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83–472 PDF 2002

S. HRG. 107–805

TERRORIST RISK INSURANCE

HEARING

BEFORE THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

ON

HOW THE INSURANCE INDUSTRY SHOULD RESPOND TO RISKS POSED

BY POTENTIAL TERRORIST ATTACKS AND THE EXTENT TO WHICH

THE GOVERNMENT SHOULD PLAY A ROLE ALONGSIDE THE INDUSTRY TO ADDRESS THESE RISKS, IN LIGHT OF SEPTEMBER 11, 2001,

AND HOW THESE DECISIONS WILL EFFECT INSURANCE COVERAGE

AND PREMIUMS ON PROPERTY AND CASUALTY REINSURANCE CONTRACTS AS THEY COME UP FOR RENEWAL

OCTOBER 24 AND 25, 2001

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

DANIEL K. AKAKA, Hawaii

PHIL GRAMM, Texas

RICHARD C. SHELBY, Alabama

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN ENSIGN, Nevada

STEVEN B. HARRIS, Staff Director and Chief Counsel

WAYNE A. ABERNATHY, Republican Staff Director

SARAH KLINE, Counsel

AARON KLEIN, Economist

STACIE THOMAS, Republican Economist

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator

GEORGE E. WHITTLE, Editor

(II)

(III)

CONTENTS

WEDNESDAY, OCTOBER 24, 2001

Page

Opening statement of Chairman Sarbanes ........................................................... 1

Opening statements, comments, or prepared statements of:

Senator Gramm ................................................................................................ 2

Senator Schumer .............................................................................................. 9

Senator Bunning ............................................................................................... 11

Prepared statement ................................................................................... 73

Senator Bayh .................................................................................................... 11

Senator Miller ................................................................................................... 12

Senator Stabenow ............................................................................................. 12

Senator Corzine ................................................................................................ 13

Senator Carper ................................................................................................. 13

Senator Allard ................................................................................................... 13

Senator Bennett ................................................................................................ 31

WITNESSES

Bill Nelson, A U.S. Senator from the State of Florida ......................................... 4

Prepared statement .......................................................................................... 73

Paul H. O’Neill, Secretary, U.S. Department of the Treasury ............................. 14

Prepared statement .......................................................................................... 75

R. Glenn Hubbard, Chairman, Council of Economic Advisers ............................. 37

Prepared statement .......................................................................................... 79

Kenneth A. Froot, Andre ́ Jakurski Professor of Finance, Harvard

University, Cambridge, Massachusetts .............................................................. 50

Prepared statement .......................................................................................... 81

Kathleen Sebelius, President, National Association of Insurance

Commissioners, Commissioner of Insurance, the State of Kansas .................. 53

Prepared statement .......................................................................................... 86

J. Robert Hunter, Director of Insurance, Consumer Federation

of America ............................................................................................................. 55

Prepared statement .......................................................................................... 94

Thomas J. McCool, Managing Director, Financial Markets and Community

Development, U.S. Government Accounting Office ........................................... 58

Prepared statement .......................................................................................... 99

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

The following statement was submitted on behalf of the following associations

and their members:

American Council for Capital Formation, Associated General Contractors of

America, American Resort Development Association, Building Owners and

Managers Association International, International Council of Shopping Centers, Mortgage Bankers Association of America, National Apartment Association, National Association of Industrial and Office Properties, National

Association of Real Estate Investment Trusts, National Association of Realtors, National Multi Housing Council, Pension Real Estate Association,

The Real Estate Board of New York, The Real Estate Roundtable, dated

October 24, 2001 ................................................................................................... 121

Page

IV

THURSDAY, OCTOBER 25, 2001

Opening statement of Chairman Sarbanes ........................................................... 131

Opening statements, comments, or prepared statements of:

Senator Gramm ................................................................................................ 145

Senator Dodd .................................................................................................... 147

Senator Corzine ................................................................................................ 151

