Expert Commentary

TRIA's Sunset: The Dawn of a New Workers Compensation Crisis?

Insureds will soon face a challenge when renewing or placing workers compensation insurance, beginning as early as this September, because of the planned demise of the Terrorism Risk Insurance Act of 2002 (TRIA) in December 2005. Advice for risk managers given at the 2004 RIMS Conference includes recommendations to go beyond modeling tools and thoroughly analyze terrorism exposures for underwriters.

Terrorism Risk Management and Insurance
May 2004

With the focus on relatively low take up rates for optional terrorism coverage for property insurance by large commercial lines accounts, many people have overlooked the one area where the take up rate is 100 percent. That is, of course, workers compensation insurance. Any company that buys it is purchasing coverage for that exposure.

Currently, the Treasury Department is in the process of determining whether to extend the mandatory "make available" piece of the Terrorism Risk Insurance Act of 2002 (TRIA) for the optional year (i.e., 2005). This is the requirement that insurers offer terrorism coverage to their insureds at some price. Given the considerable support it is receiving in the business community and among federal legislators, it seems likely that this extension will be granted. But this really has no effect on workers compensation insurance because state laws don't allow terrorism exclusions on workers compensation policies in the first place. Thus, workers compensation insurers must make terrorism coverage available whether TRIA applies or not, and the sun will set for TRIA on December 31, 2005.

This sounds like a long time away—over a year and a half—but the effects will be first felt on renewals occurring after December 31 of this year, a year before the actual sunset. This is because part of the annual coverage period for any policy written after January 1, 2005, will fall after TRIA sunsets. The later a policy renews in 2005, of course, the longer the exposure without the federal backstop.

This problem will affect renewals for many lines of coverage, but expect underwriters to be most concerned with property and workers compensation insurance. They are likely to handle it for property (when intending to provide TRIA coverage until it sunsets) by attaching endorsements to exclude terrorism losses that occur after December 31, 2005. This will allow them to write property coverage while carving out only the catastrophic terrorism peril following TRIA's sunset. Workers compensation is a different story, however, because state laws prohibit using terrorism exclusions on these polices.

Accumulation Is the Problem

One of the lessons of September 11 was that insurers can be highly exposed to catastrophic financial loss from concentrations of exposure covered under multiple types of insurance, such as property and workers compensation. Most insurers seem to have learned the lesson well, and they are prepared to take steps to reduce their accumulated exposures in their insurance portfolios. To illustrate the problem, consider that experts have developed attack scenarios where the total insured losses under workers compensation alone would be $90 billion or more.1 To ensure their survival following such an event, individual insurers will seek to arrange their portfolios in a manner that they do not cover an inordinate share of such a disaster.

We saw some evidence of this action in 2002, following the September 11 tragedy, as underwriters immediately began requesting schedules of the number of locations with 100 or more employees when underwriting large accounts. Possibly an indicator of the problems associated with insuring a large number of employees was the growth in the number of large accounts written in the residual market—the market for companies that cannot buy the insurance in the standard marketplace—that occurred in 2002.2

Since September 11, insurers have done two things to be in a better position to mitigate their catastrophe risk from terrorism. First, they have been gathering exposure data on all their accounts; and second, they have developed or purchased computer modeling systems that can estimate losses from various attack scenarios. With respect to exposure, insurers have been working to more precisely identify how many workers they cover at each location they insure. These data can then be used to analyze their exposure to loss.

In less sophisticated systems, this information is segregated by zip code or charted on maps. However, many insurers are now using software developed by such companies as AIR and RMS to do a much more precise analysis. These firms have built very sophisticated models that accept the insurer's exposure data and allow building specific analysis. They can produce estimates of the insured loss under workers compensation, property, and business interruption insurance policies from a wide range of terrorist attack scenarios, such as various sized truck bombs, different types of biological attacks, radiological dirty bombs, and nuclear bombs.

These models allow insurers to set guidelines as to how much accumulated exposure is acceptable for single events and measure how their portfolios compare to the guidelines. If they are overexposed, they can use exclusions to reduce their exposure in the property insurance lines or nonrenew some of their insureds in the workers compensation line.

