The Terrorism Risk Insurance Act (TRIA) was passed in November 2002 to provide terrorism coverage subsequent to 9/11. The insurance industry incurred huge losses due to 9/11, estimated to be as much as $70 billion.

The most obvious impact of 9/11 on the insurance industry is premium increases, but the underwriting process has also been affected. Insurers have begun declining coverage for white-collar employers in urban areas, traditionally viewed as a low-risk exposure and, correspondingly, easy to place and low in premium.

Due to the heavy losses, experience rating has become an area of concern. The State of New York decided that 9/11 claims will be coded as "Catastrophe 48," and that such claims will not be included in the employer’s experience rating as they do not accurately reflect loss experience. Other states have followed this reporting model, but it remains a question as to whether they will also exclude the 9/11 claims from employers' experience ratings.

Stand-alone terrorism coverage is now in demand in the United States. Prior to 9/11, there was demand mainly in the Middle East and in other areas where terrorism attacks were more prevalent. In the twelve months following 9/11, Lloyds of London wrote in excess of $100 million of stand-alone terrorism coverage. Other markets include AIG, Berkshire Hathaway and ACE USA.

An item of note is that these stand-alone policies do not attempt to coincide with an insured’s existing property coverages, and may result in coverage gaps.

Because reinsurers effected new terrorism exclusions as of 1/1/02, domestic carriers were unable to spread the risk of terrorist losses through reinsurance. As a result, insurance companies pursued two avenues: contract language that would exclude terrorism losses and a federal backstop.

Most of the terrorism exclusions were absolute, but a few offered coverage for damage by an ensuing fire. Even so, these concessions carry relatively low limits ($2.0 - $5.0 million).

For its part, the Insurance Services Office (ISO), the industry’s rate making and policy form provider, replaced the existing war exclusions on its policy forms with war and terrorism exclusions that are similar to those already being used by some insurers.

The ISO forms came up with two quantitative thresholds for triggering the exclusion:

• The exclusion applies when property damage reaches $25 million of insured damage (both direct damage and bodily injury) within a 72-hour period. It's important to note that this $25 million threshold applies to all insured property damage under all policies written by all insurers. Therefore, the exclusion may be applicable to an insured with far less than $25 million in insured property.
• The exclusion applies when fifty or more people are killed/seriously injured.

In addition, the forms included absolute exclusions for losses due to nuclear, chemical and biological weapons. The National Association of Insurance Commissioners (NAIC) endorsed the ISO forms and, to date, 45 states have approved them.

The States of California and New York refused to approve these ISO filings. Among California's reasons are that the bodily injury and physical damage thresholds are too low (New York agrees), and that the total exclusion of losses due to biological and chemical agents is too broad. Given the widespread concerns about this type of terrorism, California's objections seem to be well-founded.

The market conditions subsequent to 9/11 reveal the industry's reason for pursuing a federal backstop. No premiums were collected for the specific peril of terrorism, since it had never been a serious consideration before 9/11. Now, insurance carriers are liable for up to $70 billion in claims, which must be paid from their capital. In addition, the lack of established statistical models and rates hindered the availability of terrorism coverage. Hence, the passage of the Terrorism Risk Insurance Act of November 2002 (TRIA).

What is TRIA's intent?

The intent is to make terrorism coverage available to all insureds. According to the International Risk Management Institute, an "act of terrorism" must be certified by the Department of Treasury as such, in addition to the following:

• It must be a violent act or an act that is dangerous to human life, property, or infrastructure.
• It must have resulted in damage within the United States, or to an air carrier as defined in the United States code, or to a U.S. flag vessel or other vessel based principally in the United States and insured under U.S. regulation, or on the premises of any U.S. mission (e.g., an embassy or consulate).
• It must have been committed by someone acting on behalf of a "foreign person or foreign interest, as part of an effort to coerce the civilian population of the United States or to influence the policy or affect the conduct of the U.S. Government by coercion."
• It must produce property and casualty insurance losses in excess of $5 million.

Acts occuring during a declared war are not included, except as respects workers' compensation claims. This should not be a surprise as war exclusions existed before 9/11.

Who must comply?

