Quantifying the ever-present danger: the federal government could benefit from continuing reinsurance coverage for acts of chemical, nuclear, biological or radiological terrorism.

Key Points

* Millions of lives are at stake, and billions of dollars in property damage might result from a terrorist-related chemical, nuclear, biological or radiological attack.

* The government can limit its overall exposure by continuing to partner with private insurers to split the cost of insuring such CNBR-related risks.

* Lessons might be learned from the success some European governments have had providing for pooled coverage of terrorism risks.

The Terrorism Risk Insurance Act of 2002, the Terrorism Risk Insurance Extension Act of 2005 and a subsequent report by the President's Working Group on Financial Markets indicate the best way to provide terrorism-related insurance to consumers is to provide a system with both private and federal government participation.

Although a major terrorist attack has not occurred in America since Sept. 11, 2001, several have taken place abroad, and the threat of terrorism in America always exists. A federal governmental presence, even in a limited capacity, would ensure proper coverage to consumers in an age where terrorist attacks via chemical, nuclear, biological or radiological (CNBR) means remain a real and extraordinarily expensive threat.

The federal terrorism backstop will expire at the end of this year unless Congress extends it. Under the leadership of House Financial Services Chairman Barney Frank, D-Mass., Congress is expected to consider legislation that would expand TRIA's "make available" provision, which requires the industry to offer coverage for terrorism risks.

Where Things Stand

Insured losses from Sept. 11 were about $24.7 billion (adjusted for inflation), making it the costliest man-made disaster in U.S. history, according to A.M. Best Co. In that catastrophe's wake, Congress passed TRIA, which established the Terrorism Insurance Program run by the federal treasury department. TRIA's stated purposes were to address market disruptions, maintain widespread availability and affordability of commercial property and casualty insurance from terrorism risk, and allow for a transition period for private markets to stabilize and build capacity, while preserving state insurance regulation and consumer protection.

TRIA required that insurers offer certain coverage for damages stemming from foreign terrorist attacks, including terrorism-related CNBR attacks, and established the government as a reinsurer to such carriers. The need for a "federal backup for terrorism insurance" was evident, Deputy Treasury Secretary Kenneth W. Dam said, because "the reinsurance industry almost entirely stopped assuming terrorism risk, and primary insurers withdrew from the market where state law ... permitted them to do so."

Although Congress initially intended TRIA to cease at the end of 2005. there was no consensus at the time as to who should then take on the responsibility of providing terrorism-related insurance to consumers. There was. however, still a need to maintain a system of terrorism reinsurance that at least partially involved the federal government. Consequently, Congress extended TRIA. In doing so, Congress cut back on the federal presence in terrorism-related reinsurance. noting there was vast uncertainty, and charged the President's Working Group on Financial Markets with analyzing the potential for longterm insurance for terrorism risk and CNBR losses. The resulting report provides a useful road map for how the government will likely proceed when TRIEA expires.

Continuing Federal Role

The Working Group's Findings demonstrate the need for continued federal involvement as a reinsurer relating to terrorism-related CNBR coverage. "Historically, insurance coverage for losses associated with chemical, nuclear, biological and radiological risks generally has not been widely available unless it was mandated. Insurers generally did not provide CNBR coverage even before September 11, and for the most part they do not provide such terrorism coverage even with a federal backstop in place," the report stated. "Given the general reluctance of insurance companies to provide coverage for these types of risks, there may be little potential for future market development."

Additionally, the Working Group found some insurance consumers are interested in purchasing CNBR coverage, but for the most part haven't due to limited capacity and relatively high prices. Policyholder expectations regarding their own potential terrorism exposure and likelihood of post-disaster federal aid are probably higher for CNBR risks than for relatively smaller-scale conventional terrorist attacks.

UnderTRIA, an insurer need not offer any terrorist-related CNBR coverage if it does not offer general CNBR coverage (where permitted by state law). In fact, most insurers provide CNBR coverage only when subject to state mandates; only 35% of carriers offer some form of CNBR coverage. Indeed, other insurance covers the types of losses that could occur in a CNBR attack. States that follow the Standard Fire Policy, including those that bear a high risk of experiencing a terrorist attack--such as New York, California and Illinois--cover fire-related losses caused by terrorist attacks. Additionally, because it is exceptionally difficult to model the type and extent of damage that would occur in such an attack, most insurers don't offer the coverage.

The Working Group noted because most "policy forms [that do offer CNBR insurance] either include or exclude coverage for CNBR events without distinction as to the cause of the event, there should be no difference in the availability of coverage for such events caused by acts of terrorism." But there seems to be little merit to the distinction. The degree of risk and preventability associated with different CNBR occurrences can vary dramatically. Clearly, the risk of a nuclear reactor melting down or exploding on its own is not the same as the risk of its destruction from a targeted terrorist attack. Futhermore, some conventional CNBR losses are unlikely to happen in certain areas where terrorism-related ones are a real threat. New York City, for instance, has no nuclear reactors within the city limits, yet there is a prospect of a "dirty bomb" exploding there, causing damages associated with nuclear or radioactive materials.

