Terrorism Insurance
Status of Efforts by Policyholders to Obtain Coverage Gao ID: GAO-08-1057 September 15, 2008The Terrorism Risk Insurance Act of 2002 (TRIA) specifies that the federal government assume significant financial responsibility for insured losses on commercial properties resulting from future terrorist attacks. While TRIA has been credited with stabilizing markets for terrorism insurance after the September 11, 2001, attacks, questions remain as to whether certain policyholders, especially those located in large urban areas viewed as being at high risk of attack, may still face challenges in obtaining coverage. GAO was asked to conduct a study to describe (1) whether the availability of terrorism insurance for commercial properties is constrained in any geographic markets, (2) factors limiting insurers' willingness to provide coverage, and (3) advantages and disadvantages of selected public policy options to increase the availability of such insurance. To address these objectives, GAO analyzed available data and interviewed industry participants, including those with expertise in specific geographic markets considered to be at high, moderate, or low risk of attack (Atlanta, Boston, Chicago, New York, San Francisco, and Washington, D.C.). GAO provided a draft of this report to the Department of the Treasury and the National Association of Insurance Commissioners (NAIC). Treasury and NAIC said the report was informative and useful.
While some owners of high-value properties in major cities may face initial challenges obtaining terrorism insurance coverage compared with most policyholders nationwide, they generally have reported that they could meet current coverage requirements through a variety of approaches. Many industry participants said that terrorism insurance is currently available nationwide at prices viewed as reasonable and that the TRIA program was a key reason for these favorable conditions. However, some policyholders that own large, high-value properties in densely built urban areas viewed as at high risk of attack, particularly in Manhattan and to a lesser extent in Chicago and San Francisco, may still face initial challenges obtaining desired amounts of coverage at prices viewed as reasonable, according to industry participants. To address these challenges, some policyholders purchased coverage from a large number of insurers, which can be a time-consuming and complicated process for policyholders and their insurance brokers. Others purchased coverage in a separate policy (rather than as part of an overall property insurance package) which may be more costly, or self-insured. While TRIA specifies that the federal government assume substantial financial responsibility for insured losses associated with future terrorist attacks, the steps insurers take to manage the risks they do face appear to be the primary reason some policyholders face challenges in obtaining coverage. Insurers said they seek to mitigate potential terrorism losses by limiting the amount of property coverage that they offered in specific areas of cities, such as downtown locations or areas considered to be at high risk of attack. These risk mitigation efforts generally make obtaining coverage more difficult or costly for policyholders with high-value properties in these areas, according to a variety of sources GAO contacted. Industry participants also said that the availability of reinsurance (insurance for insurers) and the views of rating agencies can limit the availability of coverage in such cities. Industry participants had no consensus on whether TRIA should be modified or additional actions taken to increase the availability of terrorism coverage, and identified advantages and disadvantages of selected policy proposals that have been included in legislation, discussed in prior GAO reports, or suggested by industry participants to increase such coverage. A proposal to increase the federal government's current responsibility under TRIA for the insured losses associated with a future attack could make insurers more willing to offer coverage in affected areas. For example, one large insurer said that the proposal might make the company more willing to immediately offer additional coverage in cities viewed as at high risk of attack. However, any such benefits might be limited for reasons including the widespread insurance market disruptions that may result from another attack. This proposal, along with several other proposals analyzed in the report, also would increase the federal government's exposure to the losses associated with terrorist attacks, which is already 85 percent of losses up to $100 billion annually, after an industry deductible.
GAO-08-1057, Terrorism Insurance: Status of Efforts by Policyholders to Obtain Coverage
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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
September 2008:
Terrorism Insurance:
Status of Efforts by Policyholders to Obtain Coverage:
GAO-08-1057:
GAO Highlights:
Highlights of GAO-08-1057, a report to congressional committees.
Why GAO Did This Study:
The Terrorism Risk Insurance Act of 2002 (TRIA) specifies that the
federal government assume significant financial responsibility for
insured losses on commercial properties resulting from future terrorist
attacks. While TRIA has been credited with stabilizing markets for
terrorism insurance after the September 11, 2001, attacks, questions
remain as to whether certain policyholders, especially those located in
large urban areas viewed as being at high risk of attack, may still
face challenges in obtaining coverage. GAO was asked to conduct a study
to describe (1) whether the availability of terrorism insurance for
commercial properties is constrained in any geographic markets, (2)
factors limiting insurers‘ willingness to provide coverage, and (3)
advantages and disadvantages of selected public policy options to
increase the availability of such insurance.
To address these objectives, GAO analyzed available data and
interviewed industry participants, including those with expertise in
specific geographic markets considered to be at high, moderate, or low
risk of attack (Atlanta, Boston, Chicago, New York, San Francisco, and
Washington, D.C.)
GAO provided a draft of this report to the Department of the Treasury
and the National Association of Insurance Commissioners (NAIC).
Treasury and NAIC said the report was informative and useful.
What GAO Found:
While some owners of high-value properties in major cities may face
initial challenges obtaining terrorism insurance coverage compared with
most policyholders nationwide, they generally have reported that they
could meet current coverage requirements through a variety of
approaches. Many industry participants said that terrorism insurance is
currently available nationwide at prices viewed as reasonable and that
the TRIA program was a key reason for these favorable conditions.
However, some policyholders that own large, high-value properties in
densely built urban areas viewed as at high risk of attack,
particularly in Manhattan and to a lesser extent in Chicago and San
Francisco, may still face initial challenges obtaining desired amounts
of coverage at prices viewed as reasonable, according to industry
participants. To address these challenges, some policyholders purchased
coverage from a large number of insurers, which can be a time-consuming
and complicated process for policyholders and their insurance brokers.
Others purchased coverage in a separate policy (rather than as part of
an overall property insurance package) which may be more costly, or
self-insured.
While TRIA specifies that the federal government assume substantial
financial responsibility for insured losses associated with future
terrorist attacks, the steps insurers take to manage the risks they do
face appear to be the primary reason some policyholders face challenges
in obtaining coverage. Insurers said they seek to mitigate potential
terrorism losses by limiting the amount of property coverage that they
offered in specific areas of cities, such as downtown locations or
areas considered to be at high risk of attack. These risk mitigation
efforts generally make obtaining coverage more difficult or costly for
policyholders with high-value properties in these areas, according to a
variety of sources GAO contacted. Industry participants also said that
the availability of reinsurance (insurance for insurers) and the views
of rating agencies can limit the availability of coverage in such
cities.
Industry participants had no consensus on whether TRIA should be
modified or additional actions taken to increase the availability of
terrorism coverage, and identified advantages and disadvantages of
selected policy proposals that have been included in legislation,
discussed in prior GAO reports, or suggested by industry participants
to increase such coverage. A proposal to increase the federal
government‘s current responsibility under TRIA for the insured losses
associated with a future attack could make insurers more willing to
offer coverage in affected areas. For example, one large insurer said
that the proposal might make the company more willing to immediately
offer additional coverage in cities viewed as at high risk of attack.
However, any such benefits might be limited for reasons including the
widespread insurance market disruptions that may result from another
attack. This proposal, along with several other proposals analyzed in
the report, also would increase the federal government‘s exposure to
the losses associated with terrorist attacks, which is already 85
percent of losses up to $100 billion annually, after an industry
deductible.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-1057]. For more
information, contact Yvonne D. Jones at (202) 512-8678 or
jonesy@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Terrorism Insurance Generally Is Available Nationwide, although Some
Policyholders Had to Take Additional Steps to Obtain Coverage:
Insurer and Reinsurer Efforts to Mitigate Their Risks Appeared to Be
Why Certain Policyholders Faced Initial Challenges in Obtaining
Terrorism Insurance Coverage:
Various Proposals to Increase the Availability and Affordability of
Terrorism Insurance Coverage Have Both Advantages and Disadvantages:
Agency Comments:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Current TRIA Deductibles of Five Large Insurers versus
Deductibles under a Recent Legislative Proposal:
Table 2: Examples of National and State Reinsurance Programs:
Figures:
Figure 1: Examples of Structuring Options for Commercial Property
Insurance:
Figure 2: Purchase and Cost Rates of Property Terrorism Insurance:
Figure 3: Example of an Insurer's Underwriting Decision Based on
Aggregation of Risk in Small, Defined Areas:
Abbreviations:
FHCF: Florida Hurricane Catastrophe Fund:
ISO: Insurance Services Office:
NAIC: National Association of Insurance Commissioners:
Pool Re: Pool Reinsurance Company, Limited:
REMIC: Real Estate Mortgage Investment Conduits:
SFP: Standard Fire Policy:
TRIA: Terrorism Risk Insurance Act:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
September 15, 2008:
The Honorable Christopher J. Dodd:
Chairman:
The Honorable Richard C. Shelby:
Ranking Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Barney Frank:
Chairman:
The Honorable Spencer Bachus:
Ranking Member:
Committee on Financial Services:
House of Representatives:
The terrorist attacks of September 11, 2001, are estimated to have
resulted in insured losses amounting to $32.5 billion, as of 2006.
[Footnote 1] Subsequent to the attacks, insurers largely stopped
offering terrorism insurance coverage to commercial property owners,
which raised significant concerns about potential negative economic
consequences. For example, existing real estate development projects
faced delays and cancellations following September 11 because they
could not get terrorism coverage, which led to concerns that the
economy, which was already suffering as a result of the attacks, would
further deteriorate. To help restore confidence and stability in
property insurance markets, Congress enacted and the President signed
the Terrorism Risk Insurance Act of 2002 (TRIA).[Footnote 2] Under
TRIA, insurers generally are required to offer terrorism insurance to
their commercial clients on the same terms they offer other types of
insurance, and, in the event of a future terrorist attack, are
responsible for paying a deductible of 20 percent of their direct
earned premiums from the previous year to cover related losses.
