• U.S. Senate Banking, Housing and Urban Affairs Committee Considers TRIA Terrorism Risk Act Reauthorization
  • September 27, 2013
  • Law Firm: Colodny Fass Talenfeld Karlinsky Abate Webb P.A. - Fort Lauderdale Office
  • The U.S. Senate Banking, Housing and Urban Affairs Committee held a hearing today, September 25, 2013, entitled "Reauthorizing TRIA: The State of the Terrorism Risk Insurance Market."

    In his opening statement, Chairman Tim Johnson (D-SD) framed the issues surrounding the pending sunset of the Terrorism Risk Insurance Act ("TRIA"):

    "Two weeks ago, we observed the 12th anniversary of the tragic September 11th terrorist attacks on our country.  In the aftermath of the tragedy and after suffering steep losses, insurance companies stopped offering terrorism coverage as part of their commercial property policies.  This had a destabilizing impact on various parts of our economy.

    "Congress responded by creating the Terrorism Risk Insurance Program to provide a narrow and targeted government backstop for this insurance coverage.  The program proved helpful, creating certainty for many businesses, including developers, construction companies, commercial lenders, as well as private insurance markets.

    "The program has since been reauthorized by Congress twice.  The last time, Congress made very few changes and extended the program for 7 years.  It is my hope that once again we will be able to find bipartisan consensus for the reauthorization of TRIA well before the program expires at the end of 2014.

    "While a few may seek dramatic changes or even try to eliminate the program, we should remember that taxpayers have not lost any money on the program. The program's unique structure has fully protected taxpayers while promoting economic growth by preventing interruptions in insurance coverage and providing certainty for commercial property developers working on stadiums, universities, malls and other projects across the country.

    "Today, we review the state of the terrorism risk insurance market, and I look forward to hearing from our witnesses about how the current program has functioned and the ongoing need for the same limited government backstop we already have in TRIA."

    Dr. Robert Hartwig, President and Economist; Insurance Information Institute

    In his testimony, Dr. Hartwig said that, in 2012, more than 60 percent of businesses purchased terrorism coverage nationally--a dramatic increase from only 27 percent that did in 2003, the first full year of TRIA.  Industries responsible for much of America's critical infrastructure, such as power and utilities, telecommunications, health care, financial institutions and local government have take-up rates that approach or exceed 70 percent.  Moreover, he said, the take-up rate for workers' compensation is effectively 100 percent, meaning that, with TRIA, every worker in America is protected against injuries suffered as the result of a terrorist attack.

    Capital markets are playing an increasingly important role in providing capacity against losses arising from large natural disaster events that are becoming more frequent in the United States and beyond, Dr. Hartwig explained.  Capital market reinsurance capacity for U.S. natural catastrophe risks is estimated at $30-40 billion.

    However, investor appetite for catastrophe risk has been limited so far to natural catastrophes such as hurricanes and earthquakes, he said.  Investors are attracted to backing natural disaster risks, partially because the performance of these assets is entirely uncorrelated with that of traditional financial market instruments such as stocks and bonds.  A recession, for example, would impact the value of stocks and corporate bond prices, but will have no impact on the likelihood of sustaining a loss on a catastrophe bond.

    To date, Dr. Hartwig explained, investors have shown no appetite for terrorism risk because, in the event of a major terrorist attack, the performance of securitized terrorism risk instruments (such as catastrophe bonds) and traditional equity market and fixed income investment vehicles is likely to be highly correlated.  For example, a large-scale terrorist attack could cause bonds exposed to the event to lose all or part of their value, leading to large losses for investors, while stock markets plunge (as they did in the wake of the September 11, 2001 attack).  Investor disinterest in terrorism risk is also a function of the inability to model and therefore price such risks with anything close to the same degree of precision as tradition natural disaster risk, he said.

    Dr. Hartwig outlined how acts of terror violate all four of the basic requirements traditionally associated with insurability of a risk.  In situations where these requirements cannot be met, it is difficult or impossible to ascertain the premium to be charged and/or difficult or impossible to achieve the necessary spread of risk to avoid excessive exposure to catastrophic loss, thereby threatening an insurer's solvency.  Consequently, such a risk would generally be deemed to be commercially not viable (i.e., insurable), even partially so.

    According to Dr. Hartwig, those four requirements of insurability are:

    Estimable Frequency:  Insurers require a large number of observations to develop predictive, statistically sound rate-making models (an actuarial concept known as "credibility")

    Estimable Severity:  Insurability requires that the maximum possible/probable loss be estimable in order to calculate the insurer's exposure (in dollar terms) and minimize "probability of ruin."