Compliance is required of all commercial insurers writing business in the U.S.; NAIC-listed surplus lines carriers; federal-approved companies offering maritime, energy or aviation-related insurance and state funds. At this juncture, the language appears to include captives domicilied within the United States or fronted by domestic carriers.

How is the cost divided among insurers and the federal government?

Each carrier has a threshold that is based on direct premiums earned during previous year. For this year, the deductible is 7%. In 2004, it will increase to 10%; in 2005, it will increase to 15%. Insurers must retain 10% of all insured losses in excess of this threshold, and the federal government will pay the remaining 90%. There are no provisions within TRIA for payment of losses that exceed the $100 billion per year cap.

How does the federal government recoup the funds?

If payments by insurance carriers fall below the specified "insurance marketplace aggregate retention," they must repay the difference to the federal government. In 2003, that aggregate retention amount is $10 billion; in 2004, it is $12.5 billion; in 2005, it is $15 billion.

The federal government can also institute a premium surcharge on property and casualty insurance policies, limited to 3% of the policy premium.

What are the notification requirements?

TRIA requires that all renewals or new offers after November 26, 2002 reflect a "clear & conspicuous" disclosure of the premiums charged for terrorism coverage.

What is the penalty for noncompliance?

There is a $1,000,000 penalty for noncompliance.

Certainly, TRIA was passed with the best intentions.

However, there are outstanding issues with its implementation. Specifically:

• The high (and graduated) deductibles mean that carriers are still vulnerable to huge losses.
• TRIA required the provision of terrorism coverage without establishing the rates, which led to inconsistencies in premiums. Business Insurance reports: "...TRIA does nothing to address the issue of pricing; actuaries still have just the one, horrifically unique data point to work with. Insurers are left trying to price a product that, in the current environment, remains an unwritable risk."
• Admittedly, terrorism is not a new phenomenon and, for numbers alone, it is possible to look at similar losses incurred elsewhere in the world. A key point to consider is that while these types of costs can certainly be quantified, predictability and extent of damage are entirely different issues altogether, when taking into consideration the sociopolitical overtones of such a peril.
• TRIA did not include coverage for nuclear, biological or chemical attacks, which are perceived to be likely risks.

Further, the language seems to include captives as well, even those that have a remote chance of dealing with terrorism claims (captives that provide accountants' or attorneys' malpractice, for example). Even so, captives could still be subject to government surcharges under TRIA.

The inclusion of captives is seen to be counter to their original purpose. Briefly, the Liability Risk Retention Act of 1986 exempted captives from participation in guaranty funds (like TRIA) because they are forms of self-insurance among certain participants. Subjecting captives to government surcharges can deter businesses from maintaining captives. The captive industry is trying to work with the Department of the Treasury to see if there is more flexibility.

The Council of Insurance Agents and Brokers (CIAB) conducted a telling market survey:

1. Are clients buying the terrorism coverage?
   • 48% of producers said that fewer than 1 in 5 of their biggest accounts (netting $100K revenue per year) purchased it.
   • 65% said that fewer than 1 in 5 of small accounts (netting $25K per year) purchased it.
   • 62% said that fewer than 1 in 5 of midsize accounts purchased it.
2. Why so little interest?
   • They don’t consider themselves targets of terrorism and/or the cost is too high.
   • The larger the account, the greater the cost of terrorism coverage, as a percentage of premium.
   • Clients feel that it doesn't doesn’t do any good since it doesn't require coverage for nuclear, biological or chemical losses.

The survey indicates that the industry welcomes the higher rates, but not the added exposure to perceived terrorist targets. This aversion is easy to understand, given that domestic carriers can no longer rely on reinsurance to share the risk.

As respects domestic terrorism coverage, some carriers do not charge an additional premium, while others are excluding it altogether.

In closing, the Terrorism Risk Insurance Act simply buys time for the industry to put together a long-term solution for the provision of terrorism coverage while it heals from the symptoms of a hard market and 9/11. TRIA expires three years from inception, and these are ambitious goals for a relatively short duration. Given the challenges that insurers face, we will just have to wait and see if TRIA achieves its intended purpose.

Sincerely,
Maria Villafuerte
Associate
Equity Risk Partners, Inc.