Order Code RS21106
January 15, 2002
CRS Report for Congress
Received through the CRS Web
Terrorism Insurance - The 2002 Marketplace
S. Roy Woodall, Jr.
Insurance Consultant
Government and Finance Division
Summary
The terrorist attacks of September 11 resulted in the largest insured catastrophic
loss in history, estimated to total as much as $70 billion. Even though the insurance
industry committed to pay losses resulting from the attacks, industry spokesmen asserted
that in view of the impending unavailability of terrorism reinsurance on January 1, 2002,
primary insurers would not be able to cover future terrorism losses on renewals of
commercial risk policies without a federal backstop.
In the 107th Congress, first session, the House of Representatives passed H.R. 3210
on November 29, 2001, providing for a temporary federal backstop. In the Senate, four
similar measures were introduced (S. 1743, S. 1744, S. 1748, and S. 1751), but after
weeks of negotiations no action was taken. Senate Majority Leader Tom Daschle
indicated that backstop legislation would be considered again in 2002. Meanwhile, there
are indications that the insurance marketplace will have made strides toward resolving
a major part of the terrorism coverage issue and federal legislation may be less likely to
have its originally intended impact. This report looks at the terrorism insurance
marketplace in 2002 in the absence of federal legislation, the economic outlook for the
insurance industry, and the regulatory responses of state insurance officials. This report
will be updated as events warrant.
After the terrorist attacks of September 11 (9/11), the market for terrorism risk
insurance changed substantially. Previously, most property and casualty insurance policies
covered the risk, not as a specific named risk, but within general coverage provisions, and
usually at no separately stated premium. With insured losses from 9/11 now estimated to
total as much as $70 billion, making it the largest insured catastrophic loss in history,
insurers have indicated that even though they would pay the claims on the 9/11
occurrence, they would not do so for future such events.1 Reinsurers have told primary
insurers2 that they will not reinsure future terrorism risks; this has resulted in primary
1 For additional information on the impact of September 11 on the marketplace, see CRS Report
RS21075, Terrorism Insurance in the Post September 11 Marketplace, by S. Roy Woodall, Jr.
2 Primary or “retail” insurers spread the risks they assume in their policies by purchasing
(continued...)
Congressional Research Service ˜ The Library of Congress

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insurers saying that they would not be able to issue policies to the public covering
terrorism in the absence of such reinsurance or a specific exclusion of the terrorism risk.3
Since some 70% of the annual reinsurance contracts in force on 9/11 were to expire on
January 1, 2002, a major effort was undertaken by the insurance industry and other
business interests to get Congress to pass a bill creating a temporary backstop that would
assure the availability of terrorism insurance until the market could have sufficient time to
adjust to the problem and devise a market based solution.
Congressional Activities in 2001
In recognition of the potential economic disruption from a lack of terrorism risk
insurance, the 107th Congress, first session, considered several measures which called for
a temporary federal backstop. On November 29, 2001, the House of Representatives
passed H.R. 3210, providing for a one-year government commitment to backstop private
insurers against losses resulting from confirmed terrorist events. Any assistance would
be in the form of loans to be repaid subsequently by insurers through a series of
assessments and surcharges levied upon policyholders. Four bills were introduced in the
Senate (S. 1743, S. 1744, S. 1748, and S. 1751), but none passed before the Senate
adjourned on December 20. Efforts to agree on a last minute proposed compromise also
failed. The Senate bills varied in several aspects, but were consistent in calling for federal
assistance to be in the form of grants that would not be repaid, rather than loans.4
Senate Majority Leader Tom Daschle has indicated that the Senate will readdress the
terrorism insurance issue in 2002. Senator Daschle stated that the Senate would keep a
watchful eye on the insurance market in the coming weeks and would take the appropriate
action in 2002 to respond to any problems that might arise if the Senate did not pass
legislation addressing the terrorism insurance issue. Members of Congress from both
parties generally agreed that liability and potential lawsuits were major issues of
contention.
Initial Industry Reaction
Some industry leaders indicated that they would try again in 2002 to get the Senate
to adopt a bill. Others, however, opined that it would be too late, and that as policies
were renewed in 2002, insurers would be forced to raise their premiums substantially,
exclude coverage for the terrorism risk from their policies, write it as a separate coverage,
or just walk away from providing it altogether. Rodger Lawson, president of the Alliance
of American Insurers, said that two things could happen in early 2002 that would force
Congress to move quickly on terrorism insurance. The first would be if another major
terrorist event were to occur and most policyholders found themselves with no coverage,
and the second would be if a major upcoming event such as the Super Bowl or the Winter
2 (...continued)
reinsurance contracts from reinsurers.
3 For more on insurance exclusions, see CRS Report RL31166, Insurance Exclusions Clauses and
Coverage of the Events of September 11,
by Christopher A. Jennings.
4 For additional information on the bills considered by Congress, see CRS Report RL31209,
Terrorism Risk Insurance: A Summary of Legislative Proposals, by Rawle O. King.

