Can the stand-alone market withstand TRIA ending?

The market of last resort may soon become the only option for thousands of policyholders if the Terrorism Risk Insurance Act (TRIA) sunsets and property/casualty carriers stop offering terrorism coverage.

With a recent government report suggesting that TRIA should not be extended — and the renewal season coming up quickly — reinsurers, carriers and policyholders are taking a fresh look at the stand-alone terror insurance market.

Dismissed by many in the P/C industry as too expensive and with too little capacity, stand-alone terror insurance was intended to act as a market of last resort for the few property owners that needed terror coverage, but had it stripped from their all-risk policies following the attacks of Sept. 11, 2001.

In a post-TRIA environment, the question for carriers and policyholders alike may no longer be whether to provide or purchase stand-alone terror coverage, but how and at what price.

“If my cover expires in February 2008 and my loan covenants require some sort of terror policy, the potential of no TRIA brings up some serious questions,” says Robert V. Blumber, managing director and head of the terrorism specialty group for Marsh.

TRIA was signed into law in November 2002 as a federal government guarantee for terrorism risk insurance. The government acted essentially as a reinsurer, offering carriers a backstop for their P/C programs if a terror event caused a large loss.

TRIA was set to expire on Dec. 31, 2005, but at the last minute, Congress passed the Terrorism Risk Insurance Extension Act of 2005 (TRIEA), set to expire on Dec. 31, 2007.

A long-awaited report issued from the Presidential Working Group on Financial Markets — which includes the treasury secretary and heads of financial regulatory agencies — argues that the backstop has done its job and a private-sector solution is now needed for terrorism coverage.

The report argues that TRIA may be stymieing the stand-alone market. “[TRIA] negatively affect[s] the emergence of private reinsurance capacity because it dilutes demand for private sector reinsurance,” the report argues. If TRIA did not exist, the argument goes, additional private sector capacity would enter the market.

Existing capacity in the stand-alone terror market is around $1.3 billion, according to Aon Corp. Participants that offer the coverage include Lloyd’s, Berkshire Hathaway and Bermuda-based Axis Specialty. Aon says rates range from .025 percent to 1 percent of the total value of the property.

Often, the availability of stand-alone coverage depends on where the property is located and the insurer’s aggregate exposure. In some cities, such as New York or London, capacity is tighter and premiums are higher because of the perceived greater terrorism risk.

New entrants and the lack of any large claims may have allowed the stand-alone terror insurance market to prove its viability and make it resilient enough to act responsively without a government backstop, says Martin Roberts, a managing director at Lloyd’s Market Association in London.

“There are some that argue that now the stand-alone market is established, it would act like any other market,” he says. “If there were a large claim [after TRIA], prices would go up and new capacity would come in that would increase competition, thus lowering prices.”

Marsh’s Blumber says policyholders and insurers will need to consider how to structure their property/casualty programs during the upcoming renewal season, keeping in mind the stand-alone market could see a swarm of activity if it looks like TRIA may expire. “The aggregates [of stand-alone terror insurers] could get used up fairly quickly and they would stop writing,” he says. “That means it would be issued on a first-come, first-serve basis.”

But the government is kidding itself if it believes the stand-alone market could make up for the capacity that would be removed if TRIA ends, says Dr. James Valverde Jr., vice president of economics and research for the Insurance Information Institute.

“All of the available data shows the total size [of the stand-alone market] is around $10 billion,” he says. “I don’t think that even comes close to the reality [of potential losses] in today’s terrorism environment.”

Valverde argues that the reinsurance capacity offered by the government has artificially supported the stand-alone market. Since insurers are essentially getting “free reinsurance” through TRIA, they have been able to put their capital into stand-alone programs.

“It certainly begs the questions of what happens if TRIA goes away,” Valverde says. “I think that what was readily available will be scarce, and what was affordable will become expensive.”

Insurers may be inclined to stop offering terrorism coverage because — unlike windstorm and earthquake risks — there isn’t any reliable data to support underwriting and pricing the policies, says Lisa Stimson, a senior manager with KPMG’s Financial Risk Management practice in Hartford, Conn. “It’s almost impossible because there is not sufficient loss history from which to predict future claims” she says.

Stimson also says TRIA’s “make available” provision now requires commercial property/casualty companies to offer terror cover, however they would be free to withdraw if the law expires. “Although some may continue some terrorism coverage [without TRIA], it is likely that the vast majority would likely exclude it from their policies or that any coverage offered would be unaffordable or inadequate.”

Even proponents of a private-market solution and boosters of the stand-alone market argue that scenario could be chaotic without some sort of federal terrorism backstop in place.

“There is new capacity coming [to the stand-alone market], and there is more competition on rate, so it’s beginning to act like a legitimate funding source for terrorism risk,” Blumber says. “But it’s not a long-term solution, especially for large events that could shake the entire industry.”

The unpredictability of terrorism, and its capacity to create losses across all lines of business that could run into the billions, means that the stand-alone market’s effectiveness is limited, Roberts says.

“There are the mega-catastrophe events, which could deplete capital quickly and cause a loss of confidence in the stand-alone market,” he says. “There is also the possibility of a ‘circle-swarm’ of attacks, which would be a large number of smaller events of a long period of time.

“Both situations would cause the market to act abnormally,” Roberts says.

Christopher Westfall is the managing editor of KPMG Insurance Insider, a biweekly electronic newsletter covering audit committees. KPMG Insurance Insider can be accessed at Article reprinted from KPMG Insurance Insider with permission of KPMG LLP. © 2006 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved.