2005
Insurance Reference Manual
Personal Insurance Federation of California Insurance Reference Book
Terrorism & Insurance
The President signed the Terrorism Risk Insurance Act legislation on November 26, 2002, whereby private insurers and the federal government share the risk of future losses from terrorism for a three-year period. With the President's signature, all state exclusions for terrorism are rescinded. Insurers, over the next 90 days, must notify existing commercial policyholders of the existence of the federal backstop, offer comparable terrorism coverage and specify the cost of that coverage. Policyholders have the option to accept or decline the coverage, or negotiate other terms. These provisions apply to new policies written after enactment.
KEY BENEFITS
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This bill brings much needed capacity back to the market at a critical time.
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Without this legislation, insurers were looking at an almost incalculable risk. While still large, the potential risk to individual companies can be quantified and enables the market to function again.
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The bill does not reestablish the status quo that existed before September 11. There has been a fundamental change in the nature of risk in our society -- and the risk of further attacks is real.
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The cost of terrorism coverage will depend on many factors over time, including whether or not there is another event. Current market conditions will not change overnight. There will be added capacity, but individual companies will have to make decisions about the nature and amount of risk they want to insure.
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The reinsurance industry took the most significant hit from September 11, more than half of the losses. They are not currently in a position to assume the same amount of terrorism risk as they were on September 11, which is why the federal backstop is critical.
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Many small- and mid-sized businesses across the country will experience little change. Their premiums are going up for other reasons, but the terrorism coverage itself will not add much to their insurance costs. The major problem remains the threat of chemical, biological, nuclear and radiological attacks on high profile structures or businesses with large concentrations of employees. The bill helps make coverage available, but at least initially, it will be very expensive.
MAJOR FEATURES OF THE LEGISLATION
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An event has to cause $5 million to be certified as an act of terrorism.
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Each participating insurance company will be responsible for paying out a certain amount in claims - a deductible - before Federal assistance becomes available. This deductible is based on a percentage of direct earned premiums from calendar year 2002. The deductible is as follows:
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For losses above a company's deductible, the Federal government will cover 90%, while the company contributes 10%.
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If the Federal government pays for insured losses during the course of a year, the Treasury Secretary will be required to recoup the difference between total industry costs (individual insurers' losses up to their deductibles, plus the industry's 10 percent cost share above the deductibles) and the following fixed dollar amounts per year:
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Even with federal support, the insurance industry's share of the risk is substantial. For example, assuming that the baseline for the program is $125 billion in commercial insurance (direct premium written) and that the next terrorist attack amounts to $30 billion in commercial property and workers compensation loss, the total industry loss would be approximately:
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The recoupment will be accomplished through a surcharge on all policyholders. The surcharge cannot be more than 3% of the premium paid for a policy in a given year.
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Losses covered by the program will be capped at $100 billion; above this amount, Congress is to determine the procedures for and the source of any payments.
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The III estimates the total insured loss for the World Trade Center, Pentagon and Pennsylvania events is $32.5 billion.
Paper: Terrorism and Insurance
JULY 2004
The September 11, 2001 terrorist attack resulted in an estimated $32.5 billion in insured losses. Those losses occurred across many types of coverage, including commercial property, business interruption, workers compensation, aviation, life and disability insurance. Future attacks on U.S. soil are also likely to trigger a wide range of insurance coverages, depending on the type of event and whether policyholders have purchased terrorism insurance.
Terrorism insurance: what it is and what it covers
Terrorism insurance provides coverage to individuals and businesses for potential losses due to acts of terrorism.
Businesses
Prior to 9/11, standard commercial insurance policies included terrorism coverage as part of the package, effectively free of charge. Today, terrorism coverage is generally offered separately at a price that more adequately reflects the current risk.