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Olympics were to be hampered by a lack of terrorism coverage. He added, however, that
Congress might decide simply to handle uninsured terrorism losses on a disaster basis, by
approving payments after future terrorist events.5 At this juncture, with no terrorism
insurance backstop in place, the most dire predictions have not occurred; major economic
problems have not materialized, and the momentum for legislation has waned.6
Market Reaction
As anticipated, the demand for insurance, especially terrorism insurance, increased
after 9/11. At the same time, the industry’s capacity for risk shrank as a result of both the
9/11 related claims and the negative effects of a 10-year soft market.7 In the absence of
a federal backstop, market forces have reacted as economic theory would predict, by
insurers increasing premiums, utilizing terrorism exclusions, or refusing to write terrorism
insurance except, perhaps, as a separate coverage.
With the increase in demand for insurance and the drop in supply, prices started to
increase substantially. According to a report of the Insurance Information Institute, 8 the
rate of increases in most commercial lines of coverage for 2002 before 9/11 was to have
been in the 10% to 15% range as a result of the hardening of the market in the normal
underwriting cycle. However, after 9/11, the rate of increases for 2002 renewals for many
of the same lines roughly doubled to 30%, on average. In other lines of coverage, such
as worker’s compensation, liability protection against lawsuits, and property coverage for
skyscrapers in New York, Chicago, and Los Angeles that are considered prime terrorist
targets, prices were running five or six times the level of a year ago.9 The premium
increases have cut into the actual amount of terrorism insurance demanded, and big
insurance buyers in many cases are now choosing either to opt for low-level coverage, or
to forgo insurance altogether (self-insure), thus taking the risk of future major terrorist
events upon themselves.
Terrorism Exclusions
The reluctance of reinsurers to reinsure primary insurers for the terrorism risk and
the inability of primary insurers to shoulder the entire terrorism risk themselves has
resulted in the increased use of terrorism exclusions in new policies. Under most state
insurance laws, such exclusionary clauses are subject to regulatory approval and must be
5 Steven Brostoff, “Hope Lives for Terrorism Reinsurance Bill,” National Underwriter, Property
& Casualty/Risk & Benefits Management Edition Online News Service
,
[http://www.nunews.com/pande], visited Dec. 28, 2001.
6 Christopher Oster and Michael Schroeder, “Workers’ Comp Insurance Now Harder to Get,” Wall
Street Journal,
Jan. 9, 2002, pp. A3,A9.
7 For a discussion of the insurance market cycle, see Gregory Alff, “Returning from a Deep Soft
Market and the Largest Catastrophe in History,” Risk Management, Jan. 2002, pp.18-26.
8 Dr Robert P. Hartwig, Ph.D., “Earlybird Forecast 2002,” Insurance Information Institute,
[http://www.iii.org/media/industry/financials/forecast2002], visited Dec. 14, 2001.
9 Joseph B. Treaster, “Insurer’s Outlook (Unexpectedly) Good, Despite Big Claims,” New York
Times,
Dec. 17, 2001, p.C4.

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filed with state regulators. This has placed regulators in a not unusual regulatory conflict:
a desire to ensure that consumers can be protected against insurable risks, and their duty
not to force insurers to assume unmanageable risk and thereby increase their risk of
insolvency. The Insurance Services Office (ISO) has filed proposed terrorist exclusions
for over 200 insurers. The original filings were made in November and December 2001,
and contained a complete terrorism exclusion in anticipation of congressional action.

When Congress adjourned without having passed legislation, the regulators voted
through their trade association, the National Association of Insurance Commissioners
(NAIC), to recommend that the states approve filings of a modified exclusion submitted
by the ISO for commercial lines that would only cover losses arising from smaller acts of
terrorism. In consideration that Congress might still pass legislation early in 2002, the
regulators also recommended that approvals of even the modified exclusions be withdrawn
15 days after the President signs a bill.10
The ISO’s modified terrorism exclusion language for commercial lines is applicable
only if one or more of the following are attributable to an incident of terrorism:
! the total of insured damage to all types of property exceeds $25 million;
! 50 or more persons sustain death or serious physical injury;
! the terrorism involves the use, release or escape of nuclear materials; or
! the terrorism is attempted or carried out by means of the dispersal or
application of pathogenic or poisonous biological or chemical materials.
In other words, terrorism coverage is included so long as the insured losses resulting from
a terrorist event are less than $25 million; fewer than 50 persons are killed or seriously
wounded; and nuclear, biological or chemical materials are not involved. The ISO
indicates that the intent of the modification of the original complete exclusion is to provide
coverage for smaller events–such as bombing an abortion clinic– which might be defined
as terrorism.11 The exclusion clause also provides that multiple incidents of terrorism
which occur within a 72 hour period and appear to be carried out in concert, or to have
a related purpose or common leadership, shall be considered to be one incident. As of
January 10, 2002, according to the ISO, and since December 26, 2001, the modified
terrorism exclusion clause for commercial lines had been approved in 44 states, the
District of Columbia, and Puerto Rico. However, the states of New York and California
were not among them. With the increase in the use of terrorism exclusions, a new market
appears to be developing for the sale of terrorism insurance as a separate line of coverage,
not part of any commercial lines package, but generally at high prices.
10 The ISO has informed CRS that it has also started making filings for terrorism exclusions for
personal lines of insurance (e.g. homeowners), but the NAIC has not yet addressed this issue.
11 Daniel Hays, “ISO Filings Now Cover $25 Million Terror Loss,” National Underwriter,
[http://www.nunews.com], visited Jan. 4, 2002.

