The Unique Position of Work Comp Insurance in a Post-9/11 World

Saturday, June 16, 2007 | 0

By Wayne E. McOwen

Since September 11, 2001, the entire property casualty insurance industry has struggled with how to handle the risk of another catastrophic terrorist attack. Yet within that broader market, the workers' compensation insurance industry has had to struggle with an entirely unique set of challenges. Those challenges are why workers' compensation is different.

Background--TRIA

Following the terrible events of September 11, 2001, the Terrorism Risk Insurance Act (TRIA) was signed into law by President Bush in November of 2002. Effective immediately, its purpose was to encourage market stability by ensuring the availability and affordability of terrorism risk insurance on an interim basis, encouraging private markets to build sufficient capacity in anticipation of the Act's expiration on December 31, 2005.

The Department of the Treasury was assigned responsibility for administrative oversight, empowering the agency to recoup, through policyholder surcharges, any federal monies distributed under the program as a result of "certified" acts of terrorism as defined by the Act. Insurer participation was a mandatory prerequisite to receiving protection under the Act, provisions of which included insurer deductibles that increased annually as well as insurer disclosure requirements to the policyholder. With carrier deductible obligations satisfied, federal payments would be distributed as a percentage of insured losses, subject to an industry aggregate limit of $100 billion.

TRIAE--Terrorism Backstop Extended

Several months prior to the intended expiration of TRIA, it was determined that industry surplus remained inadequate to sustain estimated losses from terrorism risk without the continuation of some measure of federal backstop. Hence, the Terrorism Risk Insurance Extension Act (TRIEA) was signed into law on December 22, 2005.

While protection continues under TRIEA until December 31, 2007, it is not under the same terms as the original Act. Under TRIEA, a revised event "trigger" prohibits federal payments unless the aggregate industry insured loss as a result of a "certified" terrorism event exceeds $50 million in 2006 or $100 million in 2007. Additionally, insurer deductibles were increased from 15% in 2005 to 17.5% for 2006 and to 20% for 2007.

The federal share of losses above the portion retained by insurer deductibles remains at the 2005 level of 90% for 2006, and drops to 85% for 2007. Finally, the definitions of "property and casualty insurance" were revised for the purposes of the Act, eliminating some lines of business from the program. Coverage continues for workers' compensation.

As the 2007 sunset of TRIEA looms, the industry continues to be concerned for its ability to provide insurance coverage for terrorism risk in the absence of such protection. Noting the enormity of pressure that would be realized on individual carrier (and industry) surplus, industry leaders ponder terrorism risk strategies to be employed to mitigate this exposure.

But workers' compensation is different!

The workers' compensation segment of the industry faces these concerns in the absence of available options to mitigate or otherwise manage terrorism risk. Accordingly, while the need for some measure of continuing federal backstop is clear for multiple lines of business, it is all the more critical for both the providers and the beneficiaries of workers' compensation insurance coverage. To raise awareness of this need, the Workers' Compensation Terrorism Impact and Education Study Group (WC TIES Group) was formed with the following objectives:

* To educate non-industry stakeholders on the uniqueness of the workers' compensation line of business; and

* To examine various proposals for a permanent solution and evaluate the probable impact of such proposals on the workers' compensation insurance industry.

Limited Options

Generally speaking, insurance is a purchase of choice. With the exception of certain mandated minimum liability limits of coverage required by compulsory auto liability statutes, it is not against the law to be without insurance protection.

But workers' compensation is different!

State statutes in all jurisdictions (with the exception of Texas) mandate providing workers compensation coverage as a prerequisite to employing a work force. Coverage includes lifetime medical treatment and rehabilitation services for on-the-job injuries in addition to wage loss replacement subject to jurisdictional variations.

In most cases, when a decision to purchase insurance protection is made, the policy provisions may be tailored to suit the buyer or to meet the underwriting requirements of the insurer. An available choice is to include or exclude terrorism risk.

But workers' compensation is different!