When TRIA sunsets, many insurers may have no choice but to not renew some of their workers compensation accounts in an attempt to manage their exposure accumulation. Of course, this problem will probably be most severe in dense metropolitan areas and, in particular, near likely targets. Nevertheless, it has the potential to cause severe market disruptions beginning in the first quarter of 2005.

Can the Industry Solve This Problem?

It is pretty obvious that for an insurer to allow excess exposure accumulation in its book of business is to risk financial annihilation. The key to insuring catastrophic risk is to spread the risk among numerous entities. Thus, to write large amounts of insurance in high exposure areas, they must have some form of financial support, such as reinsurance or a federal backstop.

Unfortunately, it does not appear that the global reinsurance marketplace is likely to add the degree of support needed to avoid this market disruption. Everyone had high hopes the insurance industry would develop a solution to this problem prior to TRIA's sunset, but that isn't likely to happen either.

Fourteen major workers compensation insurers—accounting for roughly 40 percent of the workers compensation market—commissioned Towers Perrin to conduct a study to determine the feasibility of starting a pool to reinsure workers compensation. The study concluded that a pool could not contribute sufficient capacity to provide the industry meaningful protection in the foreseeable future. Because of this conclusion, the insurers have abandoned the concept for the time being.

As a result, only an act of Congress can prevent this problem from occurring. The insurance industry certainly seems to be placing all its hope in new federal legislation. Insurers, regulators, and others are working hard to convince Congress to move forward with an extension of TRIA. Given that no crisis is yet upon us and that this is an election year, however, it is quite possible that nothing will happen in 2004. This should make next year's renewals very interesting to say the least. In fact, some insureds may receive nonrenewal notices this fall due to the advance notice requirements of many states.

Why the Residual Market May Not Bail Us Out

When a company cannot obtain workers compensation insurance in the voluntary marketplace, it can obtain coverage in the residual market. But this probably doesn't solve the problem. While each state has its own plan, each takes one of two general approaches: a state fund or an assigned risk plan. Five states have monopolistic state funds which write the insurance for all employers (except qualified self-insurers) and fourteen more have competitive state funds that serve as markets of last resort. The remaining 31 states use an assigned risk plan.

States using either monopolistic or competitive state funds face the same catastrophic risk as do commercial insurers in other states. With those that are state agencies, any deficit experienced following a catastrophic loss will be borne by the policyholders and taxpayers. While insureds in monopolistic fund states will probably not incur the immediate market disruption that may be seen in other states, in the event of a catastrophic loss, there could be a statewide fiscal crisis.

Significantly, three of the states deemed to have the highest exposure to terrorism loss—California, New York, and Texas—have competitive state funds. In the competitive fund states, a pullback by commercial insurers will result in an equal growth in the state fund. Of course, the need to change to the state fund will be disruptive for any insureds that must do so, and if the pullback is substantial the competitive funds may be challenged to respond in a timely manner. It will also further strain the system in those states, such as California, that already have numerous employers covered by their funds.3

In some states the competitive funds are public agencies while in others they operate more like insurers, which involves participation in the state guarantee fund. In those that are public agencies, the state's taxpayers become the reinsurers of last resort, just as with the monopolistic funds.

In states with assigned risk plans, the insurers participating in the standard marketplace are allocated the risk written by the plan in proportion to their overall workers compensation premiums in the state. Thus, the taxpayers will not be the reinsurers of last resort, and any insolvencies will fall back to the industry via the guarantee funds. In the worst case, this could cause a tailspin in the marketplace. If an insurer pullback results in a huge upsurge of accounts in the assigned risk pool, the insurers may determine that their pullback failed to mitigate their catastrophe exposure since they now cover it under the assigned risk plan). This could create an incentive to reduce their writings further to lessen their allocation in the assigned risk plan. Alternatively, a catastrophic loss without reinsurance protection could have a significant impact on the solvency of the insurers operating in the state.

What Can You Do?

Of course, risk and insurance professionals can encourage their legislators to move forward with an extension of or replacement for TRIA. If the industry must bank on the government to provide a solution, it needs to work together to make it happen. There are also some actions that can be taken on an individual account level.

At the company's press conference and in a subsequent interview during the 2004 RIMS Conference, ACE USA's Chief Underwriting Officer James MacDonald offered some good advice for risk managers and their agents/brokers. Wise risk managers will do their homework now to allow them to go beyond merely providing underwriters with headcounts by location. Analyze the exposure and help the underwriter understand it. In particular, alert them to unique circumstances that would not be considered by modeling tools.

