New York Gov. David Paterson started a buzz in the market by voicing his strong interest in reviving an insurance exchange modeled after Lloyd's of London–host of the gala Manhattan dinner where the governor made his pitch. The question circulating around the banquet room was whether a new exchange could succeed after its predecessor crashed and burned over 20 years ago.

The New York Insurance Exchange debuted in 1980 as a syndicated, subscription-based market, mimicking Lloyd's. It was conceived during a capacity crunch, but folded seven years later–the victim of a softening market, capital shortages and poor underwriting, among other problems cited by critics.

However, Gov. Paterson believes the time might be right to try again because the investment infrastructure is so different.

“We have private equity funds and hedge funds and other investment funds that might be eager to place their capital in the insurance business right here in New York,” he said. “An exchange would provide such an opportunity. This would be complementary to what Lloyd's does on its side of the ocean.”

The exchange could create new capacity for hard-to-place risks–such as terrorism or hurricane-prone coastal properties–as well as bolster New York's position as a dominant player in the insurance world, Gov. Paterson said.

New York Superintendent Eric Dinallo–who first raised the possibility of reactivating the exchange in February–said “the fact is that covering noncorrelated risks via an insurance syndicate as part of a central exchange might prove to be very attractive to investors.”

Since the law authorizing creation of such a facility remains on the books, the biggest question is whether resurrecting the insurance exchange is a good idea.

Specialty market brokers and reinsurance intermediaries might certainly be interested, as the exchange could provide capacity in certain challenging lines. Buyers always benefit from more competition as well.

However, some of the all-star insurance players attending the Lloyd's dinner, while voicing genuine curiosity about how the initiative might play out, warned that recreating an exchange would be far easier said than done.

Some complained that the former exchange drew far too much “naive capacity”–investors who had no clue what they were getting into. When the market softened back then, prices plummeted, underwriters chased accounts off the proverbial cliff, and the exchange was discredited before eventually going belly-up.

It's true there are far more sophisticated institutional investors in the insurance market today. Just look at the replacement of individual “Names” with corporate capital at Lloyd's, as well as the growing use of catastrophe bonds.

But one can't ignore the debacle in the subprime lending market, in which very sophisticated institutional investors–eager for bigger yields in a low interest rate environment–blindly signed on for huge exposures via collateralized debt obligations backed by reckless homeowner loans.

It doesn't take much of an imagination to see similar woes befalling investors in a new insurance exchange. Caveat emptor!

I say you'd need to at least mutualize the liabilities of the exchange somehow–the way Lloyd's does with its Central Fund–so insureds would be confident their claims would be paid no matter what.

I also wonder how such a facility might be regulated. Will the state insurance department look carefully over the shoulders of syndicate managers and underwriters, or will there be some semi-self-regulatory structure put in place, such as at Lloyd's?

In any case, Gov. Paterson brought up an intriguing possibility–one well worth exploring. What do you folks think about it?

Special Reports /

Paterson Pitches N.Y. Exchange

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