Long-Term Fate of TRIA Uncertain

Saturday, October 7, 2006 | 0

By Robert Lund

TRIA Extended for Two Years State workers' compensation funds were among many insurers and other business groups heaving a collective sigh of relief a few days before Christmas last year when President Bush signed the Terrorism Risk Insurance Extension Act of 2005 (the Extension Act or TRIEA) (1). The Extension Act extended the federal terrorism reinsurance program for two years, through Dec. 31, 2007, and modifies some of the terms of the original program to place more of the financial burden for terrorism losses on the insurance industry.

For instance, under the original program, an act of terrorism needed to cause $5 million in insured losses to trigger any reimbursement from the federal government. Under the Extension Act, this $5 million threshold rises to $50 million after March 1, 2006, and to $100 million after Dec. 31, 2006. The Extension Act continues to cover only certified (by the Secretary of the Treasury) foreign acts of terrorism, which include acts of war only for purposes of workers' compensation coverage. Moreover, TRIEA excludes coverage for commercial automobile, surety, professional liability, and farm owners' multiple-peril lines of insurance.

Individual insurer deductible levels for years one, two and three of the original program were 7%, 10%, and 15% (respectively) of the prior year's direct earned premium. The Extension Act further increases these levels to 17.5% for 2006 and 20% for 2007. The federal government will pay 90% of insured terrorism losses in excess of an insurer's retention in 2006, reduced to 85% in 2007. The fed's overall cap on its contribution liability continues to be $100 billion, whereas the industry-wide retention/mandatory recoupment level increases from $15 billion in 2005 to $25 billion in 2006 and $27.5 billion in 2007.

Role of the President's Working Group

TRIEA also requires the President's Working Group on Financial Markets (PWG), consisting of the Secretary of the Treasury and the Chairs of the Federal Reserve Board, the Securities and Exchange Commission and the Commodity Futures Trading Commission, in consultation with the National Association of Insurance Commissioners (NAIC) and representatives of the insurance industry, the securities industry and policyholders, to study the long-term availability and affordability of insurance for terrorism risk, including coverage for chemical, nuclear, biological, and radiological events (CNBR) and to report its findings to Congress by Sept. 30, 2006.

The PWG doesn't have much time to perform its analysis and issue a report. Consequently, it has been soliciting comments and information from the insurance and business communities, and, except for a few very large insurers, the responding business community overwhelmingly favors continued financial participation of the federal government in some type of risk-sharing arrangement for the foreseeable future beyond 2007. An ad hoc group of state funds was among the insurer groups submitting comments to the PWG.

Comments from Business Favor Continued Federal Financial Participation

A group of concerned members of Congress, including Reps. Pete Sessions (R- TX) and Richard Baker (R- LA), sent a letter (2) to Treasury Secretary John Snow in June of this year requesting that the PWG address a number of issues to facilitate the objective of attaining a long-term solution for ensuring the availability and affordability of terrorism risk insurance, including: lack of a vibrant terrorism reinsurance market, difficulty in calculating terrorism risk, impediments to a functioning private insurance market, efforts to increase take-up rates and reduce government exposure, and the special challenges posed by CNBR.

The upshot of this "request" seems to be: once the PWG analyzes the facts, the only conclusion it can reach is that the continued existence of a federal backstop is vital to the continued availability of terrorism risk insurance.

The Coalition to Insure Against Terrorism (CIAT), a broad coalition of 79 major trade and professional associations and businesses claiming to represent the nation's major consumers of commercial insurance, including the National Association of Home Builders, the National Restaurant Association, the U.S. Chamber of Commerce and the NFL, NBA, NHL and NCAA (for all of you sports fans), has submitted comments to the PWG from the policyholders' perspective (3).

According to CIAT, despite the increase in take-up rates for terrorism risk insurance coverage since enactment of TRIA, policyholders remain concerned that the private insurance and reinsurance markets show no signs of developing capacity to cover terrorism losses following the expiration of the federal backstop.

