Key Coverage Issues in the TRIA Debate
September 2007
As the nation's federal terrorism insurance
program enters its final months, similarities with the legislative environment
in 2005 seem eerie. Once again, the House of Representatives has proposed a
progressive new approach, and the risk management community has voiced its strong
support. But, as expected, the Executive branch has emphatically objected to
some of the boldest changes.
by James
Macdonald
Navigant
Consulting
Insurance buyers and producers simply don't know exactly what insurance will
be in effect if a major attack occurs in 2008. The only certainty appears to
be that uncertainty will continue until the final weeks of December.
In Part 1 of this article, I considered the
changing nature of the terrorism threat. In Part
2, I explained the reasons why some form of continuation of the 2005 Extension
Act seems certain. In this third installment to my "Review and Preview" series,
I focus on the important coverage issues that are again central to the debate.
In Part 4 of this series, I will consider the
key financial parameters at issue.1
By way of introduction, it is important to emphasize that there is no clear
consensus within the underwriting community regarding what lines of insurance
should be included in the Terrorism Risk Insurance Act (TRIA) legislation or
when the program should expire. Some insurers argue that virtually all lines
of life and nonlife insurance should be included. They reason that since no
one knows exactly what type of attack will occur next or who will be affected,
almost everything should be included. Other underwriters see this as unnecessary
and essentially agree with the cutbacks made by federal legislators 2 years
ago. They point out that the 2005 Extension Act's excluded lines, such as Farmer's
Multi-Peril, Commercial Auto, and Surety, appear to have, at most, marginal
exposure even to a large terrorist loss.
However, there is a strong consensus among many stakeholders that several
important changes are urgently needed. In late 2005, the House proposed an innovative
and controversial bill (HR 4314) that included these widely supported changes.
But the Senate and the White House pushed back, and none were included in the
reauthorization. The latest House effort (titled the "Revision and Extension
Act" or HR 2761) reintroduces all of these new approaches. In Table 1, I summarize
the reforms, comparing the original law with the Extension Act and the earlier
late 2005 House proposal. Let's consider each and assess the chances that the
"second time" will be the "charm."
Table
1: TRIA Approaches
Program Duration: How Long Is Long Enough?
The new House bill, passed by the Financial Services Committee in early August,
stunned a lot of observers by proposing a 15-year extension. The Bush Administration
immediately objected, pointing out that this is in direct conflict with their
policy goal of eventually eliminating the federal program altogether. The committee's
proposed extension is 5 years longer than the 10-year extension in the previous
draft approved by the subcommittee only a week earlier. It is also 5 times the
3-year extension sought in HR 4314.
The need for a long-term extension reflects the broadly held belief that
the terrorist threat is here to stay for the foreseeable future. Based on my
informal survey, there is widespread support for an extension of at least 5
years and preferably 10 years or more. This will likely be the one of the most
hotly contested issues as the current law approaches its natural expiration.
Most stakeholders will be surprised if a reauthorization of less than 5 years
is enacted.
Should Group Life Be Included?
At numerous Senate and House hearings, life insurers have argued cogently
that they should be included in the TRIA program. Their basic reasoning is similar
to the argument for including workers compensation in the program: Accumulations
of employees at any one location present a possible large loss exposure that,
as a practical matter, would be impossible to effectively monitor or control
and could produce a huge loss. For example, imagine the consequences of a bomb
exploding in the middle of a stadium containing 20,000 employees at a national
sales conference. This kind of attack scenario could produce what many insurance
company CEOs fear the most, even more than a weapons of mass destruction (WMD)
attack. That would be a large, financially destabilizing loss that is not shared
broadly across the market but uniquely exposes their company to the risk of
ruin. In this type of scenario, the likelihood of a post-loss, market-based
inflow of capital or a Congressional bailout is slim, and the protection afforded
by TRIA is especially critical.
The argument against including group life is based on reactive assumptions
in traditional economic thinking. In brief, since no "market failure" occurred
in group life after the attacks on September 11, 2001, and since the market
for group life appears robust and competitive today, despite what many agree
is a continuing threat of a major attack, there is no reason to include group
life in the program. This is the argument we find in numerous government documents
such as the Treasury Department's 2005 Assessment report to Congress.
