Terrorism Insurance
Effects of the Terrorism Risk Insurance Act of 2002
Gao ID: GAO-04-806T May 18, 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 (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 assess Treasury's progress in implementing TRIA and describe how TRIA affected the terrorism insurance market.
Treasury and industry participants have made significant progress in implementing TRIA to date, although Treasury has important actions to complete in order to comply with its responsibilities under TRIA. Treasury has issued regulations on TRIA, created and staffed the Terrorism Risk Insurance Program office, and begun mandated studies and data collection efforts. However, Treasury has not yet made a decision on whether to extend the mandate that insurers "make available" terrorism coverage, using terms not differing materially from other coverage, for policies issued or renewed in 2005. Treasury's ongoing studies and data collection efforts will provide further insight into TRIA's effectiveness. TRIA has enhanced the availability of terrorism insurance for commercial policyholders, largely fulfilling a principal objective of the legislation. In particular, TRIA has benefited commercial policyholders in major metropolitan areas perceived to be at greater risk for a terrorist attack, largely because of the requirement in TRIA that insurers offer coverage for terrorism. Prior to TRIA, GAO reported concern that some development projects had already been delayed or cancelled because of the unavailability of insurance and continued fears that other projects also would be adversely impacted. GAO also conveyed the widespread concern that general economic growth and development could be slowed by a lack of available terrorism insurance. Largely because of TRIA, these problems no longer appear to be major concerns. Despite increased availability of coverage, limited industry data suggest that most commercial policyholders are not buying terrorism insurance, perhaps because they perceive their risk of losses from a terrorist act as being relatively low. The potential negative effects of low purchase rates, in combination with the probability that those most likely to be the targets of terrorist attacks may also be the ones most likely to have purchased coverage, would become evident only in the aftermath of a terrorist attack. Such negative effects could include more difficult economic recovery for businesses without terrorism coverage or potentially significant financial problems for insurers. Moreover, those that have purchased terrorism insurance may still be exposed to significant risks that have been excluded by insurance companies, such as nuclear, biological, or chemical events. Finally, although insurers and some reinsurers have cautiously reentered the terrorism risk market to cover insurers' remaining exposures, industry sources indicated no progress to date toward finding a reliable method for pricing terrorism insurance and little movement toward any mechanism that would enable insurers to provide terrorism insurance to businesses without government involvement.
GAO-04-806T, Terrorism Insurance: Effects of the Terrorism Risk Insurance Act of 2002
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Testimony:
Before the Committee on Banking, Housing and Urban Affairs, United
States Senate:
United States General Accounting Office:
GAO:
For Release on Delivery Expected at 10:00 a.m. EDT:
Tuesday, May 18, 2004:
Terrorism Insurance:
Effects of the Terrorism Risk Insurance Act of 2002:
Statement of Richard J. Hillman, Director,
Financial Markets and Community Investment:
GAO-04-806T:
GAO Highlights:
Highlights of GAO-04-806T, a testimony before the Senate Committee on
Banking, Housing, and Urban Affairs.
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 (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 assess Treasury‘s progress in implementing TRIA and
describe how TRIA affected the terrorism insurance market.
What GAO Found:
Treasury and industry participants have made significant progress in
implementing TRIA to date, although Treasury has important actions to
complete in order to comply with its responsibilities under TRIA.
Treasury has issued regulations on TRIA, created and staffed the
Terrorism Risk Insurance Program office, and begun mandated studies and
data collection efforts. However, Treasury has not yet made a decision
on whether to extend the mandate that insurers ’make available“
terrorism coverage, using terms not differing materially from other
coverage, for policies issued or renewed in 2005. Treasury‘s ongoing
studies and data collection efforts will provide further insight into
TRIA‘s effectiveness.
TRIA has enhanced the availability of terrorism insurance for
commercial policyholders, largely fulfilling a principal objective of
the legislation. In particular, TRIA has benefited commercial
policyholders in major metropolitan areas perceived to be at greater
risk for a terrorist attack, largely because of the requirement in TRIA
that insurers offer coverage for terrorism. Prior to TRIA, GAO reported
concern that some development projects had already been delayed or
cancelled because of the unavailability of insurance and continued
fears that other projects also would be adversely impacted. GAO also
conveyed the widespread concern that general economic growth and
development could be slowed by a lack of available terrorism insurance.
Largely because of TRIA, these problems no longer appear to be major
concerns.