Senator Reed ..................................................................................................... 154

Senator Carper ................................................................................................. 155

WITNESSES

Leslie M. (Bud) Baker, Jr., Chairman, Wachovia Corporation, representing

The Financial Services Roundtable .................................................................... 133

Prepared statement .......................................................................................... 172

Robert E. Vagley, President, American Insurance Association ........................... 134

Prepared statement .......................................................................................... 173

Ronald E. Ferguson, Chairman, General Re Corporation, representing

The Reinsurance Association of America ........................................................... 136

Prepared statement .......................................................................................... 176

John T. Sinnott, Chairman and CEO, Marsh, Inc., representing

The Council of Insurance Agents and Brokers .................................................. 139

Prepared statement .......................................................................................... 179

Thomas J. Donohue, President and CEO, U.S. Chamber of Commerce ............. 161

Prepared statement .......................................................................................... 181

Thomas J. O’Brien, Senior Vice President of Finance and Chief Financial

Officer, LCOR, Inc., representing The Real Estate Roundtable ...................... 163

Prepared statement .......................................................................................... 183

Walter K. Knorr, Chief Financial Officer, City of Chicago, Illinois ..................... 166

Prepared statement .......................................................................................... 185

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Statement of Steve Lehman, FCAS, MAAA, Vice President for

Property/Casualty, Amercian Academy of Actuaries, dated October 25,

2001 ................................................................................................................... 185

Statement of The American Council of Life Insurers, dated October 25, 2001 .. 187

Letter submitted by The Financial Services Roundtable, dated

October 10, 2001 ................................................................................................... 193

Statement of The Independent Insurance Agents of America, dated

October 25, 2001 ................................................................................................... 196

Statement of Marc H. Morial, Mayor of New Oreleans, Lousiana and

President, U.S. Conference of Mayors, dated October 30, 2001 ....................... 197

(1)

TERRORISM RISK INSURANCE

WEDNESDAY, OCTOBER 24, 2001

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, DC.

The Committee met at 10:10 a.m., in room SC–5 of the Capitol

Building, Senator Paul S. Sarbanes (Chairman of the Committee)

presiding.

OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

Chairman SARBANES. The Committee will come to order.

We have a number of important witnesses this morning and

therefore, I am going to make a very brief opening statement. I

would invite my colleagues to do the same.

[Laughter.]

It is just an invitation. It is a request, not a demand.

This is the first of 2 days of hearings that the Banking Committee intends to hold on the issue of terrorism insurance in light

of the attacks of September 11. Since that day, the Congress has

been moving in a number of directions to respond to the challenges

that has been presented.

This Committee, I think, did a first-rate piece of work with respect to the money-laundering issue and we expect the House to

pass that bill today as part of the antiterrorism package and it will

be taken up in the Senate very shortly thereafter.

Today, we examine the future availability of terrorism insurance

coverage for American business. There are a number of key questions that we obviously need to address—to what extent did the

events of September 11 threaten the availability of terrorism coverage? If such coverage should be unavailable, what impact might

that have on the functioning of our economy? Is Federal intervention necessary to prevent disruption of the economy? And if so,

what form should that take?

I want to be clear at the outset that there seems to be no question of the industry’s ability to pay the claims arising from the September 11 attack, and the industry has been clear in stating that.

Currently, the U.S. insurance industry appears to be in strong financial shape and able to weather those costs. The question there

is what is the situation going to be in the future?

We have a number of witnesses with us this morning, and I am

going to turn to them now. First, we are going to hear from our

colleague, Bill Nelson, who spoke with me about the opportunity to

come before the Committee.

2

Of course, Bill served for 6 years as the Insurance Commissioner

of the State of Florida and oversaw State insurance regulation. Of

course, insurance regulation has been at the State level traditionally in this country, not at the Federal level. Another issue that

arises in the course of addressing this issue that is before us is

what would that do to the regulatory scheme in terms of the Federal-State arrangements? And that is something I think we also

need to keep in mind.

