Risk Management

Insuring Terror

As the federal Terrorism Risk Insurance Act nears expiration, some push for permanence.
Alan RappeportApril 26, 2007

The cost of terrorism can be a terrible thing to assess. Indeed, even experts astute at calculating risk seem at a loss — both at predicting future attacks and at estimating their price. Insurers, who bear much of the financial burden when catastrophe hits, once again have begun to push the federal government for assurances that they will be indemnified in the case of a major terrorist attack.

In the wake of September 11, Congress passed the Terrorism Risk Insurance Act (TRIA) as a backstop to protect the insurance industry if another attack occurred. In 2005 the act was extended for another two years. With that extension set to expire in eight months, members of the House Committee on Financial Services met with insurance experts on Tuesday. The topics: a possible revision and another extension of the act, seen by many as vital to sustaining the industry and the U.S. economy. A decision will be made before the end of the year.

“There is still not enough supply in the terrorism risk market to meet demand,” said Rep. Gary Ackerman. “If TRIA were to expire, it would lead to the deterioration of the insurance market and the national economy.”

Under the act, the federal government would pay out a maximum of $100 billion in the event of a foreign-engineered terrorist attack. Insurers would be responsible for paying a deductible and 10 percent of the losses, while the government would cover the remaining 90 percent. The original act established a threshold of $5 million in losses to trigger application of the program. That number increased to $50 million in 2006, and it will rise to $100 million this year. The Treasury has asked before that this minimum-loss threshold be raised to $500 million — a number that many small insurers feel is too high to be of help.

Time is also an issue, as some free-traders feel that a never-ending TRIA will prevent the development of a more natural market for terrorism insurance. At the hearing on Tuesday, some suggested making the act permanent or extending it by up to 20 years. Other proposals included eliminating the distinction between foreign and domestic attacks (only foreign are now covered), adding coverage of group life insurance losses, and installing special provisions for nuclear, biological, chemical or radiological (NBCR) attacks.

“Duration of the extension will require a delicate balance,” Rep. Paul Kanjorksi, suggesting an additional six to eight years, said. “A length that is long enough to provide greater certainty, and short enough to give the market time to develop.”

According to a report by Marsh, an insurance broker and risk advisor, the market is showing signs of responding to TRIA. Purchase rates of terrorism insurance are up to 60 percent from 27 percent three years ago, while the cost of terrorism insurance dropped by 25 percent between 2004 and 2005.

“TRIA has been critical to stabilizing the insurance market and the national economy by making it possible for insurers to provide affordable terrorism insurance to businesses,” Vincent Donnelly, president and CEO of the PMA Insurance Group, said.

Although most insurers, fearful of being wiped out by a costly attack, agree with that sentiment, some observers have been less convinced. Last September the President’s Working Group issued a report to Congress saying that the “presence of subsidized Federal reinsurance through TRIA appears to negatively affect the emergence of private reinsurance capacity because it dilutes demand for private sector reinsurance.”

Academia also expresses distaste for a permanent TRIA. Howard Kunreuther and Erwann Michel-Kerjan, professors at the University of Pennsylvania’s Wharton School, have argued that despite the unpredictability of terrorism “there are better ways to deal with these financial issues than through TRIA.” They propose a multi-layered scheme that spreads risk among the insured, the insurance industry, capital markets and the government.

Republicans have argued that TRIA should remain a short-term solution, and that government assistance should be rolled back over time. Rep. Spencer Bachus said on Tuesday that, “the marketplace will always provide a more dynamic response than the government,” and that “regulatory interference” should be reduced.

But the market responds to prices, which are driven by information. Terrorism, by nature, is shadowy and secretive thus making it nearly impossible to predict. With potential liabilities limitless, insurers and re-insurers are naturally frightened. Despite such difficulties some companies have tried to make risk models for terrorism.

AIR Worldwide Corp., for instance, has created modules estimating frequency and outcomes of attacks on different locations and the costs associated with them. The model consists of a database of 300,000 potential targets, and analyzes threats by terrorist and extremist groups along with the potential impact of different types of weapons. AIR also uses “Consequences Assessment Tool Set” software to simulate and model terrorist attacks.

“Terrorism models can help companies understand and price in the TRIA environment,” David Lalonde, senior vice president at AIR, said at the Casualty Actuarial Society’s seminar earlier this month.

Arguing for a permanent TRIA, Joseph Ditchman, senior vice president of Colliers Ostendorf-Morris, a commercial real estate company, said, “We believe that the time has come for Congress to enact a long-term solution insuring against terror.” Statistical models may be helpful, but until companies trust that the intentions of terrorists can be quantified, most will be unlikely to offer insurance against terrorism without government protection.