[Footnote 3] The federal government is responsible for covering 85
percent of the insured losses up to a maximum of $100 billion on an
annual basis after insurance companies pay the deductible. While TRIA,
which was reauthorized in 2005 and again in 2007, generally has been
credited with stabilizing markets for commercial property insurance,
some building owners, Members of Congress, and others remain concerned
that there may still be gaps in coverage.[Footnote 4] In particular,
they have expressed concerns about the ability of policyholders that
are located in large urban areas viewed as being at high risk of attack
to obtain terrorism insurance coverage.
To assist the committees in their oversight efforts of the insurance
industry, you asked that we conduct a study to determine if specific
markets in the United States have any unique constraints on the amount
of terrorism insurance available and evaluate options to enhance
coverage. As agreed with your staff, we are providing a report that
describes (1) whether the availability of terrorism insurance for
commercial properties is constrained in any geographic markets and the
effect of any constraints on pricing and coverage amounts, (2) factors
limiting insurers' willingness to provide coverage, and (3) advantages
and disadvantages of some public policy options to increase the
availability of property terrorism insurance.[Footnote 5]
To assess whether the availability of terrorism insurance for
commercial properties is constrained in any geographic markets, we
compiled and analyzed available data on insurance and reinsurance
companies, terrorism insurance take-up rates, and terrorism insurance
pricing.[Footnote 6] We also interviewed more than 100 industry
participants with nationwide perspective and expertise in specific
geographic markets, including Atlanta, Boston, Chicago, New York, San
Francisco, and Washington, D.C. We selected these high-, moderate-, and
low-risk markets based on an industry analyst's ranking of cities by
risk of terrorism. Our interviews included insurer and policyholder
trade associations, policyholders in a variety of industries, national
and regional insurance and reinsurance brokers, insurance and
reinsurance companies, and state regulators. To identify the factors
that may contribute to insurers' willingness or ability to provide
terrorism insurance coverage, we selected large, national insurance
companies to interview based on their market share in the states we
studied. These national insurance companies held from 37 to 52 percent
of the market share in the states we studied. In addition, we
interviewed representatives of regional insurance companies in our
selected markets. We also spoke with risk modeling firms and credit
rating agencies. To obtain views on the advantages and disadvantages of
some public policy options that have been proposed in legislation,
discussed in our prior reports, or suggested by industry participants
to increase insurers' capacity (that is, their willingness or ability)
to provide terrorism coverage, we relied on our interviews with
industry participants described above. We also interviewed academics
who have written on the topic of terrorism insurance, research
organizations, and consumer interest groups. Although we selected
industry participants to provide broad representation of market
conditions geographically and by industry, the number of participants
may not necessarily be representative of the universe of insurers,
insurance brokers, policyholders, and regulators. As a result, we could
not generalize the results of our analysis to the entire national
market for commercial property terrorism insurance. Appendix I contains
additional details of our objectives, scope, and methodology.
We conducted our audit in California, Georgia, Illinois, Massachusetts,
New York, and Washington, D.C., from January 2008 to September 2008, in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.
Results in Brief:
While some owners of high-value properties in major cities may face
initial challenges obtaining desired amounts of terrorism coverage
compared to most policyholders nationwide, they generally have reported
being able to meet their current coverage requirements through a
variety of approaches. Many industry participants and policyholders
said that terrorism insurance currently is available nationwide at
prices viewed as reasonable, and they cited the TRIA program and the
current "soft," or competitive, insurance market for these generally
favorable conditions. However many industry participants also said that
certain policyholders, especially those seeking large policies in areas
viewed as at higher risk of terrorist attack, may face initial
challenges obtaining full coverage for terrorism at rates viewed as
reasonable. According to policyholders and brokers, these policyholders
typically own large, high-value properties such as office towers or
hotels in urban areas where many large buildings are clustered and that
are viewed as at high risk of attack, particularly in Manhattan, and to
a lesser extent certain areas of other major cities such as Chicago and
San Francisco. To address these challenges and satisfy their current
coverage requirements, policyholders and insurance brokers we contacted
reported adopting one or more of several different approaches. For
example, some policyholders purchased coverage from a larger number of
insurers in complex insurance programs, adding to what can be a time-
consuming and complicated process for the policyholders and their
brokers. Moreover, some policyholders purchased coverage in a separate
terrorism-only policy (rather than including the coverage in their
standard all-risk property insurance package) for a portion or all of
their insurance needs, which may be more costly than the traditional
approach. Other policyholders, typically large corporations, self-
insured a portion or all of their terrorism coverage requirements
through what are known as "captive" insurance companies that have been
set up to insure the risks of their owners.
While TRIA limits insurers' financial exposure in future terrorist
attacks, several insurers said they remained concerned about the
exposure they retained, and their efforts to minimize potential losses
appear to be a primary reason why some policyholders faced challenges
in obtaining coverage. Insurers said they seek to mitigate potential
losses from a single terrorism attack by limiting the amount of
property coverage that they offer in specific areas of cities, such as
downtowns or financial districts where many large buildings are
clustered, or other areas considered to be at high risk of attack, such
as parts of Manhattan. These exposure limits, referred to here as
aggregation limits, generally make obtaining coverage more difficult or
costly for certain policyholders in these areas, according to a variety
of sources we contacted. For instance, an insurer could decline to
cover a property in a certain area, offer a lower coverage amount, or
charge a higher premium rate. Industry participants also said the
limited availability of reinsurance (insurance for insurers) and the
views of credit rating agencies can affect the availability and cost of
terrorism insurance in cities viewed as at high risk of attack.
Reinsurers we contacted said that they also have established
aggregation limits in certain cities to mitigate their risks, and
rating agency officials said that their credit ratings for insurers
often depend, in part, on their ability to manage the potential losses
associated with terrorist attacks in major urban areas.
Insurance industry participants and analysts we contacted had no
consensus on whether TRIA should be modified or additional actions
taken to increase the availability of terrorism insurance coverage.
They also identified advantages and disadvantages of various policy
proposals that have been made in legislation, discussed in our prior
reports, or suggested by industry participants to increase terrorism
coverage. For example, one recent legislative proposal involves
lowering the TRIA deductible to 5 percent (from 20 percent) for
insurers experiencing losses from a future terrorist attack that
results in more than $1 billion in damages. Supporters of this proposal
argue that lowering the TRIA deductible could make insurers more
willing to offer coverage following an attack, which would stabilize
insurance markets in affected areas and facilitate rebuilding and
recovery efforts. In addition, a large insurer said that the
legislative proposal, if adopted, might make it immediately more
willing to offer terrorism insurance coverage to policyholders in
certain cities where some policyholders currently face initial
challenges in obtaining coverage. While not necessarily opposed to the
proposal, other industry participants and analysts cautioned that its
effects may be limited. For example, they said that several large
insurers already seek to manage their potential losses from a potential
terrorist attack, through aggregation limits, to levels well below the
current TRIA deductible of 20 percent. As a result, even lowering the
deductible to 5 percent would not necessarily result in a significant
increase in the coverage offered by such insurers. Further, insurance
market disruptions associated with another terrorist attack could limit
the supply and cost of coverage even if the federal government assumed
greater responsibility for such losses. Industry participants also
identified both advantages and disadvantages associated with other
proposals to increase terrorism insurance availability. The proposals
are: permitting insurers to establish tax-deductible reserves for
terrorism-related loses, forming a group of insurers to pool assets for
terrorism risks, facilitating the use of catastrophe bonds for
terrorism through amendments to the federal tax code, and limiting
certain state regulation of property insurance premiums or amending
coverage requirements. We note that while several of these proposals
(for example, establishing tax-deductible reserves) might enhance the
availability and price of terrorism coverage, any such effects likely
would take place over the longer term and not immediately address
challenges that certain policyholders initially may face in obtaining
coverage. Further, all of the proposals, except amending state
regulations, also could increase the federal government's exposure to
potential terrorism-related losses or otherwise reduce federal
revenues.
We provided a draft of this report to the Department of the Treasury
and the National Association of Insurance Commissioners (NAIC) for
their review and comment. In oral comments, Department of the Treasury
and NAIC officials said that they found the report informative and
useful. They also provided technical comments that were incorporated
where appropriate.
Background:
TRIA requires private insurers to offer terrorism coverage in
commercial property and casualty insurance, including workers'
compensation insurance policies. Insurers must make terrorism coverage
available to their policyholders on the same terms and conditions,
including coverage levels, as other types of insurance coverage. For
example, an insurer offering $100 million in commercial property
coverage must offer $100 million in coverage for property damage from a
certified terrorist attack.[Footnote 7] However, insurers could impose
an additional charge for the coverage and policyholders, except in
workers' compensation policies, generally have the option of not
purchasing it.
Under TRIA, the federal government is to reimburse insurers for a
portion of their losses from certified terrorist acts. Specifically,
the federal government would reimburse insurers for 85 percent of their
losses after the insurers pay a deductible amounting to 20 percent of
the previous year's direct earned premiums.[Footnote 8] The federal
funding is activated when aggregate industry losses exceed $100 million
and is capped at an annual amount of $100 billion.[Footnote 9]
Originally enacted as a 3-year program, Congress has reauthorized the
program twice and recently extended it until 2014. In December 2005,
Congress passed the Terrorism Risk Insurance Extension Act that
increased the required amount insurers would have to pay in the
aftermath of a terrorist attack. In December 2007, Congress approved
the Terrorism Risk Insurance Program Reauthorization Act and eliminated
the distinction between terrorist acts carried out by foreign and
domestic actors. It also clarified language on insurers' liability,
stating that insurers are not responsible for losses that exceed the
federal government's annual liability cap of $100 billion.[Footnote 10]
Commercial property insurance policies can be simple or complex,
depending on the value and location of the properties being insured.
Property owners may insure properties individually or consolidate
multiple properties in a portfolio and insure them with a single
policy. The benefits of grouping properties include spreading the cost
(premium) across more than one building on the premise that all
buildings in a portfolio are unlikely to be damaged by the same peril
in the same event. Policies with high insured values can require
multiple insurers to provide coverage, with each providing a portion of
the coverage up to the full amount of the policy, because the total
insured value is too great for any one insurer to absorb (see fig. 1).
According to a representative of a large brokerage firm, policyholders
typically buy property coverage, including terrorism coverage, through
one all-risk policy, which insures losses from multiple perils.
