Reinsurers have tried to exclude terrorism risks from treaties, but pressure on insurers in the US to continue covering terrorism risks are resulting in new wordings to accommodate both parties. By Myra E Lobel.

In the immediate aftermath of the September 11 attacks, many reinsurers stated their intention to exclude anything remotely related to terrorism risk in all treaties. Their initial underwriting stance was that coverage would be limited to named perils such as fire, explosion, smoke, theft, earthquake and wind.

Insurers reacted unfavourably. Although the insurance regulators in most US states allowed primary insurers to exclude terrorism risks from commercial policies pending the creation of a government-backed reinsurance facility, the insurers still had to provide protection for other classes. In New York, California and Florida, however, regulators did not approve even the exclusion wording created by the Insurance Services Office (ISO). Moreover, in areas where competitive forces were strong, the exclusion of terrorism coverage was not an option. Thus, insurers were looking to insulate themselves from terrorism-related losses in totality going forward.

As January 2002 reinsurance program negotiations progressed, most reinsurers reconsidered their original position and agreed to provide write-back coverage for property personal lines business but to exclude losses resulting from nuclear attacks, bio-terrorism and chemical contamination.

Terrorism exclusion endorsements
In October 2001, the Non-Marine Association (NMA), part of the overall representative body for underwriters in the Lloyd's market, proposed two endorsements designed to exclude terrorism exposures from reinsurance policies. The initial thinking behind these endorsements was that terrorism is an unquantifiable and uninsurable peril that is impossible to model.

As renewal negotiations developed, the market began to take a more measured approach to terrorism coverage. Reflecting this change, revisions of the original terrorism exclusion endorsements were issued in December 2001.

By the January 2002 renewals, four main clauses had been developed to exclude terrorism exposure to varying degrees.

  • NMA 2921: Terrorism Exclusion Endorsement (Reinsurance) defines terrorism, who could commit the act and what their goal could be.

  • NMA 2919: War & Terrorism Exclusion Endorsement (Reinsurance) replicates NMA 2921 but provides for the exclusion of any loss as a result of war.

  • NMA 2930a: Terrorism Exclusion (Property Treaty Reinsurance) sets out the consequences of an act of terrorism that are excluded and removes the `burden of proof' for the reinsured, should reinsurers dispute a loss.

  • NMA 2930b - (Property Treaty Reinsurance, Personal Lines Write-Back) replicates the content of NMA 2930a but allows for recoveries from actual loss or damage from personal lines business. However, it excludes personal lines losses caused by or resulting from biological, chemical or nuclear contamination.

    Given the relatively late release of the NMA 2930 clauses in mid-December 2001, many clients and reinsurers elected one of the following options for addressing terrorism coverage under January 2002 renewals:

  • leave the wording as `to be agreed' (TBA); or

  • use the market-accepted clauses at the time - NMA 2921 or NMA 2919.

    Those markets that chose the former option came to prefer NMA 2930 clauses when the issue was addressed post inception. Further, the reinsurance market is now accepting endorsements that amend the original terrorism exclusions to the NMA 2930 clauses. Increasingly, we expect these clauses to be used where required and are seeking lead market support for our versions of their wording.

    Examples of problematic wording
    We believe that most of the market-generated terrorism exclusion clauses contain serious drafting problems. Much of the wording in NMA 2921 and several subsequent revisions are unclear, imprecise and could be interpreted to exclude traditionally covered losses that have nothing to do with terrorism.

    For example, NMA 2921 stated in part: "...this reinsurance excludes loss, damage, cost or expense of whatsoever nature directly or indirectly caused by, resulting from or in connection with any act of terrorism regardless of any other cause or event contributing concurrently or in any other sequence to the loss.

    "For the purpose of this endorsement an act of terrorism means an act, including but not limited to the use of force or violence and/or the threat thereof, of any person or group(s) of persons, whether acting alone or on behalf of or in connection with any organisation(s) or government(s), committed for political, religious, ideological or similar purposes including the intention to influence any government and/or to put the public, or any section of the public, in fear.

    "This endorsement also excludes loss, damage, cost or expense of whatsoever nature directly or indirectly caused by, resulting from or in connection with any action taken in controlling, preventing, suppressing or in any way relating to any act of terrorism.

    "If the reinsurers allege that by reason of this exclusion, any loss, damage, cost or expense is not covered by this reinsurance the burden of proving the contrary shall be upon the reassured."

    Note the phrase: "...indirectly caused by... any act of terrorism...".

    This language is imprecise and will create confusion regarding how far down in the chain of causation is something that is "indirectly" caused by terrorism. For example, how would coverage of the following be interpreted?

  • The death of a person who suffered a broken leg running down the stairs during the terrorist attack at the World Trade Center and who subsequently died as a result of medical malpractice.

  • A fire that occurs at a demonstration of those supporting the release of terrorists.

    Note the phrase: "regardless of any other cause or event contributing concurrently or in any other sequence to the loss".

