Treasury Report on Terrorism Insurance Says Backstop Negatively Affects Private Capacity

By Andrea Wells | October 3, 2006

A new federal report has found that the long-term development of the private terrorism insurance market remains at best uncertain due to the unpredictable nature of terrorist attacks.

The President’s Working Group on Financial Markets Terrorism Insurance report says that while the quantity of terrorism risk reinsurance capacity has increased since the period following Sept. 11, the presence of subsidized federal reinsurance through the Terrorism Risk Insurance Act “appears to negatively affect the emergence of private reinsurance capacity because it dilutes demand for private sector reinsurance.”

The report, released by the Treasury Department, is skeptical about the future of a terrorism insurance market. It concludes that the “high level of uncertainty currently associated with predicting the frequency of terrorist attacks, along with what appears to be a general unwillingness of some insurance policyholders to purchase insurance coverage, makes any prediction of the potential degree of long-term development of the terrorism risk insurance market somewhat difficult.”

Insurers claim the federal backstop provided under the Terrorism Risk Insurance Act is the “single reason” that any private insurance market even exists for terrorism risks.

“A growing bi-partisan consensus is emerging in the Congress that is committed to achieving a long-term, market-based solution with a continuing role for the federal government,” said Ben McKay, senior vice president, federal government affairs, the Property Casualty Insurers Association of America. “Over time, the private sector can assume a greater portion of the responsibility, but only with a public-private partnership is there any hope for terrorist insurance to be available and affordable.”

The PWG report comes on the heels of another federal report released by the U.S. Government Accountability Office that concluded that a totally private market solution for insuring against nuclear, biological, chemical or radiological (NBCR) attacks is also unlikely in the near future. The GAO report covered the risk of NBCR attacks only, and did not address insurance for terrorist attacks by more conventional weapons.

“The PWG report and that of the GAO confirm that there remains uncertainty and constraints in the insurance market and in the ability to handle terrorism risk,” said Brendan Reilly, assistant vice president for federal government affairs for the Independent Insurance Agents and Brokers of America.

“In light of both reports, the Big “I” believes these findings highlight the need for a continued federal role for terrorism insurance, including NBCR, the most catastrophic attacks that expose consumers and taxpayers,” added Charles E. Symington Jr., senior vice president for government affairs and federal relations at IIABA. “A continued public-private partnership for terrorism insurance will allow the private sector to take on additional risk, which will serve consumers and protect taxpayers.”

Availability improves
The availability and affordability of terrorism risk insurance has improved since the terrorist attacks of Sept. 11, 2001, according to the PWG report, and despite increases in risk retentions under TRIA, insurers have allocated additional capacity to terrorism risk. Also, prices have declined and purchase rates have increased.

The take-up rate – or the percentage of companies buying terrorism coverage – has reportedly increased from 27 percent in 2003 to 58 percent in 2005, while the cost of coverage has generally fallen to roughly 3 to 5 percent of total property insurance costs. These improvements have transpired in a marketplace that has had access to a federal backstop that has gradually contracted through the life of the temporary TRIA program.

Insurers’ retention of risk has steadily increased under the TRIA program, according to the report. Deductibles have increased from 7 percent of direct earned premium in 2003 to 17.5 percent in 2006, and other changes made to TRIA in 2005 have also increased insurer retentions.

“The general trend observed in the market has been that as insurer retentions have increased under TRIA and policyholder surpluses have risen, prices for terrorism risk have fallen and take-up rates have increased,” the PWG report states.

While take-up rates have increased as prices have fallen, a significant number of policyholders are still not purchasing coverage, according to the report, which finds that the willingness of consumers to pay for terrorism risk insurance is a determinant of how much capital insurers will allocate.

The PWG report claims that the improvement in the terrorism risk insurance market is due to several important factors, including better risk measurement and management, improved modeling of terrorism risk, greater reinsurance capacity, and a recovery in the financial health of property and casualty insurers.

State regulation does not appear to have had a significant impact on capacity, according to the report, and a significant number of policyholders are still not purchasing terrorism coverage.

Nuclear, biological, chemical or radiological
The PWG report agrees with the GAO that coverage for CNBR is unlikely to develop. “[H]istorically, insurance coverage for losses associated with chemical, nuclear, biological, and radiological risks has generally not been widely available unless it was mandated. Insurers generally did not provide CNBR coverage even before Sept. 11, and for the most part they do not provide such terrorism coverage even with a federal backstop in place. Given the general reluctance of insurance companies to provide coverage for these types of risks, there may be little potential for future market development,” it says.

According to the report, the factors determining the availability and affordability of CNBR coverage in the marketplace have more to do with the nature, scale, and uncertainty of the damage and losses from CNBR events – however caused – and less to do with terrorism specifically. What coverage exists today is mostly tied to state mandates, most prominently workers’ compensation insurance, as well as some aspects of fire insurance through the standard fire insurance policy.

In addition, a federal mandate requires some nuclear coverage for reactor operators and some specialty coverage exists. There is virtually no CNBR reinsurance available, and the modeling issues both for exposure and probability become even more complicated for CNBR.

“Both the GAO report and the PWG report made it clear that nuclear, biological, chemical, and radiological (NBCR) risks can only be covered with a federal backstop,” said McKay. “The same can be said for any attack that results in this level of devastation.”

Insurer say that any federal policy developed should refrain from picking winners and losers when it comes to who can provide insurance.

“A competitive private market depends on this,” McKay said. “Study after study confirms that only with a federal backstop in place will it be possible for businesses small and large to secure terrorism insurance.”

To read the full PWG report visit:
http://www.treas.gov/offices/domestic-finance/financial-institution/terrorism-insurance/pdf/report.pdf

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