Figure 1: Examples of Structuring Options for Commercial Property
Insurance:
[See PDF for image]
This figure is an illustration of examples of structuring options for
commercial property insurance, as follows (dollars in millions):
Single insurer/single layer:
Insurer A: $1,000.
Multiple insurers/multiple layers:
Layer One: Insurer A: $400;
Layer Two: Insurer B: $400;
Layer Three: Insurer C: $200.
Multiple insurers within multiple layers:
Layer One: Insurers A, B, and C: $400;
Layer Two: Insurers D, E, F, and G: $400;
Layer Three: Insurers H, I, and J: $200.
Source: GAO.
[End of figure]
Policyholders generally do not purchase terrorism insurance in amounts
that would cover the total replacement value of the insured property,
but rather purchase insurance in amounts that reflect the maximum
amount of foreseeable losses that could occur in a terrorist attack.
Also, policyholders may determine the amount of terrorism coverage to
purchase based on amounts required by a lender providing the mortgage
on the property.
States have primary responsibility for regulating the insurance
industry in the United States, and state insurance regulators
coordinate their activities in part through the NAIC. The degree of
oversight of insurance varies by state and insurance type. In some
lines of insurance, insurers may file insurance policy forms with state
regulators that help determine the extent of coverage provided by a
policy by approving the wording of policies, including the explicit
exclusions of some perils. According to a NAIC representative, while
practices vary by state, state regulators generally regulate prices for
personal lines of insurance and workers' compensation policies but not
for commercial property/casualty policies. In most cases, state
insurance regulators perform neither rate nor form review for large
commercial property/casualty insurance contracts because it is presumed
that businesses have a better understanding of insurance contracts and
pricing than the average personal-lines consumer. Reinsurers generally
are not required to get state regulatory approval for the terms of
coverage or the prices they charge.
Terrorism Insurance Generally Is Available Nationwide, although Some
Policyholders Had to Take Additional Steps to Obtain Coverage:
According to a variety of sources, commercial property terrorism
insurance currently appears to be widely available on a nationwide
basis at rates viewed as reasonable, largely due to the TRIA program
and the current "soft" insurance market. However, some policyholders in
urban areas viewed as being at higher risk of a terrorist attack,
particularly in Manhattan and to a lesser extent in some other high-
risk cities such as Chicago and San Francisco, may be forced to take
additional steps to overcome challenges they may have initially faced
in obtaining desired amounts of coverage at prices viewed as
reasonable. Policyholders generally have been able to obtain desired or
required amounts of terrorism coverage by increasing the number of
carriers in what already may be large and complex insurance programs,
adding to what can be a time-consuming and complicated process for
policyholders and their insurance brokers. Others secure needed
coverage by purchasing all or a portion of their terrorism coverage in
a separate insurance policy, or self-insuring through a captive
insurance company.
Terrorism Insurance Generally Is Available Nationwide at Rates Viewed
as Affordable Largely Due to the TRIA Program and the Soft Insurance
Market:
According to data compiled by two large insurance brokers, a majority
of their commercial clients nationwide purchase terrorism insurance
coverage, and the premium rates for such coverage generally have been
stable in recent years. As shown in figure 2, one of these brokers
reported that approximately 60 percent of its clients purchased some
form of terrorism coverage each year from 2005 through 2007. Another
large insurance broker reported that take-up rates for its large
property clients have remained between 60 percent and 65 percent since
2004. According to a large broker, the Northeast, which includes New
York City, has the largest percentage of companies that purchase
terrorism coverage for properties, with about 70 percent having
purchased it in 2007.[Footnote 11] Real estate companies account for
the largest percentage of clients that purchased terrorism insurance
coverage, with more than 80 percent of these clients having done so in
2007. Manufacturing and construction companies had the lowest purchase
rates, with 45 percent and 34 percent, respectively, having purchased
coverage in 2007. Data collected by one of these large brokers also
show that the premiums that their clients paid for terrorism coverage,
expressed as a percentage of the commercial property premiums,
generally have been stable at around 4 percent since 2003 (fig. 2).
Another large broker also reported that premiums have been stable at
around 4 percent, on average, since 2006.
Figure 2: Purchase and Cost Rates of Property Terrorism Insurance:
[See PDF for image]
This figure contains two vertical bar graphs depicting the following
data:
Percentage of companies purchasing property terrorism insurance in the
United States:
Year: 2003;
Percentage: 27%;
Year: 2004;
Percentage: 49%;
Year: 2005;
Percentage: 58%;
Year: 2006;
Percentage: 59%;
Year: 2007;
Percentage: 59%.
Median terrorism insurance premiums as a percentage of U.S. commercial-
property premiums:
Year: 2003;
Percentage: 3.98%;
Year: 2004;
Percentage: 4.7%;
Year: 2005;
Percentage: 4.17%;
Year: 2006;
Percentage: 4.21%;
Year: 2007;
Percentage: 3.85%.
Source: GAO analysis of data from Marsh & McLennan Companies.
[End of figure]
An official from one of these brokerages told us steady purchase rates
between 2005 and 2007 may indicate that policyholders who want to
purchase terrorism coverage have been able to purchase it. According to
representatives from these two brokers, the primary reason why
approximately 40 percent of clients did not purchase terrorism coverage
is that they may not have perceived themselves at risk of a terrorist
attack, particularly those in nonurban areas or those in industries
perceived to be at lower risk of attack, such as manufacturing. Other
reasons clients may not have purchased coverage include the absence of
lender requirements or the cost of coverage, according to one large
broker.[Footnote 12]
Information we collected in a range of interviews with policyholders,
national and regional brokers, insurers, and others was consistent with
the view that terrorism insurance coverage is available nationwide at
premium rates viewed as reasonable. Several policyholders we contacted
that own large and small portfolios of real estate throughout the
United States, including national hotel chains, sports stadiums, office
towers, shopping malls, and residential buildings, told us they could
obtain as much terrorism coverage as they sought to obtain. Some
policyholders and regional brokers also said that terrorism insurance
premiums continue to decline while the quality of coverage improves.
For example, a representative from a commercial real estate company
that owns large office towers, a luxury resort, and an industrial
property in major U.S. cities said the company recently increased its
terrorism coverage by more than 50 percent and decreased its premium by
more than 20 percent. In at least one state, an insurer and state
regulator told us terrorism coverage may be provided at no additional
cost to policyholders, especially those with properties perceived to be
at low risk of a terrorist attack.
Insurers, policyholders, and other industry participants cited the TRIA
program and the current soft, or competitive, market as the key reasons
that terrorism coverage generally has been available nationwide.
Without the federal backstop for potential insurance losses related to
terrorism, industry participants said that coverage availability could
decline substantially. For example, some insurers told us the amount of
terrorism coverage they provide would decline--by more than 95 percent
for one insurer--without the TRIA provision that provides reimbursement
for insured losses that exceed the amount of an insurer's TRIA
deductible. In a soft market, insurance is widely available and sold at
a lower cost, making it easier for buyers to obtain insurance.
According to insurance industry participants, recent strong profits,
increases in investment income, and a lack of large losses from major
catastrophes have contributed to insurers' ability to increase their
capital levels in recent years. According to some brokers, high levels
of capital have increased insurers' capacity and willingness to provide
terrorism insurance coverage.
However, some interviewees cautioned that another terrorist attack or
"hardening" of the general terrorism insurance market could reduce the
current supply of terrorism insurance coverage and increase pricing. In
the past, insurers frequently have responded to catastrophic events by
cutting back coverage significantly or substantially increasing
premiums for policyholders. For example, such reactions took place in
the Florida market after Hurricane Andrew in 1992, in California after
the Northridge earthquake of 1994, and more widely following the
September 11 attacks. A broker with a large national firm told us that
the insurance industry has remained highly sensitive to the potential
financial consequences of another terrorist attack since September 11.
According to one industry analyst, even a modest terrorist attack in
the future could cause significant fear and concern in the market and
lead to increases in prices and restrictions on availability. Moreover,
some industry analysts said that insurers could suffer significant
losses for a variety of other reasons, such as the costs of a large
hurricane or earthquake or declines in the values of their investment
portfolios, which might make them less willing to offer terrorism
coverage under current terms and pricing.
Some Policyholders in Major Cities Have Faced Initial Challenges in
Obtaining Desired Terrorism Coverage at Rates Viewed as Favorable:
While terrorism insurance coverage generally is available nationwide,
many industry participants reported that some policyholders in major
cities viewed as being at higher risk of terrorist attack, particularly
in Manhattan, may initially experience challenges in obtaining desired
amounts of coverage.[Footnote 13] Specifically, industry participants
said that owners of large, high-value properties in financial districts
or downtown locations, or near government offices or transit hubs, may
face initial challenges in obtaining coverage in their all-risk
property policies. For example, a policyholder with large office and
retail properties in New York, San Francisco, and Chicago told us only
a few insurers were willing to offer it coverage that it considered
expensive and that provided only half of the $1.5 billion in coverage
sought. In spite of these initial challenges, this policyholder was
able to obtain the needed coverage by taking other approaches that will
be discussed later in this report.
Brokers and policyholders mentioned these difficulties have been more
severe in certain locations in Manhattan than anywhere else. In
particular, they said the area surrounding Times Square--or midtown--
and lower Manhattan, which contained the World Trade Center, presents
difficulties because of the dense concentration of buildings, perceived
risk of a future terrorist attack, and the overlapping insurance needs
of building owners and tenants. For example, one broker active in the
New York market told us of an approximately 15-block stretch of midtown
Manhattan with a high concentration of property values in which each
property is valued at $1 billion or more, creating strong demand by
building owners for limited and expensive coverage. Another broker told
us the availability of terrorism coverage is most constrained in the
area surrounding the World Trade Center site in lower Manhattan. The
brokers said retail clients that would like to establish themselves in
this area worry about not enough coverage being available for
terrorism, flood, and fire damage.
