two automatic fire extinguishing pumps should have been operational, but due to repairs they could only be operated manually. The explosions destroyed the bridge, thick smoke covered the platform and there was nothing left to save.
Just a year later, on 23 October 1989, a chemical plant in Pasadena, just 20 kilometres from Houston, Texas, was blown up by a similar web of technical errors and wrong decisions. A massive fire destroyed all the plants of the chemical group Philips Petroleum. Parts of the plant flew through the air up to a kilometre away. The disaster, which was watched by television crews from all over America, killed 23 people, injured 125 and caused damage estimated in the billions.
The cause of the accident was later determined. During maintenance work, a safety valve was opened contrary to instructions. Within seconds, 40 tonnes of highly flammable gas erupted, which was then ignited by a spark. A large quantity of highly flammable gas was stored under pressure in a chemical plant. Each tank contained a demolition force of 1 000 tonnes of TNT. Such time bombs cause serious headaches for insurance companies, as the damage caused is usually far in excess of the insurance premium paid.
The insurers have decided to use computer simulations to develop possible scenarios for petrochemical accidents. They had been thinking about this for a long time, the first time being back in 1974 when a similar disaster occurred at a nylon factory in England. There, the highly flammable cyclohexane began to leak into the air from a damaged vent pipe. The resulting explosion not only destroyed the factory, but also caused widespread damage within a six-kilometre radius. Computer experts have therefore combined data on various gas explosions that have occurred since 1974. They found that the escaping gas, even at the slightest puff, moves quickly back and forth and can strike a spark within a few minutes. It is these ‘travelling’ gas clouds that cause most of the damage.
In recent years, insurers have become increasingly interested in the prevention of major factory fires, as factory buildings have already reached frightening proportions in recent years. Kilometre-long halls are usually built with no partitions in between, so even a local fire can quickly spread to all sides. This is what happened in Pennsylvania in 1982, when one of the world’s largest distribution centres caught fire. The fire protection plan was completely inadequate, as hundreds of thousands of aerosol cans were stored on open shelves. The cans caught in the fire flew through the air like rockets due to the heat, causing hundreds of millions of dollars of damage in a very short time.
A major fire and explosion in Tacoa, Venezuela, in December 1982 was caused by the unwise intervention of employees. At the power plant there, technicians noticed that the temperature in the fuel oil tank had risen to 80 degrees Celsius. The team on duty assumed that there was a fault with the oil burner, which was supposed to heat the oil so that it could reach the power station more easily and quickly through the pipes. They reduced the temperature in the tank and thought that this had solved the problem. It was only in the early hours of the morning that they decided to inspect the tank more closely.
We can only assume that a lighter was used to read the temperature on the instruments. A massive explosion of oil vapours from the overheated tank killed the whole team and caused a major fire. The worst disaster occurred a few hours later, when some 500 curious people gathered near the power station to watch the unsuccessful fire-fighting. The water that had accumulated at the bottom of the tank below the oil surface turned to steam due to the excessive heat and the 10 000 tonnes of fuel oil in the tank exploded. 150 people lost their lives, 17 fire trucks were turned into flaming torches and 40 nearby houses burnt down.
Today, experts can only conclude that technical systems are so complex that it is still possible to determine for individual parts what will happen to them in the event of a hazard, but the whole system is no longer controllable. As a result, insurers are also unable to make a realistic assessment of what the risk will be.
For the same reason, insurers have a nightmare when they have to insure manned and unmanned spaceflights. In 1984, when several accidents occurred during space flights, it cost insurers three times more than the premiums paid. No wonder, if today it is the case that insurance companies sometimes set the limits of technical progress with their demands, since the entire world’s insurance capital is no longer in a position to take on such a risk. As a result of this, in Japan, they did not decide to build some super-sized and modern oil tanker because the insurance company’s demand for the insurance premium was simply too high. Even the construction of some extremely high skyscrapers in Japan, which is known as an earthquake zone, was stopped because of the insurance companies’ demands.
Reinsurance of technical installations sometimes involves several insurers. For example, Münchener Rück was involved in the reinsurance of an offshore gas platform. The platform was built in 1995, was 370 metres high and weighed 700,000 tonnes. The weight alone meant that it stood on the seabed without conventional anchoring systems. The whole project cost USD 5 billion, but even before extraction began, the platform had become a useless dinosaur. It was also the only one of its kind, due to high insurance costs, although as many as 200 of them were planned in the beginning.
Major transport projects are also booming these days. The Channel Tunnel project was one such project some time ago. During the seven-year construction, 900 minor accidents occurred, but this was assessed by the insurance company as minor damage. As a precaution, Münchener Rück only contributed 20 percent of the insurance premium, which was “heavy” at almost 5 billion dollars.
But never in the history of reinsurance has so much money flowed into so few reinsurance companies as it did in Bermuda. The Bermuda Triangle and the stories around it have been forgotten. Now all that is said is that in 1993 alone, just under USD 5 billion of capital flowed into eight new reinsurance institutions. These companies first offered reinsurance against natural disasters, which are very common in this part of the world. But while other reinsurance companies elsewhere in the world were struggling, this was not felt in Bermuda at the time.
There were of course several reasons, one of the first being that these insurance companies have a lot of capital and rich shareholders. To mention just one of them, the large financial institution J.P. Morgan. The most important thing is that their shares are not burdened by old liabilities, nor do they worry about taxes. Indeed, the British colonial administration, with its mild tax legislation, allows them to pay no sales tax. Twenty years ago, there were even rumours that Bermuda might succeed London as the place where most reinsurance is written in respect of claims arising from natural catastrophes. Of course, London would not dream of allowing such a thing, because it is still reaping huge profits.