Bill Nelson led the rebuilding of Florida’s insurance market in

the wake of Hurricane Andrew, which was the most expensive natural disaster in American history.

He will be followed by Secretary of the Treasury, Paul O’Neill.

Mr. Secretary, we are pleased that you are here with us. Then we

will hear from R. Glenn Hubbard, Chairman of the Council of Economic Advisers.

We will conclude today’s hearing with a panel of: Kathleen

Sebelius, President of the National Association of Insurance Commissioners; Thomas McCool of the General Accounting Office; J.

Robert Hunter, Director of Insurance for the Consumer Federation

of America; and Professor Kenneth Froot of the Harvard University

School of Business.

Tomorrow, we will hear from two panels, one from the insurance

industry and another from business generally. It is our current

intention that hearing will be in this room tomorrow as well, although that could be dependent on whether the Dirksen Senate

Office Building, where the Committee rooms are located, reopens.

As we all know, the Russell Building reopened today. But the

Hart and Dirksen buildings still remain closed while they complete

the environmental examinations.

Senator Gramm.

STATEMENT OF SENATOR PHIL GRAMM

Senator GRAMM. Mr. Chairman, let me say that I do believe that

we wrote a good money-laundering bill. I believe it is a prototype

of bipartisanship and I want to congratulate you.

I cannot help but notice that the last time we were in this room

together was the Financial Services Modernization Conference, and

that all turned out well.

[Laughter.]

Chairman SARBANES. Much to the surprise of many.

[Laughter.]

Senator GRAMM. But not to the surprise of us.

[Laughter.]

Let me say on this issue, it is easy to frame the parameters, but

making decisions on those parameters becomes more difficult. It is

clear the Administration believes, and most observers believe that,

ultimately, we are going to build the cost of terrorist insurance into

the rate structure of the American insurance system.

I believe it is also believed that 2 or 3 years from now, we will

have much better safeguards than we had on September 11. The

basic question that is being debated so far as I am aware, there

may be people with other ideas that we have yet to hear from, is

how do we make this transition to building this new risk into the

3

base? The question it seems to me boils down to what is going to

happen on December 31, when current insurance policies expire?

Some question has been raised about the ability of insurance

companies to bear risk, say, if I were the Hartford and I wanted

to insure, or I was asked to insure the John Hancock Building. It

seems to me that it is important for us to remember that there is

a reinsurance market. It is one of the most active insurance markets in America. It is long-standing. It is common policy for insurance companies to lay off part of their risk.

Even before September 11, if a company was going to insure the

John Hancock Building, they probably would have laid off part of

that risk, either through a syndicate like a bank where you have

a loan that is so big that the capital of the bank will not allow you

to make the whole loan.

You can either do it through a syndication or you could actually

have a lead bank go out and lay off part of the loan with other

banks. I have no doubt that this would happen. The question is

what would the price be, and how quick would the learning curve

be in terms of this insurance?

The idea that somehow we have to have a Government-sanctioned, Government-monopoly insurance pool is totally alien to my

thinking and I see that, from my personal view, as a nonstarter.

The question is, how do we get into the system?

I have no doubt that the Administration’s proposal would work.

The question I have, however, and I think it is a real question, is

if you start off with the Federal Government covering 80 cents out

of the first dollar of exposure, so you do not have massive pressure

to set up a terrorism reinsurance market in the first year, there is

the possibility that the industry would never set it up, and would

simply come back to Congress in 9 months or a year and say, we

have to have this continued because we cannot make the reinsurance market work.

I personally believe that the best thing to do if we are going to

do this is to have a threshold amount. I think it is debatable what

it is, that the insurance industry would be 100 percent liable for,

putting pressure on them to go ahead and establish this market

and establish this mechanism if, in fact, we mean for the Federal

assistance to be temporary. And I do not know of anybody who

thinks the contrary.