Representatives from large national brokers, as well as insurance
companies and other industry participants, said that certain
policyholders in Chicago and San Francisco also may face initial
challenges in obtaining terrorism insurance coverage, although to a
lesser extent than in Manhattan. As is the case in Manhattan, these
policyholders typically own large buildings in proximity to other
buildings and generally are located in financial districts or downtown
locations. While owners of large buildings in such locations may face
challenges in obtaining coverage, a broker told us that even a small
building might be difficult to insure for terrorism risk if it were
located near larger properties in high-risk areas.
Many industry participants reported that premiums were higher in cities
considered to face greater financial risks from the likelihood of
terrorist attacks occurring there, adding to the challenge of obtaining
terrorism coverage. For example, according to one large insurance
broker, terrorism insurance premiums in New York City can be twice as
high as prices for similar buildings in other cities considered to be
at high risk of a terrorist attack, and more than five times higher
than prices in lower-risk cities. The premium amount dedicated to
insuring properties in certain locations against terrorism risks may,
on a relative basis, significantly exceed the amount necessary to cover
such risks in other geographic areas. For example, a broker in the San
Francisco Bay area told us average terrorism pricing for owners of
certain buildings there can be from 20 to 30 percent of the all-risk
property premium, whereas the national median was around 4 percent in
2007.
While some policyholders in high-risk cities face challenges, we note
that this is not necessarily the case in all such cities. In
particular, policyholders we contacted with properties in Washington
D.C. said while it may have been difficult or more expensive to obtain
terrorism coverage immediately following September 11, coverage is now
readily available and affordable. For example, policyholders we
interviewed that own properties in the city said they were able to
include full terrorism coverage in their all-risk property policies
even though they own or manage commercial and residential properties in
proximity to potential targets such as the White House, the Capitol,
subway stops, or foreign embassies. Industry participants said that
policyholders generally experience fewer challenges in Washington, D.C.
because the buildings are not as high or as densely concentrated as in
downtown areas of other high-risk cities.
To Obtain Full Terrorism Coverage, Policyholders May Add Additional
Carriers to Existing Insurance Programs, Purchase Terrorism-only
Policies, or Self-Insure:
Policyholders that have experienced initial difficulty obtaining
terrorism coverage in their primary all-risk property policies
generally have been able to meet current terrorism insurance
requirements by one of several approaches or a combination thereof,
according to industry participants. For example, some policyholders and
brokers reported obtaining coverage from a greater number of insurers
in what may already have been a complex insurance program. As discussed
earlier, policies with high insured values can require multiple
insurers to provide portions of coverage up to the full amount of the
policy. However, a few policyholders told us more insurers are now
required to assemble terrorism coverage because insurers are taking
smaller amounts of risk (that is, offering smaller amounts of
coverage), requiring a greater number of insurers to fill out an
insurance program and adding to what can be a time-consuming and
complicated process for policyholders and their insurance brokers. Some
policyholders said more than 20 insurers may participate in a single
insurance program. One policyholder told us more than 40 insurers
participate in its property insurance policy. Layering an insurance
program has costs, especially for large and complex programs. A
representative of a large hotel chain told us that layering insurance
is "painful" because of the effort involved in convincing insurers to
become comfortable with a risk.
Moreover, several brokers and policyholders reported purchasing
property terrorism insurance in a stand-alone policy to cover portions
or all of the required coverage.[Footnote 14] For example, the owner of
multiple large office buildings in Manhattan's midtown and downtown
financial districts told us the company purchased all of its terrorism
coverage as a stand-alone insurance policy because it could obtain just
half of the $800 million in coverage sought. Another policyholder that
owns a nationwide chain of hotels, with properties in Manhattan,
Chicago, and San Francisco, decided to purchase all of its terrorism
coverage in a stand-alone policy to avoid the high and inconsistent
cost of embedding terrorism coverage in its all-risk policy. A
representative of this policyholder noted that cost was a particular
issue following the 2005 hurricane season when property insurance
prices generally increased. Some policyholders told us stand-alone
terrorism coverage was more expensive than obtaining coverage as part
of an all-risk property policy. However, data from a national broker
show that the difference in pricing between stand-alone coverage and
coverage included in an all-risk policy was small for most of 2007,
with the median price for stand-alone coverage at 5 percent of the
overall property premium compared to around 4 percent for coverage in
the all-risk program.
Finally, according to brokers and policyholders some policyholders have
used self-insurance as a means to assemble coverage. That is, they
placed all or a portion of their terrorism coverage in a captive
insurance company, which insures the risks of the owner.[Footnote 15]
For the purpose of insuring property terrorism risk, a captive insurer
would generally be a wholly owned insurance company within the
corporate structure of the property owner. The typical owners of
captives used for insuring terrorism risk are large corporations that
own large or well-known buildings in major urban areas and have not
been able to obtain coverage through other means. For example, a
policyholder we contacted sought to obtain $1.2 billion in property
coverage for multiple buildings in Manhattan, including terrorism
coverage, which would cover the total replacement cost of the largest
building in its portfolio.[Footnote 16] However, a representative of
this policyholder told us the company could obtain just $500 million of
all-risk property insurance that included terrorism coverage, leaving a
gap of $700 million in coverage for terrorism risk. The policyholder
considered filling the gap by obtaining terrorism coverage in the form
of a more expensive stand-alone insurance policy, but decided instead
to establish a captive insurance company to supplement the coverage
provided in the all-risk policy and make up the $700 million
difference. Another policyholder with a lender requirement to purchase
about $1.6 billion in coverage on a single building in midtown
Manhattan was unable to obtain sufficient terrorism coverage in an all-
risk policy in 2008. This policyholder purchased an all-risk policy
that excluded terrorism risk and assembled property coverage for
terrorism risk in the form of a $250 million stand-alone policy and
about $1.3 billion in a newly formed captive insurance company.
Although these examples show policyholders may create captive insurance
companies for the sole purpose of insuring terrorism risk, this
approach may not be typical of the way in which captives are used.
[Footnote 17] Representatives of two large insurance brokers said most
companies simply add terrorism risk to captives that already have been
established to cover other insurance risks, such as environmental and
product-recall risks.
Insurer and Reinsurer Efforts to Mitigate Their Risks Appeared to Be
Why Certain Policyholders Faced Initial Challenges in Obtaining
Terrorism Insurance Coverage:
While TRIA limits insurers' potential losses from a terrorist attack,
the efforts of insurers' to manage the remaining risks they faced
appeared to be the primary reasons for certain policyholders
experiencing initial challenges in obtaining desired amounts of
coverage at prices they viewed as reasonable. To mitigate their risks,
many insurers set limits on the amount of coverage that they would
provide to policyholders in confined geographic areas within a city,
such as downtown locations or financial districts where many large
buildings are clustered, or in specific areas of cities considered to
be at high risk of attack. According to a variety of sources we
contacted, these limits generally make obtaining coverage more
difficult or costly for certain policyholders in these areas. Further,
industry participants and analysts said that the availability of
reinsurance and the views of credit rating agencies also may limit the
supply and increase the price of terrorism insurance coverage in
certain high-risk cities.
Insurers' Concerns about Amounts of Future Terrorism Losses Influence
Their Willingness to Provide Coverage, Affecting Availability and Price
in Certain Cities:
Representatives from several insurance companies we contacted said that
despite the TRIA financial backstop, they remain significantly
concerned that a future terrorist attack would result in substantial
losses. In the event of another terrorist attack, industry participants
said that certain large insurers may face TRIA deductibles that would
result in losses of billions of dollars. For example, one of the
largest insurers providing commercial property coverage would face a $5
billion TRIA deductible based on 2007 data. The representative of one
large insurer said that the company's TRIA deductible was three times
the net losses the company suffered due to the September 11 attacks.
Furthermore, even a terrorist attack that caused losses below the $100
million TRIA program trigger could cause substantial losses to a small
insurer. For example, the company surplus might be exhausted from
paying the entire loss, according to the representative of a small
insurer.[Footnote 18]
Insurers said that they seek to mitigate potential losses from a single
terrorism attack by limiting the amount of property coverage that they
offer in confined geographic areas within cities. For example, some
insurers told us that they would not insure certain types of
properties, buildings over a certain size, or buildings near others
that might be considered terrorist targets. In addition, several large
insurers and brokers told us that insurers limit the terrorism
insurance they provide in these areas to amounts well below their TRIA
deductible.
To help insurers determine how much risk, or coverage, they can write
in any given location, several industry participants we interviewed
said insurers often use computer models to estimate the effect, or
severity, of terrorist attacks on their existing book of business.
Using models available from risk-modeling firms, insurers can map the
locations of properties they cover as well as other types of coverage
they provide in the area such as building contents, business
interruption, or workers' compensation. Therefore, insurers can
consider the extent to which one terrorist attack could trigger losses
among multiple lines of insurance. The models also can map the
locations of nearby properties considered to be potential terrorist
targets. With these mapped locations, an insurer is then able to
identify areas where it has the greatest aggregated exposure within a
city. The modeling program places a circle around a specific location,
such as a building in the insurer's book or a potential terrorist
target, and aggregates the amount of exposure an insurer has within
this defined area. These models take into account the severity of
various attack scenarios on properties in the area (for example, a 5-or
10-ton truck bomb) and allow users to quantify potential losses under
different attack scenarios.
Insurers we interviewed noted that they are not as comfortable with the
estimates of the probability, or frequency, of an attack, from these
models and, therefore, make more limited use of this information. While
insurers and risk-modeling firms have access to large historical
databases and scientific studies of the frequency and severity of
natural catastrophes, such as hurricanes, the data on terrorist attacks
are limited. Furthermore, according to industry analysts, the tactics,
strength, and effectiveness of terrorist groups can be very
unpredictable, so predicting the frequency of such attacks is very
difficult and perhaps impossible. For example, terrorists might respond
to increased security measures in one area by shifting attention to
more vulnerable targets in another. Without more information, industry
analysts note that it is difficult for modeling firms to make
projections about the capability and opportunities of terrorists to
undertake future attacks.