Insurance losses attributable to terrorist acts under these commercial policies are insured by private insurers and reinsured or "backstopped" by the federal government pursuant to the Terrorism Risk and Insurance Act of 2002 (TRIA). Under TRIA, owners of commercial property, such as office buildings, factories, shopping malls and apartment buildings, must be offered the opportunity to purchase terrorism coverage. A June 2004 report from insurance broker Marsh, Inc., found that the proportion of U.S. businesses that purchased terrorism during the first quarter of 2004 rose to its highest level since the enactment of TRIA in November 2002. According to Marsh, 44.2 percent of U.S. businesses obtained coverage in the first quarter of 2004, up from 32.7 percent in the fourth quarter of 2003.
Individuals
Standard homeowners insurance policies include coverage for damage to property and personal possessions resulting from acts of terrorism. Terrorism is not specifically referenced in homeowners policies. However, the policy does cover the homeowner for damage due to explosion, fire and smoke-the likely causes of damage in a terrorist attack.
Condominium or co-op owner policies also provide coverage for damage to personal possessions resulting from acts of terrorism. Damage to the common areas of a building like the roof, basement, elevator, boiler and walkways would only be covered if the condo/co-op board has purchased terrorism coverage.
Standard renters policies include coverage for damage to personal possessions due to a terrorist attack. Again, coverage for the apartment complex itself must be purchased by the property owner or landlord.
Auto insurance policies will cover a car that is damaged or destroyed in a terrorist attack only if the policyholder has purchased "comprehensive" coverage. Most people who have loans on their cars or lease are required by lenders and leasing companies to carry this optional form of coverage. People who buy liability coverage only are not covered in the event their vehicle is damaged or destroyed as the result of a terrorist attack.
Life insurance policies do not contain terrorism exclusions. Proceeds will be paid to the beneficiary as designated on the policy.
Under what circumstances is there coverage?
For the terrorism coverage to be triggered under TRIA for commercial policies, a terrorist attack has to be declared a "certified act" by the Secretary of the Treasury.
No such declaration is needed to trigger coverage under home and auto policies because there are no exclusions for terrorism.
In some states a doctrine know as "fire following" applies. This means that in the event of a terrorist-caused explosion followed by fire, insurers could be liable to pay out losses attributable to the fire (but not the explosion) even if a commercial property owner had not purchased terrorism coverage. Insurers are now seeking to limit fire coverage resulting from a terrorist attack, because commercial policyholders that choose to reject TRIA or other terrorism coverage are effectively paying no premium for the protection offered by fire-following coverage. So far, seven states have amended their standard fire policy laws to exclude acts of terrorism.
What is not covered?
There are long-standing restrictions regarding war coverage and nuclear, biological, chemical and radiological (NBCR) events in both personal and commercial insurance policies.
War-risk exclusions reflect the realization that damage from acts of war is fundamentally uninsurable. No formal declaration of war by Congress is required for the war risk exclusion to apply. Nuclear, biological, chemical and radiological attacks are another example of catastrophic events that are fundamentally uninsurable due to the nature of the risk. Under the Terrorism Risk Insurance Act (see below), if some NBCR exclusions are permitted by a state, an insurer does not have to make available the excluded coverage.
Business Interruption Insurance
Property damage to commercial buildings from a terrorist attack also may include claims for business interruption. Business interruption insurance (sometimes referred to as business income coverage) covers financial losses that occur when a firm is forced to suspend business operations either due to direct damage to its premises or because civil authorities limit access to an area after the attack and those actions prevent entry to the business premises. Coverage depends on the individual policy, but typically begins after a waiting period or "time deductible" of two to three days and lasts for a period of two weeks to several months.
Business interruption losses associated with acts of civil authority (e.g., closure of certain area around the disaster) can only be triggered when there is physical loss or damage arising from a covered peril (e.g., explosion, fire, smoke, etc.) within the area affected by the declaration. The loss/damage need not occur to the insured premises specifically. Reductions in business income associated with fear of traveling to a location, in addition to closure to areas by authorities because of a heightened state of alert, would not be covered by business interruption policies.