These are the decisions we have to make. I do want to affirm

that this is our jurisdiction in this Committee. This is about a loan

and this is about guarantees. This is about insurance. All insurance issues are under the jurisdiction of this Committee.

I would argue that when we write the bill, that it would probably

be an amendment to the Defense Production Act. I want to just reaffirm and I believe, Mr. Chairman, we are doing it by this hearing, that this is our jurisdiction. This bill should be written from

this Committee. And I know that there are other committees who

have ambitions to have this jurisdiction, but I think we are committed on a bipartisan basis to see that we protect our jurisdiction.

I am also confident that, given the experience of the Members of

this Committee, that we could do a better job of writing this bill

than any other committee in the Congress, and that it is very important that we do it.

4

Thank you, Mr. Chairman.

Chairman SARBANES. Thank you very much.

Senator Dodd, who has a very strong interest, as we know, in

this issue, is unable to be with us for today’s hearing. He is attending a funeral this morning. He has submitted a statement for the

record and we will have it included in the record. Is there any

other Member of the Committee who would like to insert a statement into the record.

Senator BUNNING. I just want to make sure that I can put my

statement into the record.

Chairman SARBANES. Certainly. Well, we will turn to Senator

Nelson.

Bill, as I said, we are very pleased you are here. We know you

have had a lot of personal experience in dealing with the insurance

market and you were regarded as probably the most effective State

insurance commissioner in the country during your tenure.

We very much welcome your observations this morning.

STATEMENT OF BILL NELSON

A U.S. SENATOR FROM THE STATE OF FLORIDA

Senator NELSON. Mr. Chairman, let me say what a great privilege it is to serve with every one of you. It has been a humbling

experience for me. And whatever I can bring to the table today, as

we work through this very thorny problem, as we grapple with a

new kind of problem.

And I would like to begin my testimony, Mr. Chairman, by saying that what we ought to approach this challenge with is the question, how are we going to protect America’s insurance consumers

by making sure that insurance is available and affordable to protect them against the despicable acts that we have seen? That is

the thrust of where I am coming from.

Insurance we know is a crucial engine to our economy. Without

it, the banks are not going to make loans. Businesses will not invest or expand. And millions of jobs would be lost as the impact

rippled through the economy. And so, you are meeting today to

make sure that this will not happen. But neither can we allow the

insurance industry, Mr. Chairman to use the September attacks as

an excuse to shirk its rightful role and responsibilities. Already, reinsurance and insurance companies are saying that they are no

longer going to cover terrorist attacks after December 31, when

about 70 percent of the commercial insurance contracts in the

United States are scheduled to expire.

Now I do not doubt that the industry’s problem is a genuine

problem. In the immediate aftermath of September 11, it is virtually impossible for insurers to calculate their potential liability in

the face of possible future terrorist attacks. We cannot allow ourselves to be held hostage by high-pressure tactics of any industry.

And I might just recall your attention to the fact of the mistake

that I personally believe that we made in the airline bail-out bill

where, on a Friday, we were faced with the fact of the following

Monday, that the insurers were going to pull the ticket on both

United and American Airlines, which was a real possibility.

We acted. We acted in haste and in the process, what happened

was that we did not get the guarantees that all of, in addition to

5

the limited liability and the victims compensation fund, we went

beyond that and did the $5 billion of grants and the additional $10

billion of loans. But we did not get in return the fact that there

was going to be commensurate saving for consumers.

I have been on flights where they have a monopoly. There were

only five people on the plane and they kept the prices still jacked

up. Nor did we get, for example, the guarantee that we were not

going to only take care of the airline companies, but we were going

to take care of the airline employees. And now, you see where we

are. We cannot even get that up because of the filibuster.

