TRIA: It's Time To Examine New Terrorism Approaches
December 2010
In response to some reported terrorism insurance
availability or affordability problems reported in high-risk areas, the Terrorism
Risk Insurance Program Reauthorization Act (TRIPRA) legislation required the
Government Accountability Office (GAO) to produce a report explaining whether
capacity may be limited in some geographic zones, and what factors limit the
willingness of insurers to provide coverage. It was also asked to review the
future public policy options that legislators should consider to ensure the
adequate supply of affordable terrorism insurance.
by James
Macdonald
JW Macdonald Associates,
LLC
In September 2008, the GAO issued the results of its research in a report
called "Status of Efforts by Policyholders To Obtain Coverage" (GAO-08-1057).
As expected, based on interviews with insurers and buyers, the report described
a generally stable commercial insurance market. Instances of property insurance
capacity shortfalls were rare and concentrated in a few major business districts.
The specific examples cited are property insurance placements in Manhattan and,
to a lesser degree, the central business districts of Chicago and San Francisco.
Captive insurance company solutions are mentioned in two examples, with a
one single-parent captive providing $700 million in limits for a Manhattan building
requiring $1.2 billion in limits. In another example, a property owner needing
$1.6 billion for a midtown Manhattan building was able to assemble this limit
by creating a new captive insurance company and buying reinsurance from standalone
underwriters.
Insurer Concerns
Insurers reported a range of concerns as respects impediments to the supply
of terrorism insurance. The main issues reported by survey respondents included:
the availability and cost of traditional reinsurance; the large net loss potential
because of the current TRIA deductible and coinsurance requirements; the challenge
of modeling probable loss scenarios (with frequency being the main hurdle);
and the views of rating agencies regarding what constitutes acceptable concentrations
of risk and adequate capital levels.
To address the concerns of insurers and insurance buyers, the GAO report
offers comments on five options for policymakers to consider. Here is a summary
of each:
-
Reset Insurer Deductibles following a Major
Terrorist Attack: Under this legislative effort (proposed in 2007
by New York Senator Charles E. Schumer), a terrorist attack resulting in
insured losses of $1 billion or more would result reduce a commercial insurer's
deductible from 20 to only 5 percent of the prior year's direct earned premium.
This after-the-fact approach appears to introduce too much uncertainty to
an insurer's capital management challenge. As such, it is unlikely to get
much support.
There is surprisingly no mention of the changes that the 2005 House bill
that was approved by a huge majority. This bill would have introduced with
retentions subject to a "risk based" formula, e.g., workers compensation
would require a lower retention than commercial auto since it exposes insurers
to theoretically unlimited losses. The bill also would have reduced insurer
retentions for nuclear, biological, chemical, or radiological (NBCR) losses
to a fraction of the 20 percent normally required. It is not clear why the
GAO decided to omit any comment on the seemingly more plausible options
in the House bill.
-
Permit Insurers to Establish Pre-Loss Tax-Deductible
Reserves: This option is often also mentioned as a solution to the
supply of insurance for all forms of extreme events, including earthquakes
and hurricanes. The basic idea is to take the same approach afforded to
the private sector in many European nations by changing the US tax code
to allow insurers to set aside of pretax loss reserves for future extreme
events (be they man-made or natural).
Proponents argue that this would reduce the cost of capital of insuring
catastrophic losses and thereby improve affordable capacity in the commercial
market. As the pre-event loss reserves accumulate, the risk to an insurer's
capital adequacy would decrease. Critics counter that insurers already enjoy
enough tax advantages. Because this decrease tax revenues, it is not likely
to receive serious consideration in the near term, particularly in Congress
returns to the "pay as you go" approach. The GAO also notes significant
challenges in determining the size of reserves that should be permitted.
-
Form a Pool of Insurers To Underwrite Terrorism
Risk: The GAO cites an innovative Aon proposal in 2006 for the creation
of a new terrorism reinsurance pool funded by the private sector and designed
to be able to finance two $40 billion losses. This pool would replace the
federal government as the first tier of protection above required insurer
retentions. In the event that a loss depleted the pool's funds, the overage
would be funded either by some combination of bonds or a second layer of
protection from the Treasury Department.
The GAO mentions two examples of operating pools that provide coverage
for extreme events: Florida's mandatory Hurricane Catastrophe Fund (FHCF)
and the United Kingdom's voluntary Pool Reinsurance Company, Ltd. (Pool
Re), as examples of pools that have been created to insure extreme events.
