Terrorism Insurance
Implementation of the Terrorism Risk Insurance Act of 2002
Gao ID: GAO-04-307 April 23, 2004
After the terrorist attacks of September 11, 2001, insurance coverage for terrorism largely disappeared. Congress passed the Terrorism Risk Insurance Act (TRIA) in 2002 to help commercial property-casualty policyholders obtain terrorism insurance and give the insurance industry time to develop mechanisms to provide such insurance after the act expires on December 31, 2005. Under TRIA, the Department of Treasury caps insurer liability and would process claims and reimburse insurers for a large share of losses from terrorist acts that Treasury certified as meeting certain criteria. As Treasury and industry participants have operated under TRIA for more than a year, GAO was asked to describe (1) their progress in implementing the act and (2) changes in the terrorism insurance market under TRIA.
Treasury and industry participants have made significant progress in implementing TRIA during its first year, but Treasury has important work to complete in order to comply with its responsibilities under the act. For example, Treasury has issued regulations to define program requirements, created and fully staffed the Terrorism Risk Insurance Program office, and begun data collection efforts in support of mandated studies. Insurers also have adjusted their operations and policies to comply with TRIA. However, insurers have expressed concerns that Treasury has not yet decided whether to extend through 2005 the requirement that insurers offer terrorism coverage on terms that do not differ materially from other coverage. Although the act gives Treasury until September 1, 2004, to decide this issue, a more timely decision is needed to avoid hindering underwriting and pricing decisions for policies that are issued or renewed through 2005. In addition, Treasury has not fully established a claims processing and payment structure. Insurers are concerned that a delayed payment of claims by Treasury, whether because of the length of time taken to certify that an act of terrorism met the requirements for federal reimbursement or from inadequate claims processing capability, might seriously impact insurer cash flows or, in certain circumstances, insurer solvency. It appears that Congress's first objective in creating TRIA--to ensure that business activity did not materially suffer from a lack of available terrorism insurance--has been largely achieved. Since TRIA was enacted in November 2002, terrorism insurance has been generally available to businesses. But most commercial policyholders are not buying the coverage. According to insurance industry experts, purchases have been higher in areas considered to be at high risk of another terrorist attack. However, many policyholders with businesses or properties not located in perceived high-risk locations are not buying coverage because they view any price for terrorism insurance as high relative to their perceived risk exposure. Further, those who have bought terrorism insurance remain exposed to significant perils. Insurers have broadened long-standing policy exclusions of nuclear, biological, and chemical events. Congress's second objective--to give private industry a transitional period during which it could begin pricing terrorism insurance and develop ways to cover losses after TRIA expired--has not yet been achieved. Industry sources indicated that under TRIA, insurance market participants have made no progress to date toward the development of reliable methods for pricing terrorism risks and made little movement toward developing any mechanism that would enable insurers to provide terrorism insurance to businesses without government involvement.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
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GAO-04-307, Terrorism Insurance: Implementation of the Terrorism Risk Insurance Act of 2002
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Report to the Chairman, Committee on Financial Services, House of
Representatives:
April 2004:
TERRORISM INSURANCE:
Implementation of the Terrorism Risk Insurance Act of 2002:
GAO-04-307:
GAO Highlights:
Highlights of GAO-04-307, a report to the Chairman, Committee on
Financial Services, House of Representatives
Why GAO Did This Study:
After the terrorist attacks of September 11, 2001, insurance coverage
for terrorism largely disappeared. Congress passed the Terrorism Risk
Insurance Act (TRIA) in 2002 to help commercial property-casualty
policyholders obtain terrorism insurance and give the insurance
industry time to develop mechanisms to provide such insurance after the
act expires on December 31, 2005. Under TRIA, the Department of
Treasury caps insurer liability and would process claims and reimburse
insurers for a large share of losses from terrorist acts that Treasury
certified as meeting certain criteria. As Treasury and industry
participants have operated under TRIA for more than a year, GAO was
asked to describe (1) their progress in implementing the act and (2)
changes in the terrorism insurance market under TRIA.
What GAO Found:
Treasury and industry participants have made significant progress in
implementing TRIA during its first year, but Treasury has important
work to complete in order to comply with its responsibilities under the
act. For example, Treasury has issued regulations to define program
requirements, created and fully staffed the Terrorism Risk Insurance
Program office, and begun data collection efforts in support of
mandated studies. Insurers also have adjusted their operations and
policies to comply with TRIA. However, insurers have expressed concerns
that Treasury has not yet decided whether to extend through 2005 the
requirement that insurers offer terrorism coverage on terms that do not
differ materially from other coverage. Although the act gives Treasury
until September 1, 2004, to decide this issue, a more timely decision
is needed to avoid hindering underwriting and pricing decisions for
policies that are issued or renewed through 2005. In addition, Treasury
has not fully established a claims processing and payment structure.
Insurers are concerned that a delayed payment of claims by Treasury,
whether because of the length of time taken to certify that an act of
terrorism met the requirements for federal reimbursement or from
inadequate claims processing capability, might seriously impact insurer
cash flows or, in certain circumstances, insurer solvency.
It appears that Congress‘s first objective in creating TRIA”to ensure
that business activity did not materially suffer from a lack of
available terrorism insurance”has been largely achieved. Since TRIA was
enacted in November 2002, terrorism insurance has been generally
available to businesses. But most commercial policyholders are not
buying the coverage. According to insurance industry experts, purchases
have been higher in areas considered to be at high risk of another
terrorist attack. However, many policyholders with businesses or
properties not located in perceived high-risk locations are not buying
coverage because they view any price for terrorism insurance as high
relative to their perceived risk exposure. Further, those who have
bought terrorism insurance remain exposed to significant perils.
Insurers have broadened long-standing policy exclusions of nuclear,
biological, and chemical events. Congress‘s second objective”to give
private industry a transitional period during which it could begin
pricing terrorism insurance and develop ways to cover losses after TRIA
expired”has not yet been achieved. Industry sources indicated that
under TRIA, insurance market participants have made no progress to date
toward the development of reliable methods for pricing terrorism risks
and made little movement toward developing any mechanism that would
enable insurers to provide terrorism insurance to businesses without
government involvement.
What GAO Recommends:
GAO recommends that the Secretary of the Treasury, as part of
Treasury‘s study of the effectiveness of TRIA and after consultation
with insurance industry participants, identify for Congress
alternatives that may exist for expanding the availability and
affordability of terrorism insurance after TRIA expires. These
alternatives could assist Congress during its deliberations about
terrorism insurance.
www.gao.gov/cgi-bin/getrpt?GAO-04-307.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Richard J. Hillman at
(202) 512-8678 or hillmanr@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Treasury and Industry Participants Have Made Progress in Implementing
TRIA, but Treasury Has Not Yet Achieved Key Goals:
Despite Availability, Few Are Buying Terrorism Insurance, and the
Industry Has Made Little Progress toward Post-TRIA Coverage:
Conclusions:
Recommendation for Executive Action:
Agency Comments:
Appendix:
Appendix I:Comments from the Department of the Treasury:
Table:
Table 1: TRIA-Mandated Studies and Data Collection:
Figures:
Figure 1: Prerequisites and Limits of Coverage under TRIA:
Figure 2: Regulations and Procedures Necessary to Implement TRIA:
Abbreviations:
GAO: U.S. General Accounting Office:
NAIC: National Association of Insurance Commissioners:
NBC: nuclear, biological, and chemical:
OMB: Office of Management and Budget:
RFP: Request for Proposal:
SFP: standard fire policy:
TRIA: Terrorism Risk Insurance Act of 2002:
TRIP: Terrorism Risk Insurance Program:
Letter April 23, 2004:
The Honorable Michael Oxley
Chairman, Committee on Financial Services
House of Representatives:
Dear Mr. Chairman:
The terrorist attacks of September 11, 2001, drastically changed the
way insurers viewed the risk of terrorism. An industry that had
considered the risk of terrorism so low that it did not identify or
price terrorism risk separate from property and casualty coverage will
pay approximately $40 billion for losses arising from September 11,
according to industry experts. In the aftermath, we reported that
insurance coverage was disappearing for terrorist events, particularly
for large businesses and those perceived to be at some risk.[Footnote
1] As contracts between reinsurers and insurers came up for renewal,
reinsurers excluded terrorism from coverage.[Footnote 2] Without
reinsurance, insurers retained greater levels of risks than they could
responsibly carry, and their reaction was to exclude these risks from
commercial policies as they were renewed.
In light of concerns that the lack of terrorism insurance could have
significant effects on the economy or that, in the event of another
terrorist attack, the economic costs would fall directly on the victims
and the government, Congress passed the Terrorism Risk Insurance Act of
2002 (TRIA), which took effect on November 26, 2002.[Footnote 3] Under
TRIA, the Department of the Treasury (Treasury) would reimburse
insurers for a large share of the losses associated with certain acts
of foreign terrorism that occur during the 3-year term of the act. The
purpose of TRIA is twofold: to make terrorism insurance widely
available and affordable to commercial policyholders for the duration
of the act and to provide a transitional period during which insurance
market participants could find ways to price terrorism insurance and
develop market-driven resources and mechanisms that would offer
terrorism insurance after TRIA expires on December 31, 2005.
