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 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.
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.
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.
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.
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.
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.
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.
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