The rebuttal to this position, simply stated, is that 9/11 changed all the
rules of extreme event risk management. Broadly applied, the classical "market
failure" prerequisite for government involvement in insurance could be used
to negate the entire federal program (given that only 2 foreign reinsurers failed
because of the 9/11 attacks of approximately 150 insurers or reinsurers sustaining
some loss). Properly understood, the TRIA program implicitly reflects the preemptive
imperative of the "Bush Doctrine" itself. Applied to insurance, this doctrine
would mandate the inclusion of Group Life because the stakes are too high, i.e.,
we cannot afford to wait to see if a "market failure" occurs if the next attack
inside the United States involves a "mushroom cloud."
Including group life, however, would broaden the program and increase taxpayer
risk, exactly the opposite of the Executive branch's policy goals. Few will
be surprised if this change is again deleted from the final bill.
Should Domestic Acts of Terrorism Be Included?
A major conceptual shortcoming of the current program, in the opinion of
many observers, is that it attempts to "fight yesterday's war" by assuming that
the next major attack in the United States will be similar to the attacks on
9/11. One of the main ways it does this is by requiring that an act of terrorism
subject to the law must be conducted "on behalf of a foreign person or foreign
interest." Opponents of the current approach argue that domestic acts of terrorism
need to be included in the next bill, pointing to two threats that are not now
covered:
- The widely reported growth of "homegrown," Internet-trained sympathizers
with Al Qaeda and other foreign terrorist organizations. Until fairly recently,
for example, the London suicide bombers of July 7, 2005, were believed to
have acted entirely independently of any direction from outside the country.
- Purely domestic large scale terrorist attacks such as the devastating
1995 bombing by Tim McVeigh of the Alfred P. Murrah Building in Oklahoma
City.
To many observers, the argument for a broadened definition including domestic
acts seems undeniable. The 2005 House bill, drafted within months of the London
attacks, attempted to make this change. However, for reasons that I have never
seen articulated, the final Extension Act continued the limitation on foreign-sponsored
acts.
One can only conclude that American policymakers are averse to formally distinguishing
between "criminal" acts or "vandalism" and political or religiously motivated
deeds. Insurers have already implicitly conceded that this distinction does
not need to be made for smaller losses. For example, the property insurance
terrorism exclusion wording promulgated by Insurance Services Office, Inc. (ISO),
only applies to industry insured losses of at least $25 million. Given the underwriting
communities' singular focus on major attacks, including domestic terrorism seems
to be much needed. But, much like group life, this important change may again
be eliminated as the clock expires on the federal program.
Should Insurers Be Required To Underwrite the "Sum of All Fears"?
For most insurers, the most unacceptable proposal in the new House bill is
the requirement that they separately make available insurance for attacks involving
a nuclear, biological, chemical, or radiological agents or devices (NBCR, or
what some would call "the sum of all fears"). The current approach requires
that TRIA-related insurance be "made available" but this insurance is subordinate
to all of the other terms of a given policy. The new House bill would require
a preemptive coverage grant specifically for these acts, so there would be no
confusion over whether the nuclear, pollution, or some other limitation applies.
This change is broadly supported by policyholders.
In my opinion, including this requirement in a late December reauthorization
would be hugely counterproductive and possibly quite disruptive to the market.
In brief:
- Many insurers have concluded that such an attack would be the equivalent
of an act of war and that an attack involving NBCR is inherently uninsurable.
The new bill attempts to address this concern by requiring only a 7.5 percent
deductible for NBCR acts instead of the 20 percent required for conventional
weapon attacks. But even 7.5 percent may be too much for insurers who have
committed to their Boards to expose none of their assets to this kind of
loss. Although it is anecdotal, I am aware of several insurers who have
made this commitment. Requiring these underwriters to offer this coverage
would likely force them to withdraw or severely ration their capacity in
the major urban centers that are generally believed to be the most likely
targets.
- According to the Reinsurance Association of America (RAA), there is
at most about $8 billion in global reinsurance capacity for conventional
terrorist attacks and not more than an additional $1.5 billion in capacity
for an NBCR attack. It is important to note that all of this capacity has
already been committed and deployed. Therefore, if a new TRIA extension
is passed in late 2007 requiring this constructive grant effective January
1, 2008, the huge increase in demand for new capacity will be impossible
for the private sector to supply.
