A.M. Best Report: Terrorism – Too Risky Without TRIA

A.M. Best Co. believes terrorism is too risky without some sort of backstop to protect insurance companies providing coverage on a primary basis.

The expiration of the Terrorism Risk Insurance Act (TRIA) of 2002 without any substantive replacement could trigger a number of downgrades in the financial strength ratings of those companies writing commercial lines policies that currently are benefiting from protection offered by TRIA, according to a special report issued by A.M. Best.

Immediately following the terrorism attacks on Sept. 11, 2001, the insurance industry responded by excluding the coverage of terrorism wherever and whenever it could. First, the reinsurers excluded coverage for terrorism, then the primary carriers followed suit. Problems arose when the primary insurers were forced to cover terrorism without the protection of reinsurance in lines of business such as workers’ compensation and property in states with “fire following” statutes. In addition, any policies that excluded terrorism forced the insureds to retain the entire risk. The federal government feared a recession driven by a lack of investment in the real estate and construction sectors for lack of insurance protection on those investments and projects.

TRIA was created to be a temporary measure that effectively made the federal government take on the role of the reinsurers that no longer were covering the risk of loss due to terrorism. The legislation was meant to be temporary so that the insurance industry could adjust to the new environment and develop new methods of quantifying, pricing and insuring the risk exposure. This temporary arrangement is set to expire Dec. 31, 2005, and the question still remains: Is terrorism too risky without TRIA?

A.M. Best initially responded to the terrorists’ attacks by having companies respond to a questionnaire about their concentrations of risk across lines and their ability to tally those accumulations at the location level of detail, as well as in aggregate. Over time, the questions were modified as data quality and modeling capabilities improved, and the questions became a part of the Supplemental Rating Questionnaire (SRQ). The main purpose of the terrorism section of the SRQ was to identify those insurers with large exposures to terrorism risk, especially when TRIA expired.

The purpose of this study is to share the industry’s responses to the 2004 year-end terrorism SRQ questions on an aggregate basis. In addition, this study will offer some insight as to what types of companies are benefiting most from TRIA and therefore are most likely to suffer a downgrade in their financial strength ratings when TRIA expires.

The amount of surplus associated with the companies in this study at year end 2004 is $117 billion. This falls well short of the surplus needed to cover some of the large-scale chemical, biological, radiological and nuclear loss estimates generated for potential terrorist attacks. Even the largest insurers could not withstand the impact of these types of attacks. In addition, this surplus is needed to protect policyholders from many other risks, including hurricanes and earthquakes. This shortfall in surplus should be enough to warrant an extension of TRIA until a more permanent solution is found.

This study is available electronically from the A.M. Best Web site at www.bestweek.com.

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