Introducing the NY Insurance Exchange!

If you were the Governor of New York State, what would you propose?

The recent collapse of Wall Street has damaged the downstate N.Y. economy. And the closures of large manufacturing facilities by former industrial titans like Bethlehem Steel, General Electric, General Motors, IBM, and Kodak have devastated the upstate N.Y. economy as well. As a result, Governor Paterson used his State of the State address last week to criticize his state legislators for failing to reduce state spending to levels that could be sustained by its shrunken economy.

But then how did Governor Paterson suggest improving New York’s economy? With stronger public education? Less government bureaucracy? More effective regulation and oversight?

Well, he did indeed address all of these issues, but he also proposed a dramatic new private sector initiative as well. Namely, he proposed the relaunching of the New York Insurance Exchange.

Back to the ’80s!

If Paterson’s mention of the New York Insurance Exchange makes you reminisce about the go-go times of 1987, when Michael Douglas conquered the financial markets in Wall Street and Michael J. Fox rose from mailroom to chief executive in The Secret of My Success, it’s likely because New York City actually did host an Insurance Exchange that folded that very year.

First launched in 1980, and patterned on the famous Lloyd’s of London market, New York’s original Insurance Exchange collapsed under the weight of its own complexity and lack of capitalization. Lloyd’s, a firm that once insured Betty Grable’s shapely legs, then resumed its role as the world’s only operator of a global exchange for insurance products.

But if an Insurance Exchange couldn’t survive in New York in 1987, why does Governor Paterson believe that it might succeed now? Does the world now require a second trading market for insurance? And is New York City now prepared to operate it?

A Persuasive Case

To be sure, an Insurance Exchange in New York City may make more sense today than it did two decades ago. One reason is that the world has become far more complex in nature, and thus insurance products have become more complex as well. Instead of simply negotiating with individual insurance companies for customized policies, organizations may well benefit by accessing a commercial market to devise risk management strategies.

Then why don’t they go to the Lloyd’s market, you may ask? Well, many organizations do so, but American firms may prefer to process transactions in an American insurance market. Organizations outside of the United States, but doing business in America, may prefer to do so as well. And even European firms that are doing business in Europe may appreciate an alternative to Lloyds; after all, a little competition is always a healthy situation!

Yet another reason for New York’s improved chances of success is today’s use of modern technology to operate electronic global markets for financial products, markets that were only in their infancies during the 1980s. The internet facilitates the shifting of financial transactions from one corner of the world to another, and global electronic market places have become commonplace; thus, a fledgling insurance exchange in New York City may well find it possible to gain acceptance (and new business) relatively quickly.

A Few Nagging Questions

Sounds like a great idea, doesn’t it? Nevertheless, before New Yorkers erect another Romanesque building with a gigantic trading floor next to the venerable home of the Stock Exchange, they might wish to ponder a few nagging questions.

First of all, who is going to regulate the new insurance products to be traded on the floor of the exchange? The N.Y. Insurance Department, after all, failed to stop AIG from creating what Warren Buffet called financial weapons of mass destruction, instruments that claimed to reduce financial risk but that eventually destroyed AIG and threatened the global economic system as well. A relaunched Insurance Exchange would challenge N.Y.’s regulators with a new array of complex securities.

Second of all, how much benefit would the state actually derive from the exchange? All trading activity on the NASDAQ exchange, and most trading activity on the New York Stock Exchange,  is electronic in nature. If an electronic system is employed by the new Insurance Exchange as well, would traders move their residences and establish offices in New York City? Or would Wall Street simply serve as a virtual address for trades that are consummated in cyberspace?

And third of all, who is going to invest in the products that are traded on this exchange? Governor Paterson suggested that hedge funds, private equity firms, and other parties who have no direct interest in insurance might establish trading strategies there. Such momentum traders, of course, have been blamed for wild and destabilizing swings in the prices of crude oil, food commodities, and other exchange traded products; it is therefore possible that new markets for insurance products would produce similarly detrimental effects.

So do the prospective benefits of an insurance exchange outweigh the risks? A believer in open competition would undoubtedly recommend that New York launch the endeavor, thereby allowing the free market to determine whether it becomes a success. Nevertheless, like the products to be traded on its exchange floors, a new Insurance Exchange would itself represent an initiative with great promise that is fraught with great risk.