Insurers clamour for fresh capital after slide in equities puts strain on reserves

The September 11 atrocities gave added impetus to trends that were already in place

This time last year, in the immediate aftermath of 11 September, heads of insurance companies were struggling to comprehend how their businesses would cope with the biggest one-off loss ever to hit the industry, created in the space of a few hours when terrorists ploughed aircraft into the World Trade Centre and Pentagon.

The early expectation was that some general insurers would fold, unable to cope with the billions of pounds of losses created by the destruction, while others would actually benefit because they could hike up premiums three or fourfold to insure a world suddenly very aware of potential risks.

It was also widely expected that the already tremulous stock market would react badly to the terrorist attacks, hitting the value of general and life insurers' reserves.

It is still not possible to make a final judgement call on the impact of 11 September on insurers. Considerable uncertainty remains over the final bill from the disaster as insurers prepare to go to court with Larry Silverstein, the American property magnate who owned the lease on the World Trade Centre. This case, to be heard on 12 November, will determine whether insurers covering the twin towers alone have to fork out as much as $7.0bn (£4.5bn), or as little as $3.5bn, depending on whether the jury believes the attack constituted one or two events.

Insurers are also still anxiously waiting to see how many victims or relatives in the US eschew the US government's compensation package to pursue the airlines and airline security companies for damages. So far only 20 per cent of families have opted for the public compensation package, leaving a large potential liability hanging over insurers.

Yet the early analysis of the impact on the sector has proved to be broadly correct. No insurers in the UK have gone bust, but some have been strained almost to breaking point. At the same time the more financially strong general insurers have been making money in spades due to the hike in rates, which have particularly affected property insurance, employer's liability and, of course, terrorism cover.

Robert Hiscox, the chairman of Hiscox, the Lloyd's of London insurer that specialises in covering large buildings and other big ticket items, remarked this week: "This is the best I've seen in my 38 years in the industry."

Meanwhile, the fall in the stock market, which has actually been worse than expected, has decimated insurers' balance sheets. A consequence of this is that general and life insurers are turning to the market to try to raise capital to shore up reserves.

Zurich Financial Services, Legal & General and Hiscox have in the past two weeks announced major rights issues and the sacrifice of Bob Mendelsohn at Royal & SunAlliance (RSA) yesterday was taken as confirmation that the troubled company was in the final stages of announcing its own capital raising plan.

Some of the rights issues have been sold to the market as stories of growth. Legal & General and Hiscox say the money they are aiming to raise between them is to finance new business.

The picture is very different at Zurich and RSA, where both companies are trying desperately to boost reserves which have been eroded by poor underwriting and unexpected massive liabilities on asbestosis claims. The number of rights issues flowing from insurers is unprecedented but most in the insurance industry believe 11 September had little to do with it.

Stephen Searby, a director of the ratings agency Standard & Poor's, said: "September 11 caused an acceleration of existing trends, such as a hardening of [premium] rates and the need for new capital."

Many of the problems to hit general and life insurers have been different but the most significant one – the fall in share prices – has affected both sides.

But the impact has been particularly pronounced for life companies, as has been reflected in the sector's share price (see graph). While general insurers hold large portfolios of bonds, UK life insurers have historically held up to 80 per cent of their funds in equities. These holdings have been reduced in the past six months, but most have still been hit hard by the direction of the stock market.

In many ways it is life companies that are under the most pressure now as they are also missing out on the rise in premiums which general insurers have been able to impose on customers. At the same time they are at the mercy of individuals who currently have no appetite to plough money into the long-term investments life companies offer.

The result has been a slashing of bonuses being paid to customers now and the view that long-term expectations will have to be firmly brought down from average returns of 20 per cent on an average with-profits policy 10 years ago, to about 6 per cent now.

While life companies hope to cash in on the fact that everyone needs to save much more for their old age, they also know that there will have to be widescale consolidation among life offices if any are to have a hope of generating profit.

On the general side, the picture has been more positive. General insurers have born the brunt of losses from the attack, but there have been some positive indications that early estimates were too high. The expectation is that the total cost is unlikely to go above $40bn, compared with early guesses of in excess of $70bn.

General insurers have also learned a lot from the events of 11 September. Robin Savage, an analyst at WestLB Panmure, said: "Some insurers are taking a lot more care about their accumulation of risk, so they are writing more in total but shrinking the size of exposure on a single line of business. There is also terrorism exclusion on a lot of policies and when insurers are writing it they are charging a lot more money for it."

The increases in some areas of general insurance premiums have been particularly dramatic because they came from such a low level. Relying on investment returns for profits in the 1990s, companies competed for customers by grinding premiums down to the point that prices did not increase at all in property insurance between 1993 and 1999. The problem for RSA and its ilk is that it can make large amounts of profit on business written now, but it has persistently under-reserved for business written in the past and now has no option but to call on the market for extra cash to cover those liabilities.

While the impact of 11 September is now falling into place, the big question is whether developments in the past 12 months will prove transitory or permanent. General insurance is a notoriously cyclical industry which sees prices start to fall away as soon as they have peaked, because it is at this point that opportunistic capital floods into the market.

The early view is that many of the shifts will be permanent. One analyst said: "Insurers cannot afford to go back to the bad old days, when they cannibalised profits by driving down premiums, because the muted stock market outlook will not allow it. The simple fact is that we will all have to pay more for our insurance in the future."