What I am saying is, in the haste to solve this problem, let us

not make a mistake on something that is so important to keep the

engine of this economy running. From our experience in Florida, I

know that the insurance industry is more willing to walk away

from its biggest risk and turn them over to somebody else. And I

can give you book, chapter, and verse, if you want it, because when

companies paid out $16 billion in claims after Hurricane

Andrew slammed across south Florida in 1992, which was the costliest natural disaster in insurance losses in the history of this country, then the major players in the industry spent the rest of the

decade trying to slip through State legislation that would shift responsibility for hurricane coverage to Florida’s government and its

taxpayers.

I am not slamming the industry. I am telling you that they provided the necessary support in crisis and they did it very well

under very difficult circumstances. But I am telling you as an insurance commissioner, I had to battle how the insurance industry

consistently wanted to shift the risk of hurricanes off onto Florida’s

government and to its taxpayers. Fortunately, we headed off almost

all of those efforts. And we fought the industry’s attempts since Andrew to force unconscionable and ever-increasing rates on Florida’s

homeowners.

Homeowner insurance rates are now stabilized in Florida and

competition has returned. And that was one of the main things

that we had to do. We had to have the Government step in temporarily, help nurture the private marketplace back to life, and then

the competition started to stabilize the prices. It was a solution

that backed up the industry if and when it had another megastorm. And surely, there will be another mega-storm. But the

emergency fund that was created in Florida, called the Florida

Hurricane Catastrophe Fund, otherwise known as the Cap Fund,

it was created by the State and it requires companies to pay for

most of the hurricane loss and to shoulder their share of the cost

of major storms. And then it spreads the risk by building up reserves with premium dollars, not taxpayer dollars.

Whatever solution that we come up with at the Federal level on

terrorist coverage, I believe that the same principles of private enterprise must be applied. Government can play an important role

in helping resolve the immediate crisis whose impact would be felt

far beyond the insurance industry. For the most part, however, we

should leave the business of insurance to the insurance business.

As you know, there are two basic plans so far, and you will hear

about them in detail, the White House proposal and another plan

that seems to have broad support from the insurance industry. And

6

they are still being fleshed out. We do not have all the details to

fully judge them. But based on the information that has emerged,

I have some major concerns. For example, what safeguards would

be provided to protect—correction—what safeguards would be

provided to prohibit insurers from doing what the industry calls

‘‘cherry-picking.’’ That is, ‘‘cherry-picking’’ the safest policies, or the

flip side of that is, redlining the others out. In other words, once

Federal help is provided, what is to stop the companies from covering only those properties or businesses that are relatively safe

from terrorism and leaving the biggest risks to someone else? And

what is to stop them from simply passing on any of the terrorism

losses they might suffer in the form of sudden and steep surcharges

against their customers? Or from finding ways, in the complex

array of State regulations, of excluding acts of terrorism from the

coverage consumers buy on their homes, their automobiles, and

their lives? I say that anything we do here at the Federal level

must assume and require that companies cover the peril of terrorism, a peril that looms so much larger since September 11.

Simply put, if the Federal Government’s taxpayer resources are

granted, then the terrorism peril cannot be dumped by the insurance industry. As I understand it, the Administration’s plan would

make the Federal Government responsible for paying 80 percent of

the first $20 billion in claims and 90 percent of the next $80 billion

resulting from any terrorist attacks next year in 2002. This proposal would increase the industry’s liability from terrorist claims in

the next 2 years, but still cap it at $23 billion in 2003 and $36 billion in 2004, with the Federal Government covering all the remaining claims. I have strong concerns about requiring the taxpayers to

assume, even on a temporary basis, such a large percentage of the

costs, especially at the front end. A more responsible approach, in

my view, would be to require the companies to cover terrorist-related losses up to a certain level before any Federal help would

kick in.

In other words, the primary insurer would cover it up to a certain dollar retention level and above that level, the risk could start

to shift to the Federal Government. We should not support any proposal involving the use of taxpayer dollars unless we are convinced

that the insurance companies have ample ‘‘skin in the game.’’ And

of course, the risk to the insurance companies could be spread by

them purchasing reinsurance.