    Diversifiable Risk:  Insurability requires that losses can be spread across a large number of risks.

    Random Loss Distribution/Fortuity:   Insurability requires that the probability of a loss occurring be random or fortuitous.  This implies that individual events must be unpredictable in terms of timing, location and magnitude.

    Additional issues Dr. Hartwig included for consideration in conjunction with consideration of a TRIA reauthorization include:

    • Certification Deadline:  While TRIA provides highly detailed criteria for an event to be officially certified as a "terrorist act," it offers no timeline or deadline by which such a certification must be made.

    Cyber-Terrorism:   The threat both to national security and the economy posed by cyber-terrorism is a growing concern for governments and businesses worldwide, with critical infrastructure such as power plants, transportation and communication infrastructure at risk.  The U.S. Department of Homeland Security received reports of some 198 attacks on critical infrastructure systems in the U.S. in 2012--a 52 percent increase from 2011.

    Peter Beshar, Executive Vice President and General Counsel; Marsh & McLennan Companies

    In his testimony, Peter Beshar, Executive Vice President and General Counsel for Marsh & McLennan Companies ("Marsh") cited heavily from his company's April 2013 report on TRIA, the only survey of its kind, and which sampled nearly 2,600 Marsh clients across the U.S. on purchasing patterns for 17 industry sectors by region, and their take-up and premium rates.

    Interestingly, Mr. Beshar said that, among U.S. captive insurers managed by Marsh, 25 percent of those underwrite at least one TRIA-specific program.  Additionally, hundreds of owners of captives provide some element of terrorism coverage.

    Calling TRIA a "model example of what a public-private partnership should be, Marsh offered three recommendations for further refining and modernizing the TRIA program, which the company believes should be re-authorized for a minimum of 10 years.

    1.    Nuclear, Biological, Chemical and Radioactive Agent ("NBCR") Coverage - Marsh recommends that Congress specifically clarify during the reauthorization process that coverage should be provided by TRIA for all forms of terrorism (i.e., conventional and NBCR) if coverage is afforded on the primary policy.  For instance, there is ambiguity in the market currently as to whether TRIA covers workers' compensation in the event of an NBCR-related act.  In fact, a leading rating agency recently stated that NBCR-related events remain outside of TRIA coverage.  It is Marsh's view that TRIA would cover workers' compensation losses if a certified NBCR event occurred.

    2.    Cyber Terrorism - In her farewell address, former Secretary of Homeland Security Janet Napolitano cautioned that "Our country will, at some point, face a major cyber event that will have a serious effect on our lives, our economy, and the everyday functioning of our society."  According to Marsh, whether it is one or a series of cyber-attacks, the impact of a "cyber 9-11" could be crippling, particularly if the attack were directed at one or several of the nation's critical infrastructures such as telecommunications networks, food and water supplies, or health care institutions.  Currently, there is uncertainty if TRIA would cover an act of cyber-terrorism that resulted in catastrophic loss.  There is no clear language in the law stating that cyber-terrorism would fall within the scope of TRIA.  Marsh therefore recommends that Congress analyze the best way to address this new terrorism risk in its consideration of TRIA's reauthorization.

    3.    Clarify Certification Process - Currently, TRIA enumerates specific requirements for an act to be certified as terrorism.  However, the process by which an act of terrorism is certified remains uncertain and there is no mandated timeline for determining an event's certification.  Marsh's recommendation is to include language in any reauthorization bill that clearly delineates a certification protocol and establishes a 90-day time period after an event for determining whether or not an act of terrorism is covered by TRIA.

    Mr. Beshar recalled that, in 2005 and again in 2007, Congress appropriately expanded the role of the private insurance market for terrorism risk and reduced the scope of the backstop provided by the federal government by increasing the program trigger from $5 million to its current level of $100 million, while also raising deductibles and co-share arrangements, and establishing the federal government's entitlement to recoup any payouts that are made.  Therefore, policymakers could revisit these same areas to further expand the private market role for conventional acts of terrorism, he said, while being mindful that large-scale attacks--both conventional and NBCR--require a federal backstop.

    Third-party groups from across the political spectrum have suggested significant changes, from abolishing the program completely, to dramatically increasing the role of the private sector, Mr. Beshar said.

