The ISO Terrorism Exclusions: Background and Analysis

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:

1. That involve the following or preparation for the following:
   1. Use or threat of force or violence;
   2. Commission or threat of a dangerous act; or
   3. Commission or threat of an act that interferes with or disrupts an electronic, communication, information, or mechanical system; and
2. When one or both of the following applies:
   1. 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
   2. 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.)

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.