TRIA requires that all insurers selling commercial lines of property
and casualty insurance "make available" coverage for certain terrorist
events in the first 2 years of the program. TRIA defines "make
available" to mean that the coverage must be offered for insured losses
arising from terrorist events and that coverage not differ materially
from the terms, amounts, and limitations applicable to coverage for
losses arising from other types of events. However, TRIA gives Treasury
the option of determining whether the "make available" requirement
should be extended through 2005, the third year of the act, and gives
the agency until September 1, 2004, to do so. Also, not all acts of
terrorism will trigger reimbursements under TRIA: the Secretary of the
Treasury must "certify" that an act of terrorism meets the criteria
specified in TRIA.[Footnote 4] For example, "an individual or
individuals acting on behalf of any foreign person or foreign interest"
must commit the act. After an event is certified, TRIA authorizes
Treasury to reimburse insurers for most of the insured losses, after
they have paid specified deductible amounts. Moreover, TRIA authorizes
Treasury to administer the Terrorism Risk Insurance Program (TRIP)
office, through which Treasury will administer TRIA provisions and
would pay claims. TRIA also mandates various studies and data
collection efforts and contains provisions affecting the National
Association of Insurance Commissioners (NAIC).[Footnote 5]
Treasury and industry participants have operated under TRIA for more
than a year. Consistent with your request, in this report we describe
(1) the progress made by Treasury and insurance industry participants
in implementing TRIA provisions and (2) changes in the market for
terrorism insurance coverage under TRIA.
To address these objectives, we reviewed and analyzed Treasury's final
and proposed regulations in the Federal Register, public comments that
were submitted about the regulations, relevant information concerning
state legislation, and publicly available and proprietary industry data
and studies on the terrorism insurance market. We interviewed officials
at Treasury, NAIC, and state insurance regulators from six states with
high insurance sales volumes. We also interviewed representatives of
insurance companies, reinsurance companies, brokers for insurance and
reinsurance companies, industry associations, property owners and
developers, and insurance filing services and credit rating
agencies.[Footnote 6] In our discussions with these organizations, we
endeavored to gain an understanding of their experience in implementing
TRIA requirements, obtain their views on the effects of TRIA on the
terrorism insurance market, and identify developments within the
industry to address terrorism risks after TRIA expires.
We conducted our work in Chicago, New York City, and Washington, D.C.,
from January 2003 through April 2004 in accordance with generally
accepted government auditing standards.
Results in Brief:
Treasury and industry participants have made significant progress in
implementing TRIA to date, but Treasury has important actions to
complete in order to comply with its responsibilities under TRIA.
Between November 2002 and December 2003, Treasury issued implementing
regulations, or final rules, on issues such as definitions of basic
terms used in TRIA and written disclosure to policyholders about TRIA
requirements, limits of coverage, and prices. During that same period,
Treasury issued a proposed rule on basic claims procedures. According
to Treasury officials, Treasury also fully staffed the TRIP office by
September 2003, decided not to extend TRIA to group life insurance
lines based on the results of a TRIA-mandated study, and began mandated
studies and data collection efforts. However, Treasury has not yet
decided whether to extend the requirement to policies issued or renewed
in 2005 that insurers "make available" terrorism insurance on terms not
differing materially from other coverage. In addition, it has not fully
established a claims processing and payment structure. NAIC, in its
advisory role, has effectively assisted Treasury in drafting guidance
and regulations, and insurance companies generally have made policy and
operational changes--including pricing decisions, policy language
revisions, and policyholder notifications--to comply with TRIA.
However, insurers have expressed concerns about some work Treasury has
not yet completed and the time frames allotted in TRIA that drive its
work and responsibilities. For example, insurers noted that if Treasury
waited until the TRIA deadline, September 1 of this year, to decide
whether insurers would have to make terrorism insurance available
through 2005, the decision would come too late for them to make
appropriate decisions for business planning for the third year of TRIA.
Moreover, a delayed payment of claims by Treasury, whether because of
the length of time taken to certify that an act of terrorism met the
requirements for federal reimbursement or from inadequate claims
processing capability, might seriously impact insurer cash flows or, in
certain circumstances, solvency.
Under TRIA, insurers and, to a limited extent, reinsurers have made
terrorism insurance available, but most commercial policyholders are
not buying the coverage and those that do remain exposed to significant
risks. According to real estate and risk management experts, TRIA
primarily has benefited high-risk policyholders, such as owners and
developers of large commercial properties located in major urban
centers and geographic locations perceived at greater risk for
terrorism. Limited, but consistent results from industry surveys
suggest between 10 and 30 percent of commercial policyholders are
purchasing terrorism insurance. However, according to insurance
industry experts, many policyholders with businesses or properties not
located near major urban centers or in perceived high-risk locations
are not buying terrorism insurance because they perceive themselves at
low risk for terrorism and thus view any price for terrorism insurance
as high relative to their risk exposure. Some industry experts are
concerned that adverse selection--where those most at risk from
terrorism are generally the only ones buying terrorism insurance--may
be occurring. The potential negative effects of low take-up, or
purchase rates, in combination with adverse selection would become
evident only in the aftermath of a terrorist attack and include more
difficult economic recovery for businesses without terrorism coverage
and potentially significant financial problems for insurers. Moreover,
policyholders with terrorism insurance may still not be insured for
certain significant perils resulting from terrorist events, even if the
events were to be certified. These perils include losses resulting from
nuclear, biological, and chemical (NBC) agents, radioactive
contamination, and in a growing number of states, fire following
terrorist events. The insurance industry has historically applied
certain of these limitations and exclusions. In the aftermath of
September 11, state legislatures have permitted their expansion and
they remain in place. Finally, under TRIA insurance market participants
have not yet developed a reliable method for pricing terrorism risks
and made little movement toward any mechanism that would enable
insurers to provide terrorism insurance to businesses without
government involvement.
The Assistant Secretary for Financial Institutions, Department of the
Treasury, provided written comments on a draft of this report. Treasury
generally believed the report was a thorough and well-balanced
discussion of the impact and implementation of TRIA. Treasury's
comments also explained how it prioritized its work at the inception of
the program to help the insurance industry implement TRIA's
requirements and expanded upon the details of its contingency plans for
a terrorist event occurring before all regulations and structures were
in place and contractors hired. Treasury's comments are reprinted in
appendix I.
Background:
Under TRIA, Treasury is responsible for reimbursing insurers for a
portion of terrorism losses under certain conditions. Payments are
triggered when (1) the Secretary of the Treasury certifies that
terrorists acting on behalf of foreign interests have carried out an
act of terrorism and (2) aggregate insured losses for commercial
property and casualty damages exceed $5,000,000 for a single
event.[Footnote 7] TRIA specifies that an insurer is responsible (i.e.,
will not be reimbursed) for the first dollars of its insured losses--
its deductible amount. TRIA sets the deductible amount for each insurer
equal to a percentage of its direct earned premiums for the previous
year.[Footnote 8] Beyond the deductible, insurers also are responsible
for paying a percentage of insured losses. Specifically, TRIA
structures pay-out provisions so that the federal government shares the
payment of insured losses with insurers at a 9:1 ratio--the federal
government pays 90 percent of insured losses and insurers pay 10
percent--until aggregate insured losses from all insurers reach $100
billion in a calendar year (see fig. 1). Thus, under TRIA's formula for
sharing losses, insurers are reimbursed for portions of the claims they
have paid to policyholders. Furthermore, TRIA then releases insurers
who have paid their deductibles from any further liability for losses
that exceed aggregate insured losses of $100 billion in any one year.
Congress is charged with determining how losses in excess of $100
billion will be paid.[Footnote 9]
Figure 1: Prerequisites and Limits of Coverage under TRIA:
[See PDF for image]
[A] The percentage of direct earned premiums increases each year: 7
percent in 2003, 10 percent in 2004, and 15 percent in 2005.
[End of figure]
TRIA also contains provisions and a formula requiring Treasury to
recoup part of the federal share if the aggregate sum of all insurers'
deductibles and 10 percent share is less than the amount prescribed in
the act--the "insurance marketplace aggregate retention amount." TRIA
also gives the Secretary of the Treasury discretion to recoup more of
the federal payment if deemed appropriate.[Footnote 10] Commercial
property-casualty policyholders would pay for the recoupment through a
surcharge on premiums for all the property-casualty policies in force
after Treasury established the surcharge amount; the insurers would
collect the surcharge. TRIA limits the surcharge to a maximum of 3
percent of annual premiums, to be assessed for as many years as
necessary to recoup the mandatory amount. TRIA also gives the Secretary
of the Treasury discretion to reduce the annual surcharge in
consideration of various factors such as the economic impact on urban
centers. However, if Treasury makes such adjustments, it has to extend
the surcharges for additional years to collect the remainder of the
recoupment.
