TERRORISM INSURANCE

(Current as of March 2004)

THE ISSUE IS: Whether the Terrorism Risk Insurance Act of 2002 (TRIA) should be: allowed to sunset, extended beyond December 31, 2005, or replaced with new federal terrorism insurance legislation.

IT’S IMPORTANT BECAUSE: Due to the tragic events of September 11 - and the ongoing threat of terrorist attacks, Congress recognized the need to establish a mechanism to assure the financial capacity to pay claims resulting from terrorism.

The September 11 attacks were of a nature and scope unlike any other catastrophe in world history, leaving deep concerns about the insurance industry’s ability to provide terrorism coverage. Congress acted to address this situation with the passage of H.R. 3210, the Terrorism Risk Insurance Act of 2002 (TRIA). TRIA created a mechanism under which the federal government would provide direct assistance to commercial insurers in the event of a terrorist attack. Federal coverage would be triggered if an attack is officially declared by the U.S. Attorney General and the Secretary of State to be an act of terrorism causing at least $5 million in aggregate losses. The federal government would pay 90 percent of the losses, and insurers would pay 10 percent of the amount above their deductibles. Individual company deductibles are 7 percent of direct earned premium in 2003, 10 percent in 2004 and 15 percent in 2005. A recoupment mechanism requiring insurers to collect a federally defined amount from their policyholders, not to exceed three percent of a policyholder’s premium, is established for participating insurers. The Treasury would be obligated to pursue repayments of at least $10 billion in 2003, $12.5 billion in 2004, and $15 billion in 2005. There is a $100 billion aggregate limit on federal assistance. If losses exceed this amount, the Treasury Secretary must report this to Congress, and going forward no insurer may be liable for coverage beyond their TRIA deductible. Participation is mandatory for commercial insurers and not available to personal lines. TRIA is scheduled to sunset on December 31, 2005.

TRIA was intended to allow the markets three years to develop adequate terrorism insurance products. However, more than two years after the attacks, predicting how, when and where future terrorist attacks against the United States will be launched remains speculative. While models are now in use it remains unclear how accurately insurers and reinsurers can assess, measure, or spread the risk resulting from acts of terrorism. The most predictive data of future attacks is intelligence information, which is – and should remain – classified. The picture of future terrorism insurance needs may be aided by reviewing who has accepted and rejected TRIA Coverage. TRIA take-up rates remain low, and acceptance or rejection appears to be based on the insured’s perception of their terrorism risk. However, another attack could change perceptions of risk leading to a shortage of coverage based on today’s usage. Work is underway to further define need, but the fact remains that time is short, and thankfully the 9/11 attacks remain the only precedent.

While TRIA has helped calm markets, it’s effectiveness as an insurance mechanism is questionable. Not knowing how to respond to a pressing national crisis, Congress chose to be over-inclusive by requiring participation of all property and casualty commercial lines insurers. Yet, TRIA’s retention levels are so high that many smaller companies would become insolvent before receiving any federal money, and many larger insurers have calculated that they would never receive federal protection. Another consequence of these retention levels is to place companies with statutory risk retention limits, who cannot obtain terrorism reinsurance, in the unacceptable position of having to choose between violating state or federal law. Further, the exclusion of personal lines insurance assumes incorrectly that personal and commercial insurance policies are cleanly delineated. This incorrect assumption has forced the Treasury to create artificial TRIA coverage distinctions that differ significantly from the remainder of the policyholder’s coverage.

The insurance industry’s best contribution to the fight against terrorism is its unparalleled ability to provide financial mechanisms that protect against risk. However, the industry does not have access to the most predictive data available and precedent is fortunately limited to the 9/11 attacks, making risk and availability less clear than in other lines of insurance. While the property/casualty insurance industry is wisely managed and well-capitalized overall, it cannot be expected to absorb unlimited losses from multiple terrorist attacks in the future while maintaining the financial strength to pay claims for auto accidents, fires, natural disasters, workplace injuries and other hazards. The question that must be answered as the evidence develops is whether the federal government has a continuing role that will enhance the insurance industry’s ability to provide terrorism insurance.

Unlike 2002, Congress has some ability to identify need, and if necessary to tailor legislation to meet that need. Today, TRIA’s shortcomings are no longer theoretical, the nation’s understanding of terrorism has grown significantly, private insurance products have begun to emerge, and the low take-up rate for TRIA coverage proves that the mandatory participation requirement is over-broad.

NAMIC POSITION: NAMIC supported the concept of a federal backstop for terrorism insurance as a response to an extraordinary national crisis, but that support came with serious reservations about TRIA’s effectiveness as an insurance mechanism. That TRIA’s mandatory participation requirement is too broad, and that many companies would never receive federal money – which could result in insolvencies - is beyond question. NAMIC is opposed to any continued federal role in terrorism insurance that perpetuates TRIA’s shortfalls, or that is not based on compelling evidence of it’s necessity. NAMIC will support a continued federal role in terrorism insurance if TRIA’s shortfalls are remedied, and a compelling need is demonstrated.

Posted: Wednesday, April 07, 2004 12:00:00 AM. Modified: Wednesday, April 07, 2004 5:31:37 PM.

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