While insurers find estimates of the probability of a terrorist attack
of limited use, they often use the estimates of the severity of
potential attacks in determining the amount of coverage they are
willing to provide. Considering potential attack scenarios and
estimated losses from the models, insurers impose internal limits,
referred to here as aggregation limits, on the amount of all types of
coverage they will offer in defined areas. Depending on the amount of
capital and risk tolerance of the company, insurers determine the
amount of coverage they are willing to provide in defined geographic
areas within a city, such as in 250-foot, 500-foot, or quarter-mile
circles around certain landmarks or areas where the insurer has high
concentrations of risk. Insurers then monitor the amount of coverage
that they provide in these areas on an ongoing basis to ensure that
they do not exceed their aggregation limits. As shown in figure 3, an
insurer might decline to provide any coverage for a new property since
adding the property to the book of business would exceed the insurer's
aggregation limit on exposures within the defined area. Alternatively,
an insurer might charge a higher price or offer a lower coverage limit
if adding the property would exceed the aggregation limit.
Figure 3: Example of an Insurer's Underwriting Decision Based on
Aggregation of Risk in Small, Defined Areas:
[See PDF for image]
This figure is an illustration of an example of an insurer's
underwriting decision based on aggregation of risk in small, defined
areas, as follows:
The illustration contains a depiction of properties within a 500 foot
radius of a new property to be insured.
Value of properties already insured (within a 500 foot radius of a new
property to be insured): $225 million;
Value of new property to be insured: $50 million;
Total property value: $275 million;
Insurer's risk limit: $250 million; insurance offered up to limit;
insurance denied above limit.
Source: GAO.
[End of figure]
The amount of coverage insurers are willing to provide in these defined
areas may change frequently as new clients or properties are added to
or removed from their books of business. An insurer may have available
capacity in a specific area one month, but be near its limit the next.
For example, one policyholder noted that her real estate investment
company contacts its insurer before considering acquiring a new
property to determine if the insurer has capacity where the new
property is located. Although the insurance company may decide it can
provide property insurance for the building at the time of the request,
the policyholder said that when the acquisition is completed several
months later, the insurance company may no longer have the capacity
available to insure the building. In that case, the policyholder said
that the company might have to purchase a stand-alone terrorism policy
for that particular building, which the policyholder reported as being
more expensive than simply adding it to the existing portfolio. As a
result, the policyholder said it might no longer be profitable for the
company to acquire the new building. In some cases, this policyholder
said the company has canceled or deferred an acquisition until it
simultaneously disposed of a building in the same area to be sure that
the insurer would have capacity available for the new building.
However, several other policyholders we interviewed said that any
concern about the availability of insurance has not affected their
companies' acquisitions or development projects.
Availability of Reinsurance Also Can Affect Insurers' Willingness to
Provide Terrorism Coverage:
Insurers and other industry analysts cited the limited availability of
reinsurance as another factor influencing insurers' willingness to
provide terrorism coverage in certain areas. Reinsurance plays a
crucial role in insurance markets by permitting primary insurers to
transfer some of the risks that they incur in offering coverage. In so
doing, reinsurance may allow primary insurers to offer additional
coverage than otherwise would be the case while mitigating potential
losses.[Footnote 19]
Insurers and other industry participants we contacted said that
reinsurance for terrorism risk, which largely was unavailable after
September 11, continues to be expensive and available in limited
amounts. In a 2004 report, we found that reinsurers had reentered the
terrorism insurance market cautiously, but that the amount of coverage
offered to primary insurers was limited and the premium rates were
viewed as high.[Footnote 20] In conducting our current work, reinsurers
and industry analysts said that reinsurance capacity for terrorism has
continued to increase for a variety of reasons including an influx of
new capital into the industry, the absence of another terrorist attack,
and improvements in insurers' ability to underwrite the risk.[Footnote
21] However, insurance brokers and large insurers with significant
exposures in urban areas told us that terrorism often still is excluded
in reinsurance contracts and that insurers have been able to purchase
only limited amounts of very expensive coverage. A recent Congressional
Budget Office report similarly found that the ability of primary
insurers to transfer terrorism risk to reinsurers is limited.[Footnote
22]
As has been the case with primary insurers, the efforts of reinsurers
to manage their aggregation levels appear to be why the coverage that
they offer for terrorism is limited. The provision in TRIA requiring
insurers to offer terrorism coverage at terms and conditions that do
not differ materially from other coverage does not apply to reinsurance
transactions, so these companies have discretion in deciding how much
terrorism coverage to offer to primary companies. Reinsurance company
representatives told us that the location of the insured risks is an
important factor that influences whether they will offer reinsurance
and at what price. For example, one reinsurance company representative
said that the company was less willing to write contracts covering
properties in cities viewed to be at high risk of terrorist attack.
Others said that while their companies still would be willing to
reinsure an insurer's book of business with concentrations of risk in
multiple high-risk cities, they might offer more expensive coverage to
compensate for the increased risk and the increased capital they need
to maintain to back up the risk.
Views of Rating Agencies Also May Influence the Availability of
Terrorism Insurance for Some Policyholders in Areas Viewed as at High
Risk of Attack:
Insurers and reinsurers cited the views of rating agencies on the
amount of capital insurers allocate to terrorism risk and the location
of risks they insure as other factors influencing their willingness to
provide terrorism coverage. Rating agencies assess the financial
strength of companies and the credit quality of their obligations.
Maintaining a high rating can be very important for an insurance
company's business because a firm with a low rating may, among other
things, pay a higher interest rate on its debt. In addition, several
policyholders and lenders told us many lenders that require their
mortgagees to carry terrorism coverage also require that they use only
highly rated insurers. A variety of industry participants and analysts
told us that rating agencies' views can be very influential on the
amount of capacity insurers decide to allocate to terrorism risk,
affecting how much coverage they provide to policyholders. For example,
one reinsurance industry analyst noted that the amount of capital
rating agencies required insurers to maintain to support terrorism risk
was significant. The representative said that these requirements may
encourage insurers not to offer this type of business because it is
difficult to maintain large amounts of capital and earn an adequate
return on the money.
In conducting their assessments, representatives of the rating agencies
we interviewed said they look closely at insurers' terrorism exposures.
They request specific information about the types of policies insurers
write, the risks in their books of business, the steps insurers take to
manage their risks, and whether they have concentrations of risk in any
areas, including large urban areas or cities considered to be high
risk. With workers'-compensation insurers, the rating agencies request
information about the number of employees at different locations across
the different insureds. As a result of discussions with the rating
agency about the company's rating, rating agency representatives said
that some companies have purchased additional reinsurance or divested
risk.
Various Proposals to Increase the Availability and Affordability of
Terrorism Insurance Coverage Have Both Advantages and Disadvantages:
Insurance industry participants and analysts did not express consensus
on whether TRIA should be modified or additional actions taken to
increase the availability of terrorism insurance coverage. They cited a
variety of advantages and disadvantages associated with five proposals
that have been offered in legislation, discussed in our prior reports,
or suggested by industry participants to increase the availability and
perhaps limit the cost of terrorism insurance. These proposals include
lowering insurers' TRIA deductibles following large terrorist attacks,
permitting insurers to establish tax-deductible reserves for future
terrorism losses, forming a group of insurance companies to pool assets
for terrorism losses, facilitating the issuance of onshore catastrophe
bonds through changes in the tax code, and limiting certain state
regulations and requirements. We note that improvements in terrorism
insurance coverage and pricing that might result from the adoption of
some of these proposals (such as tax-deductible reserves, insurance
pools, and catastrophe bonds) likely would take place over the longer
term and that such proposals could increase the federal government's
exposure to terrorist-related losses or otherwise reduce federal
revenues.
Option 1: Lowering Insurers' TRIA Deductibles following Large Terrorist
Attacks:
One recent legislative proposal to increase the availability of
terrorism insurance coverage involved lowering the TRIA deductible for
insurers from future terrorist attacks after they experience
losses.[Footnote 23] Under this proposal, if there were a terrorist
attack that resulted in more than $1 billion in damages, the insurer
deductible under TRIA immediately would be reduced to 5 percent (from
20 percent) for those insurers suffering losses in the attack.[Footnote
24] Table 1 below shows the potential effect on the deductibles of five
large insurers under this proposal.
Table 1: Current TRIA Deductibles of Five Large Insurers versus
Deductibles under a Recent Legislative Proposal (Dollars in billions):
Insurer A:
Direct written premiums: $24.8;
Current TRIA deductible: $4.9;
Proposed TRIA deductible in case of attack: $1.2.
Insurer B:
Direct written premiums: $14.6;
Current TRIA deductible: $2.9;
Proposed TRIA deductible in case of attack: $0.732.
Insurer C:
Direct written premiums: $14.4;
Current TRIA deductible: $2.8;
Proposed TRIA deductible in case of attack: $0.721.
Insurer D:
Direct written premiums: $12.7;
Current TRIA deductible: $2.5;
Proposed TRIA deductible in case of attack: $0.635.
Insurer E:
Direct written premiums: $7.5;
Current TRIA deductible: $1.5;
Proposed TRIA deductible in case of attack: $0.375.
Source: GAO analysis of Insurance Information Institute data.
Note: The legislative proposal--as outlined in S. 2621, 110th Cong. § 2
(2008) and H.R. 4721, 110th Cong. § 2 (2007)--would reset the TRIA
deductible after a large terrorist attack where aggregate industry
insured losses exceeded $1 billion.
[End of table]
Because this proposal was designed to significantly reduce potential
industry losses, some insurers and industry participants we contacted
said that it might make them more willing to offer coverage in areas
affected by a future attack. As a result, supporters of the proposal
argue that it would stabilize insurance markets in affected areas and
facilitate rebuilding and recovery efforts. Moreover, the
representative of one large insurer said that if the deductible was
lowered to 5 percent, the insurer immediately would be willing to write
more terrorism coverage, especially in downtown areas of larger cities.
Since the insurer would be able to access the federal reimbursement at
a lower level, the insurer's potential losses on its current book of
business would be lower, thus freeing up additional capacity for
terrorism coverage without having to purchase reinsurance from the
private market to cover the additional risk.