CIAT also contends that there is little coverage available for CNBR other than that included in statutorily mandated products such as workers' compensation insurance. Federal involvement in a long-term solution is appropriate, according to CIAT, because terrorism is a national security issue, and the federal government possesses significantly more expertise concerning terrorism risk than the insurance industry. CIAT suggests that the PWG should analyze how a combination of private insurance industry capacity, potentially enhanced by tax-policy based incentives, private sector financing through the capital markets, and federal participation can be used to facilitate an economic recovery in the wake of any terrorism losses.

House Homeland Security Committee Hears TRIA Testimony

On July 25, 2006, the House Financial Services Committee's subcommittee on Investigation and Oversight and the Homeland Security Committee's subcommittee on Intelligence, Information Sharing and Terrorism Risk Assessment held a joint hearing on terrorism threats and the insurance market. This hearing marked the Homeland Security Committee's first public expression of interest in the subject of terrorism risk insurance, an encouraging sign for the insurance industry.

The committee heard testimony from Terry Fleming, the External Affairs Director for the Risk and Insurance Management Society (RIMS). In an informal RIMS survey, 86% of responding members said if TRIA or some other federal backstop were not in place, they believed they would not have the ability to obtain sufficient coverage for acts of terrorism at affordable prices. While 82% thought coverage should be available for CNBR, 91% said they did not have coverage for CNBR and 86% responded that they didn't think CNBR coverage would be offered by the private sector at all without a TRIA-type backstop in place. It is noteworthy that 75% of respondents said that, prior to the passage of the Extension Act, their 2005 policies contained terrorism coverage conditioned upon the extension of TRIA (4).

Also testifying before the House joint committee was Christopher Lewis, a vice president with the Hartford Financial Services Group. Lewis noted that the foundation for private insurance rests on insurers' ability effectively to pool the loss experience of policyholders exposed to relatively homogeneous, random and independent risks where the underlying source of the risks is well-understood and, therefore, appropriately priced. The problem with terrorism is that its risks are not homogeneous, random, independent or well understood. He opined that, because insurers do not have the ability to assess the likelihood of a terrorist attack or the form or location of the attack, large-scale terrorist attacks are simply not an insurable risk.

According to Lewis, insurance companies continue to offer terrorism coverage to commercial customers through the "make available" provision within the Extension Act. However, without the ability to model the likelihood of terrorist events, companies are unable to determine an actuarially appropriate price and are forced to manage the risk by limiting exposure concentrations in potential "high-target areas."

Once terrorism exposure concentrations get too high relative to surplus, insurance companies are compelled to non-renew entire commercial policies to reduce the exposure -- often creating significant hardships for policyholders. Lewis testified that these exposure concentrations are especially difficult for certain lines of business, like workers' compensation, where exclusions for CNBR are not available.

For large carriers like Hartford, the primary benefit of TRIA is the federal government's assistance in financing huge losses associated with very large-scale terrorist attacks, most notably attacks involving CNBR.

For smaller carriers with lower retention levels, the federal backstop could finance most of the losses associated with a terrorist attack. Lewis said that without the current federal program, Hartford would be forced to reduce its exposure to terrorism risk. With the rating agencies starting to impose implicit limits on insurance company exposures to terrorism, Lewis said the lapse of TRIEA in 2007 could cause substantial market disruptions and withdrawals of coverage (5).

Actuaries Weigh in on TRIA

In March of this year, Michael McCarter, the chairman of the Terrorism Risk Insurance Subgroup of the American Academy of Actuaries, made a presentation at the NAIC's public hearing on terrorism insurance matters in New York City. McCarter discussed the potential size of insured losses that could be perpetrated by terrorists from both conventional explosive devices and CNBR (6).

As an example, the Academy Subgroup looked at potential property and casualty and group life insurance losses from delivery-truck-size bomb attacks (recall the Oklahoma City and World Trade Center incidents in the 90s) in four cities (Des Moines, San Francisco, Washington, D.C., and New York City). The modeled losses ranged from $4 billion in Des Moines to $11.8 billion in New York City (4).