Treasury is funding TRIP operations with "no-year money" under a TRIA
provision that gives Treasury authority to utilize funds necessary to
set up and run the program.[Footnote 11] The TRIP office had a budget
of $8.97 million for fiscal year 2003 (of which TRIP spent $4 million),
$9 million for fiscal year 2004, and a projected budget of $10.56
million for fiscal year 2005--a total of $28.53 million over 3 years.
The funding levels incorporate the estimated costs of running a claims-
processing operation in the aftermath of a terrorist event: $5 million
in fiscal years 2003 and 2004 and $6.5 million in fiscal year 2005,
representing about 55 to 60 percent of the budget for each fiscal year.
If no certified terrorist event occurred, the claims-processing
function would be maintained at a standby level, reducing the projected
costs to $1.2 million annually, or about 23 percent of the office's
budget in each fiscal year. Any funds ultimately used to pay the
federal share after a certified terrorist event would be in addition to
these budgeted amounts.
Treasury and Industry Participants Have Made Progress in Implementing
TRIA, but Treasury Has Not Yet Achieved Key Goals:
More than a year after TRIA's enactment, Treasury and insurance
industry participants have made progress in implementing and complying
with its provisions, but Treasury has yet to fully implement the 3-year
program. Treasury has issued regulations (final rules) to guide
insurance market participants, fully staffed the TRIP office, and
started collecting data and performing studies mandated by TRIA.
However, Treasury has yet to make the claims payment function
operational and decide whether to extend the "make available"
requirement through 2005. In its advisory role, NAIC has effectively
assisted Treasury in drafting guidance and regulations and planning
mandated studies. Insurance companies are also generally complying with
TRIA requirements by making changes to their operations, such as
revising premiums and policy terms. However, insurers do not yet know
whether they will be required to "make available" terrorism insurance
for policies issued or renewed in 2005. Additionally, they have voiced
concerns about the time Treasury might take to certify an act of
terrorism as eligible for reimbursement under TRIA and process and pay
claims after an act was certified.
Treasury Has Issued Some Regulations, Staffed the TRIP Office, and
Begun Studies and Data Collection:
To implement TRIA and make TRIP functional, Treasury has taken numerous
regulatory and administrative actions, which encompass rulemaking,
creating a new program office, and collecting and analyzing data. To
date, Treasury has issued three final rules and one proposed rule,
which provide uniform definitions of TRIA terms, explain disclosure
requirements, determine which insurers are subject to TRIA, and
establish a basic claims-paying process. Treasury has also created and
staffed the TRIP office, which will oversee claims processing, payment,
and auditing. Finally, Treasury has completed a TRIA-mandated
assessment and is working on other reporting and data collection
mandates.
To Be Ready for Possible Terrorist Events, Treasury Quickly Issued
Interim Guidance and Interim Final Rules:
After TRIA became effective, Treasury officials said they moved quickly
to provide immediate guidance to the insurance industry on time-
sensitive requirements. Because the process required to issue final
regulations would take a few months, Treasury published four sets of
interim guidance in the Federal Register between December 2002 and
March 2003. The first three sets of interim guidance were in a
question-and-answer format to provide quick answers to specific
questions, and the fourth interim guidance contained regulatory
language. The purpose of the interim guidance was to help insurance
companies and other entities determine if they were subject to TRIA and
to help insurers quickly modify forms and policies and adjust
operations by providing definitions and program parameters. Interim
guidance in December 2002 covered requirements for disclosure (e.g.,
notification to policyholders), the "make available" provision, and
which lines of property-casualty insurance were subject to TRIA. For
example, the guidance explained that under TRIA insurers are required
to send notices to their policyholders containing information about the
availability and cost of terrorism insurance and the 90 percent federal
share. Subsequent guidance provided information on topics such as how
certain insurers should allocate direct earned premiums (which are used
to determine what their deductibles would be), alternative methods for
complying with TRIA's disclosure requirement, and the application of
TRIA to non-U.S. insurers. The interim guidance remained in force while
Treasury drafted final rules.
In addition to interim guidance, Treasury also published two interim
final rules and a proposed rule. The first interim final rule laid the
foundation of the program and key definitions for terms used in TRIA.
The second interim final rule covered disclosure and "make available"
requirements. The proposed rule addressed "state residual market
insurance entities" and "state workers compensation funds"--two types
of state-created entities that will be discussed below. The interim
final rules had the force of law until they were superseded by final
rules. As a result, Treasury officials stated, had a terrorist act
occurred before final rules took effect, a regulatory structure would
have been in place to allow a faster response than would otherwise have
been possible.
Treasury Also Has Published Final Rules:
As of March 1, 2004, Treasury's interim guidance, interim final rules,
and proposed rule had been superseded by three final rules. The first
final rule was published in the Federal Register on July 11, 2003, and
addressed basic definitions of words used in TRIA, such as "insurer"
and "property and casualty insurance."[Footnote 12] Treasury officials
said they completed this regulation first to provide a foundation for
subsequent regulations, which would use these terms frequently.
Although TRIA provided definitions for these terms, TRIA also specified
that state insurance regulations be preserved where possible. According
to Treasury officials, Treasury thus devoted much effort to ensure that
TRIA's definitions of property-casualty insurance terms would be
consistently applied across jurisdictions--a difficult task because
Treasury did not have existing uniform or consistent definitions of the
terms used in TRIA. For example, the term "commercial property-casualty
insurance" includes slightly different lines of insurance in each
state's definition. Treasury decided to use information that insurers
submitted in annual statements to NAIC as the basis for defining
property-casualty insurance.[Footnote 13]
On October 17, 2003, Treasury issued its second final rule on
disclosure and "make available" requirements for insurers (see fig. 2).
These time-sensitive requirements, which insurers had to meet to be
eligible to receive federal reimbursement for terrorist losses, had
originally been spelled out in the interim final rule. Among other
things, the rule stated that insurers that had used NAIC's model
disclosure forms to notify their policyholders about TRIA and terrorism
insurance premiums had complied with TRIA disclosure requirements. The
rule also clarified that insurers did not have to make available
coverage for certain risks if the insurer's state regulator permitted
the exclusion of those risks and the insurer had made the same
exclusion from coverage on all other types of policies. For example,
Treasury's explanations in the rule specifically used policy exclusions
for NBC events to illustrate this point. (We discuss these exclusions
in more detail later in this report.):
The third final rule, also issued on October 17, 2003, instructed two
kinds of insurers that are typically created by state governments--
"state residual market insurance entities" and "state workers'
compensation funds"--on how TRIA provisions apply to them (see fig. 2).
States establish residual market insurance entities to assume risks
that are generally unacceptable to the normal insurance market, and
state workers' compensation funds are state funds established to
provide workers injured on the job with guaranteed benefits. The other
insurance companies operating in the state usually fund these state-
created entities. The rule explained how a state residual market
insurance entity and its insurance company members should allocate
direct earned premiums among themselves for the purposes of calculating
deductibles under TRIA, because the size of the TRIA deductible is
determined by the size of a company's direct earned premium. Treasury
crafted provisions specific to state residual market insurance entities
because, depending on the particular state law, both the premiums and
the profits and losses of these entities may be shared with their
insurance company members. Absent these specific provisions, in those
cases where premiums were shared the premiums would be double counted,
resulting in an unfair increase in the deductible of the insurance
company. The rule also applied TRIA's disclosure provisions to both
types of state-created entities.
Treasury also issued a proposed rule on December 1, 2003, which would
establish the first stages of a basic claims-paying process (see fig.
2). According to Treasury officials, this proposed regulation sets up
an initial framework for the claims process, including instructions to
insurers to notify Treasury when they have reached 50 percent of their
deductible. This notification provides Treasury with advance notice of
possible impending claims. The proposed rule also contains, among other
things, requirements for insurers to receive federal reimbursements and
provides associated recordkeeping requirements. Treasury intends to
supplement the proposed rule with additional, separate guidance that
will provide detailed operating procedures for claims filing and
processing. According to the officials, Treasury took this phased
approach to get the basic rules out to insurers in case a terrorist
event occurred.
Finally, a Treasury official said that Treasury staff drafted another
rule, which is currently under review by the Office of Management and
Budget (OMB). The draft, which will be published and available for
public comment as a proposed rule after OMB approves it, addresses
litigation management (see fig. 2). The draft proposed rule would apply
a TRIA provision that establishes that suits arising from certified
terrorist events are federal causes of action and establishes
litigation management procedures.
Figure 2: Regulations and Procedures Necessary to Implement TRIA:
[See PDF for image]
[A] TRIA sections that establish specific mandates or provide authority
for Treasury to develop regulations.
[B] TRIA sections for which Treasury has said that it would issue
regulations.
[C] TRIA sections that by inference require Treasury to take regulatory
or administrative actions.
[D] For example, Treasury published a final rule on July 11, 2003 that
provided basic definitions.
[E] The proposed rule details basic procedures insurers would follow to
file a claim for reimbursement of the 90 percent federal share.
Treasury also plans to issue more detailed guidance that, for example,
would provide standardized forms and explain the method of payment.
