The ISO Terrorism Exclusions: Background and Analysis
February 2002
In this article, IRMI reviews the evolution
of the ISO terrorism exclusions, explains exactly what is excluded, and provides
the approval status of these exclusions by states and other regulatory organizations.
by Jeff Woodward
IRMI
The destruction of the World Trade Center on September 11, 2001, represents
the largest single insured event in history. Knowledgeable estimates of total
covered losses—property, general, and aviation liability, workers compensation,
life—range from $30 billion to as much as $70 billion. Liability claims are
the slowest to emerge, and have been slowed even further by calls from attorney
groups for a "moratorium" on lawsuits stemming from the attacks, and by proposals
for a federal compensation program for the families of victims. (One element
of such a program would be a waiver of legal action by recipients as a condition
for receiving benefits.) No matter how the final figures shape up, September
11 will easily overshadow the next largest insured disaster: the $19 billion
in losses caused by Hurricane Andrew in 1992.
The scope of the disaster, and the disturbing ease with which the attack
was apparently carried out, struck a devastating psychological blow to the international
insurance industry, which had already begun to respond to mounting losses by
raising rates and imposing restrictions on coverage. Well before the renewal
of reinsurance treaties on January 1, 2002, reinsurers announced the imposition
of new terrorism exclusions as a condition of coverage.
Faced with an inability to spread the risk of terrorist attacks through the
worldwide reinsurance network, domestic insurers sought relief on two alternative
fronts: governmental action to fill the void left by the reinsurers; or contract
language that would exclude injury and damage caused by acts of terrorism. (Initial
moves by some insurers toward invoking standard war exclusions as a basis for
denying coverage in the September 11 attacks were quickly abandoned. See "Attack
on America: The Insurance Coverage Issues" for a detailed discussion of
insurance policy war exclusions and terrorist acts.)
In November, Insurance Services Office, Inc. (ISO), made an initial filing
of exclusionary language that would address injury and damage from terrorist
acts. A number of insurers had already by this time drafted their own similar
terrorism exclusions. As it became more and more likely through December that
Congress would not be able to reach a consensus on providing a federal "backstop"
to insured terrorism losses, state insurance departments began examining the
various approaches taken by ISO and individual insurers with regard to terrorism.
In consultation with state regulators, ISO revised its original terrorism filing,
limiting the exclusion to specifically catastrophic losses.
When the first session of the 107th Congress adjourned in December without
passing any of the federal reinsurance proposals that had been introduced, the
insurance industry acted quickly on the second of its alternatives: excluding
terrorism losses from coverage in standard property and casualty insurance policies.
On December 21, the National Association of Insurance Commissioners (NAIC) endorsed
the revised ISO language and recommended its approval by state insurance departments.
Those filings, which have to date been approved—and implemented—in 45 states,
the District of Columbia, Puerto Rico, and Guam, are the subject of the rest
of this article.
The Evolution of the ISO Terrorism Exclusions
ISO filed the first version of exclusionary language for use with standard
commercial property and liability policies in mid-November. Unlike most ISO
filings, which allow several months for regulatory approval and company implementation,
the terrorism filings were made with a proposed effective date of January 1,
2002—the date on which many reinsurance treaties would renew, presumably with
exclusions for loss arising from terrorism.
ISO's approach in the initial filings was simply to replace the war exclusion,
as it currently exists in different forms in commercial property and commercial
general liability coverage forms, with new exclusions pertaining to both war
and "terrorism." With respect to property coverages, the proposed exclusion
applied to:
loss or damage caused directly or indirectly by terrorism, including
action in hindering or defending against an actual or expected incident
of terrorism. Such loss or damage is excluded regardless of any other cause
or event that contributes concurrently or in any sequence to the loss.
In the version intended for general liability coverages, the exclusion applied
to bodily injury, property damage, and personal and advertising injury:
arising, directly or indirectly, out of "terrorism," including any action
taken in hindering or defending against an actual or expected incident of
"terrorism" regardless of any other cause or event that contributes concurrently
or in any sequence to the injury or damage.
Both sets of filings—property and liability—used the same definition of "terrorism":
"Terrorism" means activities against persons, organizations or property
of any nature:
- That involve the following or preparation for the following:
- Use or threat of force or violence;
- Commission or threat of a dangerous act; or
- Commission or threat of an act that interferes with or disrupts
an electronic, communication, information, or mechanical system; and
- When one or both of the following applies:
- The effect is to intimidate or coerce a government, or to cause
chaos among the civilian population or any segment thereof, or to disrupt
any segment of the economy; or
- It is reasonable to believe the intent is to intimidate or coerce
a government, or to seek revenge or retaliate, or to further political,
ideological, religious, social or economic objectives or to express
(or express opposition to) a philosophy or ideology.
