Terrorism Insurance Coverage for Commercial Property—A Status Report
June 2002
Based on interviews with underwriters, agents,
brokers, and risk managers, IRMI President Jack Gibson examines the current
state of the market for terrorism coverage in property insurance.
by Jack P. Gibson
IRMI
By affecting many lines of coverage, the losses associated with September
11 aggregated to a sum previously unthinkable in risk management and insurance
circles. As a result, insurers have reacted quickly and decisively over the
past 10 months to address the catastrophic exposure to loss associated with
terrorist attacks. Of course their reaction has been to limit or exclude terrorism
coverage in commercial property policies. Simultaneously, however, some insurers
see an opportunity and have begun to offer stand-alone terrorism insurance coverage
in the United States.
This article, which is based on information gathered through interviews with
underwriters, agents, brokers and risk managers at the Risk and Insurance Management
Society, Inc. (RIMS), and Public Risk Management Association (PRIMA) conferences
as well as via the telephone, attempts to document the current state of the
market for terrorism coverage in property insurance.
Terrorism Insurance Exclusions
Most commercial property insurers are routinely excluding terrorism for most
classes of large commercial accounts. While the standard Insurance Services
Office, Inc. (ISO), exclusions have been approved in most states, it isn't unusual
for insurers to use a more restrictive exclusion, particularly in the surplus
lines marketplace. A few example exclusions are shown in Figure 1.
| Example #1. This policy does not insure against any loss, damage, cost, or expense
caused by or resulting from any of the following, regardless of any
cause or event contributing concurrently or in any other sequence thereto
… any act or threatened act, by any person or persons, arising from
or related to any attempt to overthrow, coerce, intimidate or establish
any government or sovereign power (de jure or de facto) or to intimidate
or coerce a civilian population or any segment thereof, or to inflict
economic loss, property damage or personal injury, in furtherance of
any political, religious, financial or ideological objectives. |
| Example #2. This insurance does not cover any loss or damage occasioned by or through
or in consequence, directly or indirectly, of any of the following occurrences,
namely … Act of terrorism committed by a person or persons acting on
behalf of or in connection with any organization … For the purpose of
this condition, "terrorism" means the use of violence for political
ends and includes any use of violence for the purpose of putting the
public or any section of the public in fear. |
| Example #3. This policy does not cover … any 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 organization(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. In any action, suit or other proceeding where
the Insurer alleges that by reason of any provision of this exclusion
any loss or damage is not covered by this insurance, the burden of proving
that such loss is covered shall be upon the Insured.
|
These are just a few examples of the exclusions our industry friends have
shared with us in recent months. Pretty much any form of violence or vandalism
would come within their purview, and one of them even attempts to negate an
age-old legal doctrine that requires the insurer to prove the applicability
of an exclusion (instead requiring that the insured prove it doesn't apply).
Note that many of the exclusions preclude coverage not only for terrorist acts,
but also actions taken by authorities to prevent such acts. Obviously, these
are intended to be absolute exclusions, leaving no room for coverage. However,
a few insurers do offer an alternative exclusion that makes an exception for
damage by ensuing fire.
Question of Enforceability
Such apparently widespread use of very restrictive manuscript endorsements
after all the controversy surrounding the development by ISO of a standard exclusion that would be accepted by state
regulators makes one question the effectiveness of the regulatory process. One
also must wonder if such exclusions might be considered by courts to be against
"public policy." However, underwriters seem to think that their exclusions will
be enforceable because insureds are well aware that the exclusions are going
to be included in their policies. Nevertheless, in the event any of these exclusions
are ever the subject of a coverage dispute, the insured's legal counsel will
certainly raise this issue.
Coverage Subject to a Sublimit
There does seem to be a trend toward a different approach to the terrorism
peril. Some insurers are providing coverage for loss from terrorist acts subject
to a sublimit. This is the same approach commonly used in insuring against the
perils of earthquake and flood. It allows the insurer to limit the terrorism
coverage provided to an amount that it can retain without reinsurance. It also
makes the amount of coverage and the premium to be charged for it the subject
of negotiation rather than a total exclusion. This approach should be much easier
to defend in court than a broadly worded absolute exclusion.
Most of the insurers that are providing coverage subject to a sublimit are
setting the limits relatively low. For example, sublimits of $2 to $5 million
are not uncommon. However, one insurer of highly protected risk (HPR) accounts
is reportedly offering a terrorism sublimit of up to $50 million to some of
its insureds.
