Order Code RS21106
Updated June 12, 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 no
action was taken. Senate Majority Leader Tom Daschle indicated that backstop
legislation would be considered again in 2002, and on June 7, 2002, Senators Dodd,
Sarbanes, Schumer, and Reid introduced S. 2600, the Terrorism risk Insurance Act.
Meanwhile, there are indications that the insurance marketplace has 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. However, recently the Joint Economic
Committee found that the market for terrorism insurance remains limited, and that the
problems associated with terrorism insurance pose a significant threat to sustained
economic growth. 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
1 For additional information on the impact of September 11 on the marketplace, see CRS Report
(continued...)
Congressional Research Service ˜
The Library of Congress
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primary insurers2 that they will not reinsure future terrorism risks; this has resulted in
primary 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 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 proposed compromise during 2001
also failed.
Senate Majority Leader Tom Daschle indicated that the Senate would readdress the
terrorism insurance issue in 2002. Senator Daschle stated that the Senate would keep a
watchful eye on the insurance market 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. During the early part of 2002, Senate efforts to reach a
unanimous consent (UC) agreement to bring H.R. 3210 to the floor of the Senate and
amend it by substituting the language of a compromise proposal, the Terrorism Risk
Insurance Act, were unsuccessful. On June 7, 2002, Senators Dodd, Sarbanes, Schumer,
and Reid introduced the compromise proposal as a separate bill (S. 2600).4 Members of
Congress from both parties generally agree that liability and potential lawsuits have been
major issues of contention.
Initial Industry Reaction
Some insurance industry leaders indicated at the close of 2001 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
1 (...continued)
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
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 H.R. 3210 and S. 2600, see CRS Report RS21211,
Terrorism
Insurance – Comparison of H.R. 3210 and S. 2600, by S. Roy Woodall, Jr.
CRS-3
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 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
In early 2002, with no terrorism insurance backstop in place, the most dire
predictions had not occurred; major economic problems had not materialized, and the
momentum for legislation had 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 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.
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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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
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 at the end of 2001 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.
Some of 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 J. Robert
Hunter, director of insurance for the Consumer Federation of American, maintains that
terrorism insurance is widely available and any federal backstop should be limited to high
profile buildings in New York and other major cities.16 However, according to
government sources, there is increasing evidence that some sectors of the economy are
beginning to experience difficulties because some properties and businesses are unable
to find sufficient terrorism coverage, at any price. Such was the finding of the General
Accounting Office in its testimony on February 27, 2002, before the Subcommittee on
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 Treaster, “U.S. Is Urged to Be Selective on Terrorism Insurance,”
New York Times,
June 11, 2002, p. C12.
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Oversight and Investigations of the House Committee on Financial Services.17 On May
23, 2002, the Joint Economic committee issued a report (available at
[http://www.house.gov/jec]), which found that the market for terrorism insurance remains
limited, and that the problems associated with terrorism insurance pose a significant
threat to sustained economic growth.
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, go beyond the scope of insurance, and have a negative impact on the nation’s
economy. 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 U.S. General Accounting Office,
Terrorism Insurance – Rising Uninsured Exposure to Attacks
Heightens Potential Economic Vulnerabilities, GAO-02-472T (Washington: Feb. 27, 2002), p.
2.