What the Reauthorization of TRIA Means to the P/C Industry

On Dec. 26, President George W. Bush signed the Terrorism Risk Insurance Program Reauthorization Act of 2007 to reauthorize the federal backstop for seven years.

First and foremost, reauthorization of TRIA means it is working. Without a federal backstop, the real estate, hospitality, transportation, construction and other industries would operate in an environment of extreme financial uncertainty. TRIA has enabled economic stability and fostered continued growth of not just the insurance industry, but the entire business sector, as well as international markets.

Many outside of our industry do not understand the critical importance of reinsurance markets. According to one estimate, reinsurers covered as much as 80 percent of insured 9/11 losses. Since 2002, we have felt the repercussions of tenuous bi-annual renewals of TRIA in the reinsurance market as the law approaches sunset. Having a seven-year window should help stabilize reinsurance markets.

The reduced uncertainty associated with TRIA has had an immeasurable effect on insurance pricing and should play an even more important role in the next seven years. Insurance prices are directly proportional to the perceived risk of insured exposures as measured by their predictability, frequency and potential severity. A federal backstop limits the maximum possible loss faced by the industry, again reducing uncertainty.

Increased certainty fosters availability and reduces affordability problems. The ready availability of terrorism coverage and the steady decline, aside from general hard market influences, in the cost of terrorism coverage is a testament to the role of TRIA in stabilizing the insurance marketplace.

The signing of the bill also means that we have a seven-year window of opportunity to address several issues that were tenuous when the long-term existence of TRIA was uncertain.

First, this time frame should encourage an increased private market risk transfer capacity through the refining of predictive terrorism risk models, loss reserving and increasing the availability of reinsurance for all P/C exposures.

Even with TRIA, there have been instances of workers’ compensation market availability problems because of exposure concentrations and lack of reinsurance capacity. Due largely to the unlimited medical expense provisions of workers’ comp laws, worst case scenario model predictions indicate the possibility of a terrorism event that would create workers’ compensation liabilities alone that would exceed 50 percent of the entire industry’s TRIA-exposed surplus. Because terrorism coverage is mandated by workers’ compensation statutes by the absence of statutory exclusions, given the size of the exposure, the TRIA backstop is indispensable.

Second, it is critical that more small- to mid-sized businesses participate in TRIA via the purchase of terrorism insurance to avoid adverse selection and a drive-up in pricing.

According to Marsh, on average, more than 60 percent of larger businesses have terrorism coverage and, needless to say, the penetration is far greater in high profile cities and industries. Unfortunately, there are no reliable numbers for small- to mid-sized businesses. Anecdotal evidence indicates that, unless terrorism coverage is required as an underwriting condition of risk acceptance, the number is well below that figure for direct property coverages.

It is safe to say that the number is significantly lower for indirect property coverages, despite the fact that one-third of 9/11 insured claims were attributable to business income losses. Purchase of terrorism insurance for liability exposures is reportedly far lower than property exposures, despite relatively low premiums. One reason cited for that is the inability to conceptualize the risk presented by terrorism from the standpoint of legal liability of the business.

According to some agent feedback, many smaller risks purchase terrorism insurance only if required to do so by lenders, government entities and other parties that have some control over such insurance requirements. The reticence of those businesses to purchase terrorism insurance seems based largely on a low perceived risk or cost/value of the coverage.

Third, it is critical that the industry take the lead in encouraging, fostering and enabling improved risk management and loss control.

Hurricane Katrina demonstrated the challenge of responding to wide-scale catastrophic loss and the importance of coupling loss control with insurance and a formal disaster plan. Yet, indications are that few of us have heeded this lesson.

The results of a poll conducted for the Council for Excellence in Government and the American Red Cross before and during Hurricane Katrina, and then replicated two months later, showed that 38 percent of Americans were not motivated at all by Hurricanes Katrina and Rita to prepare for an emergency. Only 12 percent said that they have done a great deal to prepare for a natural disaster, terrorist attack or other major emergency.

Those figures illustrate one of the potential pitfalls of a catastrophic insurance program akin to what some allege has happened with national flood insurance. We must be careful that TRIA does not create a false sense of security and dampen the urgency for emergency planning and loss control. That can be mitigated by the industry via the development of underwriting and loss control incentives and premium discounts that can reduce premiums and redirect the savings toward prevention and mitigation measures.

Finally, the issue of chemical, nuclear, biological and radiological (CNBR) terrorism perils must be addressed, and the study of this issue is contemplated in the bill.

No standard insurance policies cover CNBR exposures, including most terrorism coverage forms. Because of their catastrophic nature, those exposures have long been considered uninsurable by the private sector. According to some predictive models, losses arising from the detonation of a nuclear device in New York City could approach $800 billion.

Topics Catastrophe Profit Loss Workers' Compensation Reinsurance Market Property Casualty