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Insurer Terrorism

Property/casualty carriers predict dire insurance shortfalls if Congress fails to pass another backstop law. Finance chiefs and risk managers should be skeptical.
David M. Katz, CFO.com | US
May 12, 2005

Leave it to the insurance industry to turn a threat to its advantage.

Faced with the prospect of losing federal backing for terrorism insurance, property/casualty insurers are jacking up prices on the coverage, insurance brokers say. What's more, some insurers are apparently making a market out of the fear that corporations could end up shorn of insurance if the Terrorism Risk Insurance Act is allowed to expire at year's end.

Indeed, insurers have made it very clear what will happen if Congress fails to reinstall TRIA, which banned insurers from excluding terrorism coverage from their property/casualty policies: They would immediately start excluding it again.

That position inevitably puts pressure on Congress to continue its support of the industry — or else risk "a severe, negative effect on the national economy, including job loss, stalled commercial transactions, and delayed construction projects," as Brian Duperreault, chairman of ACE Ltd., said in testimony before the Senate banking committee last month.

It's understandable that insurers would trot out their big rhetorical guns. The act's passage seems to be somewhat in jeopardy, since it's by no means clear that the Bush administration will support it. The President might, after all, have trouble justifying public backing for the currently flush insurance industry as he tries to drum up support for privatizing Social Security.

For their part, p/c insurers have greatly benefited from TRIA, which has curbed their terrorism risk. Under the act, the federal government would pay 90 percent of an insurer's losses, above a deductible, in the event of a foreign-engineered terrorist attack; a carrier would pay the deductible and 10 percent of the losses. The entire program would pay out a maximum of $100 billion.

Besides providing insurers with a structure in which their losses would be limited, the act bought them time to spawn models of the risk, setting the stage for them to create a potentially lucrative pricing structure for the future. In recent years, the industry has hatched a "stand-alone" market for terrorism risks not covered by TRIA, including domestic exposures and threats to foreign subsidiaries of U.S.-based multinationals.

Lacking taxpayer-supported backing, however, insurers claim that they won't be able to amass nearly enough private reinsurance to write the coverage. In fact, they're poised to exclude it from future policies. In May 2004, the industry began filing policy-form changes that would reinsert coverage limits banned by TRIA if the act isn't extended, Acting New York Insurance Superintendent Howard Mills said at the Senate banking committee hearing.

Besides protecting carriers from added exposure, "the filings demonstrate that the insurance industry is not yet willing to assume the full risk of terrorism losses at this time," said Mills, who's also chairman of the National Association of Insurance Commissioners' terrorism insurance working group.

The filings could erase terrorism insurance from policies that extend coverage into 2006. "For policies renewing this year, underwriters are putting in [a provision that says,] "if TRIA isn't renewed, we have the option to cancel," Wendy Peters, a senior vice president with Willis, the big insurance brokerage, told CFO.com. Further, prices are rising, and insurers' capacity to cover terror risks in major cities is shrinking, she said.

Coverage Gaps
The potential for wholesale erosion of coverage is apparently creating fears among certain corporate insurance buyers — fears that some carriers could exploit handsomely. "Some clients have tried to lock up capacity commitments now at predetermined prices should TRIA not get renewed," says Bob Blumber, a Marsh managing director. Executives in the lending, real-estate, and hotel industries have been especially anxious to retain coverage, he notes.

But corporate insurance buyers who want to purchase such peace of mind would have to pay a pretty penny. Insurers are charging "fairly significant" upfront fees for the privilege of buying terrorism coverage for next year and beyond, according to Blumber.

Cautioning that fees and premiums could vary widely by location, the broker offered a hypothetical example of how such a deal might be structured for a company in a potentially high-risk area like midtown Manhattan or downtown Boston for a year's worth of coverage starting June 1. For the option to buy $100 million worth of stand-alone property terrorism insurance at a premium of $2 million to $3 million, a company might have to shell out a fee of between $200,000 and $300,000 "to reserve the capacity," he says. If TRIA founders, the fee could be applied to the premiums; if the act is renewed, the fee would be nonrefundable, although the buyer could choose not to buy the coverage.