Despite increased availability of coverage, limited industry data
suggest that most commercial policyholders are not buying terrorism
insurance, perhaps because they perceive their risk of losses from a
terrorist act as being relatively low. The potential negative effects
of low purchase rates, in combination with the probability that those
most likely to be the targets of terrorist attacks may also be the ones
most likely to have purchased coverage, would become evident only in
the aftermath of a terrorist attack. Such negative effects could
include more difficult economic recovery for businesses without
terrorism coverage or potentially significant financial problems for
insurers. Moreover, those that have purchased terrorism insurance may
still be exposed to significant risks that have been excluded by
insurance companies, such as nuclear, biological, or chemical events.
Finally, although insurers and some reinsurers have cautiously
reentered the terrorism risk market to cover insurers‘ remaining
exposures, industry sources indicated no progress to date toward
finding a reliable method for pricing terrorism insurance and little
movement toward 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 deliberations on the
insurance industry‘s capacity to provide terrorism insurance.
www.gao.gov/cgi-bin/getrpt?GAO-04-806T.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Richard Hillman at
202-512-8678, hillmanr@gao.gov.
[End of section]
Mr. Chairman and Members of the Committee:
I am pleased to be here today to discuss our report on the
implementation of the Terrorism Risk Insurance Act of 2002 (TRIA) and
the act's impact on the terrorism insurance market and, more generally,
the economy.[Footnote 1] 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 ultimately pay approximately $40 billion for
losses arising from September 11, according to industry experts.
Responding to terrorism risk after September 11, reinsurers began
excluding terrorism from coverage as contracts between reinsurers and
insurers came up for renewal.[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 short, believing that neither the frequency nor
magnitude of terrorism losses could be estimated, insurance companies
withdrew from the market.
In the aftermath of September 11, we reported that terrorism insurance
was disappearing in the marketplace, particularly for large businesses
and those perceived to be at some risk.[Footnote 3] We also reported
significant concern that some development projects had already been
delayed or cancelled because of the unavailability of insurance and
fears that others would follow. Furthermore, there was widespread
concern that general economic growth and development would be slowed by
a lack of insurance availability and uncertainty in the marketplace.
Because of concerns about the lack of available and affordable
terrorism insurance, Congress passed TRIA, which took effect on
November 26, 2002. TRIA is currently scheduled to expire at the end of
2005.
Our report on the implementation of TRIA has two objectives. First, we
describe the progress made by the Department of the Treasury (Treasury)
and insurance industry participants in implementing TRIA. Second, we
discuss the changes in the market for terrorism insurance coverage
under TRIA. As requested, my statement today discusses both of these
objectives. Additionally, I have included an appendix to this statement
that provides background information on TRIA.
In summary, Treasury and industry participants have made significant
progress in implementing TRIA to date, although Treasury has important
actions to complete in order to fully comply with its responsibilities
under TRIA. Treasury's progress includes issuing regulations on TRIA,
staffing the Terrorism Risk Insurance Program (TRIP) office, and
beginning mandated studies and data collection efforts. For example, in
compliance with one such study, Treasury decided not to extend TRIA to
group life based on its determination that insurers had continued to
provide group life coverage, although the availability of reinsurance
was reduced. Treasury also issued proposed rules defining a framework
for the claims process and litigation management under TRIA.
Additionally, Treasury recently hired a contractor to provide claims
payment services, according to a Treasury official. However, insurers
have expressed reservations about Treasury's implementation of TRIA.
Specifically, insurers are 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 TRIA's impending expiration at
the end of 2005.[Footnote 4] The industry has also expressed concern
about the timing of Treasury's pending decision to extend the "make
available" requirement to policies issued or renewed in 2005.[Footnote
5]
TRIA has largely achieved Congress's first goal--to ensure that
business activity did not suffer materially from a lack of available
terrorism insurance. Since TRIA was enacted in November 2002, terrorism
insurance generally has been available to businesses; however, most
commercial policyholders are not buying terrorism coverage. According
to insurance industry experts, purchase rates have been higher in areas
considered to be at high risk of another terrorist attack. Many
policyholders with businesses or properties not located in perceived
high-risk locations may not be buying coverage because they view any
price for terrorism insurance as high relative to their perceived risk
exposure. Industry experts view overall low purchase rates in
combination with a high concentration of purchases in areas thought to
be most at risk as increasing the potential for negative effects should
a terrorist event occur--either making economic recovery more difficult
for those not insured or causing financial problems for insurers with
many policies in the affected area. Further, those that have bought
terrorism insurance remain exposed to significant perils because
insurers have broadened longstanding policy exclusions for nuclear,
biological, and chemical (NBC) events. Finally, Congress' second key
goal in establishing TRIA--to give private industry a transitional
period during which it could begin pricing terrorism insurance and
develop ways to cover losses after TRIA expires--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 little movement toward
any mechanism that would enable insurers to provide terrorism insurance
to businesses without government involvement.