Stand-Alone Terrorism Insurance
There has long been a marketplace for stand-alone terrorism insurance coverage.
However, in the past it was only needed in the Middle East and other areas with
a high incidence of terrorism. Now these underwriters are quoting terrorism
coverage on commercial properties in the United States. The Lloyd's of London
marketplace wrote over $100 million in terrorism insurance premiums between
September 2001 and May 2002. Other markets for stand-alone terrorism insurance
include AIG, Berkshire Hathaway, ACE USA, AXIS Specialty, Endurance Re, and
Renaissance Re.
I spoke with Ian Harrison of Beazley Specialty Lines (a large and prominent
Lloyd's of London syndicate) at the annual RIMS conference. He has been underwriting
stand-alone war and terrorism insurance for 15 years. Mr. Harrison explained
that the London market has the capacity to write limits of $150 million to $200
million. Many insureds are asking for quotes, and about 1 in 20 is purchasing
the coverage.
These stand-alone policies make no attempt to dovetail with the insured's
property insurance coverages, which may contain varied types of terrorism exclusions.
Instead, these policies cover direct damage and, if endorsed appropriately,
business interruption loss from a terrorist event, as defined in the policy.
Lloyd's uses a standard definition of "terrorism" called the T3.
This definition is similar to the definitions of terrorism used in the exclusions
in Figure 1. There, are, however, some important differences to note. No coverage
applies to loss from nuclear hazard, chemical or biological release, discharge
of pollutants or contaminants, or attacks by electronic means, including computer
hacking or computer virus. Also excluded is any loss from seizure or illegal
occupation and loss that is the result of a threat or hoax, in the absence of
physical damage due to a terrorist act. Finally, there is an exclusion of "any
consequential loss or damage caused by any other ensuing cause."
This exclusion may only be intended to prevent coverage for business interruption
loss, unless the policy has been endorsed to provide this coverage, or for other
remote consequential loss, such as loss of license or contract. However, the
language used is broad enough to raise questions as to whether coverage is provided
for, say, fire or collapse damage that ensues from a terrorist act, as it did
in the case of the World Trade Center attacks. It might be well to obtain written
clarification of the intent of this exclusion, if possible.
For obvious reasons, the terrorism coverage underwriting process has not
been very scientific. Instead of using sophisticated models and actuarially
developed rates, underwriters are relying on their experience and instincts
to select the risks they feel are least likely to be hit. They pay careful attention
to aggregation of values, making certain that they do not insure multiple properties
in close proximity so as to achieve a spread of risk.
To avoid this aggregation problem, Mr. Harrison's syndicate prefers to write
industrial facilities and stays away from real estate investment trusts. An
underwriter who insures real estate investment trusts, of course, could quickly
encounter an aggregation of risks from buildings in metropolitan areas. While
Beazley covers some downtown office buildings along with the industrial plants
of its insureds, its approach avoids a substantial accumulation. There are other
markets that will cover metropolitan real estate risks.
This insurance is expensive. To explain how the premium is developed, Mr.
Harrison offered the following example.
For a large industrial concern with total insurable values of $1 billion,
Beazley might apply a rate of 10¢ to arrive at a premium of $1 million for a
$1 billion limit. However, for a "first loss value" limit equal to 10 percent
of the total insurable values—in this case, $100 million—Beazley would charge
60 percent of the premium charge for full limits—in this case, $600,000. The
reason for charging 60 percent of the full premium for a limit equal to 10 percent
of the total values is the increased likelihood of a total limits loss, since
coverage is being provided on a first loss basis.
Conclusion
Treatment of terrorism in commercial property policies will likely continue
to evolve rapidly in the months to come. Many reinsurance treaties renew on
July 1 and this may or may not be a watershed event in the evolution of the
coverage. Of course, the most significant factors that will affect the availability
of coverage in the future—additional terrorist attacks or the establishment
of a "financial backstop" for the industry by the government—remain wild cards.
The U.S. Congress seems to be once again moving toward providing the backstop
the industry has requested, but there is still a long path ahead. Regardless
of whether these wild cards are dealt, it is unlikely that coverage for terrorism
risks will ever again be a throw-in within the coverage of basic commercial
property insurance policies.
Note: See other terrorism articles
on IRMI.com.
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