Options available to moderate exposure risk in policies covering other lines of insurance are unavailable to workers' compensation insurers, placing them in an untenable position if some measure of continuing federal backstop becomes unavailable following the expiration of TRIEA. Work-related injuries, provided such injuries arise out of and in the course of employment, are covered by workers' compensation policies under terms dictated by state statutes, which require terrorism risk to be an included peril.

Unlike other lines of business, the protection provided by workers' compensation policies cannot be modified. (Although the Commonwealth of Pennsylvania allows "acts of war" to be excluded, the application of such exclusion to "certified" acts of terrorist attack has not been tested.)

The uncertainty of the risk, the randomness of the act, and the potential for great loss suggest that it is unlikely for any business to choose to self-insure terrorism risk.

Definition of Terrorism

For coverage purposes, acts of terrorism are defined in the law. To be eligible for federal participation through TRIEA, a terrorism event must be committed by individuals acting on behalf of foreign interests and as part of an effort to influence the policies of the United States and the implementation of those policies globally. Further, the Act requires that terrorism events be certified by the Secretary of the Treasury with the concurrence of the US Attorney General and Secretary of State. Domestic acts of terrorism are not covered by the Act.

But workers' compensation is different!

Workers' compensation policies do not differentiate between foreign and domestic terrorism events. State workers compensation statutes require insurers to pay for work-related injuries that result from terrorist attacks whether the attacks are foreign or domestic in origin. With foreign acts of terrorism, there is protection under TRIEA; with domestic, there is no protection under TRIEA.

Insurability

Risk assessment is critical to a determination of insurability. Some risk can be anticipated; we know there will be automobile accidents. Insurance actuaries can estimate the anticipated risk from certain types of exposures based on historical data and future trends; construction-related work injuries can be anticipated for employees classified as roofers, for example. Some risks can be prevented; eye protection devices can make an uninsurable group of workers who are susceptible to eye injury insurable.

Some risks can be measured; a building has a replacement value that can be determined before or after the loss occurs. Some risks, although potentially catastrophic, can be estimated and may be manageable; hurricanes are seasonal and develop over a time line that enables specific steps to be taken to limit loss of life and mitigate property damage.

Terrorism loss is neither predictable nor reliably measurable; ultimately, it may not be preventable. These characteristics support a conclusion that terrorism risk is uninsurable.

But workers' compensation is different!

Because of the requirement to include terrorism risk coverage in workers' compensation policies, insurers must choose between offering to insure the uninsurable or decline to provide a policy.

Residual Market and Guaranty Fund Exposures

Insurance carriers can choose where to market their products. Risk evaluation and the probability of loss drive the decision to offer a policy to a prospective insured. Accordingly, insurers doing business in a particular jurisdiction can mitigate their exposure to terrorism loss by simply choosing to not accept a particular risk.

But workers' compensation is different!

Because it is a mandated coverage, there must be a resource in each jurisdiction from which employers can purchase workers' compensation insurance. In the event a private carrier is unwilling to provide coverage due to risk factors deemed to be unacceptable, the residual market mechanism exists to ensure coverage availability.

In some jurisdictions, these mechanisms are state funds, operating similarly to private insurers but as a "market of last resort." In other states, the residual market mechanism is an assigned risk plan--essentially the quota-share distribution of "unwanted" risks, required to be covered by private market insurers in numbers proportional to those insurers' voluntary market share. Unless they withdraw completely from a market--rendering their voluntary participation 0%--private carriers cannot avoid terrorism risk exposure either voluntarily or involuntarily.

Guaranty funds were created to ensure that funds are available to pay claims in the event of carrier insolvencies. Through state-mandated assessments, private carriers contribute to the funding of such entities. Assessments vary, depending on need. In the event a fund's reserves dip below a predetermined threshold, insurers may be required to make more frequent and/or greater contributions of funding.

If the terrorism risk could render a private carrier or a state fund insolvent, guaranty fund assessments would be required to fund injured worker claims. Again, as a result of this process, there is no way for the industry to avoid terrorism risk if it is to stay in the business of serving the workers' compensation needs of injured workers, their families, and employers.