Workers compensation and other coverages
Workers compensation -- a compulsory line of insurance for all businesses -- covers employees injured or killed on the job and therefore automatically includes coverage for acts of terrorism. Workers compensation is also the only line of insurance that does not exclude coverage for acts of war. Coverage for terrorist acts cannot be excluded from workers compensation policies in any state.
There are essentially three types of workers compensation benefits. The first reimburses workers for lost wages while they recover from their injuries. The second covers workers for all medical expenses incurred as a result of the injuries they sustain. The third type of benefit provides payments to the families of workers killed on the job.
Life/health and disability insurance policies may provide coverage for loss of life, injury or sickness to individuals in the event of a terrorist attack.
What is the Terrorism Risk Insurance Act (TRIA)?
TRIA is a public/private risk-sharing partnership between the federal government and the insurance industry. The program is designed to ensure that adequate resources are available for businesses to recover and rebuild if they become the victims of a terrorist attack.
Specific provisions of the legislation are:
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An event must cause at least $5 million in aggregate property and casualty insurance losses to be certified by the Secretary of the Treasury as an act of terrorism.
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The bill is limited to international terrorism committed on behalf of any foreign person or foreign interest on U.S. soil. (Damage to an air carrier or vessel outside the U.S., or to a the premises of a U.S. mission is covered by TRIA, however)
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Each participating insurer is responsible for paying out a certain amount in claims - a deductible -- before Federal assistance becomes available.
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For losses above a company's deductible, the federal government will cover 90 percent, while the insurer contributes 10 percent.
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The aggregate insurance industry retention in 2004 is $12.5 billion in 2004 and $15 billion in 2005.
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Losses covered by the program are capped at $100 billion.
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Lines excluded from the program are: personal lines (auto and home), assumed reinsurance, federal crop, mortgage guaranty, financial guaranty, medical malpractice, flood insurance and life & health.
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The Act sunsets after three years on December 31, 2005.
Does TRIA affect the availability and price of coverage?
Yes, by sharing potential losses from terrorist attacks between private insurers and the government, TRIA has brought much needed additional capacity to the terrorism market. Before TRIA, businesses were left with little or no terrorism coverage, but now they are able to purchase the cover they need.
Terrorism coverage is very difficult to price because the frequency and severity of an attack is so unpredictable. Pricing of terrorism coverage varies according to the individual risk (based on factors such as location and industry, for example), but it is clear that TRIA has had a stabilizing influence on the market.
Does an insurer have to make terrorism coverage available?
Yes. Under TRIA, all property and casualty insurers in the U.S. are required to make terrorism coverage available. The "make available" provision applies to commercial lines of p/c insurance. Insurers are required to make an offer of coverage for "certified acts" to policyholders. If the insured rejects an offer, the insurer may then reinstate a terrorism exclusion.
Under TRIA, the "make available" provision was scheduled to sunset at the end of 2004. However, in June 2004, the Treasury Department extended this provision through the end of 2005.
What if terrorism coverage has not been purchased and a loss occurs?
A business that has not purchased TRIA or other terrorism coverage will not be covered for damage caused to their property by a terrorist attack. An individual that has homeowners or renters coverage may be covered, according to the individual terms of their policy.
Will TRIA expire? What happens if it does?
TRIA is scheduled to expire on December 31, 2005 and the threat of future catastrophic terrorist attacks on U.S. soil remains very real. Unless TRIA is extended by the United States Congress, any commercial insurance policy with an inception date beyond January 1, 2005 will include a period where no federal "backstop" is in place. Attacks occurring on or after January 1, 2006 could be financially destabilizing and lead to insurer insolvencies. Consequently insurers and regulators are developing language that would allow insurers to exclude losses associated with terrorist attacks (except workers compensation losses). Regulators in the majority of states approved such exclusions in the pre-TRIA period.
Today, dozens of business groups and professional societies, as well as individual corporate risk managers, insurance agents and brokers support a two-year extension of TRIA. Failure to renew TRIA would leave insurers and the wide range of businesses, organizations and individuals that they service, vulnerable to economic disaster in the event of another catastrophic terrorist attack.
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