[End of figure]
Writing the regulations has been a lengthy and difficult process, not
only because of the multiple procedural review requirements of federal
rulemaking, but also because TRIA established that state insurance
regulations should be preserved where possible.[Footnote 14] For
example, as previously discussed, creating definitions in accord with
the statutory definitions of more than 50 jurisdictions (the states,
District of Columbia, Puerto Rico, and U.S. territories) required
extensive discussions among the state regulators, which in turn
required additional time to plan and execute.
Treasury Has Fully Staffed the TRIP Office:
In addition to developing regulations to implement TRIA, Treasury fully
staffed the TRIP office by September 2003. The TRIP office develops and
oversees the operational aspects of TRIA, which encompass claims
management--processing, review, and payment--and auditing functions.
The TRIP staff consists of an executive director, a senior advisor, two
attorneys, two policy analysts, and two administrative staff. Since
becoming operational, TRIP staff have drafted regulations and performed
other tasks necessary to make the program functional. For example,
staff reviewed and incorporated appropriate public comments to proposed
regulations and visited reinsurers to learn more about paying claims
submitted by insurers as a prelude to developing criteria for claims
payment and processing. Staff also will be issuing contracts for
vendors to supply these claims services. (We discuss the claims
processing function in more detail later in this report.) Additionally,
TRIP staff have ongoing work such as issuing interpretive letters in
response to questions submitted by the public and participating in
conferences across the United States to inform regulators, industry
participants, and the public about TRIA provisions.
Treasury Has Begun Mandated Data Collection and Analysis:
Treasury has completed one TRIA mandate for data collection and a study
and has begun work on others. Specifically, TRIA mandated that Treasury
provide information to Congress in four areas: (1) the effects of
terrorism on the availability of group life insurance, (2) the effects
of terrorism on the availability of life and other lines of insurance,
(3) annual data on premium rates, and (4) the effectiveness of TRIA
(see table 1). Treasury's Office of Economic Policy is responsible for
organizing and analyzing information associated with the mandated
studies and assessments.
Table 1: TRIA-Mandated Studies and Data Collection:
TRIA citation: Sec. 103(h)(1);
Description of study or data-collection effort:
* Determine whether adequate and affordable catastrophe reinsurance for
terrorist events is available to life insurers that issue group life
insurance;
* Determine the extent to which the threat of terrorism is reducing the
availability of group life insurance.
TRIA citation: Sec. 103(i);
Description of study or data-collection effort:
* Study the potential effects of terrorism on the availability of life
insurance and other lines of insurance, including personal lines;
* Report results to Congress no later than 9 months from enactment of
TRIA.
TRIA citation: Sec. 104(f);
Description of study or data-collection effort:
* Annually collect information on terrorism insurance risk premium
rates for previous year;
* Make results available upon request of Congress.
TRIA citation: Sec. 108(d)(1);
Description of study or data-collection effort:
* Assess the effectiveness of TRIA;
* Project the capacity of the property-casualty insurance industry to
offer terrorism coverage after TRIA expires;
* Project the availability and affordability of terrorism insurance for
different types of policyholders, including railroads, trucking, and
public transit;
* Report results to Congress no later than June 30, 2005.
Sources: TRIA (data); GAO (analysis).
[End of table]
Pursuant to TRIA section 103(h)(1), Treasury completed an assessment of
the availability of group life insurance and reinsurance for insurers
issuing group life policies. Treasury concluded that the terrorism
threat had not reduced the availability of group life insurance, but
had reduced the availability of reinsurance, finding a general lack of
catastrophic reinsurance for group life coverage. After completing the
assessment, Treasury issued a press release in August 2003 stating that
it had decided not to make group life insurance subject to TRIA because
it found that insurers had continued to provide group life coverage.
According to life insurance experts, life insurers have done so to
maintain customer relations that would be difficult to reestablish if
the coverage were discontinued. Additionally, life insurance experts
noted that business from other lines of insurance would be lost if
insurers were to discontinue group life, which is typically sold as
part of a package with disability and medical coverage.
Treasury has not yet completed a mandated study on the effects of
terrorism on the availability of life and other lines of insurance. The
study was to have been completed by August 2003, 9 months after TRIA
was enacted. As of March 1, 2004, according to Treasury officials, the
report based on this study was in draft form. Because internal Treasury
reviews of the draft have not been completed, the draft report has not
yet been made public.
Pursuant to TRIA sections 104(f)(1) and 108(d)(1), Treasury officials
said they began collecting data on annual premium rates and working on
the study that would assess the effectiveness of TRIA and project the
availability and affordability of terrorism insurance for certain
groups of policyholders after TRIA expires. Treasury hired a private
firm to collect premium data and other information in surveys from
policyholders, insurers, and reinsurers. In the surveys, policyholders
are asked to provide information such as business size, geographic
locations of insured properties, premium data for TRIA-related
terrorism insurance, and risk management measures used. Insurers are
asked about the types of insurance sold that contain TRIA coverage,
number of policies sold, number of policies sold with TRIA coverage,
and methods used for estimating risks.[Footnote 15] Reinsurers will be
asked for similar information. The data collected from the survey will
provide information for the data collection efforts on annual premium
rates and also provide the basis for assessing the effectiveness of
TRIA. According to Treasury officials, Treasury began sending surveys
to a nationally representative sample of 25,000 policyholders in
November 2003 and approximately 700 insurers and insurance groups in
January 2004. The first surveys will collect data for 2003, as well as
2002, to establish a baseline for analysis and reporting. The second
and third surveys will be sent in 2004 and 2005.
Treasury Has Tasks to Complete before TRIA Can Be Fully Implemented:
Before TRIA can be fully implemented, Treasury has to make certain
decisions, develop additional regulations, and make certain TRIP
functions operational. More specifically, TRIA gave Treasury until
September 1, 2004, to decide if the requirement that insurers offer
terrorism coverage on terms that do not differ materially from other
coverage should be extended for policies issued or renewed in 2005, the
third and final year of the program. Treasury did issue a press release
on December 23, 2003, clarifying that the "make available" requirement
for annual policies issued or renewed in 2004 extends until the policy
expiration date, even though the coverage period extends into 2005. As
of March 1, 2004, Treasury officials said they had not made a decision
on the "make available" extension for policies that will be issued or
renewed in 2005. The officials indicated that they would be in a better
position to make this decision after they obtained enough preliminary
data from their surveys, which they anticipate receiving in spring
2004. The survey data are expected to provide an analytical framework
for Treasury's decisions by collecting information on factors such as
premium rates, geographic locations of covered property, policy limits
and deductibles, and the extent to which certain terrorism risks are
covered.
Treasury has yet to develop all the regulations necessary to carry out
TRIA provisions and make operational certain functions relating to
claims administration, auditing, and oversight. While the
implementation of some of these provisions and functions was covered by
the proposed rule (see fig. 2), Treasury has not drafted final rules to
cover the latter stages of the claims process, which would encompass
resolving disputed claims with insurance companies, dealing with
insurers that become insolvent, adjusting claims payments for over-and
underpayments (netting), and handling claims submitted by insurers
after aggregate insured losses have exceeded the $100 billion cap.
Treasury officials said they plan to complete these regulations in the
spring and summer of 2004, after they have fully addressed the claims-
paying process. Treasury also has yet to write regulations addressing
recoupment and surcharges and the collection of civil monetary
penalties in cases of noncompliance or fraud. Treasury also plans to
assess the need to develop additional regulations or refine past
regulations on captive insurers and self-funded pools--types of self-
insurers. Additionally, Treasury has not yet developed processes for
auditing claims payments to insurers. However, Treasury plans to issue
a request for proposal (RFP) for a postclaims auditing contractor in
the third quarter of fiscal year 2004. The contractor will review
claims and conduct field audits of insurers after an event to ensure
that underlying documents support claims submitted to Treasury.
Treasury officials anticipate awarding a contract in the fourth quarter
of fiscal year 2004. Moreover, Treasury plans to develop guidance
encompassing business procedures and audit parameters that will trigger
reviews and audits. Treasury officials also said that other ongoing and
completed work associated with the claims-processing function lays the
foundation for the claims auditing process. Finally, a Treasury
official estimated that by the end of fiscal year 2004, Treasury would
implement all of the processes that would have to be in place before an
event occurred. After fiscal year 2004, Treasury plans to develop
procedures for requirements that will not need to be in place until
after an event has occurred--such as recoupment and surcharge.
Lastly, a key TRIP function--the actual processing and payment of
claims--is not yet operational. From the beginning of its planning
efforts, Treasury had envisioned that contractors would handle TRIA
claims processing in the aftermath of a terrorist attack. According to
TRIP officials, after incorporating a basic regulatory framework, one
of the first priorities for the TRIP office was to write and issue a
RFP to procure contractors to perform claims services. Treasury issued
an RFP for claims-processing and payment services in December 2003, but
had not hired any contractors as of March 1, 2004. Treasury attempted
to accelerate the procurement process by reducing the number of days
allowed for bidders to respond to the RFP and dedicating all TRIP staff
to reviewing the proposals. However, the number of proposals received
has pushed the contract award date beyond original estimates of
February 2004. Treasury officials now believe they will award a
contract by April 2004. Treasury has also continued to develop a
proposed rule, related guidance, claims management requirements for the
claims contractor and processes necessary to manage the claims
function, and worked with industry to devise standard forms. Moreover,
once the claims processing contract is awarded, Treasury plans to
establish electronic interfaces between itself and the contractor, test
the contractor's systems and processes by using "dummy" claims
submitted by insurers, and establish an electronic fund transferring
process to speed reimbursement of insured losses.
