Insuring Against Acts of Terrorism

Impact of September 11, 2001 Attacks

Insurance Industry Response

State Regulation

Federal Intervention

Terrorism Risk Insurance Act (TRIA) 2002

Current Situation

Property Insurance on theWorld Trade Center

• Cause of Loss– Aircraft– Explosion– Fire

• Type of Loss– Direct

• Real property• Personal property

– Consequential• Loss of income

• Potential Exclusion– Act of War

• Additional Issue– One or two occurrences?

Other Covered Losses in World Trade Center

• Life• Health• Disability• Workers Compensation• Liability

World’s 10 Largest Catastrophes (by insured loss)

$40

$19.6$16.3

$7.1 $6.1 $6.0 $5.9 $4.6 $4.2 $4.2

$0$5

$10$15$20

$25$30$35$40

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$ Billions, in 2001 $

*III Estimate; Includes life, liability and workers compensation losses.Source: Swiss Re, Insurance Information Institute.

World Trade Center Losses Current Estimate $40.2 billion

Property – Towers 1 and 2 3.5 Other 6.0

Business Interruption 11.0Workers Compensation 2.0Aviation (Aircraft Hulls) 0.5Event Cancellation 1.0Liability Airlines 3.5

Other 10.0Life 2.7

The Effect of the WTC Loss• Primary insurers will pay approximately 1/3 of the WTC

losses• Reinsurers will pay approximately 2/3 of the loss• The insurance industry can afford to pay for the WTC loss• The industry cannot afford to cover another loss of this

magnitude in the near future• When capital levels are replenished, the industry would be

able to withstand another major loss• Significant price increases have occurred on all lines since

9/11

Excluding Coverage for Terrorist Acts

• Reinsurers are now excluding terrorism coverage– Many reinsurance contracts renewed 1/1/02

– These contracts do not provide coverage for terrorism

• Primary insurers filed for terrorism exclusions• 45 states allowed terrorism exclusions• Primary insurers are beginning to exclude terrorism

as policies renewed• In states that do not permit an exclusion, commercial

property coverage will be difficult to obtain

ME

NH

MA

CT

PA

WVVA

NC

LA

TX

OK

NE

ND

MN

MI

IL

IA

ID

WA

OR

AZ

HI

NJ

RI

MDDE

AL

VT

NY

DC

SC

GA

TN

AL

FL

MS

ARNM

KYMOKS

SDWI

IN

OH

MT

CA

NV

UT

WY

CO

PR

Terrorism Exclusions

Exclusions Approved,Mandatory Fire Following

No Terrorism Exclusion

Exclusions Approved,Fire Following NOT Mandatory

Terror exclusions approved in 45 states + DC and PR

Factors Affecting Exclusion

• Workers Compensation– No exclusions for a particular event allowed

• Standard fire policy language– Laws in 30 states require use of standard fire

policy– Covers all fire losses, regardless of cause

Coverage for Another Terrorist Act

• If another major loss had occurred early in 2002, primary insurers would have born most of the cost– Solvency concerns

• If the loss occurs after insurers have added the exclusion, the individuals and businesses would bear most of the cost

Examples of Problems Caused by Lack of Terrorism Coverage

• Property owners without adequate coverage– Particular problem for “trophy” properties

• Cost increases for property coverage are impacting companies of all types– Double the cost for 1/5th of the coverage

• Lenders requirements for insurance coverage– Many borrowers are in violation of loan covenants

• Financing for new construction projects is being withheld• Insurers are concerned over concentration of risk in Workers

Compensation• Construction work is slowing down• Lack of terrorism coverage could cause economic problems

Federal Role in Terrorism Coverage

• House of Representatives passed bill in November 2001

• Senate failed to pass legislation in 2001

The Issue Re-Emerges

• Summer 2002, President Bush makes renewed calls for legislation.

• Senate passes legislation in July 2002, but substantial differences from House bill remained.

• Finally the differences were ironed out

Terrorism Risk Insurance Act of 2002 (TRIA)

• Finally passed on 11/26/2002• Established program through 12/31/2004• Treasury Secretary can extend one year

through 2005• This legislation overrides state regulation• McCarran-Ferguson Act (1945) allows states

to regulate insurance unless Federal legislation specifically applies to insurance

Impact of TRIA 2002• Insurers must offer policyholders the option

of removing terrorism exclusions• It is not mandated that anyone purchase the

insurance• Insurers had 90 days (late February, 2003)

to quote price for this provision• Insureds had 30 days to accept/decline

Results of Terrorism Coverage Provisions

• Cost of removing exclusion varied widely based on location and “target” value

• Examples ranged from 2-100% of basic property insurance coverage

• Typical cost – about 10% of property insurance coverage

• Fewer than 20% of policyholders are purchasing this coverage

When is Coverage Triggered?

• Treasury Secretary (State & AG) Certification• “Act of Terrorism”

– A violent act or act dangerous to human life, property or infrastructure

– Results in damage within the US (or to US air carrier or vessel, or on premises of US mission)

– Committed … on behalf of any foreign person/interest, as part of effort to coerce civilian population or influence policy of US government

• Excludes declared acts of war• Loss must exceed $5 million in losses

What is Covered?• Commercial lines of P&L insurance, including:

– Property insurance (BPP policy)– Workers’ compensation– Business interruption

• Excludes:– Personal lines– Life & health insurance– Crop & flood insurance, PMI, etc.

Coverage Overview

• Company deductibles based on prior year U.S. P&L premiums – 2003: 7% of 2002 direct earned premiums

– 2004: 10% of 2003 direct earned premiums

– 2005: 15% of 2004 direct earned premiums

• Below this amount, insurer pays 100%• Government pays 90% of losses above this

deductible, but may recoup some of these losses from the industry

Aggregate Retention Amount• An industry wide deductible

– $10 billion in 2003– $12.5 billion in 2004– $15 billion in 2005

• Until aggregate industry losses exceed this amount, any government payments will be recouped through surcharges on future policies

• Government losses are capped at $100 billion

Example• ABC insurer had $5 billion 2002 direct earned premiums

– 2003 deductible = $350 million • U.S. endures a $15 billion terrorism loss in 2003

– ABC’s share of the loss is $1.35 billion • Government reimburses ABC

– 90% of losses above $350 million (ABC’s deductible), or $900 million (.9x(1.35 billion- 350 million))

• Similar payments to all other insurers with losses in excess of their deductibles– Assume deductibles and coinsurance total $3 billion– U.S. payments would total $12 billion

• Government surcharges on the insurance industry recoup $7 billion • Net cost to U. S. government (all taxpayers) is $5 billion

Liability Provisions

• Provides for a Federal cause of action for property damage, personal injury, or death arising from terrorist event

• No caps on punitive damages, but punitive damage awards are not eligible for federal reimbursement

What Does the Future Hold?• The 3 major risk modeling agencies (AIR, Equicat,

RMS) have terrorism risk models• The industry has incentive to make this work

– They pushed hard for the legislation

– Want to be viewed as “the only insurer” a company needs

• But some may prefer not to have exposure, especially in high risk locations (Ex: NYC, DC, Chicago)

• Most insured’s are choosing to “go without”• Risk sharing for terrorism losses will develop

The Future – Longer Term

• Will program be extended for third year?– Highly likely because the decision will come a

few months before 2004 Presidential election!

• Great consternation among insurers and insureds about sunset – will likely push for continued federal role beyond 12/2005

• Brings to the forefront issues of federal versus state insurance regulation