In conducting our work, we reviewed and analyzed relevant information
concerning state legislation and publicly available and proprietary
industry data and studies on the terrorism insurance market. We
interviewed officials at Treasury, the National Association of
Insurance Commissioners (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 this work in Chicago, New York City, and
Washington, D.C., from January 2003 through April 2004 in accordance
with generally accepted government auditing standards.
Treasury and Insurers Have Made Progress in Implementing TRIA, although
Important Work Remains:
More than a year after TRIA's enactment, Treasury and insurance
industry participants have made progress in implementing and complying
with its provisions, although 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 begun
collecting data and performing studies mandated by TRIA. For example,
Treasury complied with a mandate to collect and assess data on the
availability of group life insurance and reinsurance; based on that
data, Treasury determined that group life would not be covered by TRIA.
However, Treasury has yet to make the claims payment function fully
operational, although it has recently hired contractors to perform
claims payment functions. Moreover, even though the act does not
require Treasury to make a decision about whether to extend the "make
available" requirement through 2005 until September of this year, some
insurers expressed concerns about whether such a late decision would
allow them sufficient time to make and implement changes to policy
rates and terms. Additionally, insurers have voiced concerns about the
time Treasury might take to certify an act of terrorism as eligible for
reimbursement under TRIA and pay claims after an act was certified.
Finally, as TRIA's midpoint nears, many insurers and other market
participants are concerned whether TRIA will be extended or not and the
timing of such a decision.
Treasury Has Issued Regulations, Staffed the TRIP Office, and Begun
Studies and Data Collection Efforts:
To implement TRIA and make TRIP functional, Treasury has taken numerous
regulatory and administrative actions that include rulemaking, staffing
a program office, and collecting and analyzing data. To date, Treasury
has issued several final and proposed rules to implement TRIA; these
rules were preceded by four sets of interim guidance issued between
December 2002 and March 2003 to address time-sensitive requirements. As
of March 1, 2004, Treasury had issued three final rules that provided
uniform definitions of TRIA terms, explained disclosure (that is,
notification to policyholder) requirements, and determined which
insurers were subject to TRIA. Currently, Treasury is soliciting public
comments on additional proposed rules addressing claims processes and
litigation management issues. Also, as of September 2003 Treasury had
fully staffed the TRIP office. The office develops and oversees the
operational aspects of TRIA, which encompass claims management--
processing, review, and payment--and auditing functions. Staff will
also oversee operations performed by the contractors that actually pay
claims and audit insurers that have filed claims. Additionally, TRIP
staff perform ongoing work such as issuing interpretive letters in
response to questions submitted by the public and educating regulators,
industry participants and the public about TRIA provisions.
Treasury completed a TRIA-mandated study on group life insurance and
has begun other mandated studies and data collection efforts.
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. After Treasury
completed an assessment of the availability of group life insurance and
reinsurance, it decided not to make group life insurance subject to
TRIA because it found that insurers had continued to provide group life
coverage, although the availability of reinsurance was
reduced.[Footnote 7] Treasury has not yet reported to Congress the
results of a mandated study concerning the effects of terrorism on the
availability of life and other lines of insurance. The study was to
have been completed by August 2003, but as of March 2004 the report had
not been issued. Also, in November 2003 and January 2004, Treasury
began sending surveys to buyers and sellers, respectively, of insurance
to collect data on annual premium rates as well as other information
for the study that will assess the effectiveness of TRIA.
Treasury Has Tasks to Complete before TRIA Can Be Fully Implemented:
Before TRIA will be fully implemented, Treasury has to make certain
decisions and make additional TRIP functions operational. As of April
2004, Treasury had not yet decided whether to extend the "make
available" requirement to policies issued or renewed in 2005. TRIA gave
Treasury until September 1, 2004, to decide if the "make available"
requirement should be extended for policies issued or renewed in 2005,
the third and final year of the act. Treasury did clarify in a press
release 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.