NAIC Is Fulfilling Its Advisory Role under TRIA:
NAIC is working with Treasury on various aspects of implementing TRIA,
effectively fulfilling its advisory role. In January 2003, NAIC formed
the Terrorism Insurance Implementation Working Group to work with
Treasury. The working group consists of representatives from nine
states and the District of Columbia, who are led by a state insurance
commissioner, and has provided input to Treasury on an ongoing
basis.[Footnote 16] In particular, the working group assisted Treasury
each time it issued guidance and rules, according to Treasury and NAIC
officials. For example, Treasury officials reported that NAIC aided
them in writing a detailed definition for "insurer" for its first
interim final rule published in the Federal Register in February 2003.
NAIC coordinated meetings between Treasury and state insurance
regulators to align or address differences in definitions that exist
across the 50 states, the District of Columbia, Puerto Rico, and three
U.S. territories. As noted previously, TRIA directed that state
regulations be preserved when possible; thus, the definitions had to be
highly consistent with state regulations. The NAIC official also
explained that NAIC tried to ensure that the language of its
suggestions to Treasury, when implemented, would be enforceable by all
state insurance regulators.
NAIC also aided Treasury in outreach and education efforts. In the
weeks before TRIA was enacted, NAIC issued press releases informing
insurers of the impending act and urging them to prepare for its new
requirements. Moreover, NAIC applied its expertise in developing a
model bulletin, regulations, and forms to help state regulators and
insurers expeditiously carry out TRIA responsibilities. For example,
NAIC issued a model bulletin, which state regulators could use to
communicate key terms and definitions and explain the application of
TRIA to losses resulting from foreign sources versus domestic sources
of terrorism. NAIC made the model bulletin available on its Web site
immediately upon the enactment of TRIA. NAIC also developed model
disclosure forms for insurers to use when informing their policyholders
about the availability of terrorism insurance under TRIA. As discussed
previously, TRIA requires insurers to send disclosure notices to their
policyholders about the availability and cost of terrorism insurance
and the 90 percent federal share.
Insurance Companies Made Changes to Their Operations to Comply with
TRIA:
In order to comply with TRIA requirements, primarily those concerning
disclosure to policyholders, insurers generally have made changes to
their operations. According to an official of a large insurance
company, to develop and disseminate information about TRIA terms and
coverage, insurers have changed policies, software, and forms; trained
staff; revised actuarial information and underwriting procedures; and
expanded outreach and marketing. For example, the insurers had to send
revised premium information in disclosure notices to hundreds of
thousands of policyholders as well as submit thousands of new premium
rates and the associated policy language to state regulators for
approval. If the insurers had failed to make these disclosures, they
would have lost their eligibility for reimbursement under TRIA.
While the disclosure requirements required many revisions to insurer
operations, the insurers did have the benefit of a "safe harbor." As
previously discussed, Treasury determined that use of NAIC's model
disclosure form constituted compliance with TRIA's disclosure
requirements. Moreover, insurers using NAIC's model form could get
coverage decisions from their policyholders without first investing
time in devising a disclosure notice--a time-consuming process that
would include review by an insurer's legal staff for compliance with
TRIA requirements. Given that TRIA invalidated terrorism exclusions as
soon as it was enacted, insurers were exposed to uncompensated risks
(i.e., the potential for having to pay for all the losses in a
terrorism event without having received a premium) until their existing
policyholders received written disclosures, accepted the coverage, or
rejected it.
Insurers Are Concerned That the Pace of TRIA Implementation Could
Affect Business Planning, Reduce Cash Flow, or Result in Insolvency:
Insurers have expressed a number of concerns about Treasury's
implementation of TRIA. Insurers are concerned that Treasury has not
already made a decision about extending the "make available"
requirement through 2005; they are also concerned about the potential
length of time it may take for the Secretary of the Treasury to certify
a terrorist event, potential inefficiencies and time lags in processing
and paying claims once an event is certified, and the issue of TRIA
expiration. TRIA gives Treasury until September 2004 to make a decision
about whether to require insurers to make terrorism insurance
available--on terms that do not differ materially from that of other
coverage--for policies issued or renewed in 2005, the third year of the
program. Insurers have stated that this deadline is too late. Insurers
need to make underwriting, price, and coverage decisions for these
policies in mid-2004. However, Treasury has yet to make a decision
about the "make available" requirement for policies issued or renewed
in 2005.
If Treasury did not extend the requirements through 2005, insurers
would have to evaluate and possibly revise prices and terms for newly
issued and renewing policies, according to an insurance official.
Moreover, regulatory approval for these changes might take longer than
the time it took to approve the changes to policies and procedures that
insurers initially made to implement TRIA. TRIA allowed for federal
preemption of the states' authority to approve insurance policy rates
and conditions, but the preemption expired on December 31, 2003--
returning insurers to the previous regulatory scheme in which they must
obtain regulatory approvals from each state that has these requirements
to sell insurance. Thus, the timing of Treasury's announcement on the
extension may cost both companies and policyholders money if policy
changes cannot be implemented in time to issue or renew policies.
Insurers also are concerned that a delay in Treasury's certification of
a terrorist event as eligible for federal reimbursement, in conjunction
with state regulations requiring prompt payment of claims, could create
cash flow problems or even lead to insolvency for some insurers. While
TRIA does not specify the length of time available for determining
whether an event meets the criteria for certification, insurers are
bound by law and regulations in most states to pay claims in a timely
manner, which means they may have to pay policyholder claims in full
without waiting for Treasury to certify an event, said an NAIC
official.
Because of this requirement to pay claims in a timely manner, insurers
face potentially negative financial consequences under two possible
scenarios: if Treasury made the certification decision after an
extended period of time or if Treasury ultimately made the decision not
to certify an event after an extended period of time.
Under the first scenario, insurance industry observers have said that
they could potentially experience a cash flow problem while awaiting a
certification decision, and thus for reimbursement of the 90 percent
federal share, because they have already paid 100 percent of the
claimed losses. Insurers brought up the anthrax letter incidents as an
example of their concerns about certification time frames, because law
enforcement officials still have not identified the source, whether
foreign or domestic, more than 2 years after the incidents. Under the
second scenario, insurers could become insolvent if Treasury decided
not to certify an event (i.e., decided the act was not the work of
terrorists working on behalf of foreign interests) after insurers had
already paid policyholder claims. Unless the policyholder had paid for
coverage of all terrorist events--including those caused by domestic
terrorists, which would be excluded from reimbursement under TRIA--
insurers would have paid for losses for which they had collected no
premium. Insurers would have no way to recover payments already made to
policyholders for losses associated with the event other than to seek
remedies through the courts, an NAIC official explained.
Treasury has responded that the certification process is complex and
possibly would require extensive investigation and correlation of
information from many sources, most not under Treasury's control. As a
result, although Treasury officials said that they understood the
difficulties facing insurers, they also felt that placing specific time
limits on those making the certification decision would impose
unworkable constraints on an already complex and difficult process.
Treasury has taken some steps to facilitate the certification process
by communicating with the Department of Justice and the Department of
State. Specifically, Treasury has identified contacts within these
agencies and has met with relevant individuals to discuss their roles
in the certification process.
Insurers are also concerned that the length of time Treasury may take
to process and pay claims could impact an insurer's cash flow.
Treasury's capacity to pay claims relatively quickly will determine how
fast insurers receive the 90 percent federal share. According to an
insurance company official, because of the long-standing relationships
and familiarity that insurers have with reinsurers, it is often
possible to receive speedy payment for losses.[Footnote 17] Insurers
are concerned that this might not be possible with the TRIP office,
especially since the claims-paying mechanism has yet to be created.
Treasury officials explained that without a close preexisting
relationship like that between an insurer and reinsurer, some
procedures may, of necessity, differ. As noted previously, Treasury
published a proposed rule addressing the claims-paying process.
However, the proposed rule does not specify the maximum number of days
in which Treasury must pay claims. According to a Treasury official,
establishing a time frame for payment would not be appropriate.
However, to address insurer concerns about prompt payment, Treasury has
taken into consideration input received from the insurance industry and
has been developing mechanisms to expedite the review, approval, and
payment of claims. Treasury has also decided to use electronic fund
transfers to insurer's accounts to speed reimbursement to insurers with
approved claims. Treasury officials said such a mechanism should reduce
the potential for insurers to experience cash flow problems by
eliminating the wait for Treasury to issue checks.