Making the Case

The Working Group observed that potential insureds probably do not perceive a need for terrorist-related CNBR coverage--only 3% of all policyholders purchased this kind of insurance (not including workers' compensation policies) in 2002, 2003 and 2004. Instead, they expect the government will provide aid after a major terrorist attack. This, along with the current high prices for terrorist-related CNBR coverage, has led to small acceptance of such coverage, despite the presence of a federal backstop.

If policyholders eschew this coverage because they don't believe they need it, they are relying on other coverage or they don't understand the extent of the potential damage, it is incumbent upon government and industry to educate them. Undoubtedly, millions of lives and billions of dollars in property values are at stake. Without federal sharing of the financial burden of insurance, the result seems obvious: Companies won't offer CNBR-related coverage unless mandated, and small companies that incur workers' compensation-related CNBR losses will be obliterated. The uninsured face devastation.

The government, which would be called on to provide aid to victims of a terrorist attack, can limit its overall exposure by continuing to partner with the private insurance industry to split the cost of insuring such CNBR-related risks, rather than shoulder the entire cost on its own. The desirability and availability of such coverage should then be publicized.

There is no doubt the insurance industry is concerned with the inherent unpredictability of potential damage. As a result, the industry must examine alternative solutions. Given that it would be difficult to rely on capital markets for relief, the report noted, the only seemingly viable option is risk spreading among private reinsurers and the federal government. It would be shortsighted for the federal government to abandon this arena, or significantly decrease its role.

Underwriting the Risk

If the federal government teams with insurers to provide CNBR coverage and, to the extent it can, shares information on CNBR risks and associated costs, insurers would be better able to assess and price CNBR terrorism risk.

Reinsuring for such losses also would create a financial benefit for the federal government. If no CNBR attack occurs, the government would keep the reinsurance prenaiums and invest them. If there is an attack, the government could help the affected population through federal aid and reinsurance coverage to insurance companies that would have insured policyholders. In the event the government dedicates substantial resources to provide relief and to rebuild or support affected areas, its reinsurance premiums would help defray the costs. If the government becomes aware of an increased risk of a CNBR terrorist attack, it could adjust the reinsurance premiums it charges cedents. Additionally, the government could set up one-year or six-month reinsurance contracts to re-evaluate the level of risk and adjust its corresponding reinsurance premiums. Accordingly, as a reinsurer, the government would be in the best position to use the premiums--whether or not there is an attack.

The U.S. government may look to its European counterparts for a more permanent system. The United Kingdom, for instance, has long had a permanent government reinsurance pool that covers some commercial property damage and business interruption losses caused by CNBR contamination. The pool allows insurers to set premiums at the underlying level, which in turn has expanded competition in the field. Coverage and participation are optional for insurers; losses are capped.

France, by contrast, has a temporary reinsurance pool that mandates all property owners purchase coverage and all insurers join the pool. Insurers bear the initial losses, private reinsurers handle the middle layers, and the government reinsures the higher-level catastrophic losses, with no cap, in return for a share in the premiums. Germany has a similar program, but it is not compulsory, and government reinsurance is capped.

So far, these foreign reinsurance programs have been successful, especially since the 9/11 attacks. The U.K. reinsurance pool's revenue from premiums tripled between 2001 and 2004, and its reserves increased by a third during the same period.

Therefore, the federal government should transform TRIA/TRIEA into a more permanent reinsurance program that considers, and accounts for, terrorism-related CNBR losses. The U.S. Chamber of Commerce has put the extension of TRIA/TRIEA among its priorities for 2007, according to R. Bruce Josten, its executive vice president of government affairs, who said "[we would] like to see it be permanent." Chamber President and Chief Executive Officer Thomas J. Donotree noted:"I think there is a great sentiment in the states.... States view legal reform as a means [for TRIA] to be more attractive economically."

Contributor Aluyah Imoisili is a litigation associate in the Los Angeles office of Milbank, Tweed, Hadley & McCloy. He can be reached at aimoisili@milbank com. Jeffrey Goldman, Esq., contributed to this article.

Insured Loss Estimates of Large CNBR Event ($ Billions)

                        New York   Washington,     San      Des Moines,
Line of Business          City         DC        Francisco      Iowa

Total                      778.1         196.8       171.2         42.3
Auto                         1.0           0.6         0.8          0.4
Commercial Property        158.3          31.5        35.5          4.1
Residential Property        38.7          12.7        22.6          2.6
Workers' Compensation      483.7         126.7        87.5         31.4
General Liability           14.4           2.9         3.2          0.4
Group Life                  82.0          22.5        21.5          3.4

Source: American Academy of Actuaries