And then, under the separate industry-backed proposal, apparently, their proposal is that insurers would pool their premiums

through the creation of a new Government-backed insurance company called the Homeland Security Mutual Reinsurance Company.

And each participating company would retain 5 percent of terrorism and 5 percent of workers’ compensation war risk, and leave

the remaining 95 percent of each to the insurance pool.

Well, I hold true to the belief that private market solutions are

more desirable than Federal intervention. But if I understand this

plan correctly, the Federal Government would be responsible for

covering 100 percent of any claims resulting from terrorism next

year, while the new insurance pool starts to build up its capital.

So look at it carefully, and as this debate progresses, we must conVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 83472.TXT SBANK4 PsN: SBANK4
7

stantly keep in mind that insurance companies are well equipped

to handle most large-scale disasters.

It is true, this is a new kind of disaster. But nobody thought of the possibility a decade ago of a $50 billion hurricane. And had

Andrew turned one degree to the north, instead of drawing a bead

on downtown Homestead, a relatively sparsely populated area that

produced a $16 billion storm loss, had it turned one degree to the

north and drawn a bead on downtown Ft. Lauderdale, it would

have been a $50 billion insurance storm that would have taken

down into insolvency almost every company in the country that

was doing business in the path of the storm.

The industry is recognized by many financial rating agencies, institutional investors, and economists as one of the strongest in the

global economy. They have a lot of experience coming out of

Andrew as a result of the near-death experience that they had

there. Even one of the strongest companies, like State Farm, at the

time had about $17 billion in surplus. Had that storm gone on one

degree to the north, it would have just about wiped out State

Farm’s surplus at the time.

The fact is the companies have learned a lot from that experience

and between them, the property and casualty and life and health

insurance industry now counts nearly $3 trillion in invested assets.

And the NAIC, whose president will testify here later today, has

estimated that the capital cushion for the entire industry, including

the life, is more than $550 billion of surplus to absorb unexpected

downturns in the financial markets and adverse loss experience on

its policies, including terrorist acts. In other words, the industry is

flush right now with huge surpluses.

Whatever our solution in the Congress is to this aspect of the terrorist crisis, we must require insurers to pay their fair share. And

as we consider the public policy implications of terrorism, reinsurance. I believe we must proceed in a deliberative fashion. And in

my view, Mr. Chairman, this is just one suggestion from one Member of the Senate, that means reaching agreement in the coming

weeks because of the shortness of time, on a short-term, what I

would argue, no more than a 1 year or interim solution, to ensure

that insurance protection against terrorist attacks remains available for the new year in 2002, and then to resume our work after

January 1, to develop a more permanent plan.

That approach would also enable us to consider reform of the

current system of insuring against natural catastrophe disasters.

Despite our progress in Florida in dealing with the hurricane

threat, the fact remains that no single State, no single industry, no

single insurance company, could cope with the kind of mega-catastrophe of the big one of the hurricane or the earthquake located at

exactly the right place because you are talking about in excess of

$50 billion in insurance losses from the big one, either earthquake

or hurricane.

In lieu of the perennial debate that we have over establishing a

Federally backed insurance pool, I have been intrigued by other

proposals of the way that you could approach it, by setting aside

part of the profits for a rainy day. The idea is to let companies develop tax-deferred reserves and thereby, increase their capacity to

respond to catastrophic loss. There needs to be a lot of deliberation

8

on this and that is why, when I respectfully suggest that you may

want to meet this immediate crisis that we are facing coming at

the end of this year, with an interim solution, and then come back

next year.

I know this Committee is clearly one of the ones that takes a

keen interest in these problems, along with the Commerce Committee, and I look forward, Mr. Chairman, to working with you toward legislation, both short-term and long-term, that will keep our

economic engines running, but also protect the consumers that we

all serve.

Thank you for the opportunity. I am happy to take your questions or comments.

Chairman SARBANES. Thank you for a very helpful statement.