In addition, Treasury has not fully established a claims processing and
payment structure. Treasury has issued a proposed rule that would
establish an initial framework for the claims process, which includes
procedural and recordkeeping requirements for insurers. However, the
actual claims processing and payment function is not fully operational.
A Treasury official said it has recently hired a contractor that would
perform payment functions in the aftermath of a terrorist attack, but
has not yet written regulations to cover the latter stages of the
claims process such as adjusting over-and underpayments or hired a
separate contractor to review claims and audit insurers after an event
to ensure that underlying documents adequately support the claims paid
by Treasury. Treasury officials anticipate awarding this audit and
review contract in the fourth quarter of fiscal year 2004.
Insurers Have Expressed Some Concerns Related to TRIA's Implementation:
Insurers have expressed some 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. As
discussed already, TRIA gives Treasury until September 2004 to make a
decision about the "make available" requirement for policies issued or
renewed in 2005. Insurers have stated that this deadline does not give
them enough time to make underwriting decisions and evaluate and
possibly revise prices and terms, actions they normally would want to
undertake in mid-2004. Moreover, in most states insurers will have to
obtain regulatory approval for such changes because TRIA's preemption
of the states' authority to approve insurance policy rates and
conditions expired on December 31, 2003. Thus, insurers are concerned
that delay of Treasury's announcement on the "make available" extension
until the legal deadline may cost both companies and policyholders
money because policy changes will not be implemented in time to issue
or renew policies.
Insurers are also concerned that delays in the 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
to process and pay claims, might seriously impact insurer cash flows
or, in certain circumstances, solvency. While TRIA does not specify the
length of time available for determining whether an event meets the
criteria for certification, an NAIC official told us that insurers are
bound by law and regulations in most states to pay claims in a timely
manner. As a result, an insurer may have to pay policyholder claims in
full while still awaiting a certification decision, which could create
a cash flow problem for insurers. Insurers identified the anthrax
letter incidents as an example where law enforcement officials still
have not identified the source, whether foreign or domestic, more than
2 years after the incidents. Moreover, if Treasury decided not to
certify an event after insurers had already paid policyholder claims,
some insurers could become insolvent. 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. An NAIC official explained that 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. Treasury
officials have said that they understand the difficulties facing
insurers but cannot impose a time frame on the certification process
because it could involve complex fact-finding processes. To facilitate
the certification process, Treasury has met with relevant individuals
within the Department of Justice and the Department of State to discuss
their roles in the certification process. Insurers are similarly
concerned that the length of time Treasury may take to process and pay
claims could impact insurers' cash flow. In response to this concern,
Treasury has decided to use electronic fund transfers to insurer's
accounts to speed reimbursement to insurers with approved claims.
Treasury expects this method could speed payment of claims and reduce
potential cash flow problems for insurers.
Finally, insurance industry officials are worried that uncertainty
about the extension of TRIA past its stated expiration date of December
2005 would impede their business and planning processes. Although TRIA
does not contain any specific extension provisions, industry
participants are concerned that a late decision on whether or not to
extend TRIA would deny them the time needed to tailor business
operations and plans to an insurance environment that either would or
would not contain TRIA.
Although Available, 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 10-30 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--that is, those meeting statutory criteria for reimbursement
under TRIA--such as those involving NBC agents or radioactive
contamination. 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, Particularly
for Some High-Risk Policyholders:
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. TRIA requires that insurers "make
available" coverage for terrorism on terms not differing materially
from other coverage. Largely because of this requirement, terrorism
insurance has been widely available, even for development projects in
high-risk areas of the country. 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.
To the extent that the widespread availability of terrorism insurance
is a result of TRIA's "make available" requirement, Treasury's decision
on whether to extend the requirement to year three of the program is
vitally important. While TRIA has ensured the availability of terrorism
insurance, we have little quantitative information on the prices
charged for this insurance. Treasury is engaged in gathering data
through surveys that should provide useful information about terrorism
insurance prices. TRIA requires that they make the information
available to Congress upon request. In addition, TRIA also requires
Treasury to assess the effectiveness of the act and evaluate the
capacity of the industry to offer terrorism insurance after its
expiration. This report is to be delivered to Congress no later than
June 30, 2005.
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. 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 (for example, 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 8] 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 9] 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
marketwide 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 10]
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 policy 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.
