After TRIA, what price terror? The federal reinsurance backstop program has entered its second year, but it expires at the end of 2005. That means policies issued in January 2005 would still be in effect after the expiration of TRIA, leaving insurance companies on the hook if a terrorist attack took place in early 2006
In less than a year, risk managers will have to start worrying about the availability of terrorism coverage again.
The Terrorism Risk Insurance Act created a temporary solution to terrorism losses by requiring insurers to make terrorism coverage available. In return, the federal government has agreed to provide catastrophic reinsurance in case of a terrorist attack.
The federal reinsurance backstop program has just entered its second year, but it expires at the end of 2005. That means policies issued in January 2005 would still be in effect after the expiration of TRIA, leaving insurance companies on the hook if a terrorist attack took place in early 2006 or thereafter.
“Underwriters will have to address the issue of the expiration of TRIA on Jan. 1 of 2005,” says Richard Thomas, chief underwriting officer at American International Group Inc. Therefore, because renewals for January 2005 typically begin in the fourth quarter of the previous year, “the issue of the extension of TRIA needs to be addressed in 2004,” he says.
If TRIA is not extended, or another similar program is not enacted, insurers may once again begin excluding coverage for terrorism from commercial property policies.
“If Congress allows TRIA to expire, I think we’ll see underwriters return to the type of behavior they had after Sept. 11,” Thomas says. “They will be very conservative, very restrictive in providing coverage where they think it’s likely to see a loss.”
There are a couple of initiatives currently underway that may help provide government and the industry with some direction.
The U.S. Treasury is in the process of surveying the insurance industry to assess the effectiveness of TRIA and the capacity of the insurance industry to offer terrorism risk insurance after the program expires. The report is due no later than June 30, 2005.
The insurance industry also is exploring the feasibility of a workers’ compensation terrorism reinsurance pool. The study is being facilitated by the American Insurance Association and is funded by 14 insurers that account tot roughly 40 percent of the workers’ compensation market.
Two California-based organizations, Santa Monica based nonprofit think tank RAND and Newark-based Risk Management Solutions, have also been working to study the risk of terrorism and improve modeling techniques.
In addition, the insurance industry later this year plans to intensify lobbying efforts to get TRIA renewed.
Because this year is an election year, however, it’s unclear whether anyone in Congress will be paying much attention to the issue.
“Right now there don’t seem to be any parties predisposed in Congress to make this their priority next year,” says Robert Hartwig, chief economist of the Insurance Information Institute. “It is an election year and getting re-elected will be the priority of everyone who’s up for election–including the president,” he says.
A Capacity Crisis
TRIA was enacted to provide a transition period to stabilize the insurance market and allow the industry time to build capacity. TRIA has succeeded in stabilizing the insurance market; companies that want to buy terrorism coverage are now able to do so.
The problem is that once the transition period is over, the federal government has said it expects the insurance industry to come up with a solution of its own–one that leaves the government out of it. But without reinsurance, the insurance industry would be on the hook for 100 percent of a loss and that’s something the industry does not have the capacity to handle.
Consider that the commercial property casualty industry has about $120 billion in capital available to pay claims. The insured loss from the terrorist attack on the World Trade Center is estimated at $40 billion. In a worst-case scenario, however, a terrorist attack could cause an insured loss of hundreds of billions of dollars, wiping out all of the industry’s capital in one fell swoop.
“A lot of those loss projections show losses greater than the capital of the property casualty insurance industry” Thomas says. “If the loss is going to cost more money than we have, that’s not insurable,” he says. “As you scale down from there, there are a lot of other terrorist events that are, in our view, insurable” TRIA provides no mechanism, however, that would allow the insurance industry to build capacity. Without such a mechanism, the industry has few ways to build the capacity, and they are not allowed to shelter any of that income on a reserve for future catastrophic events.
“The objective [of TRIA] was to give the industry time to develop a market mechanism,” says Samir Shah, a managing consultant at Tillinghast. “TRIA would be successful if at the expiration of TRIA there is already a market. Three years would give the industry time to develop the market. What was missing in hindsight is that the industry needed not just time to underwrite the risk, it needed more capacity,” he says.
The insurance industry has responded to the problem by trying to improve its capital management. Insurers have changed their underwriting practices to diversify their risk. Better modeling can help insurers gain understanding of how to price terrorism coverage. A workers’ compensation terrorism reinsurance pool could help workers’ comp writers improve the management of its capital. But those initiatives still do not bring new capital into the industry, Shah says. New capital has come into the industry through the start-up of new reinsurers, but that has not been enough to offset the industry’s overall loss of capital.
“What insurers know is they cannot assume an unlimited risk. All the modeling in the world won’t help,” Hartwig says. Reinsurance would cap the insurance industry’s exposures. But the private sector has been unwilling to provide reinsurance without the support of TRIA.
Reinsurers were hit hard by the Sept. 11 terrorist attacks, paying for about 55 percent of the insured losses, and they are not willing to put themselves at such risk again. Reinsurers have been providing some limited coverage in conjunction with TRIA and might continue to provide some small-scale coverage post-TRIA. “It’s unlikely that the private reinsurance market will fill that gap,” AIG’s Thomas says.
A Cloudy Future
With little reinsurance available from the private sector and the future of TRIA still unclear, insurers may begin limiting their exposure by excluding coverage for terrorism on commercial property policies. Or, isurers may decide not to renew certain policies at all.
Insurers are especially concerned about state laws that require them to pay for damage arising from a fire following an event. Insurers may be allowed to exclude terrorism, but they cannot exclude the damage caused by fire following the act. In the workers’ comp sector, where terrorism coverage is mandatory, insurers may simply choose not to renew the policies of risky clients.
Even though many in the industry say TRIA is flawed, it would be better than nothing. “If Congress is willing to look at this and extend it for another three years, we’d be delighted,” Thomas says. “We could live with that outcome.” A plan such as TRIA would allow the insurance industry to understand its risk exposure better and then to plan and commit capital ahead of time.
“The message is pretty simple. When you envision the possible scenarios and you look at the capacity in the industry, you come to the conclusion that there isn’t enough capacity. The question to be answered is where do you get that capacity?” Shah says. “You either get it from the industry–but the only way to get it is to build it up over time and there is no mechanism now to do that; there’s not the proper tax structure and so forth to build up that–or the government comes in. If the government comes in, they could either come in and plan it out ahead of time or wait until it happens and then do it.”
COPYRIGHT 2004 Axon Group
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