The broad scope of these original ISO terrorism filings paralleled that of
exclusionary language already being developed and used by some individual insurers.
For example, one major commercial insurer began endorsing its property policies
at the end of the year with an exclusion of:
any act of one or more persons, whether known or unknown and whether or not
agents of a sovereign power, for Terrorist Purposes …
…Terrorist Purposes means the use or threatened use of any unlawful means,
including the use of force or violence against any person(s) or property(ies),
for the actual or apparent purpose of intimidating, coercing, punishing or affecting
society or some portion of society or government.
The problem with language like this—or the language of the original ISO filing,
which it resembles closely—is that it is broad enough to encompass even an act
of simple vandalism if ideological or coercive motives can be seen in it. Under
the original ISO language, damage caused by a brick thrown through the window
of a political party headquarters by a member of the opposing party would be
an excluded act of terrorism. In response to criticisms of this kind—and to
charges from some state regulators that the language in question could even
be used to deny insurance coverage to victims of hate crimes—ISO decided to
amend its filings.
The most significant of the amendments was the imposition of two quantitative
thresholds for triggering the exclusion. The threshold is designed to make the
exclusion applicable only when the terrorist act causes catastrophic injury
or damage. A property damage threshold was set at $25 million, including both
direct damage and business interruption. A bodily injury threshold was also
imposed—50 or more persons killed or seriously injured. Only when one or both
of these thresholds are met does the terrorism exclusion apply—but then it applies
to all injury and damage caused by the terrorism, both below and above the threshold.
(A second amendment to the ISO filings was made in late December, specifying
that the $25 million property damage threshold is applicable only to insured
damage.)
With the imposition of a threshold came the need to specify rules for measuring
that threshold. Accordingly, ISO defined in the revised exclusions what constitutes
a single "terrorism incident," since both the bodily injury and property damage
thresholds apply on what may be termed a "per-incident" basis. (Further motivating
ISO to address this point in its filings may have been the suits and counter-suits
filed by the World Trade Center leaseholder and its insurers, disputing whether
the plane crashes that brought the buildings down were one occurrence of property
damage, or two.) The ISO definition of a single terrorism incident is expressed
as follows:
Multiple incidents of "terrorism" which occur within a 72 hour period
and appear to be carried out in concert or to have a related purpose or
common leadership shall be considered to be one incident.
In its amended filings, ISO also revised the definition of "terrorism" to
remove terminology that could invite dispute or that required too subjective
an application. For example, the original reference to "chaos among the civilian
population" was dropped, perhaps to avoid arguments over what constitutes "chaos."
Likewise, "revenge or retaliation" as one of the triggering motives for "terrorist"
acts was dropped, since it was needlessly specific and added nothing to the
scope of the definition.
Finally, additional provisions regarding terrorism that involves the use
of nuclear, chemical, or biological weapons were added to the exclusions, in
light of the anthrax incidents that had followed on the events of September
11 and growing fears that known terrorist groups might have or be seeking access
to nuclear weapons.
The ISO terrorism exclusions for both commercial property and general liability
policies were filed in their final amended form in late December 2001, and state
regulatory approval began almost immediately, to implement the exclusions' use
as quickly after January 1, 2002, as possible.
What the Exclusions Exclude
It should be noted here that the new exclusions filed by ISO, and already
being used in 45 states, are technically not just "terrorism" exclusions. For
property policies, the endorsement is entitled "Exclusion of War, Military Action
and Terrorism." The endorsement for use with CGL policies is entitled "War or
Terrorism Exclusion." Both endorsements combine a terrorism exclusion with the
standard war and military action exclusion already found in commercial property
causes of loss forms.
The net effect on coverage under a standard commercial property policy, therefore,
is limited to terrorism claims (since the war exclusion is identical to the
one already applicable to the same policy). For some other property lines (e.g.,
commercial crime), the endorsement will arguably impose a broader war exclusion
as well as imposing a new terrorism exclusion. With respect to the CGL policy,
which excludes only contractually assumed war risks, the "war or terrorism"
exclusion will significantly restrict coverage for liability arising out of
war. On the assumption that the new ISO exclusions (or their equivalent) will
be attached to most new commercial property and liability policies, the "war"
portion of the exclusions alone will mean a considerable narrowing of coverage.