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2002 Outlook
Although 2001 was arguably the most difficult and trying year in the history of the
property-casualty insurance industry, the forecasts for 2002 suggest that the industry will
emerge from the financial shock of 9/11 with its best prospects for growth in many years,
as underwriting performance improves substantially. With increased premiums and a high
demand for insurance coverage, the industry could grow at its fastest pace since 1986.12
Analysts point to the big surge in insurance prices after Hurricane Andrew in 1992 and the
resulting increase in profits as the insurers more than recouped their losses. Standard and
Poors predicts that the upward surge in reinsurance pricing that accelerated after 9/11 also
paints a very positive near-term earnings picture for the global reinsurance industry. It
predicts that reinsurers will benefit across the board in the near term, and points out that
the investment and lending communities which supply the industry with funds have not
missed this opportunity. Reinsurers have already raised approximately $25 billion in new
capital since 9/11, $6.5 billion going into startup operations and $18 billion going into
existing reinsurance operations. In return, the investment and lending communities are
looking for 25% to 30% returns on equity.13 The increased premium rates could also
cause insurers to look at innovative capital market alternatives developed following
Hurricane Andrew, such as catastrophe bonds, in which insurance risk is transferred to
bond holders through the broad and deep capital markets.
The dire economic disruptions predicted in the absence of congressional agreement
on a terrorism backstop have not yet become apparent. In particular, banks have not
stopped their financing for clients who lack terrorism insurance. Instead, banks are
charging somewhat higher fees for some customers who are going without terrorism
coverage, when there is a perception of increased risk of default as a result.14 Lenders
have not tightened credit, however, and apparently do not plan to do so for the vast
majority of projects; federal bank regulators have indicated that they are not planning to
put out any guidance since they have not seen any curtailment of lending.15
There has been, however, some scrambling by owners of high-profile properties to
determine alternatives to proceeding without terrorism insurance, according to the Real
Estate Roundtable, which is working in conjunction with the General Accounting Office
(GAO) to gather evidence as to any problems in the insurance market.16 The GAO report
is to be presented at hearings before the House Financial Services Committee, tentatively
set for January 23, 2002. In a January 7 conference call initiated by Administration
officials, business leaders from the insurance, real estate, and banking industries were told
that the White House needs hard evidence of any market problems to continue to make
12 Hartwig, “Earlybird Forecast 2002,” p. 1.
13 Donald S. Watson, “Reinsurance Outlook 2002: Pricing Surge Bullish For Earnings,” published
Dec. 18, 2001, available at [www.standardandpoors.com], visited Dec. 18, 2001.
14 Christopher Oster, “Terror-Insurance Costs Cut Into Demand,” Wall Street Journal, Jan. 4,
2002, p. A4.
15 Michele Heller, “In Focus: No Terror Insurance, But Lenders Still Lending,” American Banker,
Jan. 7, 2002, pp. 1-2.
16 Joseph J. Schatz, “Insurers Ask States for Shelter from Terrorism Losses,” CQ Monitor News,
Jan. 4, 2002, available at [http://oncongress.cq.com], visited Jan. 7, 2002.

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a case for a federal backstop. Karl Rove, the President’s chief political advisor, was
quoted as saying, “The world was supposed to collapse on December 31 and we’re still
around.”17
The major question for federal intervention remains: at what point is terrorism no
longer an insurable risk? To the extent that the insurance industry can underwrite the
terrorist risk, it will do so, earn a profit, and help to increase economic stability in the
process. But at some point terrorist events, by their massiveness or unpredictability, can
cross a line and be beyond the scope of insurance. In such cases, federal intervention may
be warranted on economic efficiency grounds, whether on a temporary backstop basis (as
considered to date), or on an after-the-fact disaster relief basis. It remains to be seen
where the events of 9/11 have redrawn that line.
17 Jackie Spinner, “Bush Aides Seek Evidence of Insurance Woes,” Washington Post, Jan. 8, 2002,
p. A8.