At those prices, one wouldn't expect many takers, and Blumber reports that few of the options have been sold. Instead, most potential buyers appear to holding off on their purchasing decisions until Secretary of the Treasury John Snow comes out with his report on the terrorism insurance program. That report, slated to be issued no later than June 30, is widely expect to send the re-enactment debate into overdrive. But the current political uncertainty, says Blumber, presents corporate executives with a choice: "Do I want to pay this cost now, [or] take the chance that TRIA is not renewed?"


Given the narrowness of the coverage, corporations outside major urban areas might well choose not to buy it. For one thing, the act covers only a very specific risk: a violent or dangerous act of terrorism resulting in damage within the United States that produces property and casualty insurance losses worth more than $5 million.

The terrorism must also have been committed by "an individual or individuals acting on behalf of any foreign person or foreign interest, as part of an effort to coerce the civilian population of the United States or to influence the policy or affect the conduct of the United States Government by coercion."

Thus, a company that bought only the TRIA protection wouldn't have been covered for a domestic act of terrorism, like the Oklahoma City bombing. Under the act, property carriers can also continue to exclude coverage for nuclear, biological, chemical, and radiological attacks — meaning that the damage caused by a "dirty bomb" wouldn't be covered.

Receiving prompt payment could also be a problem. Under TRIA, the triggering event must have been certified as a terrorist act by the Secretary of the Treasury, acting in agreement with the Secretary of State and the U.S. Attorney General. "To try to get the concurrence of three areas of the U.S. government could take years," Willis's Peters noted at last month's annual conference of the Risk and Insurance Management Society in Philadelphia.

With all those caveats, risk managers working for companies with diverse exposures might find it hard to gauge how the coverage might be of use. Not long after the law was enacted, Karl Zimmel, then the risk manager for Ace Hardware Corp., had doubts about whether the TRIA coverage was broad enough for the company's purposes.

On the one hand, he realized that the company's Oak Brook, Illinois, home office was located "a stone's throw" from the corporate headquarters of McDonald's Corp. "I saw the [Ace] corporate office as a true foreign terrorist exposure," he says. But Zimmel also knew that the company's greater risk was to its warehouses in rural settings, which he saw as being exposed to domestic terrorism risks. As a result, he bought a policy that covered those hazards along with the perils covered under TRIA.

The coverage, on the other hand, won't work if the exposure is on foreign soil. When Zimmel took over his current job as director of risk management for the Alberto-Culver Co., he found that TRIA-backed insurance couldn't come into play for the company's non-U.S. facilities, many of them in Europe and South America. To cover those sites as well as its domestic operations, the company had bought a comprehensive terrorism policy from a group of insurers in the United Kingdom. (Only U.S.-licensed insurers and captive insurance companies are covered under the act.)

Considering all that the federally backed insurance doesn't cover, and the growing availability of stand-alone policies, opponents of the act seem to have a point in disputing the dire consequences of its nonrenewal. In January, the Congressional Budget Office issued a report on the act that made the point — contested by some in the insurance industry — that "the development of financial instruments for spreading the [terrorism] risks would probably be more rapid in the absence of TRIA." Specifically, catastrophe bonds might be used to fund terrorism risks, according to the CBO report. The authors also stated that there are signs that private reinsurers "would fill in much of the gap in supply left by TRIA's expiration," although "that outcome is not certain."

Even from within the industry, the forecasts aren't uniformly dire. Jim Maden, an assistant vice president with Lexington Insurance Co., a Boston-based affiliate of American International Group Inc., said at the RIMS meeting that for businesses in most locations, nonrenewal of the act wouldn't make much of difference in terms of property terrorism insurance. "We could expect some dislocation, especially in terms of lender covenants," as well higher prices and lower limits of coverage, he added.

At the same time, insurers are reportedly doing a brisk business in stand-alone coverage, and new players might be poised to enter the market. "We have had several requests for data from new insurance companies currently analyzing whether they want to get into the marketplace," says Marsh's Blumber.

CFOs mulling what to do about managing their companies' terrorist risks would do well to view insurers' grimmest outlooks with skepticism. For most companies in most situations, it seems that there will be a reasonable amount of at least somewhat affordable coverage available.

But that doesn't mean finance chiefs and risk managers shouldn't prepare for the worst, Alberto-Culver's Zimmel suggested at the risk management conference. "I don't think it will be a significant blip in terrorist [insurance] pricing" if the act isn't passed, he said. "But if there's a substantial loss, all bets are off."




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