With respect to incidents that meet the exclusions' definition of "terrorism,"
there will now be no coverage of damage to insured property under the following
circumstances:
- When nuclear materials are used in the terrorist act
- When the terrorist act consists of the "dispersal or application" of
chemical or biological weapons—that is, chemicals or biological materials
that are poisonous or cause disease
- When poisonous or disease-causing chemicals or biological materials
are released by a terrorist act in such a way that it appears the release
was one purpose of the act
The distinction drawn by the second and third categories above is between
a terrorist act that involves the direct release of a chemical or biological
agent (such as the mailing of anthrax-contaminated letters); and the use of
non-chemical, non-biological terrorist tactics to cause such a release (for
example, the terrorist bombing of a military facility where chemical or biological
agents are stored). Terrorism under either of these sets of conditions, or when
nuclear materials are involved, is excluded regardless
of the scope of the resulting injury or damage. Under any other scenario
involving a release of biological or chemical agents - where, for example, it
appears that the release is an unintended result of other terrorist acts—the exclusion applies only when a property damage
threshold (see next paragraph) is met.
With respect to terrorist incidents that do not fall into one of the three
categories listed above—that is, non-nuclear, non-chemical, non-biological—the
exclusion in property policies is triggered when the total insured damage (including
business interruption losses sustained by owners and occupants of the damaged
property) exceeds $25 million. It is important to understand that, when applying
this threshold, all insured property damage under all policies written by all
insurers for all insureds is totaled. Thus, the exclusion may be applicable
even to an insured with far less than $25 million in insured property.
Damaged property must be located in the United States, its territories and
possessions, Puerto Rico, and Canada. As mentioned earlier, the $25 million
threshold applies to all related terrorist acts (i.e., those carried out in
concert, or with a related purpose, or under common leadership) within a 72-hour
period. And it applies, once triggered, to all damage stemming from the terrorist
act—not, in other words, only to damage that exceeds the threshold.
The ISO terrorism exclusion that applies these restrictions to property coverage
exists in two forms: one that imposes the exclusion absolutely, without regard
to the nature of the property damage; and another that makes an exception for
direct loss or damage by fire. This exception is mandated by law in certain
jurisdictions where property coverages of whatever type may not be more restrictive
than the provisions of the standard fire policy (SFP) recognized by statute
in that jurisdiction. (Standard fire policies insure direct loss by fire regardless
of the cause of the fire.) The exception that applies in these so-called SFP
jurisdictions applies only to direct fire damage—not to any consequential loss
(loss of income, for instance) resulting from the fire.
In non-SFP states, the terrorism exclusion applies to property losses without
exception, including terrorist acts that cause direct damage from fire. Figure
1 lists the SFP and non-SFP jurisdictions. (This list refers only to the applicable
law of the jurisdiction and the form of the commercial property terrorism exclusion
filed in that jurisdiction. It is not a list of jurisdictions that have approved
the filing. Approval information is contained at the end of this article.)
| Arizona California
Connecticut
Georgia
Hawaii
Idaho
Illinois
Iowa
Louisiana
Maine
Massachusetts
Michigan
Minnesota
Missouri
Nebraska
New Hampshire
New Jersey
New York
North Carolina
North Dakota
Oklahoma
Oregon
Pennsylvania
Rhode Island
Texas
Virginia
Washington
West Virginia
Wisconsin
|
Alabama Alaska
Arkansas
Colorado
Delaware
District of Columbia
Florida
Indiana
Kansas
Kentucky
Maryland
Mississippi
Montana
Nevada
New Mexico
Ohio
Puerto Rico
South Carolina
South Dakota
Tennessee
Utah
Vermont
Wyoming
|
With respect to commercial general liability (CGL), the ISO "war or terrorism"
exclusion alters the policy's basic coverage considerably. As pointed out above,
the CGL war exclusion already contained within the policy applies only to liability
assumed in a contract. The "war" portion of the new ISO endorsement, on the
other hand, imposes a sweeping exclusion of liability arising out of war and
any "warlike action," including defensive and preventive governmental actions,
and not limited to contractual assumptions.
The terrorism portion of the exclusion (the actual exclusionary language
and the definition of "terrorism") is the same as the property insurance version,
with two exceptions. First, the $25 million dollar property damage threshold
is not limited to property in the United States and Canada; a total of $25 million
dollars in property damage anywhere in the world—arising out of one terrorism
"incident"—will trigger the exclusion. Since CGL coverage applies under certain
circumstances on a worldwide basis, the exclusion is made equally broad.
Second, in light of the fact that liability claims may involve either property
damage or bodily injury, a "serious physical injury" component is added to the
trigger. The exclusion applies to liability claims when a terrorist incident
causes either $25 million of insured property damage or the death of or serious
physical injury to 50 people. As in the property exclusion, the threshold does
not apply to terrorist incidents involving nuclear, biological, or chemical
weapons. Liability stemming from terrorism using such weapons is excluded regardless
of the scope of the resulting injury and damage.