    The following is Marsh's range of estimates based on the ongoing discussion for TRIA reforms:

    1.  Company deductible:

    • May be increased from 20 percent in line with growth in reinsurance industry surplus

    2.  Aggregate threshold:

    • Industry aggregate loss trigger may be increased from $100 million to $1 billion or more over time

    3.  Company co-insurance:

    • Potentially increase insurers co-participation from 15 percent to 20 percent or more

    In advocating a TRIA reauthorization, Mr. Beshar also warned senators that if the program is not reauthorized, potential market disruption could occur on two fronts:

    First, he said, the fact that insurers' capital has increased does not mean that, in the absence of TRIA's mandatory "make available" provision, insurance carriers would offer terrorism coverage in the future.  Marsh believes there is a meaningful risk that, if TRIA is not renewed, many property and casualty carriers will decline to underwrite this difficult-to-model peril.

    The second area of concern is workers' compensation insurance.  Terrorism exposure presents a unique challenge for that line of business, because--with few exceptions--states require coverage to be provided on an unlimited basis without the option to exclude any form of terrorism.  Whether TRIA exists or not, workers' compensation carriers must pay claims without regard to fault; however, TRIA at least provides a backstop, he said.

    Without that backstop, however, there is a substantial risk that workers' compensation carriers will decline to provide coverage in high-risk areas.  That would potentially have a chilling impact on economic development and job creation, Mr. Beshar explained.

    Erwann O. Michel-Kerjan, Professor and Managing Director, Center for Risk Management and Decision Processes; The Wharton School, University of Pennsylvania

    In his presentation, Wharton School Risk Management Professor Erwann O. Michel-Kerjan contemplated the following questions:

    • How is TRIA currently designed and has it achieved its goal? Is there room as part of the reauthorization process for modifying TRIA without disrupting the market?
    • Why (he has) argued that letting TRIA expire would increase taxpayers' financial exposure to terrorist attacks, not reduce it.
    • How have other countries that are members of the Organisation for Economic Co-operation and Development addressed the terrorism risk coverage challenge?

    Professor Michel-Kerjan noted that, in the discussion about TRIA's future, there has been no recent analysis of terrorism insurance market penetration for small businesses, which constitute a vital part of the U.S. economy and are the most vulnerable to financial shocks.

    While surveys from leading brokers have provided a great deal of information about how much terrorism coverage their clients purchase and how much they pay for it, he said, these surveys do not indicate much about how sensitive that demand is to changes in terrorism insurance cost.  A recent analysis shows that terrorism insurance is very "price inelastic," a finding that has profound policy implications as Congress contemplates different design changes for the law, he cautioned.

    The Professor also noted that, based on his research, firms that bought that coverage really need and/or want it.  These businesses would keep demanding the coverage even if insurers were to slightly increase the premiums they charge.

    If TRIA deductibles were slightly increased from the current 20 percent, he said, there would likely be no market impact.  When deductibles increased in prior years, no significant demand change was evidenced.

    Further, if TRIA were to be modified so the federal government now charged for the financial protection it currently provides (as is done in a number of other countries), insurers could pass part of this cost to the firms.  Most likely, he said, if the surcharge was reasonable and incremental, it would not result in significant market disruption, either.

    In another recent study, Professor Michel-Kerjan related that he performed an economic analysis to evaluate how the supply of an additional unit of coverage differed between terrorism insurance (with government intervention) and property insurance (without it) with TRIA in place.  Evidence was found that insurers in the U.S. are much less diversified for terrorism coverage than they are for property lines of coverage and, to some extent, for other types of catastrophe risks (e.g., wind and flood).  According to Professor Michel-Kerjan, this means that they would more easily provide additional coverage to a client for terrorism risk than for these other risks.

    This result can be interpreted in two ways, he said.  While there might be some occurrence of "gaming," some insurers might be taking on much more terrorism risk with the current free up-front reinsurance from the federal government than they otherwise would, knowing that, under TRIA, they collect all the terrorism insurance premiums but are responsible for only a portion of the loss.

    On the other hand, this also means that insurers have provided much more capacity to this market that they would have done otherwise, which was precisely the intent when TRIA was designed.  Given the strong demand for terrorism insurance, Professor Michel-Kerjan explained, this has been an important reason for TRIA's success.

    Going forward, he recommended that senators ponder these questions:

    • Should chemical, biological, radiological and nuclear terrorist attacks be covered or not?
    • Should cyber attacks be covered and, if so, which ones?
    • Should the federal government continue to provide free coverage or should it charge for it?  If a charge, what would be regarded as a fair premium?
    • How involved are reinsurers in the U.S. terrorism risk insurance markets today?  How much more capacity could they provide; at what level, and at what price?  How is reinsurance capacity and price likely to change in the aftermath of a large terrorism attack?
    • While TRIA focuses on commercial lines, who will pay for the losses to residents from a terrorist attack?
    • How do we address the workers' compensation challenge if TRIA expires?