Finally, insurance industry officials are worried that uncertainty
about TRIA's extension past 2005 will impede their business and
planning processes. Although TRIA does not contain any specific
extension provisions, Treasury officials have used forums such as NAIC
and industry meetings to state that TRIA was designed to provide a
program of three years duration. However, industry participants
continue to believe that an extension is both possible and likely. As a
result, they are concerned that a late decision to extend TRIA would
create confusion and disarray in the industry because of the lead time
needed to tailor business operations and plans to an insurance
environment with TRIA or a federal government backup or, alternatively,
without one.
Despite Availability, Few Are Buying Terrorism Insurance, and the
Industry Has Made Little Progress toward Post-TRIA Coverage:
While TRIA has improved the availability of terrorism insurance,
particularly for high-risk properties in major metropolitan areas, most
commercial policyholders are not buying the coverage. Limited industry
data suggest that 10 to 30 percent of commercial policyholders are
purchasing terrorism insurance, perhaps because most policyholders
perceive themselves at relatively low risk for a terrorist event. Some
industry experts are concerned that those most at risk from terrorism
are generally the ones buying terrorism insurance. In combination with
low purchase rates, these conditions could result in uninsured losses
for those businesses without terrorism coverage or cause financial
problems for insurers, should a terrorist event occur. Moreover, even
policyholders who have purchased terrorism insurance may remain
uninsured for significant risks arising from certified terrorist events
involving NBC agents, radioactive contamination, or fire following the
events. Finally, although insurers and some reinsurers have cautiously
reentered the terrorism risk market, insurance industry participants
have made little progress toward developing a mechanism that could
permit the commercial insurance market to resume providing terrorism
coverage without a government backstop.
TRIA Has Improved the Availability of Terrorism Insurance, and Some
High-Risk Policyholders Have Bought Coverage:
TRIA has improved the availability of terrorism insurance, especially
for some high-risk policyholders. According to insurance and risk
management experts, these were the policyholders who had difficulty
finding coverage before TRIA. Although industry data on policyholder
characteristics are limited and cannot be generalized to all
policyholders in the United States, risk management and real estate
representatives generally agree that after TRIA was passed,
policyholders--including borrowers obtaining mortgages for "trophy"
properties, owners and developers of high-risk properties in major city
centers, and those in or near "trophy" properties--were able to
purchase terrorism insurance.
Additionally, TRIA contributed to better credit ratings for some
commercial mortgage-backed securities. For example, prior to TRIA's
passage, the credit ratings of certain mortgage-backed securities, in
which the underlying collateral consisted of a single high-risk
commercial property, were downgraded because the property lacked or had
inadequate terrorism insurance. The credit ratings for other types of
mortgage-backed securities, in which the underlying assets were pools
of many types of commercial properties, were also downgraded but not to
the same extent because the number and variety of properties in the
pool diversified their risk of terrorism. Because TRIA made terrorism
insurance available for the underlying assets, thus reducing the risk
of losses from terrorist events, it improved the overall credit ratings
of mortgage-backed securities, particularly single-asset mortgage-
backed securities. Credit ratings affect investment decisions that
revolve around factors such as interest rates because higher credit
ratings result in lower costs of capital. According to an industry
expert, investors use credit ratings as guidance when evaluating the
risk of mortgage-backed securities for investment purposes. Higher
credit ratings reflect lower credit risks. The typical investor
response to lower credit risks is to accept lower returns, thereby
reducing the cost of capital, which translates into lower interest
rates for the borrower.
Most Policyholders Have Not Bought Terrorism Insurance:
Although TRIA improved the availability of terrorism insurance,
relatively few policyholders have purchased terrorism coverage. We
testified previously that prior to September 11, 2001, policyholders
enjoyed "free" coverage for terrorism risks because insurers believed
that this risk was so low that they provided the coverage without
additional premiums as part of the policyholder's general property
insurance policy.[Footnote 18] After September 11, prices for coverage
increased rapidly and, in some cases, insurance became very difficult
to find at any price. Although a purpose of TRIA is to make terrorism
insurance available and affordable, the act does not specify a price
structure.
However, experts in the insurance industry generally agree that after
the passage of TRIA, low-risk policyholders (e.g., those not in major
urban centers) received relatively low-priced offers for terrorism
insurance compared to high-risk policyholders, and some policyholders
received terrorism coverage without additional premium
charges.[Footnote 19] Yet according to insurance experts, despite low
premiums, many businesses (especially those not in "target" localities
or industries) did not buy terrorism insurance. Some simply may not
have perceived themselves at risk from terrorist events and considered
terrorism insurance, even at low premiums (relative to high-risk
areas), a bad investment.[Footnote 20] According to insurance sources,
other policyholders may have deferred their decision to buy terrorism
insurance until their policy renewal date.
Some industry experts have voiced concerns that low purchase rates may
indicate adverse selection--where those at the most risk from terrorism
are generally the only ones buying terrorism insurance. Although
industry surveys are limited in their scope and not appropriate for
market-wide projections, the surveys are consistent with each other in
finding low "take-up" rates, the percentage of policyholders buying
terrorism insurance, ranging from 10 to 30 percent. According to one
industry survey, the highest take-up rates have occurred in the
Northeast, where premiums were generally higher than the rest of the
country.
The combination of low take-up rates and high concentration of
purchases in an area thought to be most at risk raises concerns that,
depending on its location, a terrorist event could have additional
negative effects.
* If a terrorist event took place in a location not thought to be a
terrorist "target," where most businesses had chosen not to purchase
terrorism insurance, then businesses would receive little funding from
insurance claims for business recovery efforts, with consequent
negative effects on owners, employers, suppliers, and customers.
* Alternatively, if the terrorist event took place in a location deemed
to be a "target," where most businesses had purchased terrorism
insurance, then adverse selection could result in significant financial
problems for insurers. A small customer base of geographically
concentrated, high-risk policyholders could leave insurers unable to
cover potential losses facing possible insolvency. If, however, a
higher percentage of business owners had chosen to buy the coverage,
the increased number of policyholders would have reduced the chance
that losses in any one geographic location would create a significant
financial problem for an insurer.[Footnote 21]
Tighter Exclusions Leave Policyholders Exposed to Significant Perils:
Since September 11, 2001, the insurance industry has moved to tighten
long-standing exclusions from coverage for losses resulting from NBC
attacks and radiation contamination. As a result of these exclusions
and the actions of a growing number of state legislatures to exclude
losses from fire following a terrorist attack, even those policyholders
who choose to buy terrorism insurance may be exposed to potentially
significant losses. Although NBC coverage was generally not available
before September 11, after that event insurers and reinsurers
recognized the enormity of potential losses from terrorist events and
introduced new practices and tightened treaty language to further limit
as much of their loss exposures as possible. (We discuss some of these
practices and exclusions in more detail in the next section.) State
regulators and legislatures have approved these exclusions, allowing
insurers to restrict the terms and conditions of coverage for these
perils. Moreover, because TRIA's "make available" requirements state
that terms for terrorism coverage be similar to those offered for other
types of policies, insurers may choose to exclude the perils from
terrorism coverage just as they have in other types of coverage.
According to Treasury officials, TRIA does not preclude Treasury from
providing reimbursement for NBC events, if insurers offered this
coverage. However, policyholder losses from perils excluded from
coverage, such as NBCs, would not be "insured losses" as defined by
TRIA and would not be covered even in the event of a certified
terrorist attack.
In an increasing number of states, policyholders may not be able to
recover losses from fire following a terrorist event if the coverage in
those states is not purchased as part of the offered terrorism
coverage. We have previously reported that approximately 30 states had
laws requiring coverage for "fire-following" an event --known as the
standard fire policy (SFP)--irrespective of the fire's cause.[Footnote
22] Therefore, in SFP states fire following a terrorist event is
covered whether there is insurance coverage for terrorism or not. After
the terrorist attacks of September 11, 2001, some legislatures in SFP
states amended their laws to allow the exclusion of fire following a
terrorist event from coverage. As of March 1, 2004, 7 of the 30 SFP
states had amended their laws to allow for the exclusion of acts of
terrorism from statutory coverage requirements.[Footnote 23] However as
discussed previously, the "make available" provision requires coverage
terms offered for terrorist events to be similar to coverage for other
events. Treasury officials explained that in all non-SFP states, and
the 7 states with modified-SFPs, insurers must include in their offer
of terrorism insurance, coverage for fire following a certified
terrorist event because coverage for fire is part of the property
coverage for all other risks. Thus, policyholders who have accepted the
offer would be covered for fire following a terrorist event, even
though their state allows exclusion of the coverage. However,
policyholders who have rejected their offer of coverage for terrorism
insurance would not be covered for fire following a terrorist event.
According to insurance experts, losses from fire damage can be a
relatively large proportion of the total property loss. As a result,
excluding terrorist events from SFP requirements could result in
potentially large losses that cannot be recovered if the policyholder
did not purchase terrorism coverage. For example, following the 1994
Northridge earthquake in California, total insured losses for the
earthquake were $15 billion--$12.5 billion of which were for fire
damage. According to an insurance expert, policyholders were able to
recover losses from fire damage, because California is an SFP state,
even though most policies had excluded coverage for earthquakes.