The liability exclusion applies both to bodily injury and property damage
under Coverage A of the policy; and to personal and advertising injury under
Coverage B. Medical payments coverage under the ISO CGL is subject to its own
war exclusion, which is absolute in much the same way as the war component of
the new "war or terrorism" exclusion. When the latter exclusion is applied to
the policy, the basic medical payments war exclusion already in the policy is
deleted. But since medical payments coverage is subject to all exclusions applicable
to Coverage A, the "war or terrorism" exclusion, in effect, will apply to bodily
injury under medical payments coverage as well.
The general liability exposures related to terrorist acts are still unclear,
since lawsuits connected to the events of September 11 have been slow to emerge.
Nonetheless, a number of potential causes of action have been discussed in the
media and among risk management and legal professionals. Among the most frequently
discussed are claims of failure to warn of a possible terrorist act and negligence
in responding to the emergency conditions created by an actual terrorism incident.
Negligent hiring and supervision could also be the basis for claims against
an employer who provided an employee with the opportunity or means to commit
an act of terrorism meeting the exclusion's threshold.
Approval of the ISO Filings
With the endorsement of the NAIC, the ISO terrorism filings have won rapid
approval by most state regulatory authorities, and are already in use in the
jurisdictions that have approved them. Another policy-drafting and advisory
insurance organization, the American Association of Insurance Services (AAIS),
has filed terrorism exclusions for use with its commercial coverage forms that
are equivalent to ISO's and also conform to the terms approved by the NAIC.
Moreover, ISO has given permission to insurers not affiliated with it to use
the ISO filings, which means that the language of the ISO exclusions should
become an almost universal industry standard.
Forty-five states, the District of Columbia, Puerto Rico, and Guam have approved
the ISO filings. In each of those jurisdictions, regulatory approval was granted
with an effective date of January 1, 2002, except for Alaska, where the effective
date was January 12. ISO expects approval in three additional states: Florida,
Georgia, and Texas.
Two states, California and New York, have refused to approve the filings
in their current form, and are pursuing discussions with ISO about possible
further amendments. The California Insurance Department cited the following
reasons for its refusal: (1) the bodily injury and property damage thresholds
are unreasonably low; (2) the 72-hour definition of a single "incident" may
be unfair; (3) the total exclusion of terrorism involving biological or chemical
agents (without any threshold) is overly broad; (4) the exclusion may have an
anti-competitive effect. The New York Insurance Department also voiced an objection
that the $25 million threshold is too low.
In several of the states that have approved the ISO filings, steps have been
taken to put in place some form of "sunset" provision governing use of the exclusion.
These provisions would suspend the applicability of the exclusions at some point
(15 days, for example) after federal action is taken to provide reinsurance
or other financial guarantees to insurers for terrorism claims. Additionally,
in some states, use of the ISO filing by an individual insurer is made contingent
on the insurer's documentation of a lack of reinsurance for terrorism claims.
ISO has stated that it will act promptly to review its terrorism language in
the event of federal action addressing the lack of reinsurance.
Conclusion
Given an insurance policy exclusion that applies only when terrorists have
killed or injured 50 people; or employed nuclear, chemical, or biological weapons;
or destroyed more than $25 million worth of property, the only legitimate response
is a fervent hope that no insurer ever has occasion to use it. Beyond that,
a wait-and-see attitude seems especially appropriate with respect to this particular
coverage issue.
For those who question the reality of the "reinsurance crisis" that has caused
commercial insurers' concerns regarding terrorism, some answers may come in
those states that require insurers to prove a lack of reinsurance before using
the exclusions. Our sources indicate that most of the reinsurance treaties that
renewed in January indeed do not cover terrorism. Another major round of renewals
will take place on July 1, and we expect those reinsurers will take a similar
stance at that time. This will, of course, affect insurers who rely heavily
on reinsurance more than those that do not.
With the reconvening of Congress on January 23, speculation has renewed about
federal action to provide the insurance industry with some form of financial
guarantee regarding catastrophic terrorism claims. As discussed above, any ongoing
use of the new ISO exclusions is contingent in a number of states on the failure
of the federal government to enact so-called backstop legislation. And ISO itself
is committed to "responding promptly" to any federal program that would make
the exclusion unnecessary. In the meantime, commercial insureds and their insurance
and risk management advisers should take a close look at the new terrorism exclusions;
they just might find one on their next policy.
Note: See other terrorism articles
on IRMI.com.
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