While other insurers and industry participants we contacted were not
necessarily opposed to this proposal, they remarked that its effects
might be limited. As discussed previously, some large insurers already
try to limit potential losses associated with a future terrorist attack
to levels well below their current TRIA deductible of 20 percent of
direct premiums. Therefore, it is not clear what effect lowering the
TRIA deductible would have for such insurers in terms of the terrorism
coverage that they are willing to offer. Second, as also discussed
earlier, there may be significant market disruptions associated with
another terrorist attack, which could limit coverage availability even
if the federal government did assume greater liability for associated
losses. For example, reinsurers, which are not subject to TRIA's
requirements to make terrorism coverage available, again might limit
the coverage they were willing to provide in the wake of another
attack, which might limit the amount of coverage that primary insurers
could offer. In addition, as happened following Hurricane Katrina,
ratings agencies might increase the capital requirements or other
standards insurers must follow to maintain and improve their ratings,
potentially further limiting insurers' willingness to continue
providing terrorism coverage in certain areas. Further, we note that
lowering the TRIA deductible would increase the federal government's
potential liability for terrorism-related losses.
Option 2: Permitting Insurers to Establish Tax-Deductible Reserves for
Future Terrorism Losses:
Another option would permit insurers to establish tax-deductible
reserves, over a period of years, to cover the potential losses
associated with future terrorist attacks. Under current federal tax
law, insurers can take a deduction for losses that already have
occurred and for setting aside reserves for fair and reasonable
estimates of the amount the insurer will be required to pay on future
losses. However, reserves for uncertain future losses are not currently
tax deductible. Because the size and timing of terrorist attacks are
uncertain, any reserves set aside for potential terrorism losses would
be taxed as corporate income in the year in which they were set aside.
[Footnote 25]
We have reported previously that amending the tax code and permitting
insurers to establish tax-deductible reserves could provide insurers
with financial incentives to increase their capital and thereby expand
their capacity to cover catastrophic risks, such as terrorism.[Footnote
26] We also reported that supporters of this proposal argued that
establishing such reserves would lower the costs associated with
providing coverage and encourage insurers to charge lower premiums,
which could increase coverage among policyholders. In addition,
industry participants we interviewed said if insurers were able to
establish tax-deductible reserves, a large terrorist attack could cause
less of a strain or shock to industry surplus, or capital, which could
help prevent insurer insolvencies in the wake of an attack.
However, several important challenges and tradeoffs may be associated
with this option. For example, some industry participants we contacted
said it would be difficult for insurers to determine the amount of
funds to contribute to such a reserve each year because of the
significant challenges associated with estimating the frequency of
potential terrorist attacks. Without a reliable method for conducting
such estimates, insurers would lack an analytical basis for reserving
funds to cover potential losses.
Furthermore, we have reported that overall terrorism insurance capacity
might not increase because insurers might use the reserves as a
substitute for reinsurance that may have been purchased previously to
manage the risks of potential terrorist attacks (reinsurance premiums
are already tax-deductible).[Footnote 27] Because reserving also would
convey tax advantages, some insurers might feel that they could limit
the expense of purchasing reinsurance. To the extent that insurers
reduced their reinsurance coverage in favor of tax-deductible reserves,
the industry's overall capacity would not necessarily increase.
Insurers also might use the reserves to shield a portion of their
existing capital (or retained earnings) from the corporate income tax
or inappropriately use tax-deductible reserves to manage their
financial statements by increasing the reserves during good economic
times and decreasing them in bad times. Finally, we note that this
proposal likely would reduce federal tax revenues.
Option 3: Forming a Group of Insurance Companies to Pool Assets for
Terrorism Risks:
Another proposal involves establishing a group of insurance companies
to pool their assets, which may allow them to provide a greater amount
of terrorism insurance coverage than could be provided by individual
companies acting independently of one another. Insurance pools
typically are formed to cover large risks, such as hurricanes, which
traditional insurance markets do not address readily. For example, a
pool could be created at the national level or state level; it could
involve mandatory or voluntary participation from insurers; it could be
prefunded or postfunded; and if losses exceed the reserves of the pool,
the government could provide a financial guarantee or the pool could
draw on some other method such as issuing bonds or borrowing funds to
make up any shortfall. Table 2 shows that insurance pools have been
established in Florida to cover hurricane risks and in the United
Kingdom for terrorism risks.
Table 2: Examples of National and State Reinsurance Programs:
Program: Florida Hurricane Catastrophe Fund (FHCF);
Program description: The State of Florida created the FHCF after
Hurricane Andrew. FHCF is a state-administered reinsurance program for
insurers that offers residential property/casualty insurance in the
state. Its purpose is to ensure reinsurance will remain available at
relatively stable rates in the aftermath of hurricanes;
Coverage: Residential property in case of hurricane in Florida;
Reinsurance or insurance: Reinsurance;
Government backstop: None. FHCF may issue bonds, collect reimbursement
premiums, or impose assessments on Florida insurance companies if funds
are insufficient to meet obligations;
Voluntary or mandatory participation: Mandatory.
Program: Pool Reinsurance Company, Limited (Pool Re);
Program description: A mutual reinsurer in the United Kingdom that
provides pooled industrywide reinsurance of terrorism risks after a
specified industry retention level. Pool Re was formed in 1993
following reductions in reinsurance availability after terrorist
bombings in London;
Coverage: Commercial property, business interruption, and consequential
losses for acts of terrorism;
Reinsurance or insurance: Reinsurance;
Government backstop: Full government guarantee if pool resources are
exhausted, after a 10 percent call upon insurers;
Voluntary or mandatory participation: Voluntary.
Source: GAO analysis of information from Coalition to Insure Against
Terrorism.
[End of table]
In addition to these programs, one large insurance broker, in
consultation with several industry groups, has developed a proposal to
form a $40 billion national reinsurance pool for commercial property
terrorism risk.[Footnote 28] Under this proposal, all insurance
policies would cover losses from acts of terrorism and insurers would
continue to charge policyholders their own rates for terrorism coverage
in accordance with state laws. Insurers would purchase reinsurance
coverage from the pool, which would determine its reinsurance premium
rate based on analysis of a range of potential losses in urban,
suburban, and rural areas. The claim reserves of the pool would be tax-
exempt, allowing it to accumulate reserves tax-free from which to pay
future losses. In the event of a certified terrorist attack, the
insurance industry would pay 5 percent of losses and the pool would pay
95 percent of losses up to $40 billion. In the event the pool did not
have the resources to pay its share of losses, the pool would be funded
through the issuance of bonds.[Footnote 29] The federal government
would be responsible for losses in excess of $40 billion up to $100
billion. According to the plan, losses above $100 billion would be
reviewed by Congress.
Some industry participants we contacted expressed general support of an
insurer pool to enhance the availability of terrorism insurance
coverage. For example, they said a pool could allow insurers to
transfer a significant portion of their terrorism-related risk to an
outside entity over time, and they could use the accumulated surplus in
the pool to provide higher amounts of coverage in the future. Industry
participants also noted that a national pool would spread out terrorism
risk across a wider base of policyholders of varying risk levels than
individual insurers could do alone and would allow insurers to better
manage their total accumulations of terrorism risk.
However, several challenges and disadvantages also may be associated
with this option. For example, as is the case with tax-deductible
reserves, it may be difficult to develop a reliable basis for
determining the appropriate size of the pool because of the inherent
challenges in estimating the frequency of terrorist attacks. Moreover,
other information suggests that insurance pools would not necessarily
increase the industry's capacity or ability to offer additional
terrorism insurance coverage. According to a study by a global
consulting firm on a proposed workers'-compensation pool for terrorism
risk and other industry participants, a reinsurance pool might not
create new industry capacity or bring in additional capital to support
writing more business.[Footnote 30] The study notes that if the
industry as a whole does not have enough capital to manage terrorism
risk, then neither can an industry pool that simply combines existing
industry capital in a new structure. Furthermore, we note that if
premiums paid to the pool were tax deductible as are traditional
reinsurance premiums, insurers simply might substitute pool reinsurance
for traditional reinsurance, as might be the case with tax-deductible
reserves for individual insurers. Finally, if the pool was a tax-exempt
entity, tax-deductible reserves for an insurance pool could reduce
federal revenues.
Option 4: Facilitating the Issuance of Onshore Catastrophe Bonds
through Revisions to the Federal Tax Code:
Another proposal is that the federal government establish certain tax
advantages for catastrophe bonds, which supporters argue could
facilitate their use for covering terrorist attacks.[Footnote 31]
Catastrophe bonds generally have been issued to cover natural events,
such as earthquakes or hurricanes, rather than terrorist attacks and
historically have been created in offshore jurisdictions where they are
not subject to income or other tax. Under this proposal, tax treatment
of catastrophe bonds would be similar to the treatment received by
certain issuers of asset-backed securities, which generally are not
subject to tax on the income from underlying assets that is passed on
to investors.[Footnote 32] We previously reported that the total costs
of issuing catastrophe bonds--including transaction costs such as legal
fees--significantly exceed the costs of traditional reinsurance, which
may have limited the expansion of the market.[Footnote 33] Facilitating
the creation of onshore transactions by changing the tax code to
encourage issuance of catastrophe bonds within the United States could
reduce transaction costs.
Some insurance industry participants we contacted said that catastrophe
bonds, by tapping into the securities markets, offered the opportunity
to expand the pool of capital available to cover terrorism risk. They
also said that amending the tax code to facilitate the bonds' issuance
in the United States could be beneficial in achieving that goal.
However, many industry participants said, consistent with findings in
our previous reports, that the development of catastrophe bonds for
terrorism risks involves significant challenges. These challenges may
greatly exceed any benefit that would be derived from amending the tax
code. As with other options discussed previously, the industry
participants said that because of the difficulties associated with
estimating the frequency of terrorist attacks, it would be very
difficult to structure a catastrophe bond for terrorism that would be
acceptable to investors. Data are available on the historical frequency
and severity of natural events, such as hurricanes and earthquakes,
which helps investors assess the risks that they face in purchasing
catastrophe bonds for such risks. Without similar data for terrorist
attacks, it is unlikely that a viable market for catastrophe bonds will
be established regardless of revisions to the tax code that are
designed to help ensure such an outcome. We also have previously
reported that the federal government could lose tax revenue under this
option and that the proposed changes to the tax code might create
pressure from other industries for similar tax treatment.