Reinsurers Have Cautiously Returned to the Terrorism Insurance Market,
but Many Insurers Have Not Bought Reinsurance:
Under TRIA, reinsurers are offering a limited amount of coverage for
terrorist events, specifically for the insurer deductibles and 10
percent share, but insurers have not been buying much of this
reinsurance. According to insurance industry sources, TRIA's ceiling on
potential losses has enabled reinsurers to return cautiously to the
market. That is, reinsurers generally are not offering coverage for
terrorism risk beyond the limits of the insurer deductibles and the 10
percent share that insurers may have to pay under TRIA. In spite of
reinsurers' willingness to offer this coverage, company representatives
have said that many insurers have not purchased reinsurance. Insurance
experts suggested that the low demand for the reinsurance might
reflect, in part, commercial policyholders' generally low take-up rate
for terrorism insurance. Moreover, insurance experts also have
suggested that insurers may believe that the price of reinsurance is
too high relative to the premiums they are earning from policyholders
for terrorism insurance.
The relatively high prices charged for the limited amounts of terrorism
reinsurance available are probably the result of interrelated factors.
First, even before September 11 both insurance and reinsurance markets
were beginning to harden; that is, prices were beginning to increase
after several years of lower prices. Reinsurance losses resulting from
September 11 also depressed reinsurance capacity and accelerated the
rise in prices.[Footnote 24] The resulting hard market for property-
casualty insurance affected the price of most lines of insurance and
reinsurance. A notable example has been the market for medical
malpractice insurance.[Footnote 25] The hard market is only now showing
signs of coming to an end, with a resulting stabilization of prices for
most lines of insurance. In addition to the effects of the hard market,
reinsurer awareness of the adverse selection that may be occurring in
the commercial insurance market could be another factor contributing to
higher reinsurance prices. Adverse selection usually represents a
larger-than-expected exposure to loss. Reinsurers are likely to react
by increasing prices for the terrorism coverage that they do sell.
In spite of the reentry of reinsurers into the terrorism market,
insurance experts said that without TRIA caps on potential losses, both
insurers and reinsurers likely would still be unwilling to sell
terrorism coverage because they have not found a reliable way to price
their exposure to terrorist losses. According to industry
representatives, neither insurers nor reinsurers can estimate potential
losses from terrorism or determine prices for terrorism insurance
without a pricing model that can estimate both the frequency and the
severity of terrorist events. Reinsurance experts said that current
models of risks for terrorist events do not have enough historical data
to dependably estimate the frequency or severity of terrorist events,
and therefore cannot be relied upon for pricing terrorism insurance.
According to the experts, the models can predict a likely range of
insured losses resulting from the damage if specific event parameters
such as type and size of weapon and the location are specified.
However, the models are unable to predict the probability of such an
attack.
Even as they are charging high prices, reinsurers are covering less. In
response to the losses of September 11, industry sources have said that
reinsurers have changed some practices to limit their exposures to acts
of terrorism. For example, reinsurers have begun monitoring their
exposures by geographic area, requiring more detailed information from
insurers, introducing annual aggregate limits and event limits,
excluding large insurable values, and requiring stricter measures to
safeguard assets and lives where risks are high.[Footnote 26] And as
discussed previously, almost immediately after September 11 reinsurers
began broadening NBC exclusions beyond scenarios involving industrial
accidents, such as nuclear plant accidents and chemical spills, to
encompass intentional destruction from terrorists. For example, post-
September 11 exclusions for nuclear risks include losses from
radioactive contamination to property and radiation sickness from dirty
bombs.
As of March 1, 2004, industry sources indicated that there has been
little development or movement among insurers or reinsurers toward
developing a private-sector mechanism that could provide capacity,
without government involvement, to absorb losses from terrorist events.
Industry officials have said that their level of willingness to
participate more fully in the terrorism insurance market in the future
will be determined, in part, by whether any more events occur. Industry
sources could not predict if reinsurers would return to the terrorism
insurance market after TRIA expires, even after several years and even
if no more major terrorist attacks were to occur in the United States.
They explained that reinsurers are still recovering from the enormous
losses of September 11 and still cannot price terrorism coverage. In
the long term and without another major terrorist attack, insurance and
reinsurance companies might eventually return. However, should another
major terrorist attack take place, reinsurers told us that they would
not return to this market--with or without TRIA.
Conclusions:
TRIA gave Treasury a very challenging task--to develop what is
effectively the world's largest reinsurer. This task was complicated by
the very real possibility that Treasury could have been called on to
perform at any time, without advance notice. More than a year after
TRIA took effect, key pieces of this reinsurance entity are either in
place or nearly in place. Perhaps most importantly for Treasury, the
U.S. government, and the American people, no further terrorist attack,
major or minor, has yet occurred on American soil. In spite of this
breathing space and all that Treasury has accomplished, considerable
work remains. Key components of the Terrorism Risk Insurance Program
defined by TRIA remain uncompleted. At best, all the components will be
in place shortly before the second anniversary of the 3-year program.
Recognizing the complexity of the task, it is difficult to be critical,
particularly given the lack of a terrorist event. However, had an
attack occurred, the incomplete preparation could have added to the
plight of the victims.
Congress had two major objectives in establishing TRIA. The first was
to ensure that business activity did not suffer from the lack of
insurance by requiring insurers to continue to provide protection from
the financial consequences of another terrorist attack. Since TRIA was
enacted in November 2002, terrorism insurance generally has been
available to businesses. While most have not purchased this coverage,
purchases have been higher in areas considered to be at high risk of
another terrorist attack. Quantifiable evidence is lacking on whether
having TRIA coverage available has contributed to the economy. However,
the current revival of economic activity suggests that the decision of
most commercial policyholders to decline terrorism coverage has not
resulted in widespread, negative economic effects. As a result, the
first objective of TRIA appears largely to have been achieved.
Congress's second objective was to give the insurance industry a
transitional period during which it could begin pricing terrorism risks
and developing ways to provide such insurance after TRIA expires. The
insurance industry has not yet achieved this goal. We observed after
September 11 the crucial importance of reinsurers for the survival of
the terrorism insurance market and reported that reinsurers' inability
to price terrorism risks was a major factor in their departure from the
market.[Footnote 27] Additionally, most industry experts are tentative
about predictions of the level of reinsurer and insurer participation
in the terrorism insurance market after TRIA expires. Unfortunately,
insurers and reinsurers still have not found a reliable method for
pricing terrorism insurance, and although TRIA has provided reinsurers
the opportunity to reenter the market to a limited extent, industry
participants have not developed a mechanism to replace TRIA. As a
result, reinsurer and, consequently, insurer participation in the
terrorism insurance market likely will decline significantly after TRIA
expires.
Not only has no private-sector mechanism emerged for supplying
terrorism insurance after TRIA expires, but also to date there has been
little discussion of possible alternatives for ensuring the
availability and affordability of terrorism coverage after TRIA
expires. Congress may benefit from an informed assessment of possible
alternatives--including both wholly private alternatives and
alternatives that could involve some government participation or
action. Such an assessment could be a part of Treasury's TRIA-mandated
study to "assess—the likely capacity of the property and casualty
insurance industry to offer insurance for terrorism risk after
termination of the Program.":
Recommendation for Executive Action:
As part of the response to Treasury's TRIA-mandated study requiring an
assessment of the effectiveness of TRIA and evaluating the capacity of
the industry to offer terrorism insurance after TRIA expires, we
recommend that the Secretary of the Treasury, after consulting with the
insurance industry and other interested parties, also identify for
Congress an array of alternatives that may exist for expanding the
availability and affordability of terrorism insurance after TRIA
expires. These alternatives could assist Congress during its
deliberations on how best to ensure the availability and affordability
of terrorism insurance after December 2005.
Agency Comments:
We requested comments on a draft of this report from the head of the
Department of the Treasury or his designee. The Assistant Secretary for
Financial Institutions at Treasury provided written comments that are
included in appendix I stating, in general, that Treasury believed our
report provided a thorough and well-balanced discussion of the impact
and implementation of the Terrorism Risk Insurance Act of 2002. These
written comments also provided amplification of certain points related
to Treasury's implementation of the Act. For example, Treasury
commented that its "— implementation of TRIA has been guided by
prioritizing the actions that were needed to make the program
operational right away." Treasury also described the emergency
procedures in place since "the early days of the program." Treasury
believes these contingency plans would have allowed it to establish and
implement a process for receiving, reviewing, and paying claims that
would have enabled it to respond quickly to a terrorist event, if it
had been necessary. Treasury also provided technical comments on the
report that were incorporated as appropriate.
As agreed with your offices, unless you publicly release its contents
earlier, we plan no further distribution of this report until 30 days
after its issuance date. At that time, we will send copies of this
report to the Chair and Ranking Minority Member, Senate Committee on
Banking, Housing and Urban Affairs; the Ranking Minority Member,
Committee on Financial Services, House of Representatives; and other
interested congressional members and committees. We will also make
copies available to others upon request. In addition, this report will
also be available at no charge on GAO's Web site at [Hyperlink,
http://www.gao.gov].