According to McCarter, losses of these magnitudes would largely be absorbed by the insurance industry without significant recoveries from the feds under TRIEA. He noted, however, that, as demonstrated on 9/11, it is certainly possible for terrorists to cause losses significantly larger than these even without using CNBR.

The Academy Subgroup also looked at two different CNBR scenarios, medium and large, in the same four cities, assuming the events occurred during normal business hours and were targeted to affect large numbers of buildings and their occupants. The modeled property and casualty and group life insurance losses ranged from $27 billion (4) for a medium event in Des Moines to $778 billion for a large event in New York City. A large event in any of the largest U.S. cities caused insured losses in excess of $170 billion.

The Insurance Information Institute indicates that policyholder surplus for the entire property and casualty industry was $414 billion as of September 2005 (4). Of course, only the capital of insurers providing coverage for the terrorist event is relevant. According to the Academy Subgroup, in the aftermath of almost any CNBR event in a large city, many commercial lines insurers would be devastated in the absence of TRIA or some other national framework for dealing with terrorism insurance losses. While McCarter points out that these loss estimates are on a primary basis before considering any reinsurance that might be available, he notes that after 9/11, most reinsurance contracts that did not already exclude terrorism coverage were amended to exclude it (7).

The Academy Subgroup's analysis led it to two main conclusions:

* Because of the potential for terrorist attacks that could cause very large losses, the Subgroup does not believe there is any strategy that can develop sufficient terrorism insurance capacity without some form of legislation that limits insurer liability should these events occur.

* There should be a mechanism to develop recommendations for a permanent way of dealing with the risk of terrorism.

McCarter also voiced concern about the inability of workers' compensation carriers to control accumulations of terrorism exposure except by avoiding the underlying risks altogether.

Workers' Comp Insurers and (Especially) State Funds Uniquely Vulnerable

As we well know, workers' compensation carriers are in a unique and rather precarious position when it comes to terrorism risk. Insurers of other commercial lines have several means available to reduce or even eliminate their exposure to these risks. Without the "make available" requirement under TRIEA, most insurers could simply exclude all coverage for terrorism events. Unlike other carriers, workers' compensation insurers cannot limit their liability exposure to a particular policyholder through coverage limits or policy exclusions. Moreover, since 9/11, no state has modified its workers' compensation law to permit insurers to amend workers' comp policy terms to exclude or limit an insurer's liability for terrorism losses. And it's unlikely to happen in the future.

As McCarter contends, the only strategies available to workers' compensation carriers to mitigate the risk of terrorism losses are (i) to avoid writing business in certain high-exposure areas in and around large cities and (ii) to attempt to insure risks that are geographically dispersed, so as not to create a concentration of terrorism risk exposures.

Unfortunately, even these tools are not available to state funds that also serve as the insurer of last resort in their jurisdictions and are only minimally available to other state funds who, as a matter of public policy, offer coverage to all sectors of their home state's business community.

Unlike direct writers of workers' compensation insurance, the line's reinsurers have no legal constraints on their ability to exclude terrorism exposure. Because of the existence of TRIEA, there is some availability, albeit limited and expensive, of reinsurance for non-CNBR workers' comp losses. CNBR events are generally excluded, and specific CNBR coverage must be purchased separately at a cost that is too high for many insurers.

It is clear that the continued availability of a federal terrorism risk program, even the watered-down version contained in TRIEA, is vital to maintaining the affordability of workers' comp coverage and to facilitating the availability of any meaningful terrorism reinsurance coverage from the private market. Moreover, absent TRIEA, a major CNBR event could literally destroy a smaller carrier with significant workers' comp exposure or a smaller state fund or other residual market mechanisms.

The Bush Administration May Not be Convinced

Although the insurance industry and business trade organizations present compelling arguments for significant federal financial participation as part of a long-term solution for insuring against terrorism, the Bush administration appears to have little interest in keeping TRIA alive beyond December 2007, (4) its current expiration date.