Option 5: Revising Certain State Regulations and Insurance Coverage
Requirements:
Some industry participants have suggested that states could take
certain actions to revise their insurance statutes or regulations to
increase insurer capacity for terrorism risk, including amending rate
regulation policies and laws on coverage requirements. While, according
to information from NAIC, most state insurance regulators do not review
rates for large commercial property/casualty insurance contracts,
several insurance company representatives said that their ability to
charge risk-based prices for terrorism coverage was constrained by
insurance statutes and regulations in certain states and the prices
these states approved did not reflect the risk to which the insurers
were exposed.[Footnote 34] Additionally, a few industry participants
said that terrorism insurance availability may be limited in states
that have adopted the Standard Fire Policy (SFP).[Footnote 35] Under
the SFP, property insurers are required to cover losses from fire
regardless of the cause of the fire, including a terrorist attack, even
if the policyholder declined terrorism coverage. Consequently, the
industry participants said that the SFP influences the amount of
property insurance that insurers provide, including terrorism
insurance, and the premiums that they charge in states that have
adopted it. Therefore, some insurers have suggested that states amend
their SFP statutes so that insurers would not be responsible for fire
losses resulting from terrorism.
While most states do not regulate prices for commercial property risks,
where prices are regulated the state regulators are unlikely to
disapprove insurers' rate requests because insurers are in a better
position to judge the necessity of the price than the regulator, as
long as the request is generally in line with current market prices,
according to a representative from NAIC. In addition, other available
information suggests that state actions on rate regulation or coverage
requirements may have a limited effect on the availability of terrorism
insurance coverage. As discussed in this report, some policyholders,
particularly in Manhattan, may face initial challenges in obtaining
terrorism coverage at prices viewed as reasonable. However, according
to state regulatory officials, New York is one of the states that
generally does not regulate premium rates for large commercial
properties, so state regulation does not appear to be a significant
factor in the city where insurance challenges appear to be most
pronounced.[Footnote 36] On the other hand, unlike several other
states, New York and California have not revised the SFP to limit
insurer liability resulting from the fires associated with terrorist
attacks, according to information from industry analysts. While the SFP
may therefore have an influence on the availability of terrorism
insurance in such locations as Manhattan and San Francisco, it is
difficult if not impossible to determine the influence as compared to
other factors in these cities, particularly the potential losses
associated with attacks on high-value buildings that may be in
proximity to one another.
Agency Comments:
We provided a draft of this report to Department of the Treasury and
NAIC for their review and comment. In oral comments, Treasury and NAIC
officials said that the report was informative and useful. They also
provided technical comments that were incorporated where appropriate.
We are sending copies of this report to the Department of the Treasury,
NAIC, and other interested committees and parties. We will also make
copies available to others upon request. In addition, the report will
be available at no charge on GAO's Web site at [hyperlink,
http://www.gao.gov].
If you or your staffs have any questions about this report, please
contact me at (202) 512-8678 or jonesy@gao.gov. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this report. GAO staff who made major contributions to
this report are listed in appendix II.
Signed by:
Yvonne D. Jones:
Director, Financial Markets and Community Investment:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
Our objectives were to describe (1) whether the availability of
terrorism insurance for commercial properties is constrained in any
geographic markets and the effect of any constraints on pricing and
coverage amounts, (2) factors limiting insurers' willingness to provide
coverage, and (3) advantages and disadvantages of some public policy
options to increase the availability of property terrorism insurance.
To assess whether the availability of terrorism insurance for
commercial properties is constrained in any geographic markets and the
effect of any constraints on pricing and coverage amounts, we reviewed
relevant literature and compiled and analyzed available data on
insurance and reinsurance industry capacity, terrorism insurance take-
up rates, and terrorism insurance pricing. We also interviewed
representatives of more than 100 organizations with knowledge of the
nationwide terrorism insurance market and with expertise in specific
geographic markets. Entities with a national perspective included
insurer and policyholder trade associations, individual policyholders,
national insurance and reinsurance brokers, and insurance and
reinsurance companies. We obtained information on specific geographic
markets from state regulators, regional insurance brokers and insurance
companies, and local property owners. The geographic markets we studied
represent locations considered to be at high, moderate, and low risk of
exposure to terrorist attacks--Atlanta, Boston, Chicago, New York, San
Francisco, and Washington, D.C. We selected these markets based on
rankings of locations by risk of terrorism exposure that accounts for
the risk of terrorist attacks and the potential for associated losses
from the Insurance Services Office, an insurance industry analytics
firm. We spoke with representatives of policyholders that own hundreds
of properties nationwide, including:
* more than 200 properties in New York City;
* more than 100 properties in Washington, D.C.;
* at least 30 properties each in Chicago and San Francisco;
* about 30 properties in Boston and 60 in Atlanta, and:
* numerous properties across the United States including major cities
such as Los Angeles and Houston.
These properties included large office towers in major U.S. cities,
properties in proximity to high-profile federal buildings, hotels,
industrial buildings, hospitals, sports stadiums, and residential
properties in locations throughout the United States. The policyholders
also represented a variety of industries that included real estate,
transportation, financial services, health, hospitality, and
entertainment. In addition to one-on-one interviews, we also conducted
group discussions with representatives of 14 policyholders at the
annual Risk and Insurance Management Society conference in San Diego,
California, in April 2008. Although we selected industry participants
to provide broad representation of market conditions geographically and
by industry, their responses may not necessarily be representative of
the universe of insurers, insurance brokers, policyholders, and
regulators. As a result, we could not generalize the results of our
analysis to the entire national market for commercial property
terrorism insurance. We determined that the selection of these sites
and participants was appropriate for our objectives and that this
selection would allow coverage of geographic areas, key markets, major
insurers and policyholders, and other organizations related to
terrorism insurance so as to generate valid and reliable evidence to
support our work.
To identify the factors limiting insurers' willingness to provide
terrorism insurance coverage, we selected large, national insurance
companies to interview based on their market share in the states we
studied. These national insurance companies held from 37 to 52 percent
of the market share in the states we studied, according to information
provided by the Insurance Information Institute. In addition, we
interviewed representatives of regional insurance companies in our
selected markets. We also spoke to representatives of seven reinsurance
companies, including two of the largest worldwide reinsurance
companies, risk modeling firms, state regulators, and two credit rating
agencies. Although we selected insurers to provide broad representation
of size and geographic scope, we could not generalize the results of
our analysis to the entire population of commercial property insurers.
To explore the advantages and disadvantages of some public policy
options to increase the availability of property terrorism insurance,
we relied on our interviews with the industry participants described
above. We also interviewed academics who have written on the topic of
terrorism insurance, and representatives of research organizations and
consumer interest groups. We selected the option that would reduce
insurers' TRIA deductibles in areas affected by a future large
terrorist attack from two recent legislative proposals. We selected the
other options--allowing insurers to establish tax-deductible reserves,
forming a group of insurance companies to pool assets, and facilitating
the use of catastrophe bonds through changes in the tax code and
amending state regulations or statutes--from literature we reviewed,
our prior reports, and interviews we conducted with industry
participants. The selected options were representative of the range of
possible options. We did not attempt to evaluate the prospective effect
of these options and, therefore, did not come to any conclusions about
the advisability of implementing these options.
We conducted this audit in Atlanta, Georgia; Boston, Massachusetts;
Chicago, Illinois; New York, New York; San Diego, California; San
Francisco, California; and Washington, D.C., from January 2008 to
September 2008, in accordance with generally accepted government
auditing standards. Those standards require that we plan and perform
the audit to obtain sufficient, appropriate evidence to provide a
reasonable basis for our findings and conclusions based on our audit
objectives. We believe that the evidence obtained provides a reasonable
basis for our findings and conclusions based on our audit objectives.
[End of section]
Appendix II: GAO Contact and Staff Acknowledgments:
GAO Contact:
Yvonne D. Jones, (202) 512-8678 or jonesy@gao.gov:
Staff Acknowledgments:
Wesley M. Phillips, Assistant Director; Farah Angersola; Joseph A.
Applebaum; Rudy Chatlos; Andrea Clark; Katherine Bittinger Eikel; Barry
Kirby; Rich LaMore; Marc Molino; Jill M. Naamane; Linda Rego; Barbara
Roesmann; Kathryn Supinski; Thomas Taydus; and Shamiah Woods made key
contributions to this report.
[End of section]
Footnotes:
[1] Department of the Treasury, Board of Governors of the Federal
Reserve System, U.S. Securities and Exchange Commission, and Commodity
Futures Trading Commission, Terrorism Risk Insurance: Report of the
President's Working Group on Financial Markets (Washington, D.C.,
September 2006), 8.
[2] Pub. L. No. 107-297, 116 Stat. 2322 (Nov. 26, 2002).
[3] Department of the Treasury regulation codified at 31 C.F.R. §
50.5(d) defines direct earned premiums as a direct earned premium for
all commercial property and casualty insurance issued by any insurer
for insurance against all losses, including losses from an act of
terrorism, occurring at locations within the United States, or on U.S.
air carriers or U.S. flag vessels, or at the premises of any U.S.
mission. The Department of the 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 NAIC is the National Association of
Insurance Commissioners, which is an organization representing state
insurance regulators.
[4] See Terrorism Risk Insurance Extension Act of 2005, Pub. L. No. 109-
144, 119 Stat. 2660 (Dec. 22, 2005) and Terrorism Risk Insurance
Program Reauthorization Act of 2007, Pub. L. No. 110-160, 121 Stat.
1839 (Dec. 26, 2007).
[5] Under the 2007 statute that reauthorized TRIA coverage, GAO was
required to report to Congress on similar objectives by June 23, 2008.