Catastrophe Modeling

Numerous publications and studies have recited loss scenarios that underscore the threat to safety and soundness of the insurance industry. The American Academy of Actuaries cites insured losses in New York City in excess of $775 billion from a CBRN (chemical, biological, radiological, nuclear) terrorist event. (The estimated workers' compensation component from such an event was estimated at just under $500 billion.)

Although predicting the frequency and severity of terrorism events is problematic, it is clear from estimates of credible analysts that damages could be well beyond the range of the available surplus of the total US insurance marketplace. Faced with this potential, insurers will consider taking steps to mitigate or avoid such catastrophic outcomes.

But workers' compensation is different!

To the extent workers' compensation providers are unable to avoid such risk, the potential magnitude of such events portends the elimination of a large number of providers, thereby threatening the stability and continued viability of the entire system.

Industry Efforts

Faced with the reality that TRIA and TRIEA were intended to be temporary solutions, industry leaders, admonished by lawmakers to craft a private market solution, have worked tirelessly to find a permanent solution sufficient to enable the broadest level of insurer support.

A number of industry organizations have organized ad hoc research and development working groups, recruiting expertise from key member carriers, and charged them with crafting a solution. The focus of most of these initiatives has been to consider the creation of a public-private partnership. Over a defined time line, this partnership would rely less on federal participation as the availability of tax deferrals and other accommodations would enable private markets to build sufficient surplus to shoulder an increasing share of loss.

We applaud the diligent efforts of industry leaders to create a solution amenable to all stakeholders. And, for all of the reasons cited above, we remain optimistic for that outcome, particularly in terms of their addressing issues unique to workers' compensation. Accordingly, it is the intent of the WC TIES Group to continue to make that case and to facilitate meaningful dialogue to achieve that outcome.

Potential Solutions

While it is not the intent of the WC TIES Group to advocate for a specific solution, for purposes of discussion it is useful to cite some of the solutions that have been suggested:

* Pooling mechanisms with tax incentives to encourage capital appreciation;

* Risk sharing of target or otherwise problematic risks among a number of unaffiliated insurers;

* Incentives to reinsurance carriers to encourage greater participation;

* Creation of a federal government-administered insurance facility;

* Creation of a federal reinsurance program through which additional reinsurance capacity would be available to primary insurers;

* Continuation of some measure of federal backstop;

* Preemption of state workers' compensation statutes to eliminate the requirement to include terrorism risk; and

* The inclusion of domestic terrorism in any program being considered.

Hopefully, the insurance industry and government leaders will employ a collaborative approach to achieving a long-term solution to terrorism risk. As has been suggested in the aftermath of recent natural catastrophes, the reliance on and cost of post-event federal reimbursements to victims is high and may be less efficient than relying on the claims management expertise of insurers. Most problematic would be that the expectation of state or federal victims' relief being available post-event would discourage the purchase of insurance protection.

But workers' compensation is different!

Employers cannot be discouraged from securing coverage; this potentially places the most pressure in the insurance system on workers' compensation providers.

Final Thoughts

Insurance is a promise to pay in the event of loss. That the industry well serves the interests of all stakeholders who depend upon that promise being kept became clear following the September 11 attacks in New York and Washington, DC.

But workers' compensation is different!

Although purchased by employers, its promise is to injured workers and their families. In the September 11 tragedy, it kept that promise by providing survivor benefits. Well before victims' funds and other relief mechanisms were organized and funded, the families of September 11 victims relied on the immediacy of workers' compensation benefits. Because of situations like this, it may be argued that workers' compensation is among the most socially responsive lines of insurance--and it must be preserved.

Wayne McOwenis senior vice president for government affairs and industry relations for GUARD Financial Group. This article was published in NCCI Holdings Inc.'s 'Workers' Compensation 2007 Report' and has been republished here with the permission of NCCI. The entire report can be read at www.ncci.com.

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