Key Elements of PCI’s ‘Market-Based’ Plan for Terrorism Risk Insurance

July 27, 2005

Key Elements in a Market-Based Approach to Terrorism Insurance

Property Casualty Insurers Association of America
Presented to the House Financial Servcies Committee
July 26, 2005

Fundamental Objectives
Fundamental objectives to be achieved by a market-based approach to the problem of terrorism insurance risk.
1. Protect the economy against the risk of terrorist attack – continue high level federal support to finance and bear the shock of an attack.
2. Encourage the development of robust private markets to assume more of this risk over time:
• Make improvements in insurance markets to promote their ability to respond.
• Enable and encourage the development and growth of market tools to add private sector layers of coverage wherever possible.
3. Reduce taxpayer exposure to insurance and terrorism risk over time – reduce federal support in a measured, orderly manner that encourages private capital markets to assume more of this risk.

Protect the economy against terrorist attacks
Terrorism remains an uninsurable risk with catastrophic exposures well beyond the capacity of private insurance markets to bear. The threat of a major terrorist attack remains the single biggest risk to the economy.
1. Continue federal protection of the economy against the threat of terrorism through a terrorism insurance program. Provide for a measured and orderly transfer of risk to market-based solutions as private markets are able to assume more risk.
2. End the TRIA distinction between domestic and foreign terrorism. Add “soft roll off” language for unexpired policies written while the program is still in effect.
3. Continue the mandatory offer of terrorism insurance coverage to the consumer, but no mandatory purchase by the consumer. No coverage will be provided to the consumer if they don’t accept the mandatory offer and no non-program extraordinary federal assistance outside the program will be forthcoming after an attack. This is essential to the development of a viable private market.
4. Address the significant terrorism exposure facing homeowners by including a required study of the risk to homeowners, the coverage that currently exists in the market, and potential policy options to address this risk.

Encourage the development of market solutions to assume more of this risk
1. Enable and encourage development of a terrorism catastrophe bond market to bring new non-insurance capital into the market.
• Create a facility intended to provide a private market for pre-event catastrophe bonds and encourage the development of this market.
• Use a free-market auction process to solicit non-insurance private capital to determine how much capital will be freely offered and the risk premium required to attract new capital.
• Encourage any insurance terrorism pools to use the catastrophe bond process in order to encourage development of this market.
• Encourage (or require) Treasury to participate in this market as an “investor of last resort” for some period of time in order to support its development and growth and to demonstrate the viability of the market.
• Address necessary questions of accounting and tax treatment to provide insurers with appropriate and attractive incentives to use this facility.
• Create a special terrorism catastrophe bond “commission” charged with developing and implementing this facility. Give this commission authority to make these decisions subject to appropriate federal regulatory (i.e., Treasury) review.
2. Enable the creation of a facility to allow insurers to share some of the additional risk assumed as federal support declines and provide individual insurers the voluntary option to reduce their own attachment point to some acceptable level.
• Allow any assets held in the facility to accumulate tax-free. At the same time, consider keeping pre-event asset accumulation to a minimum, in order to reduce inefficiencies in capital allocation.
• Allow the facility to issue post-event bonds to finance losses above the level of accumulated assets. Allow use of a mandatory, policyholder surcharge to amortize these bonds over time.
• Beyond minimum level mandatory participation, offer the opportunity for insurers to purchase additional reinsurance coverage from the facility to “buy down” their exposure to a more manageable level.
• Give the facility the ability and encouragement to purchase private reinsurance in the market given that the facility may be a more attractive and more diversified risk.
• Give the facility incentives to use new capital sources, such as newly-developed catastrophe bonds. This is intended to provide additional sources of capital to the terrorism risk market and to encourage development of this market.
• Create a special facility commission charged with developing and implementing an operating plan for this facility, determining appropriate accounting treatment, and addressing other questions. Give this commission authority to make these decisions subject to appropriate federal regulatory (i.e., Treasury) review.
3. Make meaningful improvements in the ability of private markets to assume risk by introducing greater market freedom. This is intended to allow current participants to expand their participation in the market wherever possible and attract new capital not currently in the market. To attract capital, market participants must be able to
negotiate acceptable terms of coverage, obtain prices commensurate with the risk, and earn a competitive rate of return.
• Provide rating freedom for terrorism coverage using the TRIA language from the first year of the program.
• Repeal the remaining 16 commercial Standard Fire Policy laws in the states to allow more innovative commercial property coverage options to develop over time.
• Clarify that states will not have power to mandate provision of terrorism coverage in the absence of federal protection.
4. Establish the ability for insurers to establish and build voluntary pre-event terrorism catastrophe reserves to better allow them to manage risk and risk appetite. Ensure that the decision to use this vehicle is voluntary and that funds used for this purpose remain with the insurer.

Reduce taxpayer exposure to insurance and terrorism risk over time.
1. Reduce taxpayer exposure over time by means of a gradual increase in the individual company deductible – perhaps by one percent per year. Another alternative might be to reduce federal involvement (and raise the individual insurer attachment point) as alternatives take hold and provide new capacity. Use a measured, orderly process to encourage capital markets to respond and enter this market.
2. If the TRIA “payback” of taxpayer funds continues to be used, recognize that the payback must not be allowed to disrupt or artificially tilt the competitive balance between insurance and non-insurance financing mechanisms.

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