NYIE: New York's mulligan

Revival of New York Insurance Exchange has support—and challenges

By Michael J. Moody, MBA, ARM

Despite the continued soft commercial property/casualty insurance market, several innovative alternative risk transfer (ART) concepts have surfaced over the past few years. One of those ideas is the concept of an insurance exchange. Most notable is the concept of a health insurance exchange, which got a lot of initial buzz, and has been incorporated into President Obama's health insurance overhaul. It requires that each state establish an insurance exchange where unemployed people and small businesses can "shop" for health coverages. According to the legislation, implementation of the health insurance exchanges is not required until 2014.

Another approach to the insurance exchange concept is one used within the property/casualty insurance arena. And while there are several models for these types of exchanges, most would be structures similar to a Lloyd's of London insurance approach where one lead underwriter establishes the terms, conditions, and pricing. Then after the initial pricing is established, other underwriters "follow the lead" by assuming a portion of the risks. This approach has allowed the London market to maintain its business for more than 300 years.

Historical perspective

The United States has, in fact, had prior experience with the property/casualty-type exchanges. In the early 1980s, Illinois, Florida and New York all established insurance exchanges. While there were numerous reasons for establishing them, the primary one was the hardening U.S. commercial insurance market. Many businesses in a variety of industry sectors were facing serious availability and affordability issues with regard to their commercial insurance.

The hard market had actually begun in the mid-1970s with concerns about product liability coverage. This issue was significant enough that Congress passed the original risk retention group (RRG) legislation to help alleviate the issue. But, a brief softening of the market left the RRG legislation an underutilized solution. However, as things have a habit of doing, the hard market returned in the early 1980s, prompting Congress to expand the scope of the RRG legislation to include any liability risks. Congress was swift to act and, as a result, the RRG act has become a viable alternative risk transfer (ART) vehicle ever since.

Two of the three insurance exchanges (Florida and Illinois) had difficulty from the start, but New York initially fared much better. Following the opening of the New York Insurance Exchange (NYIE) on March 31, 1980, interest grew rapidly for the fledgling operation and it began writing significant amounts of business. On opening day, it already had 16 separate syndicates or underwriting members. This number would ultimately grow to 50 syndicate members at its high point. As originally planned, the NYIE was extensively modeled after the Lloyd's centralized market that facilitated the underwriting of insurance/reinsurance worldwide. However, despite its promising beginning, the NYIE closed its doors in 1987.    

Key issues caused the downfall

As with most other business failures, it was not one single thing that caused the NYIE to close its doors. While some believe that it was all due to poor capitalization, it really was more like "death by a thousand cuts." Following are several of the major shortcomings, presented in no particular order. These and a number of other problems left the exchange with little choice but to close.

The NYIE was originally formed in response to demands for more alternatives to the capacity crisis in the U.S. insurance market in the mid-1970s. The legislation was finally passed in 1979; however, actual operation of the exchange did not begin until 1980. By the time the exchange was operational, a soft market had returned to the insurance industry. Thus, in order to compete, members of the exchange were forced to take "bottom drawer" business that could not find a home elsewhere. As a result, the exchange quickly became known as a "dumping ground" for bad risks.

Despite this dubious distinction, the exchange members believed that they could work effectively within the high-end excess treaty business segment. Many of the underwriters felt that there was little exposure in this area and, as a result, charged little in the way of premium. Within a matter of a few years, this became a high loss area as well. And for poorly capitalized syndicates, it meant real problems. As a result, by August 1986, five syndicates were declared insolvent and five more followed shortly thereafter.

The exchange came up with a unique way to handle the above adverse loss problem known as "Syndicate 101." It would allow the exchange to isolate the adverse claims and set aside those liabilities. The concept did not gain much traction and was ultimately abandoned. It is interesting to note that a similar approach was utilized by Lloyd's when it established "Equitas." This was a move that was necessary to "wall up" the losses from toxic waste and asbestos liability claims from the United States.

Another major shortcoming was that, for the most part, the syndicates were formed by U.S. insurers that ultimately found they had little need for them. These ownership problems created structural issues where the syndicates were competing with their owners. Additionally, the syndicates never really fully understood the concept of the "lead underwriter" that is so critical to the success of the Lloyd's model. The fact that insurers would have to do business with a competitor never set well with management at the major U.S. insurers.

The good news is that all of these obstacles have viable solutions.

The "do-over"

Off and on over the past few years, the New York Insurance Department has hinted at the possibility of resurrecting the NYIE. Insurance Superintendent Eric Dinallo on a number of occasions had stated that the Department was considering the feasibility of putting the Exchange together again. For the most part, industry experts questioned the viability of such a move. Typical of the responses was: "It would be like dredging up the Titanic and taking it out for another voyage."

However, the idea began to be taken seriously when New York Governor David Paterson announced during his 2010 "State of the State" address that he was backing a plan to create a new NYIE. The governor noted that this was part of a broader plan to help rebuild the state's struggling economy. Subsequent to the governor's address, estimates surfaced stating that the NYIE could do around $7 billion to $10 billion in premium volume, thus producing additional tax revenue. Additionally, estimates also noted that the increase in employment from the exchange would be in the 2,000 to 3,000 range.

While Dinallo has since left the New York Insurance Department, his successor, James Wrynn, has taken the baton and is now actively involved in making the NYIE a reality. In addition to Governor Paterson, the project has the blessing of New York City Mayor Michael Bloomberg and many other state and local officials. In addition, significant interest has come from both the financial and insurance communities. All of these diverse groups are interested in making downtown Manhattan, once again, an international insurance center.

Since the original exchange legislation remains on the books, establishment of the exchange could be accomplished in a relatively short time, according to the Insurance Department. Under Wrynn's direction, the Department has formed seven working groups to review various aspects of the project and determine the overall feasibility of re-establishing the NYIE. The working groups have been operational since the middle of the year and have recently come together to provide the results of their analysis.

As was widely expected, the basic conclusion was positive. However, the presenters were quick to point out that more work is needed in order to put together a detailed business plan. This detailed business plan is needed in order to move forward with the project. The working groups found that "the exchange would likely be a competitive addition to the state and national insurance market." One of the primary reasons for this optimistic view is "the possibility to serve as a single entry point for insurers to write in all 50 states."

Much still needs to be done for the exchange to rise from the ashes of its prior life. The Insurance Department has indicated that chief among these is building support for the exchange within the insurance industry. Additionally, another major obstacle would be finding seed money to help create the physical and technical infrastructure of the exchange. It's this infrastructure that will be critical in order to employ the latest computer technology that will allow the business to be transacted as quickly and efficiently as possible. Preliminary drafts of the business plan were expected in the fall of 2010; however, that goal was not met.

Conclusion

The concept of the mulligan began in golf, and it is a great idea. Hit a bad shot? No problem, take a mulligan and replay the stroke. If life were only that easy! However, it should be pointed out that the Obama administration began its term in office with a similar "reset" concept. But can the NYIE pull off a similar feat? Can it correct the problems that plagued its predecessor? That is the question that many industry observers are asking. Certainly, there appears to be significant active support both within and outside the insurance industry.

For the most part, putting downtown Manhattan back into the center of the international insurance community has a lot of merit. The exchange concept, for that matter, has a lot of merit. Today, over 50% of the business that is placed in Lloyd's originates from North America.

Whether the U.S. insurance market can capture some of that business remains to be seen. While there are certainly a number of challenges and the project has its share of "Doubting Thomases," never bet against an idea whose time has come—or, for that matter, a hedge fund manager with a bag of money.