The Terrorism Risk Insurance Act will sunset on 31 December 2007. A bill proposing its renewal for the next 15 years should provide much needed stability. But only if it does not mandate insurers to cover attacks using weapons of mass destruction. Ben McKay explains why.

In the aftermath of the terrorist attacks of September 11 2001, the market for commercial property and liability insurance in large urban areas was in turmoil, as reinsurance for acts of terrorism became expensive and scarce. Congress responded in 2002 with a federal backstop – the Terrorism Risk Insurance Act (TRIA) – to compensate commercial insurers for large, foreign-inspired conventional terrorism losses.

The original two-year programme helped stabilise the economy and addressed the availability of coverage for terrorist attacks using conventional weapons, as well as coverage for both conventional and nuclear, biological, chemical, and radiological (NBCR) terrorism in workers’ compensation policies. In 2005, Congress extended TRIA for two more years, but it is now set to expire on 31 December 2007.

The Property Casualty Insurers Association of America (PCI) supports a long-term extension of TRIA, which has successfully protected millions of individuals, businesses, and the US economy since its implementation in January 2003. A long-term TRIA programme is needed to ensure that a stable and competitive market for terrorism insurance remains intact for the growing number of businesses electing to purchase such policies.

TRIA extension bil

A bill (HR 2761) to extend this critical public/private partnership recently passed the US House of Representatives by an overwhelming bipartisan majority, 312 to 110. The legislation has moved on to the US Senate, which must either vote on this bill, or pass an alternative before 31 December to prevent this crucial programme from expiring. Should the Senate pass a different TRIA bill, a conference committee with the House would be required to produce a unified bill for final approval by President Bush.

The current bill would extend the programme through to 31 December 2022, providing long-term stability for policyholders and financial markets. Coverage would include most commercial property and casualty lines, including workers’ compensation and farmowners’ multi-peril, a provision the PCI worked hard to have included as an amendment.

There are many essential provisions in the bill as it is at present. A reduced trigger level (the threshold at which the programme would kick in) and the elimination of the distinction between foreign and domestic terrorist attacks will enhance the terrorism insurance market. It will allow more insurers to provide this coverage to more businesses and the workers they employ. Several other parts of the bill, including a long-term extension and a “reset” provision helping areas previously attacked, would also strengthen the programme considerably.

“No insurer can face the risk of any single loss that can wipe out its entire capital base

To expand on some of these positive aspects, the trigger level would be reduced from a $100m event under the existing legislation to $50m under the new bill – and in some cases as low as $5m, depending on whether there has been a previous terrorist attack. This is very important, because no insurer can face the risk of any single loss that can wipe out its entire capital base. As of 2005, 75% of all companies writing terrorism insurance had surplus less than the existing $100m trigger.

The lower trigger would reduce the threat of insolvency for many small and medium-sized insurers – who write 22% of TRIA-covered lines of businesses and account for 94% of US companies writing terrorism insurance. Their expanded participation in the market, as the result of a reduced trigger, would help spread the risks from a future terrorist attack across the global marketplace. It would also create more choice and lower costs for consumers. Ultimately, is would lead to a greater percentage of future losses being insured by the private market.

Positive provisions within the extension bill include:

• Capping the total liability of the Terrorism Risk Insurance Act and insurers at $100bn in any programme year. This would provide finite limits and legal certainty regarding insurer liability;

• A “reset” provision, which resets the trigger and deductible after a terrorist event, helping areas that have previously been attacked or that may be vulnerable to future attacks;

• Removal of the distinction between foreign and domestic terrorist acts, which is important because it may be difficult or impossible to identify the perpetrators or their motives in a timely manner; and

• Restoration of farm owners’ mutliple-peril coverage to the programme, which helps small insurers and farmers.

“With potential losses as high as $778bn, it is virtually impossible to price coverage for NBCR losses because historical claims data is nonexistent

These items within the bill will not only benefit consumers, but the entire US economy as well. It will enable continued commercial lending and building where lenders may well be hesitant to make loans without readily available and affordable terrorism insurance.