Assistant Secretary of the Treasury Emil Henry Jr. commented earlier this year that President Bush had only intended TRIA to be a temporary solution to ease "market dislocation" caused by 9/11 (8). Despite all of the evidence to the contrary, the administration has adhered to the notions that post-TRIA private insurance capacity would continue to expand and that the private reinsurance markets have begun to make more terror coverage available.

Recent Proposals Acknowledge Political Reality

The American Insurance Association recently published a proposed long-term solution to the terror coverage quandary, calling for the federal government to assume financial responsibility for all CNBR events and including a provision to recoup CNBR losses of up to $10 billion via insurer-administered policyholder assessments (9). The proposal also includes a high-level federal backstop for conventional terrorist attacks, a mechanism for the Treasury Department periodically to adjust insurer retention levels depending on the amount of private capacity available for terrorism, insurer tax incentives, and the potential for the creation of voluntary terrorism insurance pools.

Although this radically scaled-back approach may ultimately be acceptable to Congress, the White House and much of the insurance industry (and some federal protection is certainly better than none), it would continue to leave many writers of workers' compensation insurance, and especially state funds, vulnerable.

There's Still Hope for a Rational Solution

Given the complexion of recent events -- geopolitical upheaval on many fronts in the Middle East, the multiple airplane bomb plot that was thwarted in Britain, and the renewed interest that at least some members of Congress have shown in the terrorism insurance issue -- there is still hope that both Congress and the Bush administration will seriously take up this issue in 2007 and work toward a long-term solution that includes meaningful federal participation. The contents of the PWG report will undoubtedly have a major impact on the course and scope of the debate.

Footnotes

1. TRIA, Pub. L. No. 107-297, 116 Stat. 2 *4.22, as amended by Terrorism Risk Insurance Extension Act of 2005 (TRIEA), Pub. L. 109-144.

2. Letter dated June 22, 2006 from the Congress of the United States to The Honorable John Snow, Secretary of the Treasury.

3. Comments of the Coalition to Insure Against Terrorism to the President's Working Group on Financial Markets, submitted via electronic mail and available at www.treasury.gov.

4. Statement by Terry Fleming on behalf of the Risk and Insurance Management Society before a Joint Hearing of the House Committee on Financial Services, Subcommittee on Oversight and Investigations and the Committee on Homeland Security, Subcommittee on Intelligence, Information Sharing, and Terrorism Risk Assessment, July 25, 2006.

5. Statement by Christopher M. Lewis, Vice President, Alternative Market Solutions, P & C Capital Management, The Hartford Financial Services Group, before a Joint Hearing of the House Committee on Financial Services, Subcommittee on Oversight and Investigations and the Committee on Homeland Security, Subcommittee on Intelligence, Information Sharing, and Terrorism Risk Assessment, July 25, 2006.

6. All references to McCarter and to the analyses of the AAA Academy Subgroup have been taken from the Statement of Michael G. McCarter, FCAS, MAAA, Chairperson, Terrorism Risk Insurance Subgroup of American Academy of Actuaries, to the Terrorism Implementation Working Group of the National Association of Insurance Commissioners, Public Hearing on "Terrorism Insurance Matters," March 29, 2006.

7. The Reinsurance Association of America estimates that only between $6 and $8 billion of reinsurance is available to cover foreign acts of terrorism.

8. "TRIA Not Likely to be Renewed in 2008," insurancenews's blognshare.com, March 18, 2006.

9."Plan seeks federal cover for costliest terror risks," Mark A. Hoffman, Business Insurance, Vol. 40, No. 4. August 21, 2006.

Robert Lund is the vice president of business services and general counsel at SFM. SFM is the largest writer of workers' compensation insurance in Minnesota. -------------------------------

The views and opinions expressed by the author are not necessarily those of workcompcentral.com, its editors or management.