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After TRIA goes away: with the Terrorism Risk Insurance Act due to expire in 2005, insurers and policyholders must develop long-term solutions that deliver financial stability and accountability.

Key Points

* The Terrorism Risk Insurance Act will expire on Dec. 31, 2005.

* Insurers must create and support a new, long-term back-stop solution.

* An alternative to TRIA is to require terrorism coverage as part of all property/casualty policies.

The debate over whether the Terrorism Risk Insurance Act will expire on Dec. 31, 2005, or be extended only postpones the inevitable--what comes after and will the markets and policyholders be ready?

Following the terrorist attacks of Sept. 11, 2001, TRIA provided policyholders with the assurance that coverage would be available for a price and would provide insurers with government reimbursement for terrorist events that fell within the definitions listed in TRIA. It was not intended as a long-term solution. TRIA's stated purpose is "to establish a temporary federal program that provides for a transparent system of shared public and private compensation lot insured losses resulting from acts of terrorism in order ... to allow for a transitional period for the private markets to stabilize, resume pricing of such insurance, and build capacity to absorb any future losses...."

In addition to providing an important financial backstop and minimizing market disruption during a period of uncertainty, one of TRIA's main functions was to "buy time" until something better could be developed. While most would agree that TRIA served this purpose, it cannot be relied upon indefinitely.

Congress has considered bills to extend TRIA through at least 2007. Even if extensions are granted, the federal government will not likely backstop terrorism insurance forever. Instead, insurers and policyholders must construct and support long-term solutions that deliver financial stability and accountability in the post-Sept. 11 world. Terrorism insurance should be available, policyholders should take responsibility in minimizing terrorism risk, and insurance and reinsurance markets should be structured to spread the risk. Such risk spreading could include federal programs, capital markets and mandatory coverage and premiums.

Not Long-Term Solution

Although many policyholders and insurers believe insurance capacity and availability problems are solved under TRIA, it's unlikely to be a long-term solution.

Industry capacity hasn't rebounded. The Insurance Information Institute reports that reinsurers bore more than halt" of the losses from Sept. 11, and "are not currently in a position to assume the same amount of terrorism risk as they were on Sept. 11." The prospects for recovery also are not good over the next several years, according to Gary Marchitello, Aon's managing director, National Property Syndication.

Even with TRIA, some insurers balk at the high retention levels, and maw policyholders still believe terrorism is someone clse's risk. As Damian Testa, president of Kaye Insurance Associates, the New York office of Hub Inter national, said, "the further away one gets from New York, the fewer the number of clients who believe they have any type of real terrorism exposure." A Marsh Inc. study of 2,400 businesses showed that one in three companies purchased terrorism coverage in 2003. Premium rates dropped 43% last year during the second to fourth quarters, but the percentage of those buying terrorism coverage still increased to only 32.7% from 27.3%. Even when they consider the coverage, clients are deterred by the high cost and high deductibles, Marchitcllo said.

The financial supports of TRIA may not solve these problems. Testa reports that some insurers openly question the act's value, noting that if they had TRIA prior to Sept. 11, they would have received no federal reimbursement. To receive payments under TRIA, an event must cause at least $5 million of damage. In addition, the event must be "certified" as an act of terrorism by the federal government, which must determine that the act was committed by persons acting on behalf of a foreign interest in an effort to coerce U.S. citizens or U.S. policy or conduct. Finally, before any federal reimbursement would be available, the insurer's deductible, based on a percentage of earned premiums, must be met. For losses above a company's deductible, the federal government will cover 90%, while the company contributes 10%. If the federal government pays for insured losses during any given year, it can recoup some or all of its payments through a "terrorism loss risk-spreading premium" imposed as a surcharge on policyholder premiums. Fortunately, no terrorist event has occurred in the United States since Sept. 11; therefore it remains unclear just how TRIA would work, how much would be paid to insurers and how much would be charged back.

Possible Replacements for TRIA

Whenever TRIA expires, the federal government, insurance markets and policyholders will all need to participate in crafting long-term replacements. These solutions should recognize that terrorism risk is difficult to underwrite, that terrorist attacks can happen anywhere and that terrorism risk should be shared broadly.

Federal and State Programs: Many insurers believe terrorism coverage cannot exist without some form of federal assistance. They contend that terrorism is pervasive and other federal programs provide successful models.

One model worth considering is the National Flood Insurance Program, which, according to its Web site, was created by Congress in 1968 "in response to the rising cost of taxpayer funded disaster relief for flood victims and the increasing amount of damage caused by floods." Flood insurance generally is not underwritten by the private insurance industry because only those who are susceptible to flood damage want to be insured. The industry would be required to charge a high premium to these high-risk insureds. Since the market would not accept these high premiums, the federal government developed a flood insurance program. In order to ensure that those at risk purchased the coverage, the federal government turned to the financial institutions and required that all mortgages on homes in flood plains carry flood insurance. If a bank failed to enforce the requirement, it could lose its Federal Deposit Insurance Corp. coverage.