However, the bill’s mandate that insurers be required to make available coverage for NBCR attacks will undermine the very foundation of the programme. It will threaten the solvency of many insurers, and leave many commercial consumers with fewer choices and higher premiums. It is also an unnecessary programme expansion. Expansion of the programme is the chief driver behind a Bush Administration Statement of Administration Policy threatening a veto of the bill as written in the House.

Because the mandatory NBCR provision is the most significant threat to the extension of the TRIA programme, the problems presented by this issue require a great deal of attention. The existing programme – which does not have a mandatory make-available requirement for NBCR attacks – has had the extremely beneficial effect of transforming an uninsurable risk into an insurable one. Thanks to TRIA, 60% of US businesses – of all types and sizes in all parts of the country – can purchase affordable terrorism insurance at lower prices. This financial protection benefits individual businesses, the workers they employ and the US economy.

HR 2761’s mandate that insurers be required to make NBCR coverage available would undermine TRIA’s goals by reducing competition, raising prices, and lowering take-up rates for terrorism insurance. With potential losses from such an attack, as estimated by the American Academy of Actuaries, as high as $778bn, it is virtually impossible to price coverage for NBCR losses because historical claims data is nonexistent – even with a reduced deductible.

A requirement for insurers to make available coverage for attacks using weapons of mass destruction is a solution in search of a problem. Under the existing programme, without a mandatory make-available provision, TRIA is working in all parts of the country and in all industries. Conversely, if NBCR coverage were to be required of insurers selling terrorism policies, there would be a variety of negative consequences (see box).

Because there are so many positive aspects to the legislation, PCI hopes that the final bill produced by Congress will reflect consideration of these important issues and removal of the mandatory NBCR coverage provision. It would be unfortunate for an otherwise good and necessary bill to be derailed by an unworkable requirement that the industry insure against an uninsurable threat. The US needs TRIA because it works. It has protected consumers and the economy, and this crucial backstop must remain in place to ensure continued security.

TRIA: Reality of covering NBCR events

If insurers are required to provide cover for nuclear, biological, chemical and radiological events, it could have the following consequences:

• An increased surplus at risk for a significant number of insurers, creating the potential for a credit downgrade and reluctance by investors to put new capital into these companies;

• Increased insurance prices resulting in reduced consumer demand and, ultimately, a lower percentage of covered losses after a new terrorist attack;

• Unfair benefits to the owners of the riskiest properties, who would be the only commercial consumers likely to buy NBCR coverage (“reverse cherry-picking”);

• Unfair burdens to small and mid-sized insurers through increased administrative costs and higher likelihoods of insolvency after an NBCR attack. This could ultimately cause many companies to stop offering terrorism coverage thus decreasing competition and availability for consumers; and

• A significant number of operational issues that cannot be addressed in a short period of time, including: accuracy of loss models; regulatory controls on insurer pricing; correlations between NBCR risk and other risks; complications from “mixed” attacks; proper protection of claims workers; delayed access to claim sites; and injuries or illnesses that may not appear until many years after an attack.

It is important to note that it is not just the PCI, nor insurers in general, who have warned of negative consequences to a mandatory NBCR coverage provision. A number of well-respected public and private agencies have studied the issue extensively and arrived at similar conclusions:

• The Financial Services Roundtable has advised Congress to establish a separate mechanism for handling these types of losses;

• The Government Accountability Office stated that “NBCR risks largely fail to meet most or all of the principles of an insurable risk”;

• The President’s Working Group on Financial Markets found that insurers have limited confidence in their ability to evaluate their risk exposures for non-conventional attacks;

• The Risk and Insurance Management Society reported that smaller companies would exit the market under a mandatory NBCR offer, leaving the field to larger companies, meaning higher prices and less coverage; and

• The RAND Center for Terrorism Risk Management Policy suggested it may be appropriate to cover NBCR risks through a direct government programme.