Congress Should Help, Not Hinder, Private Terror Insurance Markets

Earlier this week, I took part in what I found to be a lively and enlightening panel discussion on the Terrorism Risk Insurance Act, the now-12-year-old federal program that provides a $100 billion reinsurance backstop for terrorism-related claims in the workers’ compensation, commercial property and commercial liability insurance markets.

Set to expire at the end of the year, TRIA continues to divide business interests, who have called for a speedy renewal and extension (some even suggest the program should be permanent) and free-market partisans, some of whom argue it should be allowed to sunset. We at R Street have attempted to carve out something of a middle ground, conceding that some federal role in insuring terrorism is likely inevitable, particularly for workers’ comp and for nuclear events, while arguing that there are key improvements that should be made to protect taxpayers and shift more risk back on to the private sector.

After a series of fits and starts over the past year and a half, Congress may finally be ready to start debating the topic in earnest. Last week, a bipartisan group of Senate Banking Committee members – including Sens. Chuck Schumer, D-N.Y.; Dean Heller, R-Nev.; Mark Kirk, R-Ill.; Jack Reed, D-R.I.; Chris Murphy, D-Conn.; and Mike Johanns, R-Neb. – introduced a reauthorization bill that is expected to serve as the main legislative vehicle in the upper chamber.

The measure extends the program for an additional seven years. Importantly, unlike other extension bills that have been filed thus far, it makes some changes, albeit minor ones, to the program’s terms. While preserving the current deductible (20 percent of prior year direct earned premiums in covered lines) that must be paid by industry before the backstop kicks in, it increases the co-payment paid by private insurers for amounts above that deductible to 20 percent from the current 15 percent.

What’s more, while current law has a provision requiring the government to recoup at least $27.5 billion of any expended funds, using post-disaster assessments, the proposed Senate bill would raise that mandatory recoupment to $37.5 billion. (The Treasury would maintain discretionary authority as to whether to recoup larger amounts.)

Both provisions, which would be phased in over a five-year period, represent improvements over the current law. Our preferences would be to go much further – to scrap the post-event recoupment model altogether and have companies pay premiums upfront; to significantly raise the “trigger” mechanism, which currently is just $100 million, but could easily be upped to $5 billion or even $10 billion; and to end altogether any backstop for commercial liability insurance, which as a public policy matter, currently amounts to subsidizing companies for behavior a court has found to be reckless.

But beyond simply shrinking the TRIA program itself, we hope Congress will place a greater priority on seeking ways to encourage private capital to play a bigger role in the market for terrorism insurance. And most importantly, we would urge Congress not to head down certain roads that could result in crushing that market altogether.

As R Street Associate Fellow Ernie Csiszar told the House Financial Services Committee last fall, adopting a more uniform and sensible regulatory framework, including appropriate accounting and fiscal guidance, could go a long way toward encouraging the burgeoning insurance-linked securities market to take on terrorism risks. Securitization of terrorism-related risks has gotten a bad rap, basically ever since the existence of DARPA’s proposed Policy Analysis Market – developed in part by George Mason University economist Robin Hanson – was unfairly tarred as “betting on terrorism” by a handful of opportunistic senators. But given the enormous rush of institutional investors into the reinsurance sector in recent years, and the accompanying soft market in which all players are scrambling to find yield, it would be utterly irresponsible not to seek ways to turn those market forces toward solving the thus-far intractable problem of getting the private sector to play a bigger role in insuring against terrorism.

Congress also could examine the tax treatment of catastrophe reserves to provide insurers and reinsurers financial incentives to increase their capital and expand capacity for terrorism risks without endangering their solvency or contractual commitments. One idea to do just that – developed by R Street Associate Fellow Larry Mirel and introduced as legislation in 2011 by Rep. Eleanor Holmes-Norton, D-D.C. – would designate the District of Columbia as a special tax jurisdiction where catastrophe reserves and related investment income set aside by insurers and reinsurers could be deposited free of federal income tax.

Perhaps the greatest looming threat to the existing private market for terrorism insurance is the potential for changes to the tax treatment of affiliate reinsurance. Both the White House’s proposed 2015 budget and in bills introduced by Rep. Richard Neal, D-Mass., and Sen. Bob Menendez, D-N.J., propose disallowing some or all of the deduction for reinsurance purchased by U.S.-based insurers from affiliates located overseas.

This protectionist proposal, which also was included in a tax reform package floated by the Senate Finance Committee last fall, would almost certainly drive up the cost and drive down the availability of private insurance and reinsurance to cover catastrophic terrorism. In fact, analysis of one version of the proposal conducted by the Brattle Group found the tax would reduce the supply of reinsurance (for all types of perils) to the United States by 20 percent and raise prices paid by insurers by between $11 and $13 billion.

There are obvious practical limits on how far Congress can be expected to go, either in scaling back TRIA or in opening new paths for private capital to insure terrorism. But first, they should endeavor to do no harm.

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