According to publications of the NFIP, "nearly 20,000 communities across the United States and its territories participate ... by adopting and enforcing flood plain management ordinances to reduce future flood damage. In exchange, the NFIP makes federally backed flood insurance available to homeowners, renters and business owners in these communities." According to these NFIP sources, the program saves "nearly $1 billion in flood damage every year through partnerships with communities, the insurance industry, and the lending industry," mostly through better construction and compliance with NFIP building standards.

This model could be adapted for terrorism insurance. Federally sponsored flood insurance is available in those communities which have adopted management programs designed to reduce losses caused by future floods. Federal terrorism insurance also could be offered to the businesses in those communities that have reduced the severity of damage that could be caused by future terrorist events. Such steps could include disaster and data back-up plans designed to minimize risks.

Another approach is illustrated by the Florida Hurricane Catastrophe Fund, which was created in 1993 to build capacity in the state by reimbursing insurers for a portion of their catastrophic hurricane losses. The FHCF. which acts as a state-administered reinsurance program, is financed by three sources: reimbursement premiums charged to participating insurers, investment earnings and emergency assessments on Florida property/casualty insurers.

The fund provided $11 billion of reinsurance capacity for Florida in 2003, and will likely be used extensively in 2004. A specific fund to reimburse insurers who pay terrorism losses could be created and funded over time through assessments on insurers and accumulation of investment income. To spread the risk even further, such a terrorism-insurance fund could access the capital markets for additional or emergency funding.

Mandatory Coverage: Another solution is to require terrorism coverage as part of all property/casualty coverage with additional premium built in. The potential for terrorism is everywhere all the time. The insurance industry cannot select those areas where terrorism can occur--it can only estimate where terrorism is most likely to happen or where its effects would be greatest. Such predictions may ultimately be incorrect, however, and insurance coverage should be available for losses regardless of their geographic location. The economic, social and political consequences will be felt wherever a future terrorist event might occur.

Accordingly, one approach to the possible expiration of TRIA may be to add terrorism as a new "peril" to be included in every property/casualty insurance policy issued on both personal and commercial lines. The premium charged would be universal, and the coverage could apply to any terrorism attack anywhere in the United States without a need for federal certification. The government or industry could build a fund from these premiums, which would be invested to grow as time passes. Again, capital markets also could participate in raising cash for such a fund, which would further spread the risk.

Insurance policies already contain perils that are likely only to occur in certain areas but for which everyone pays. They include "sinkhole collapse" in Florida and "volcanic eruption" in Hawaii, Alaska and Washington. While not used to support a special fund, the premiums are collected by insurance companies. This would be a way to spread the risk, which is fundamental to any insurance contract.

Aon's Marchitello said mandatory terrorism coverage makes economic sense, but questions whether the political will exists to do it. Sometimes it is necessary to step out of the box and look at unusual possibilities to meet problems such as funding the social and economic loss potential of future terrorism. The industry did not include terrorism as a standard peril because it is difficult to underwrite and was largely unthinkable, at least in the United States. Difficult as it is to fathom, this peril is no longer unthinkable, and a way must be found to insure it permanently for all.

RELATED ARTICLE: Policyholders must take responsibility, too.

The risks of future terrorist attacks cannot be borne exclusively by the insurance and reinsurance markets. If a company suffers a terrorist attack, TRIA does not protect loss of market share or diminished customer service. Depending on how the company rebounds, lawsuits from investors, vendors or customers could follow, especially if the company had not taken adequate precautions against the possibility of terrorist attacks.

The effects of terrorism cannot be fought solely by shifting the risk to others, even to the government. Protection rests with everyone. For corporations, protection begins with the basics, which many, but not all, companies have heeded. These basics include:

* A comprehensive disaster plan that considers various scenarios and is updated continually;

* Diligent, consistent security in buildings and grounds, as well as data security;

* Where possible, spreading out employees among multiple facilities in different states or regions; and

* Creating multiple, off site back-up systems. Companies also may consider using captives, whether pure captives or industry captives, to manage the terrorism risk. TRIA-specific captives already exist in the market, including protected cell captives. New captives could expand the coverage beyond what TRIA covers and could be used in conjunction with reinsurance protection or the capital markets.

Steven R. Gilford and Marc E. Rosenthal are partners at Mayer, Brown, Rowe & Maw L.L.P. in Chicago, specializing in insurance and reinsurance.
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Title Annotation:Terrorism
Comment:After TRIA goes away: with the Terrorism Risk Insurance Act due to expire in 2005, insurers and policyholders must develop long-term solutions that deliver financial stability and accountability.(Terrorism)
Author:Rosenthal, Marc E.
Publication:Best's Review
Geographic Code:1USA
Date:Dec 1, 2004
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