See 15 U.S.C. § 6701 note (Terrorism Insurance Program § 108(g)(3)). To
satisfy this mandate, we made presentations to the Committee on
Financial Services of the House of Representatives and the Committee on
Banking, Housing, and Urban Affairs of the U.S. Senate on June 20 and
June 23, 2008, respectively. The presentation, GAO, Initial Results on
Terrorism Insurance Availability in Specific Geographic Markets, GAO-08-
919R (Washington, D.C.: July 11, 2008) is available on GAO's Web site
at [hyperlink, http://www.gao.gov]. This report is based largely on our
prior work. However, we added additional information and analysis,
including information on two additional public policy options that were
not discussed in our prior work.
[6] Reinsurance companies provide insurance to insurers.
[7] TRIA defines an "act of terrorism" as any act that is violent or
dangerous to human life, property, or infrastructure and is certified
as an act of terrorism by the Secretary of the Treasury, in concurrence
with the Secretary of State, and the Attorney General of the United
States, which has resulted in damage within the United States, or
outside of the United States in the case of an air carrier or vessel
(as defined for purposes of TRIA) or to the premises of a U.S. mission,
and was committed by an individual or individuals, as part of an effort
to coerce the civilian population of the United States or to influence
the policy or affect the conduct of the U.S. government by coercion.
Acts of war and losses that in the aggregate do not exceed $5,000,000
are specifically excluded. See 15 U.S.C. § 6701 note (Terrorism
Insurance Program § 102(1)).
[8] 15 U.S.C. § 6701 note (Terrorism Insurance Program §§ 102(7)(F) and
103(e)(1)(A)).
[9] 15 U.S.C. § 6701 note (Terrorism Insurance Program § 103(e)).
[10] See 15 U.S.C. § 6701 note (Terrorism Insurance Program §
103(e)(2)(A)(ii)).
[11] Representatives of this broker noted that these data are limited
because locations are typically recorded where the client is
headquartered, not necessarily where the insured properties are
located. For example, a company headquartered in New York City would be
included in New York even if the vast majority of the company's
property holdings are located elsewhere.
[12] According to a national trade association representing lenders,
commercial real estate lenders typically require that terrorism
insurance be included as part of the mortgaged property's all-risk
insurance policy and that property insurance, including terrorism
coverage, is maintained for the property for the duration of the loan.
[13] According to a national insurer trade association, insurance
policies are typically in force for a 1-year period. The process of
putting an insurance contract out for bid or negotiating new terms and
conditions of the contract can take several months.
[14] A stand-alone terrorism insurance policy limits coverage to losses
from terrorist attacks, in contrast to an all-risk policy that would
cover losses from multiple risks or perils.
[15] Captive insurance companies provide value to large corporations
using them for terrorism coverage. Under TRIA, insurers required to
participate in the program are defined as entities "licensed or
admitted to engage in the business of providing primary or excess
insurance in any state." See TRIA Section 102(6). Because captives are
licensed and admitted by the states, just like traditional insurance
companies, captives are "insurers" under TRIA and participate in the
program. Captives receive compensation for insured losses under the
program, enabling captive owners to transfer a significant portion--85
percent--of their terrorism exposure to the federal government for
qualifying terrorist attacks, after paying a deductible. Captives also
have direct access to the private reinsurance market, enabling captive
owners to transfer a portion of their exposure to private insurers,
according to a reinsurer and captive manager. Finally, policyholders
can reduce their insurance costs by creating captive insurers and
setting premium rates according to their own claims experience.
However, there are significant costs to establishing and maintaining
captive insurers, as well as the possibility of the parent company
experiencing significant financial losses.
[16] Policyholders generally determine the amount of coverage to
purchase based on lender requirements or the amount of losses that
could result in a terrorist attack, which for some is the total
replacement cost of the largest building in a portfolio.
[17] In a September 2004 letter interpreting its implementation of
TRIA, the Department of the Treasury raised questions regarding the
integrity of forming or utilizing captive insurers to only provide
stand-alone, single-risk TRIA-only coverage for losses from acts of
terrorism. In this letter, the department explained that it would
continue to monitor developments in the market for terrorism risk
insurance to determine if future rulemaking is needed to address the
role of captives under TRIA. The letter stated that the Department of
the Treasury has concerns about the possibility that captives may be
used as a tool for avoiding the program's requirements and deductible
because captives providing stand-alone terrorism coverage would be able
to access reimbursements through TRIA at a much lower level than other
insurers writing multiple lines of insurance. This is because the
deductible is calculated on all lines of coverage written, not only
coverage for terrorism. The department's letter is online at
[hyperlink, http://www.treas.gov/offices/domestic-finance/financial-
institution/terrorism-insurance/pdf/0924_2.pdf].
[18] An insurer's surplus is the difference between its assets and
liabilities, or the company's net worth. The surplus is the financial
cushion that insurers can draw on in case of unexpectedly high
policyholder claims.
[19] For terrorism insurance, primary insurers typically purchase
reinsurance up to the difference between what the primary insurers are
willing to lose in a terrorist attack and their TRIA deductibles as
well as coverage for their 15 percent co-share under the program.
[20] GAO, Terrorism Insurance: Implementation of the Terrorism Risk
Insurance Act of 2002, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-04-307] (Washington, D.C.: Apr. 23, 2004).
[21] According to a trade insurance association representative, the
capacity of the global reinsurance market has increased significantly
in recent years. The representative said that a wave of $20 billion in
new capital entered Bermuda companies after the September 11 attacks.
Similarly, a second wave of $43 billion in new capital entered the
market after Hurricane Katrina.
[22] Congressional Budget Office, Federal Reinsurance for Terrorism
Risks: Issues in Reauthorization (Washington, D.C., August 2007).
[23] See S. 2621, 110th Cong. § 2 (2008) and H.R. 4721, 110th Cong. § 2
(2007). The proposal would reset the TRIA deductible after a large
terrorist attack where aggregate industry insured losses exceed $1
billion.
[24] The proposal also would increase the deductible by 0.5 percent in
each subsequent year with no terrorist attack.
[25] A "property casualty company loss reserve" is an accounting entry,
a liability on the balance sheet, for the amount of money the company
expects to pay out in the future to cover indemnity payments that will
come due on policies already written for losses that already have been
incurred and the costs of dealing with the associated claims. Loss
reserves do not reflect the pattern of future claims payments. Premium
payment funds that cannot be put into loss reserves must be treated as
underwriting profits.
[26] GAO, Catastrophe Risk: U.S. and European Approaches to Insure
Natural Catastrophe and Terrorism Risks, [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-05-199] (Washington, D.C.: Feb.
28, 2005).
[27] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-199].
[28] Aon, Property Terrorism Update, TRIA in the Balance (New York,
N.Y.: October 2005).
[29] The plan specifies that the U.S. government would provide a
contingent guarantee to buy bonds issued by the pool if bonds could not
be sold in the open market due to a terrorist attack. The bonds would
be repaid by assessments levied on all policies from covered lines
during the life of the bonds. The bonds would be tax-exempt and have a
maturity of up to 30 years.
[30] The Tillinghast and Reinsurance businesses of Towers Perrin,
Workers' Compensation Terrorism Reinsurance Pool Feasibility Study,
Summary of Study Findings and Conclusions (March 2004). The study was
facilitated by the American Insurance Association and funded by 14
insurers that account for roughly 40 percent of the workers'-
compensation market.
[31] Catastrophe bonds are risk-based securities that pay relatively
high interest rates and provide insurance companies with a form of
reinsurance to pay catastrophe losses. A catastrophe bond offering
typically is made through an investment entity that may be sponsored by
an insurance or reinsurance company. The investment entity issues bonds
or debt securities for purchase by investors, thus spreading risk.
[32] Asset-backed securities, for example, are backed by loans or
accounts receivable originated by banks, credit card companies, or
other providers of credit. Certain issuers of these securities, Real
Estate Mortgage Investment Conduits (REMIC), are generally not subject
to federal income tax. Instead the income of the REMIC is taxable to
the holders of interests in the REMIC. See 26 U.S.C. §§ 860A-860G; GAO,
Catastrophe Insurance Risks: The Role of Risk-Linked Securities and
Factors Affecting Their Use, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-02-941] (Washington, D.C.: Sept. 24, 2002).
[33] For additional information about catastrophe bonds and related tax
issues, see [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-02-941];
Catastrophe Insurance Risks: Status of Efforts to Securitize Natural
Catastrophe and Terrorism Risk, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-03-1033] (Washington, D.C.: Sept. 24, 2003); Natural
Disasters: Public Policy Options for Changing the Federal Role in
Natural Catastrophe Insurance, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-08-7] (Washington, D.C.: Nov. 26, 2007); and GAO-05-199.
[34] According to information provided by NAIC, the following 10 states
and district require prior approval of commercial property rates:
California, Hawaii, Iowa, Maryland, Michigan, New Mexico, New York,
North Carolina, North Dakota, South Carolina, and Washington, D.C.
While the State of Michigan has a prior approval law, an NAIC
representative said that the Commissioner has exempted insurers from
filing rates and forms for commercial lines insurance products. Some
states, like New York, also have exceptions for large commercial risks,
which are discussed in this report.
[35] According to information from the Insurance Information Institute
and the Insurance Services Office (ISO), states that do not allow
exclusions to the SFP for terrorism, thereby requiring coverage for
fire following an act of terrorism, are California, Georgia, Hawaii,
Iowa, Illinois, Maine, Massachusetts, Missouri, North Carolina, New
Jersey, New York, Oregon, Rhode Island, Washington, West Virginia, and
Wisconsin. The Virgin Islands also do not allow SFP exclusions for
terrorism. Some of these states exempt the SFP requirements for the
commercial inland marine line of business. Connecticut and Virginia
enable an exclusion of fire following a certified act of terrorism.
Fire coverage in both of these states would be required if TRIA
expired.
[36] New York Insurance Department officials told us that large
commercial property policies (above $100,000 in premium) as well as
certain types of other risks can operate in what is called a "Free
Trade Zone" in the state, where insurers have more discretion on
determining the prices and terms of coverage they offer as long as they
adhere to New York's statute that they are "neither excessive,
inadequate, nor unfairly discriminatory." According to information from
NAIC, several other states also have similar provisions exempting large
commercial risks from rate regulation.
[End of section]
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