This report was prepared under the direction of Lawrence D. Cluff,
Assistant Director. If you or your staff have any questions regarding
this report, please contact the Assistant Director or me at (202) 512-
8678. Barry Kirby, Tarek Mahmassani, Angela Pun and Barbara Roesmann
also made key contributions to this report.
Sincerely yours,
Signed by:
Richard J. Hillman:
Director, Financial Markets and Community Investments:
[End of section]
Appendixes:
Appendix I: Comments from the Department of the Treasury:
DEPARTMENT OF THE TREASURY WASHINGTON, D.C.
ASSISTANT SECRETARY:
April 15, 2004:
Mr. Richard J. Hillman:
Director of Financial Markets and Community Investment
United States General Accounting Office:
411 G Street, NW
Washington, DC 20508:
Dear Mr. Hillman:
Thank you for providing the United States Department of the Treasury
the opportunity to comment on the General Accounting Office's (GAO)
report entitled "Terrorism Insurance: Implementation of the Terrorism
Risk Insurance Act of 2002.":
In general, we believe the GAO has drafted a thorough, well-balanced
report on the impact and implementation of the Terrorism Risk Insurance
Act of 2002 (TRIA). As it relates to the implementation of TRIA, we
would like to stress a couple of points:
First, because TRIA became effective immediately on November 26, 2002,
when the President signed the bill into law, Treasury's implementation
of TRIA has been guided by prioritizing the actions that were needed to
make the program operational right away. To meet this challenge,
Treasury issued three interim guidance notices from December 3, 2002,
through January 22, 2003. These actions and formal rulemakings that
took place beginning in early 2003, set forth the basic framework of
TRIA; they provided the insurance industry with the information and
guidance to make the Program operational on the part of insurance
companies, enabling the companies, for example, to comply with
policyholder disclosure requirements and the "make available"
requirement, calculate their insurer deductibles, and understand the
scope of the Program.
Second, from the early days of the program we have been prepared at
short notice to be able to process claims, initially standing ready to
exercise emergency procurement and regulatory procedures to implement a
claims process expeditiously if needed, while moving forward under more
formal procedures to develop a more regular claims process. The
subsequent development of the formal claims procedures regulation also
reflects Treasury's prioritization of issues. The proposed claims
regulation that was published on December 1, 2003, sets forth a
complete framework for the claims process under the Program. In
conjunction with this rulemaking, Treasury has also developed detailed
operating procedures and forms for claims filing, processing and
payment, which will be issued under the authority of this regulation.
Other issues secondary to those associated with the claims process
(e.g., final netting of losses and how to address the $100 billion cap)
being of a lower operational priority, will be addressed subsequently-
though we will continue to be ready to invoke expedited procedures in
this case as well should the need arise.
In summary, the extensive work done by Treasury in developing the basic
framework of TRIA through interim guidance notices and regulations, the
proposed claims regulations, the drafting of claims forms and review
with industry organizations and the National Association of Insurance
Commissioners, and contingency procurement plans, all have contributed
to the Department being ready to respond in case of a covered event
from the very early days of the Program.
In addition to these general comments, we have separately provided
technical comments to your staff and hope that such comments were
useful. Thank you again for the opportunity to comment on your report.
Signed by:
Wayne A. Abernathy:
Assistant Secretary for Financial Institutions:
[End of section]
(250124):
FOOTNOTES
[1] U.S. General Accounting Office, Terrorism Insurance: Rising
Uninsured Exposure to Attacks Heightens Potential Economic
Vulnerabilities, GAO-02-472T (Washington, D.C.: Feb. 27, 2002).
[2] Reinsurance is a mechanism that insurance companies routinely use
to spread risk associated with insurance policies. Simply put, it is
insurance for insurance companies. Reinsurance is a normal business
practice that satisfies a number of needs in the insurance marketplace,
including the need to expand capacity and obtain protection against
potential catastrophes.
[3] When the President signed TRIA into law on November 26, 2002, its
provisions took effect immediately.
[4] Section 102 of TRIA provides that the Secretary of the Treasury, in
concurrence with the Secretary of State and the Attorney General of the
United States, shall determine whether an event should be certified as
an act of terrorism, based on certain criteria.
[5] NAIC is a voluntary organization of the chief insurance regulatory
officials of the 50 states, the District of Columbia, and four U.S.
territories.
[6] Filing services perform many services for insurance companies,
including submitting to state insurance regulators the documents
required to sell a line of insurance.
[7] Aggregate insured losses are the sum of insured property and
casualty losses from all commercial policyholders as a result of a
certified act of terrorism.
[8] Section 102(4) of TRIA defines direct earned premiums as "a direct
earned premium for property and casualty insurance issued by any
insurer for insurance against losses—." Treasury provided further
clarification that direct earned premiums are "earned as reported to
the NAIC in the Annual Statement in column 2 of Exhibit of Premiums and
Losses (commonly known as Statutory Page 14)" and cover all risks, not
only for risks from terrorism. The percentage of the direct earned
premium allowed as an insurer deductible varies over the program years:
7 percent in 2003, 10 percent in 2004, and 15 percent in 2005.
[9] Sections 103(e)(2)(A)(i-ii) and 103(e)(3) of TRIA.
[10] According to Treasury officials, the formula for the mandatory
portion of the recoupment is intended to ensure that the insurance
industry is financially responsible for a prescribed level of the first
dollars of losses. The prescribed loss levels are as follows: $10
billion in 2003, $12.5 billion in 2004, and $15 billion in 2005.
Therefore, if the sum of insurers' aggregate payments for deductibles
and the 10 percent share--the amounts paid by industry--is less than
the level prescribed for that year, then a recoupment would be required
to collect the difference. On the other hand, if the amounts paid by
industry exceed the prescribed level, then a recoupment would not be
needed.
[11] "No-year money" is budget authority that remains available for
obligation until expended, usually until the objectives for which the
authority was made available are attained.
[12] The first final rule received a technical revision, dealing with
the definition of direct earned premium. Treasury published this
technical revision in August 2003 in volume 68 of the Federal Register,
page 48280.
[13] As previously noted, the information to define "property-casualty
insurance" comes from the exhibit of premiums and losses found in the
annual statement that insurers submit to NAIC.
[14] The procedural requirements for federal rulemaking include
reviewing proposed regulations prior to publication in the Federal
Register. Pursuant to the "Regulatory Planning and Review" rule
(Executive Order 12866), the Regulatory Flexibility Act (5 U.S.C. 601
et seq.), and the Paperwork Reduction Act (44 U.S.C. 3501 et seq.),
respectively: (1) all regulatory actions that are considered
significant should be reviewed by OMB; (2) the economic impact of the
proposed regulation on small entities should be assessed; and (3) the
recordkeeping requirements of the proposed regulation should be
assessed. In addition, Section 101(b)(2) of TRIA provides that state
insurance regulations should be preserved.
[15] Treasury has implemented mechanisms to ensure that sensitive
business data on individual insurers would not be made public through
the Freedom of Information Act.
[16] In 2003, the working group was chaired by the insurance
commissioner for the state of Iowa and representatives from the
insurance departments of the District of Columbia, Florida, Montana,
Nebraska, New Jersey, New York, North Dakota, Oklahoma, and South
Dakota.
[17] For example, the insurance official explained that to abate the
risk in lines of business that cover catastrophic risks such as
terrorism, an insurer would typically obtain reinsurance. Through
repeated interactions, the insurer and reinsurer develop a relationship
in which the reinsurer becomes familiar with the insurer's operations
and finances. When a catastrophe strikes, the reinsurer is already
familiar with the information that is necessary to substantiate the
claims and can pay the insurer without first completing a review of the
insurer's accounting information; differences in over-or underpayment
are settled later.
[18] GAO-02-472T.
[19] According to industry experts, the insurers that provided "free"
terrorism insurance likely did so for policies already in place at the
time TRIA was enacted and may have deferred operational changes and
difficult pricing decisions because they lacked the resources to do so.
[20] Howard Kunreuther, Erwann Michel-Kerjan, and Beverly Porter,
Assessing, Managing and Financing Extreme Events: Dealing with
Terrorism (National Bureau of Economic Research: December 2003), 13.
[21] Casualty Actuarial Society, Foundations of Casualty Actuarial
Science, 4TH ed. (United Book Press, Inc.: 2001), 51, 86.
[22] GAO-02-472T.
[23] According to the National Association of Mutual Insurance
Companies, Louisiana, Michigan, Minnesota, Nebraska, New Hampshire,
Oklahoma, and Virginia have amended their standard fire policy to allow
for exclusion of terrorism from their statutory fire coverage. State
legislators in Massachusetts have introduced a similar bill.
[24] Capacity is the amount of reinsurance or insurance that is
available for a defined risk.
[25] U.S. General Accounting Office, Medical Malpractice Insurance:
Multiple Factors Have Contributed to Increased Premium Rates, GAO-03-
702 (Washington, D.C.: June 27, 2003).
[26] Christian Brauner and Georges Galey, "Terrorism Risks in Property
Insurance and Their Insurability after 11 September 2001," (Swiss
Reinsurance Company: 2003), 25.
[27] GAO-02-472T.
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