Mr. MacDonald emphasized that the quality of the underwriting information provided may mean the difference between getting a quote and not getting a quote. Underwriters use the estimated number of employees at peak times to peg a foreseeable maximum loss (FML) and a probable maximum loss (PML). FML is normally the number of exposed employees multiplied by an estimate of the average fatality benefit in the given state. The higher the FML the more catastrophe risk the underwriter faces. Thus, the risk manager, agent, or broker, needs to work to make the underwriter comfortable with the account's exposure.

Here are a few considerations mentioned by Mr. MacDonald and others at the 2004 RIMS Conference.

  • If workers are assigned to shifts, the head count should consider how many employees are present at the peak time rather than simply reporting the total workforce at the location. If you have as many as 9,000 employees working in one casino, for example, it's one thing to tell the underwriter that there are 9,000 employees at the location. It's quite another to tell the underwriter that they work in 3 shifts and there should never be more than 3,500 on site at any given moment.
  • While many insurers have traditionally only asked for lists of locations with 100 or more employees, it may be necessary to provide counts for any likely target locations with smaller numbers of employees. Consider developing this information now rather than having to scramble at the last minute to compile it.
  • Be sure to review and summarize security systems, such as perimeter control, for the underwriter.
  • Advise the underwriter of any unique aspects of your locations which may mitigate your risk. For example, a truck bomb is likely to have far less impact on the highest floors of a high rise than on the lower floors, and the computer models don't take this into account. If your operations are on higher floors, inform the underwriter.
  • Ask your underwriter what attack modes are being used to analyze your exposure and assess the reasonableness of the chosen mode(s). For example is it a 2-ton truck bomb or a 10-ton truck bomb? A 2-ton truck bomb would be similar to the truck used by Timothy McVeigh while a 10-ton is a tractor trailer truck. Given your location and security systems, is the selected mode reasonable?
  • Provide the underwriter with details about your evacuation procedures and how often you perform practice drills.

Additionally, some of the following information might shed additional light on the exposure faced by your organization.

  • The tenant mix of the building
  • The construction of the building and the number of floors
  • The surrounding environment (e.g., surrounded by grounds thus limiting vehicular access or next door to a trophy property?)
  • Positioning of the garage in relation to the building (e.g., is it detached?)

The bottom line is to be certain you've taken all the steps you can to mitigate your company's risk. Then carefully and explicitly communicate the steps you've taken to your underwriters.


Will TRIA's impending sunset be the dawn of a workers compensation capacity crisis that will send many businesses into the residual market? While we cannot know with certainty the extent of the problems we will face, it seems clear there will be problems of some magnitude.4 Since many states require notice of an insurer's intent not to renew coverage 60 or 90 days in advance of expiration, many insurers will begin analyzing their portfolios and making renewal decisions this September for accounts renewing in January and February 2005. Thus, some insureds may receive nonrenewal notices only 4 months from now.

It is time for risk managers, agents, and brokers to take a careful look at this issue. Make certain you have performed a thorough exposure analysis, done what you can to mitigate the risk, and developed superior underwriting information to allow you to make your case. Start a dialog with underwriters to determine their strategies and consider developing a contingency plan in the event your insurer encounters an accumulation problem that makes it unable to continue writing your account. Barring an act of Congress, this will become an issue in the fall of 2004.

1Towers Perrin, Workers Compensation Terrorism Reinsurance Pool Feasibility Study (March 2004) p. 42. This $90 billion figure would be a worst-case scenario. According to RMS, a plausible, but major truck bomb attack might cause losses of $4 billion and a large scale anthrax attack $32 billion. See Catastrophe, Injury, and Insurance: The Impact of Catastrophes on Workers Compensation, Life, and Health Insurance by RMS for a detailed review of possible loss scenarios.

2National Council on Compensation Insurance, Residual Market Management Summary 2002, p. 6.

3The California State Compensation Fund has become the largest workers compensation insurer in the nation with $7.63 billion in written premium in 2003.

4For another commentary asserting similar premises to those in this article, see the April 28, 2004, testimony of Gregory V. Serio, Superintendent of Insurance for the State of New York before the U.S. House of Representatives Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises and the Subcommittee on Oversight and Investigations.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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