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Terrorism Insurance: Pray As You Go

Without a government safety net, companies are left with little coverage against terrorist attacks.
Russ Banham, CFO Magazine
February 1, 2002

The Metropolitan Transportation Authority oversees New York City's subway system, buses, railways, tunnels, and bridges, from the Triboro to the expansive Verrazano Narrows connecting Staten Island to Brooklyn. Had a terrorist destroyed the latter prior to September 11, the MTA would have had recourse to $1.5 billion in property insurance to defray the cost. Were this to happen tomorrow, the state agency would confront financial chaos. "The most insurance I could buy to protect against terrorism was $100 million," says Gary Caplan, MTA director of budgets and financial management.

As for losses above that amount, New York State taxpayers and farepayers are on the hook. Having absorbed up to $50 billion in claims following the September 11 disaster (in comparison, Hurricane Andrew cost the industry $20 million), insurers and the reinsurance companies that spread their risk are loath to put their capital on the line for future terrorist attacks. That means that companies, municipalities, and other organizations must bear much of the risk themselves on their balance sheets.

In fact, in the past weeks, thousands of companies whose commercial-property, commercial inland marine, farm, crime, and business-owners insurance policies expired on January 1 have received letters stating that the policies will not be renewed as written. While the standard property policy, for example, will still guard against the perils of fire, explosion, smoke, theft, and wind, it will not cover them if terrorism caused the problem.

Companies are left with two options: a separate terrorism policy offering modest limits of protection (up to $150 million), or an add-on to their current policies that provides marginal coverage (about $5 million) through a separate limit of protection--if the insurer is willing to offer it. The implications of such limited coverage have created quite a bit of angst.

"When we tell clients there is no more insurance beyond $150 million, they are nonplussed," says Suzanne Douglass, executive vice president of Willis Risk Solutions, the MTA's New York-based insurance broker. "'What do you mean, we can't get it?' they demand. But people are living in la-la land, thinking insurers will change their tune. It's not going to happen."

That angst is especially acute in such industries as construction and transportation, considered high risk for terrorism. But some observers fear the lack of coverage could affect the broader economy, as lenders restrict credit to businesses unable to transfer their terrorism risks. "Either they won't get a loan or the bank assuming the risk will add many basis points and/or fees to the lending rate," predicts Robert Hartwig, chief economist at the New York-based Insurance Information Institute. "It could unnecessarily put an additional drag on the economy."

Little Protection
Few blame the insurance industry for rushing for the exits, given the enormous losses caused by September 11. While the industry is in business to bear risk, terrorism is too unwieldy a foe to tackle. "There is no actuarial history from which insurers can ascertain the potential frequency and severity of terrorism risks in order to price it appropriately," explains Hartwig.

Until this past Christmas, the industry was hopeful that Congress would intervene to establish a federal safety net that would backstop overall losses for insurers and reinsurers. While the House of Representatives approved such legislation, the Senate was unable to get its bill off the floor before it adjourned for the holidays.

While the possibility of federal intervention isn't likely in the near future, some carriers have at least opted to provide the low-limit endorsement. "It's more politically palatable to offer something rather than nothing," says Gary Marchitello, managing director of the global property insurance practice at insurance broker Aon Risk Services in New York. "But that doesn't mean significant coverage will be offered."

The $5 million in coverage that is being offered is downright "paltry," complains Douglas Rousseau, director of risk management at $2.5 billion Perrier Group of America Inc., in Greenwich, Connecticut. "Companies our size want catastrophic coverage protecting against the one-time huge event, but it's just not available," he says. For the moment, however, Perrier is covered for terrorism losses--Rousseau finalized an 18-month property insurance policy last July 1.

For other companies, such as $10 billion Illinois Tool Works Inc., a Glenview, Illinois-based diversified industrial products manufacturer, the impact on premiums is more disturbing than the coverage limits. "I don't think we face substantial risk," says Richard Schmidt, director of risk management, whose insurer, FM Global, added a terrorism endorsement with a $5 million sub-limit to Illinois Tool's property/casualty policy. "We're very widespread, with about 600 facilities worldwide. Fortunately, I'm not sitting here with a Sears Tower exposure. Nevertheless, my premium increased more than 40 percent, now that the terrorism coverage is built into it."

Limiting the Limits
Such endorsements just don't cut it for organizations like the MTA, which have massive risk exposures. For them, the only salvation is the three insurance facilities--Lloyd's of London, American International Group Inc., and Berkshire Hathaway--that are offering stand-alone terrorism policies. But the price of that salvation is high, ranging from 5 percent to 10 percent of their limits (a determination based on location, type of building, and so on), with coverage limited to $50 million to $150 million.


