The Current Status of Terrorism Insurance: Are We Headed for an Independent Private Marketplace?

As we all know, the terrorist attacks of Sept. 11 caused significant harm to the United States economy.

It has been estimated that the insurance industry paid between $30 and $40 billion in insurance losses due to the Sept. 11 attacks. As a result of the massive losses, the domestic insurance marketplace has changed forever.

Immediately following Sept. 11, insurers turned their attention to potentially excluding future terrorism losses in their policies, while many questioned whether Sept. 11 related losses would be denied based upon war risk exclusions. In the wake of such confusion, many state insurance departments were becoming uncomfortable with the idea of insurers excluding terrorism losses knowing that a potential uninsured terrorism loss could lead to economic devastation. It became increasingly clear that the federal government would be forced to address the problems associated with coverage for terrorism losses.

The result was the passage of the Terrorism Risk Insurance Act (“TRIA”), which was signed into law by President Bush on November 26, 2002. TRIA provided a federal backstop for losses resulting from certified “acts of terrorism.” To fall within the new federal program, the Secretary of the Treasury is responsible for certifying whether a specific event is an “act of terrorism.”

Notably, TRIA identified the following criteria: (1) there must have been a violent act that is dangerous to human life, property, or infrastructure; (2) the act resulted in damage within the Unites States or certain other defined areas (i.e. air carrier, U.S. flag vessel, or on the premises of any U.S. mission); (3) the act must have been committed by an individual acting on behalf of a foreign person or as part of an effort to coerce the civilian population or influence policy or affect the conduct of the U.S. Government by coercion; and (4) the act must produce property and casualty insurance losses in excess of $5 million. As part of the new federal legislation, insurers were required to make certain forms of terrorism insurance available in the marketplace and were also responsible for a percentage of any terrorism related losses via deductibles and a co-insurance program.

While there remains a persistent threat of terrorism against the interests of the United States, TRIA is currently set to expire at the end of 2005. In turn, there has been considerable discussion as to whether the private insurance market should be responsible for terrorism losses without the aid of the federal government.

Interestingly, there are reports that the private market for terrorism insurance has seen some significant increases. In a Dec. 15, 2004, press release, AON reported that 57% of companies that the organization studied had decided to “take up” some kind of terrorism insurance – an increase from a 24% reported figure from earlier in 2004. While not specifically addressed in the press release, it is relatively well known that several companies offer reinsurance products to help insurers cover the deductible and co-insurance provisions of TRIA. Thus, the private marketplace has been able to offer a certain level of coverage for terrorism related losses.

In contrast, some maintain that it is becoming abundantly clear that the marketplace for terrorism coverage is severely lacking in some areas and is predicated on unbalanced models for potential loss. For instance, there remains a sizable gap between the needs of some insureds for coverage related to damage that could be caused by weapons of mass destruction and what is available in the marketplace.

In addition, the market is reportedly still driven by a limited number of urban areas that are the most likely targets for future terrorists attacks. Thus, while the private insurance and reinsurance markets are offering a fair amount of coverage to cover terrorism exposures, many feel that important problems remain unanswered.

AON’s press release also stated: “TRIA’s importance as a backstop cannot be overstated. Its expiration will cause an immediate and significant diminution of the available supply of terrorism capacity that is likely to leave the market hard pressed, if not unable, to meet the potential demand for risk transfer capacity.”

It appears that the private insurance market has made every attempt to embrace terrorism risk insurance, but significant obstacles remain. For instance, while many companies are able to model for potential losses in a given area, there is almost no way to model frequency of losses. Thus, companies area aware of potential severity without a gauge for frequency.

Of potentially greater concern is that some of the modeled terrorism losses exceed a loss of $100 billion or more. In testimony before the Senate Banking Committee, Ernie Csiszar, president and CEO of the Property Casualty Insurers Association of America, had this to offer regarding the challenges in this area, “But the unknown size and frequency of terrorism losses makes it virtually impossible to develop accurate risk models. The [insurance] industry has also been working over the past three years to develop terrorism risk models and analyze the implications of future attacks. Despite their infancy, these models indicate that a loss of $100 billion or more is not far-fetched. This would easily exceed the financial capacity of the [insurance] industry.” Insurers Tell Senate Panel of Possible Long-Term Terrorism Solution; Urge Swift Action, Insurance Journal, April 14, 2005.

As with all complex business driven legislation, the target goals are constantly shifting. Compounding the discussions related to new legislation are the business pressures attendant to the insurance business.

For instance, in a letter from the National Association of Insurance Commissioners to the Chairman of the U.S. House of Representatives Committee on Financial Services, the potential for significant market disruptions was identified. Of importance, the letter identifies that the commercial insurance business cycle operates in such a way to require many insureds and insurers to make decisions about insurance programs for 2006 as early as the fall of 2005.

In turn, it is noted in the letter that many insurers will be forced to include conditional terrorism exclusions that will become effective should TRIA not be extended beyond 2005.

The arguments relating to new legislation are complicated. Many have equated TRIA to a “corporate bailout.”

Further, many were under the, perhaps, mistaken impression that it was a temporary solution to a long-term problem. In turn, some have advocated a simple extension of TRIA with limited modification, while others have called for an extension with significant revisions and a potentially greater financial burden for the insurance industry in the event of a terrorism related loss.

Still others have noted that some form of federal legislation should be in place for terrorism related losses and that such legislation should address both commercial and personal policies in the context of weapons of mass destruction related losses.

The result? Other than confusion, there is little to report.

Despite the call for immediate action by some, Congress seems to be inclined to wait until after a Treasury Department report is delivered in June of 2005.

In early March, there were bills introduced in both the House and Senate that would extend the federal government’s role in terrorism insurance. The exact parameters and future success of such bills remain in question.

Andrew S. Boris is a partner in the Chicago office of Tressler Soderstrom Maloney & Priess. His practice is focused on litigation and arbitration of insurance coverage and reinsurance matters throughout the country, including general coverage, directors and officers liability, professional liability, environmental, and asbestos cases. Questions and responses to this article are welcome at aboris@tsmp.com The Tip of the Month runs each month on claimsguides.com