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The God Clause

Reinsurers make their living thinking about the things that almost never happen and are devastating when they do.

“The psychology piece dominates, even in boardrooms,” says David Bresch. “People measure against the perceived reality around them and not against possible futures.”

Bresch is in charge of sustainability and risk management for Swiss Re, founded in 1863 after a city fire in Glarus, Switzerland, and now the world’s second-largest reinsurer. “If the gap between modeled reality and perceived reality is too big,” says Bresch, “that tells you something about the market share you’d like to achieve.” In other words, what the models show as a best guess of a risk may not be what the insurers perceive the risk to be, and it can take more than just data alone to scare insurers into paying for risks at a rate that keeps reinsurers solvent over the long term. That takes an industry loss event. It takes a catastrophe.

Heike Trilovszky runs corporate underwriting for Munich Re, the world’s largest reinsurer. The afternoon of September 11, the press and the company’s shareholders needed to know what Munich Re’s losses would be. “To get answers we had to ask the brokers,” she says. “Aon Benfield (AON), Guy Carpenter, they had offices in those buildings. It was odd. Is my counterpart still alive?” Before the end of the week, Munich had an initial estimate. In October, Trilovszky was at an off-site meeting when a board member arrived late. He had seen the revised loss estimate and he was pale. “We will survive,” he said, “but it’s serious.” Munich Re’s losses after September 11 ultimately came to $2.2 billion.

Reinsurance treaties are full of exclusions, but before September 11 terrorism was not considered significant enough to be one of them. Most reinsurance treaties renew on Jan. 1 and the meeting oriented itself around a new question: What do we do on 1/1/2002? “There were 15 managers, all with a background in property,” says Trilovszky. “We had flip chart paper and we put it on the floor. We were kneeling on the floor, working out concepts, brainstorming ideas … that was the Munich Re strategy for terrorism risk in the first days after 9/11.” In 2002, together with the rest of the industry, the company wrote terrorism risk out of any treaty with an insured value of greater than $50 million. Terrorism is what Trilovszky calls “nonfortuitous.” It stems from a few angry, motivated people, and nothing says there can’t be 10 World Trade Center events in a single year. “There cannot be a mathematical model,” she says, “for people like bin Laden.”

Reinsurers prefer to underwrite risks they can name; such a treaty is called a “named perils” cover. Far more often, however, the market forces them to sign an all-perils cover. Although reinsurers can exclude risks they already know about from an all-perils treaty—an act of terrorism, for example—they cannot exclude what Donald Rumsfeld might call an unknown unknown. That’s the God clause.

Models exist for some low-frequency risks such as hurricanes, earthquakes, and oil spills, but they don’t exist for every one. Trilovszky doesn’t have a model for airplane crashes. “Would it hurt us if crashes became more frequent? It would,” she says. “As it is now, I’m not sure we ever had a property loss from an aircraft crash. It’s theoretical. It lives within the error of the models we have.” The second something unexpected happens, though, it’s no longer theoretical or unimaginable.

“The history of the industry,” says Newhouse, the broker, “is we cover everything in a catastrophe until after the catastrophe. Then we rewrite it.” Until the Sixties there was no hours clause—a time limit—on damage that can be claimed to be from a hurricane. Now the standard is 96 hours. Newhouse has been a reinsurance broker for 35 years. Every new industry loss event—every new catastrophe—is the biggest in his career, he likes to say, and he knows by now that every catastrophe teaches the industry something. “If you want to be able to price [an event], if you want to be able to build an industry and a capital base that can handle it … then you’d better figure out a way to define it. Then capital can be accumulated to deal with it.”

I ask him why the reinsurance industry failed after the World Trade Center bombing of 1993 to either raise prices for terrorism coverage or to exclude acts of terrorism from coverage altogether. He looks at me as if he would like for me to figure it out for myself so he doesn’t have to say it. “Because it wasn’t big enough,” he says, pausing before adding, “economically.” The cost of an event, he explains, dictates how much the industry spends on understanding and preventing it. “I’m not saying people didn’t react to it,” he adds, “but you know, if your company’s life is threatened by the size of the loss, you’re going to react much differently.”

Newhouse keeps in his office a collection of plaster monkeys, the kind that come in sets of three with hands over ears, mouths, and eyes. They remind him when approaching a reinsurer about a client to hear, speak, and say no evil. The monkeys are all gifts, given to him to rebuild a much larger collection that was lost when his last office disappeared.

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