Stacking the limits of these policies--basically, buying all three to obtain greater coverage limits--is difficult because the contract wording varies. "Some offer protection for business interruption to all clients, while others are restrictive," explains Robert Howe, managing director at insurance broker Marsh in New York. "Others have variances in the coverage language with respect to how 'terrorism' is defined. It has become difficult, though not impossible, to stack the limits."

The lack of catastrophic coverage limits is forcing Keith Kennedy, director of risk management at FPL Group Inc., a Juno Beach, Florida-based electrical utility whose property insurance policy expires in June, to make choices. "If you're offered a very little bit of insurance at a high price, it's almost a 'why bother?'" says Kennedy. "We will certainly evaluate terrorism insurance if it's available, but we may have to go bare [without insurance for terrorism]. If there is no catastrophic protection, then there's no catastrophic protection. It makes no sense to anguish over it."

Ironically, Kennedy is less concerned about FPL's two Florida nuclear facilities, although they may carry a higher risk. That's because the nuclear industry has a mutually owned insurance company, known as Nuclear Electric Insurance Ltd., that would likely fund terrorism-related losses. The industry is also privy to a federally supported payout cap of $9.5 billion per incident through the Price-Anderson Act.

The MTA's Caplan figured even a modest amount of terrorism coverage was better than none. "What else could I do?" he asks. "My broker told me the best it could do was secure one-third the property insurance limits at three times the cost. And, by the way, I'd have only $100 million in terrorism coverage. Do I rest easy at night? What do you think?"

Before September 11, the MTA's property insurance policy absorbed up to $1.5 billion in property damages, minus a $15 million deductible, at a cost of $6.4 million. Now the agency has two property insurance policies, one providing $500 million of plain property coverage with a $30 million deductible for $18.6 million, the other offering $100 million in terrorism coverage with a $30 million deductible for $7.5 million. The policies were secured by the MTA's wholly-owned captive insurer, First Mutual Transportation Assurance Co., which purchased coverage from a consortium of insurers and reinsurers that included Lloyd's of London and Berkshire Hathaway.

Economic Ramifications
The insurance industry maintains that unless the government steps in at some point to share catastrophic terrorism risks, the status quo is likely to remain. "There will be pockets of coverage, geographic in nature and corresponding to certain industry groups, that will continue to be offered," says Hartwig, "but as for substantial limits of protection across the board, it will be virtually impossible to come by through much of 2002."

One bright spot is that terrorism cannot be excluded from workers' compensation insurance, because of statutory protections for workers. But its elimination from other policies could have even broader implications for certain industries, including construction, transportation, recreation, and lending, all of which complained to federal legislators in recent weeks. "Without builders' risk insurance broad enough to cover any acts of terrorism, property owners would find it difficult to qualify new projects for construction loans or permanent financing," stated Stephen Sandherr, CEO of The Associated General Contractors of America, in a letter to the Senate.

Such concerns are not unfounded, says Marchitello. "Will lenders lend for new construction or plant expansions knowing the ultimate borrower doesn't have terrorism protection? That is the question."

The American Bankers Association confirms that banks are leery. "The issue for banks is simple: weighing the probability they will get paid back," says James Chessen, the ABA's chief economist in Washington, D.C. "Anything that adds to the risk of not getting paid is something to consider. The existence of insurance generally is a very important consideration. And certainly terrorism insurance, or the lack thereof, is an element of that."

(For an indepth look at other types of insurance policies post 9/11, see CFO.com's 2002 Insurance Buyer's Guide, "Insurance at RIsk."

Sidebar: No Lender of Last Resort

Blame politics for deferring a federal safety net for insurers against terrorism losses. Although the House of Representatives succeeded in cobbling together legislation, the Senate failed to get its bill to the floor in time for the holiday recess. Trial lawyer groups and business interests squared off over tort reforms in the bill releasing companies from punitive damages in cases where their employees had committed a terrorist act.

The Senate bill sought to limit insurers' aggregate losses from terrorism to $10 billion, above which co-insurance provided by government and industry would absorb the remainder. The bill got caught in a political crossfire, with plaintiff attorney groups arguing that the business community was using the terrorism issue to advance an antitrial bar agenda. But the Association of American Trial Lawyers countered that without punitive damages, companies that knowingly hired a terrorist who later committed a crime could not be punished. "Do we really want to immunize companies that fail to perform adequate security checks of their employees?" says AATL spokesman Carlton Carl.


The irony is that insurers greatly preferred the Senate bill over the House legislation. In that bill, the government would cover 90 percent of losses exceeding $1 billion up to $100 billion. The money would be recouped by an assessment on insurance companies and/or a surcharge on policyholders. While the Senate will pick up where it left off now that Congress has resumed, getting Republicans and Democrats, much less both houses of Congress, to agree on a solution that would be supported by the insurance industry, business, and interest groups is far from certain.




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