That said, this issue is critically important to resolve. It would be a major
error to allow this change to once more die on the "cutting room floor." Possible
coverage litigation in the aftermath of an NBCR attack, with insurers almost
certainly attempting to invoke nuclear or pollution exclusions, would be exponentially
worse than the "wind versus flood" litigation we have witnessed in the aftermath
of Hurricane Katrina. It is in everyone's interest to resolve this issue.
Instead of deleting this reform or adding it without the careful consideration
that is needed, policymakers should make the implementation of the NBCR coverage
grant requirement subject to further review during 2008 with an effective date
not sooner than 2009. As we saw in the creation of the American Nuclear Insurance
(ANI) pool in 1957 (in response to the Price Anderson Act), creative risk takers
can develop innovative approaches to insure even the "unthinkable" loss scenarios,
but it takes time to develop these new approaches. This issue would appear to
be a logical top priority for the House bill's proposed "Commission on Terrorism
Risk Insurance."
Conclusion: Is Other Liability the Sole Remaining "Elephant in the Room"?
Although these proposals will again be at the center of the upcoming debate,
opposition to the House bill will likely focus as much on what it does not propose.
Unlike the Extension Act of 2005 or the earlier House bill, the new effort does
not include any more cutbacks to the lines of insurance included in the program.
One of the important policy objectives of the Bush Administration has been progressive
reductions each year in federal taxpayer risk. Although much of this is achieved
through changes in the program's financial parameters, the Extension Act surprised
many underwriters by significantly cutting back the lines of insurance in the
program.
As we see in Table 2, using direct written premium in 2006 as our base year,
the initial TRIA legislation eliminated almost half of the nation's P&C premium
by eliminating personal lines (totaling $223 billion in 2006 of a total $488
billion). The 2002 program also eliminated almost $30 billion (or more than
10 percent) of the commercial lines premium through the elimination of selected
lines (see Table
1) clearly not related to terrorism exposures.
Table
2: Premium Impact
The 2005 Extension went even further, increasing the eliminated premium to
almost $56 billion, mainly through the exclusion of commercial auto and all
professional liability (other than directors and officers Liability). My best
estimate is that the elimination of professional liability excluded about 25
percent of the premium booked to an eclectic line called "other liability."
In 2006, this mixture of general liability, excess and umbrella liability, professional
liability, D&O, and miscellaneous lines such as warranty insurance totaled $53.3
billion, with about $40 billion still included in the TRIA program. Liability
premium from commercial multi-peril (CMP) added another $14.4 billion in 2006.
If yet another legislative surprise is pending this December, the sole remaining
"elephant in the room" may very well be the approximate $54 billion in combined
other liability and CMP liability premium. I have heard that further reductions
in these lines are being considered. Needless to say, most underwriters and
risk managers will argue passionately that liability for terrorism acts must
be included in the program particularly in light of the completely unknown new
standards for what will be considered "prudent" in our new world of risk post-9/11.
What appears to be an insurmountable problem, however, could be a unique
opportunity. Simply stated, the single most glaring deficiency in the TRIA program
from an underwriting perspective is the complete lack of any explicit incorporation
of loss mitigation or preparedness requirements. As the first 9/11 lawsuits
come to trial in September 2007 in Judge Hellerstein's New York City courtroom,
federal policymakers should consider the many benefits of embracing preparedness
in the new legislation.
One way to achieve this goal, already in progress on a voluntary basis, would
be to require the Department of Homeland Security to develop minimum, economically
feasible benchmarks for preparedness and loss mitigation in collaboration with
the private sector. In addition to limiting the human casualties and the economic
impact of the next attack, minimum national or regional standards could enable
a more efficient liability insurance market to develop. Minimum required mitigation
standards would also reduce taxpayer risk, particularly if compliance with these
standards became a precondition for inclusion in the federal program. Much like
the concept of requiring an affirmative grant of NBCR coverage, developing a
new approach toward defining liability for terrorism attacks requires thoughtful
consideration and collaboration prior to implementation. This is another logical
issue for the proposed Commission on Terrorism Insurance to prioritize.
In the next installment of this article, I
will consider further how introducing the principle of preparedness to the policymaking
debate could help resolve some of the current disagreements over the financial
parameters of the program.
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