    If there is an unrelated accident in a building at the same time that a terrorist bomb threat is made, is coverage of the accident excluded? A terrorism exclusion should not apply in situations where the principal peril is covered under the treaty and the terrorism component is not the main cause of the loss.

    Note the phrase: "committed for political, religious, ideological or similar purposes including the intention to influence any government and/or to put the public, or any section of the public, in fear."

    This language could exclude arson, riot or other risks that would otherwise be covered under property policies. The definition of terrorism is so imprecise that it would exclude coverage for such actions as, for example, the defacing of a building by one student or group of students opposed to the government's position on mandatory education.

    Similarly, this language might eliminate coverage for the Tylenol scare of years ago, which was covered under certain products liability and products recall insurances.

    Note the phrase: The exclusion of "loss, damage, cost or expense of whatsoever nature directly or indirectly caused by, resulting from or in connection with any action taken in controlling, preventing, suppressing or in any way relating to any act of terrorism."

    Many ceding companies are willing to accept that the cost of preventative measures is not reimbursable, as was typically the case in the Year 2000 situation. However, the "indirectly caused by" language is still problematic for the reasons stated above.

    Note the phrase: "If the reinsurers allege that by reason of this exclusion, any loss, damage, cost or expense is not covered by this reinsurance the burden of proving the contrary shall be upon the reassured."

    With this statement, the NMA endorsement reverses the traditional burden of proving that an exclusion does not operate. In any dispute between an insured and an insurance company, if the insured has shown that coverage exists, the burden of proof is on the insurer to demonstrate than an exclusion applies.

    Similarly, in the reinsurance context, once the cedant has shown that the loss in question is of the class of business covered and that it occurred during the term of the reinsurance contract, the burden should be borne by the reinsurer to demonstrate that an exclusion should operate to defeat coverage.

    There is no reason that the burden of proof should be shifted to the reinsured with regard to the application of a terrorism exclusion. Many `standard' and specific exclusions can be found in reinsurance agreements, none of which require the cedant to demonstrate that they are inapplicable as a condition precedent to coverage. Given this precedent and the difficulties inherent in proving the absence of terrorism, the shifting of the burden of proof is not warranted or customary.

    The NMA later retreated somewhat from this approach by issuing an endorsement without this provision, but some markets are still clinging to this onerous requirement.

    Suggested amendments to NMA 2930b
    From the start, Guy Carpenter argued against a blanket approach to terrorism that was not based on any analysis of the actual exposure. Right after September 11, we issued suggested exclusionary language that addressed some important coverage points that we did not feel were reflected in the statements drafted by the market. Our wording met with market resistance.

    Since then, the Guy Carpenter terrorism task force has since developed revised exclusionary wording designed to take account of the changing positions of the market, while still focusing on coverage issues that we feel have not been adequately addressed. We are in the process of meeting with our top 20 reinsurers in an effort to forge agreement on this new wording.

    Recognising that the balance of markets was not adopting our original exclusionary wording, we developed an alternative version. We sought to incorporate the main components of NMA 2930b - which writes back terrorism coverage for personal lines except in the case of biological, chemical or nuclear contamination - but to address certain coverage problems. Our suggested wording tracks the main components of NMA 2930b but with the following differences:

    l the references to indirect losses and contributing causes have been deleted, thus tightening the definition of terrorism. The fact that only direct losses are excluded has been clarified. "This exclusion should not apply to situations where the principal peril is covered under the treaty and the terrorism component is not the main cause of the loss"; and

    l language has been added that confirms the pre-existing coverage for strikes, riots and vandalism. It is expressly stated that riot, malicious mischief and vandalism will be covered.

    We also recommend, where possible, that in order to track the underwriting guidelines of the ceding company, the exclusion wording defers to that used in the original policies and applies only in the absence of such original policy exclusions.

    Conclusion
    The reinsurance industry is facing a great deal of uncertainty and confusion about how to deal with future coverage after the largest single event loss in our history. Exacerbating the uncertainty about the type of coverage or exclusion to offer in reinsurance treaties was the failure of Congress to deliver on a federal solution to the terrorism exposure/coverage issue.

    Understandably, reinsurers need to limit exposure to a level that will not deplete their capital. Nonetheless, it is critical for companies to make clear-headed decisions about what risk they are eliminating from their portfolios and where they can provide coverage. An overly broad, open-ended definition of terrorism creates more uncertainty than necessary for ceding companies and puts a strain on the `good faith' reinsurance relationship. Also, markets should bear in mind that there is precedent for previously `untouchable' catastrophic exposures based on human behaviour - such as riot - becoming acceptable to the insurance and reinsurance market once they are properly underwritten.

    By Myra E Lobel

    Myra E Lobel is a senior vice president in the contracts area of Guy Carpenter & Co. In this capacity she is responsible for contract negotiation as well as developing innovative reinsurance and insurance contract wording to address emerging issues.