The PWG Report on the Future of Terrorism Insurance Availability and Affordability: Something for Everyone?

Whither "Make Available"?

The most striking omission from the report's Executive Summary is the failure to even mention the federal law's critically important "make available" requirement. In explaining the success of the federal program since the original law (TRIA) was enacted in late 2002, the PWG paints a deceptive picture of an insurance market that has apparently developed a strong appetite for underwriting terrorism risk. Secretary Paulson's introductory letter to Congress discounts the importance of the federal program by saying that TRIA "has helped support a continued increase in private sector participation in the terrorism risk insurance marketplace."

The lead finding in the Executive Summary then states:

Despite increases in risk retentions under TRIA, insurers have allocated additional capacity to terrorism risk, prices have declined, and take-up (purchase) rates have increased.

Remarkably, the "make available" requirement is mentioned only twice in the report's 80 pages, i.e., once in the Background section (page 13) and a second time in the final section's discussion on CBRN (page 76). Not mentioning this feature of the federal law in the introductory letter to Congress or the Executive Summary, which regrettably is all a lot of people read, is roughly equivalent to discussing the high American troop levels during the Vietnam War, but not mentioning the draft. In a real sense, insurers have been "drafted" into what had been a very small terrorism insurance market before the late 2002 enactment of the federal backstop program.

Although the federal law allows exclusions that otherwise apply to possibly preclude a terrorism loss (notably the nuclear and pollution exclusions in most policies), the unconditional requirement that insurers subject to the law offer TRIA coverage is easily the single most important reason why the terrorism market has stabilized. The PWG report also ignores recent surveys that indicate that a large percent of insurers will leave this market or change their approach if and when the law is allowed to expire (e.g., as reported in the June 2005 Treasury Department "Assessment" report on page 6). The attempt to downplay the importance of the "make available" requirement is, in itself, a strong message that should not be ignored.

Impact of the Softening Property and Casualty (P&C) Market

Although the PWG authors mention the cyclical nature of the insurance marketplace (in their discussion of Economic Framework on page 16), the second conclusion in the Executive Summary gives the complete change in the commercial cycle since 2002 no credit in improving availability or affordability of terrorism insurance. Instead, the report states that the improvement is due to improved modeling, better risk measurement and management, "greater reinsurance capacity," and a "recovery in the financial health of property and casualty insurers" (page 2). The PWG authors frequently cite the Marsh Marketwatch 2006 report, improperly suggesting that the survey's reported reduced property insurance terrorism rates reflect an improved underwriting appetite for terrorism risk.

The PWG authors ignore the fact that, in the 5 years since the September 11 attacks, with the exception of natural catastrophe exposed property insurance, the commercial insurance market has swung from a seller's to a buyer's market. Falling insurance premiums encourage underwriters to offer insurance quotations to accounts that, in a "hardening" market, they would likely avoid. The more competitive commercial market also encourages underwriters to charge less (or even charge nothing) for optional coverage extensions like terrorism insurance that present little probable exposure to loss over the next policy year.

The failure of the PWG report to consider the role of the increasingly competitive P&C market is a serious flaw. One can only assume it is another indirect expression of the administration's ideological opposition to a permanent or continued federal program.

Is Terrorism Risk "Not Inherently Uninsurable"?

In a section entitled "Two Commercial Terrorism Insurance Markets," the PWG report wanders outside its statutorily defined objectives to make one of its most questionable conclusions. In discussing the positive state of the domestic terrorism insurance and reinsurance market (which is not included in the federal TRIA program), the authors suggest that the health of this segment proves that all terrorism is insurable:

Although not the subject of this report, the functioning private market for domestic terrorism risk insurance (not including CNBR) indicates that terrorism risk is not inherently uninsurable." [Emphasis added, page 12.]

This surprising inference ignores at least four practical considerations that encourage insurers to underwrite domestic coverage, particularly whenever the foreign coverage under TRIA is purchased:

• According to the modeling firms, the risk of a major domestic terrorism act is much lower than a foreign-sponsored act.
• Although only modest compared to the charge for foreign coverage under TRIA, some additional premium is permitted if domestic terrorism is included.
• Commercial insurance policies exclude coverage if a given loss is expected or intended from the standpoint of the insured. However, losses from intentional acts by third parties are often insured (regardless of whether the third party is a criminal, a prankster, or a terrorist). For example, commercial property insurance frequently includes coverage for crime, vandalism and malicious mischief. Liability policies normally have a significant duty to defend, and are also exposed to possible vicarious liability claims or allegations that better safety measures should have been taken.
• Terrorism presents a unique insurability challenge in that, by definition under the TRIA law, the intention of the perpetrators and the sponsorship of the act are the critical coverage determinants. As we have seen in the still unknown details of the 2002 anthrax letter attacks, we may never know whether the next attack in the United States qualifies as a "terrorist" act, and whether it is sponsored by a foreign interest or person as required by TRIA.

In combination, agreeing to provide domestic terrorism coverage adds only limited additional exposure, adds some additional premium, and reduces the probability of disputes with policyholders. The sum of these "real-world" factors explains why an ample market for domestic terrorism insurance exists today. Property and liability underwriters have essentially "drawn a line in the sand," agreeing to cover smaller losses regardless of the intentions involved.

Property insurance terrorism exclusions filed by Insurance Services Office, Inc. (ISO), and many insurers do not apply if the total industry insured property loss is less than $25 million (with the exception of CBRN attacks). Liability terrorism exclusions have two thresholds below which the terrorism exclusion does not apply (also excepting CBRN): a total insured property loss of less than $25 million or less than 50 defined "serious injuries" (mainly death or permanent injury).

It is important to note that there is no "line in the sand" that can be established in the uniquely challenged workers compensation line. This is due to the fact that no state allows workers compensation insurers to exclude terrorism risk or place a limit on their coverage.

These practical initiatives do not, in any sense, imply a theoretical underwriting agreement that all terrorism risk is insurable. The PWG report's conclusion is best understood as an inappropriate ideological "zinger." It is an apparent effort to dismiss the important argument that, much like war, terrorism is a uniquely "public" risk essentially different from the "private" risks that are the traditional subjects of the voluntary insurance market.

Conclusion

In conclusion, discounting the PWG report as an ineffectual "something for everyone" addition to the TRIA debate is a mistake. As the terrorism insurance debate resurfaces, the many questionable omissions and conclusions in the PWG report need to be clearly addressed. It is also a mistake to lose valuable time "dancing in the end zone" over the PWG report's concession that CBRN is a long-term problem. In fact, the current focus on CBRN attacks could prove to be dangerously myopic. As we all saw on September 11, 2001, weapons of mass destruction take many forms. Any new solution we develop to ensure the future availability and affordability of commercial terrorism insurance needs to be as dynamic as the terrorism threat itself. It also needs to recognize the unique challenges terrorism risk presents to workers compensation, the single largest line of commercial insurance.