Therefore, in SFP states fire following a terrorist event is covered
whether there is insurance coverage for terrorism or not. After
September 11, 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 11] 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 seven 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 Market, but Many Insurers
Have Not Bought Reinsurance:
Under TRIA, reinsurers are offering a limited amount of coverage for
terrorist events for insurers' remaining exposures, 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 would pay under TRIA (see app. I). 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 rates 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 12] 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 13] 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 still would 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 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 and event limits, excluding
large insurable values, and requiring stricter measures to safeguard
assets and lives where risks are high.[Footnote 14] And as discussed
previously, almost immediately after September 11 reinsurers began
broadening NBC exclusions beyond scenarios involving industrial
accidents, to include events such as nuclear plant accidents and
chemical spills and 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 in
the absence of further major terrorist attacks 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:
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 widely
available even for development projects in high-risk areas of the
country, in large part because of TRIA's "make available" requirement.
Although most businesses are not buying coverage, there is little
evidence that commercial development has suffered to a great extent--
even in lower-risk areas of the county, where purchases of coverage may
be lowest. Further, although quantifiable evidence is lacking on
whether the availability of terrorism coverage under TRIA has
contributed to the economy, 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. 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 to date there also 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 the TRIA-mandated study that requires
Treasury to assess the effectiveness of TRIA and evaluate 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, 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.
Mr. Chairman, this concludes my prepared statement, and I would be
pleased to respond to any questions that you or other members of the
Committee may have.
Contacts and Acknowledgments:
For further information regarding this testimony please contact Richard
J. Hillman, Director, or Lawrence D. Cluff, Assistant Director,
Financial Markets and Community Investment, (202) 512-8678. Individuals
making key contributions to this testimony include Rachel DeMarcus,
Barry Kirby, Tarek Mahmassani, Angela Pun, and Barbara Roesmann.
[End of section]
Appendix I: TRIA 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 15] TRIA specifies that an insurer is responsible (that
is, 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 16] 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.
Figure 1: Prerequisites for 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 17] 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 the Terrorism Risk Insurance Program (TRIP) office
--through which it administers TRIA provisions and would pay claims--
with "no-year money" under a TRIA provision that gives Treasury
authority to utilize funds necessary to set up and run the
program.[Footnote 18] 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 55-60 percent of the budget for each fiscal year. If no certified
terrorist event occurrs, 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.
FOOTNOTES
[1] U.S. General Accounting Office, Terrorism Insurance: Implementation
of the Terrorism Risk Insurance Act of 2002, GAO-04-307 (Washington,
D.C.: Apr. 23, 2004), and Terrorism Insurance: Effects of the Terrorism
Risk Insurance Act of 2002, GAO-04-720T (Washington, D.C.: Apr. 28,
2004).
[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] U.S. General Accounting Office, Terrorism Insurance: Alternative
Programs for Protecting Insurance Consumers, GAO-02-199T (Washington,
D.C.: Oct. 24, 2001), and Terrorism Insurance: Rising Uninsured
Exposure to Attacks Heightens Potential Economic Vulnerabilities,
GAO-02-472T (Washington, D.C.: Feb. 27, 2002).
[4] 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. For example, "an individual or
individuals acting on behalf of any foreign person or foreign interest"
must commit the act. Under TRIA, insurers can claim reimbursement only
for losses in events thus certified. See Appendix I for more
information.
[5] 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.
[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] According to life insurance experts, life insurers have continued
to sell group life policies in order 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.
[8] 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.
[9] 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.
[10] Casualty Actuarial Society, Foundations of Casualty Actuarial
Science, 4th ed. (United Book Press, Inc.: 2001), 51, 86.
[11] According to the National Association of Mutual Insurance
Companies, Louisiana, Michigan, Minnesota, Nebraska, New Hampshire,
Oklahoma, and Virginia have amended their standard fire policies to
allow for exclusion of terrorism from statutory fire coverage. State
legislators in Massachusetts have introduced a similar bill.
[12] Capacity is the amount of reinsurance or insurance that is
available for a defined risk.
[13] 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).
[14] Christian Brauner and Georges Galey, "Terrorism Risks in Property
Insurance and Their Insurability after 11 September 2001," (Swiss
Reinsurance Company: 2003), 25.
[15] Aggregate insured losses are the sum of insured property and
casualty losses from all commercial policyholders that result from a
certified act of terrorism.
[16] 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.
[17] 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.
[18] "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.