S&P: Company Ratings Could Suffer in Federal-State Squeeze on Terrorism Risk

November 13, 2001

Commercial insurers face a potentially untenable situation if the federal government fails to pass legislation that would help cushion terrorism costs to the industry by the end of November, and if state insurance regulators do not allow terrorism exclusions from commercial policies by year-end, Standard & Poor’s reported.

With recent delays in passing federal backstop insurance legislation and no clear indication that the states will allow policy exclusions, it is becoming more likely that insurers may have to choose between continuing to offer terrorism coverage and withdrawing completely from commercial risks. Either choice would result in rating downgrades, S&P said.

“With each day that federal legislation is not passed, pressure mounts on commercial insurers to withdraw from lines of business that unduly expose their capital to these potentially large and unpredictable risks,” commented Steve Dreyer, head of insurance ratings at S&P. “To ensure continuity of coverage through 2002, the industry and insurance regulators would need at least a month, we believe, to react to federal government legislation.”

In an article entitled “Mitigating Terrorism Risks is Key to Maintaining Insurer Ratings” published on Oct. 23, S&P warned that insurer ratings could fall if underwriters opted to continue offering terrorism coverage into the new year absent support from reinsurers or the federal government. Reinsurers have signaled their intent to exclude coverage for terrorism risk.

“While many companies are willing to provide commercial insurance cover excluding these risks, they have generally found state regulators unreceptive to allowing terrorism exclusions on commercial insurance policies. If legislation is not passed and state regulators do not allow exclusions, property/casualty insurers that concentrate on commercial lines will be caught in a squeeze that could have serious financial consequences,” Dreyer said.

Should insurers withdraw from business risks altogether, or place a moratorium on business risks, the resulting impact on revenue and cash flow could have a serious credit impact, resulting in pressure on ratings. Concerned that Congress may fail to protect insurers in time from inestimably large terrorism-related claims, and with the practical difficulties with gaining state approval for new policy exclusions, insurers have begun to send provisional notices of non-renewal to corporate customers whose policies expire on or before year-end.

Insurers have had success in obtaining exclusions for certain types of large risks, such as for environmental pollution, asbestos, and for the so-called Y2K computer risk. Terrorism risk, however, poses some complications, including the lack of a consistent definition of the peril and covered risks, the approaching Jan. 1 renewal deadline and the broad range of insurance classes affected.

Insurers have been reluctant in the past to continue to offer coverage when perceptions of risk change dramatically and suddenly. Several major insurers abandoned Florida in 1992 after Hurricane Andrew, which far exceeded its predecessors in terms of wind speed and resultant damage. Two years later, some insurers withdrew from the California home insurance market following the Northridge Earthquake, which surprised seismologists and actuaries by causing substantial damage from a type of fault that had not been seen in previous California earthquakes. Eventually, state government-sponsored risk pools and opportunistic new market entrants combined to restore coverage in these markets.

The S&P report goes on to say that because terrorism risk is not localized in any single state or region, insurers would need to withdraw from certain business lines nation-wide to avoid potentially devastating terrorism-related losses. For some insurers, that would mean shutting down much of their business production.

The events of Sept. 11 changed dramatically the risk profile of commercial property/casualty insurers by revealing a class of hazard not previously witnessed or priced by the market. As a group, insurers have sufficient capital to pay for the resulting claims, but do not have capacity to absorb additional unexpected losses of similar magnitude. The primary insurance industry faces a further challenge in terms of the reinsurance market, which may elect to exclude terrorism, and leave the insurance market with a net risk. As indicated in the earlier article, insurers that continue to expose capital to terrorism risk invite downgrades of S&P credit ratings.

According to the Insurance Services Office Inc., commercial lines insurers’ premium grew nearly 18 percent in the first half of 2001, but incurred claims grew at a faster pace.

Overall, commercial lines’ insurers lost 10.6 cents for every dollar of premium income, before consideration of investment income in the first six months. Undoubtedly, underwriting losses will increase as the results of terrorist attack claims hit third-quarter results.

Meanwhile, in the wake of Sept. 11, all U.S. airports and operators of airport-related facilities received notification that their war risk and terrorism coverage had been canceled. Potential losses from acts of war and terrorism had been included as part of most airport operators’ comprehensive liability coverage, usually subject to a 15-day notice of termination. Currently, many airports are without coverage while others have signed new policies as the market has come back, albeit at higher prices and lower coverage levels typically capped at $50 million in losses.

The airport industry organizations are seeking either a legislative solution to explicitly provide some federal relief or an administrative interpretation that would allow the insurance provisions extended to the airlines in the Air Transportation Safety and System Stabilization Act to be broadened to include airports. On Sept. 20, 2001, S&P placed all North American airports and related special facilities on Credit Watch with Negative Implications due to many issues confronting the industry.

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