The report cites numerous obstacles to forming a pool including the difficulty
in determining the optimal size for a pool given the uncertainty inherent
to estimates of the frequency and severity of terrorism attacks. In addition,
the GAO mentions a key conclusion of a major 2004 report into the feasibility
of creating a workers compensation pool, i.e., that a pool in itself does
not expand the total amount of capacity that is available for the private
sector to insure terrorism risk. The GAO fails to note, however, that this
study assumed that pool participation would be in a voluntary basis and
never considered the prospects of a mandatory approach.
-
Facilitate Issuance of Onshore Catastrophe
Bonds: To create new risk-bearing capacity, the GAO considers the
feasibility of encouraging capital market solutions through new forms of
debt obligations. Like the loss reserve option, this would require the changes
to the US tax code, and it would likely not be revenue neutral. One can
also reasonably assume that rating agencies would be reluctant to give the
investment grade ratings that many investors require, particularly in the
aftermath of the subprime crisis. The GAO concludes that, even with changes
in the tax code, a viable market for catastrophe bonds is unlikely to develop
because of the lack of reliable data to form the basis for estimates of
terrorism losses. Much like the first two options, this approach is unlikely
to gain legislative traction at a time when reducing the deficit is an imperative
concern.
-
Revise State Regulatory Requirements:
Some states require insurers to pay for fire losses following a terrorist
attack, even if the policy excludes loss from terrorism. These so-called
Special Fire Policy (SFP) states arguably limit the capacity that private
insurers are willing to commit. Several insurers also reported that certain
state regulators limit capacity by preventing insurers from charging what
they consider to be actuarially fair, risk-based prices. The GAO correctly
notes that commercial pricing is not strictly regulated in high-risk areas
of concern. Although the authors concede that the "fire following" issue
may limit available capacity, they provide no final position, concluding
instead that other factors, such as potential losses on high-value buildings,
are of greater import.
Report Omissions
In general, the report is most notable for the options it ignores rather
than the limited number of alternatives it explores. There are no clear recommendations
or even preferred next steps for policy makers to consider. The slant of the
authors appears to be almost entirely negative, with an almost singular focus
on what won't work. For example, in the discussion of pools, we see no mention
what is probably the best example of a successful program similar to Terrorism
Risk Insurance Act (TRIA): the American Nuclear Insurers Pool. This successful
public and private sector program was launched in 1957 in response to the Price
Anderson Amendment to the Atomic Energy Act. Similar to TRIA, the goal was to
assure the availability of affordable liability insurance for nuclear incidents
in order to encourage the development of nuclear energy facilities. One would
think this would serve as a better point of comparison than the hurricane fund
or a private sector funded feasibility study that failed to produce any substantive
results.
The most surprising (and disappointing) omission from the GAO report is its
failure to explicitly address what many believe is TRIA's greatest failing,
i.e., the lack of adequate or affordable insurance for terrorist attacks involving
NBCR agents or devices. The 2006 PWG report (see
PWG Report on the Future
of Terrorism Insurance) and broker surveys of the property insurance market
have consistently concluded that, despite the fact that Treasury guidance has
been clear that TRIA would cover these losses (if the primary insurance applied),
almost all commercial policies exclude these perils. The limited coverage that
is available is generally considered far too expensive, as reported in recent
reports to the PWG from Aon and CIAT. The sole exception is workers compensation,
due to the fact that no state allows insurers to exclude or place sublimits
on losses from terrorist attacks.
At minimum, one would have expected the GAO to consider some of the bold
changes proposed in the revision to TRIA approved by the House in December 2005
(HR 4314, 109th Congress, 1st Session), or by the strong
opposition by many conservatives to what they call the "subsidy" TRIA needlessly
affords to highly profitable private insurers.
Other Proposals
The notable proposals that merit future consideration as we approach the
final years of TRIPRA include:
- Eliminating the "subsidy" aspect of the program by requiring an actuarially
sound premium for the federal reinsurance;
- Including group life insurance (especially given the significant losses
incurred on 9/11 and continuing exposure to terrorist attacks); and
- Encouraging more capacity for NBCR losses by lowering the insurer deductible
to less than 10 percent.
Conclusion
Since it was issued in 2008, the GAO report's report has, for very solid
reasons, already become a distant memory. In all probability, it will be replaced
by one or more improved studies more typical of the normal GAO work product.
If the current intensely competitive commercial insurance market turns, or if
we sustain another major attack, some fresh thinking may be needed to maintain
a stable market. In this event, Aon's thoughtful 2006 pool proposal will likely
receive renewed attention as the basis for a possible long-term solution.
Note: James Macdonald authored "Changes
Loom for Federal Terrorism Insurance Program" in the December 2010 issue
of
The Risk Report.
If you subscribe to The Risk Report on Sage/ReferenceConnect or IRMI Online,
you may access his article at the relevant link.
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