I might just observe that, while you are not on this Committee,

you are a Member of the Senate, and every Member of the Senate

will have an opportunity to deal with this legislation and to address this. We need to draw in as many opinions in terms of what

ought to be done and how people react to the problems.

I have a couple of questions that I want to ask and they go back

to your experience as an insurance commissioner. Did you have the

authority to require insurance companies to offer coverage for terrorism events as insurance commissioner?

Senator NELSON. Mr. Chairman, I believe so. That question

never came up because it was never a question of whether it was

not to be covered. It was always assumed to be covered. And there

was no exclusion.

Insurance companies are very specific about what are excluded

in the coverage in a policy. And under most homeowners’ policies

in Florida, there was no specific exclusion for terrorism.

Chairman SARBANES. Well, suppose the companies were now to

say, we are not going to cover terrorism. Could a State insurance

commissioner say to the company, no, you are going to cover terrorism. If you are going to offer a policy, the policy must encompass

terrorist coverage.

Senator NELSON. Were I still the insurance commissioner, I

would try, Mr. Chairman, but I am not sure I would be successful.

Chairman SARBANES. Well, did they try to exclude hurricane coverage after the Florida experience?

Senator NELSON. No. That was required by law.

Chairman SARBANES. By Florida law?

Senator NELSON. Yes, as part of the homeowner’s policy.

Chairman SARBANES. In other words, you could withdraw altogether from the business. But if you are going to offer a homeowner’s policy, it had to encompass hurricane coverage.

Senator NELSON. That is correct.

Chairman SARBANES. And was that the law before Hurricane Andrew hit?

Senator NELSON. Yes, sir. It is called the Wind Risk.

Now there were times which, in the history of the development

of coverage of Wind Risk, that there were attempts to, for example,

in high wind risk areas, such as the Florida Keys, a consortium of

250 to 300 insurance companies came together to create a pool.

And that was offered as an alternative of covering the wind risk

in that high-risk area.

9

That was part of the problem when Hurricane Andrew hit, that

they wanted to have that pool, that consortium of companies, cover

all of the wind risk instead of an individual company, particularly

in your high-density urban areas of south Florida.

And that is where we drew the line and said that we are not

going to let you continue to expand and get rid of your wind or hurricane risk.

Chairman SARBANES. Did your authority as insurance commissioner also extend to the reinsurance business?

Senator NELSON. Reinsurance typically is not regulated by a

State insurance commissioner or department of insurance. However, we would require certain data to be set forth so that we had

some idea. But, typically, the reinsurance was not.

Chairman SARBANES. Anything else?

Senator GRAMM. Mr. Chairman, we have so many other witnesses—first of all, Bill, thank you for your testimony. I think it

was very helpful to us. But out of respect for our other witnesses,

I believe Bill has given us a far more comprehensive statement

than we would have allowed anybody else to give, so I am not going

to ask any questions.

Thank you, Bill.

Chairman SARBANES. Senator Schumer.

Senator NELSON. There is a similarity, Senator Gramm, on some

of the things that you expressed and some of the things that I

expressed.

Senator GRAMM. There are.

STATEMENT OF SENATOR CHARLES E. SCHUMER

Senator SCHUMER. Well, thank you, Mr. Chairman, and I have

just a couple of questions for the witness.

First, I do want to thank you for having this hearing. From my

State of New York, it is vital that we get something done. And having this hearing—this is a very interesting hearing because we are

not bouncing a proposal off, nor is it a general exploratory hearing.

There is lots of division, Senator Nelson, as you ably brought out.

And therefore, having this hearing will really help make up our

minds on what to do and where to go to maybe seek a consensus.

Let me just express a couple of thoughts to you and get your reaction to them.

I worry that if we do not have some kind of legislative remedy,

downtown New York will not be rebuilt, that given that we are at

the epicenter of what happened, given that, while the insurance

companies are clearly paying off all of the prior claims, that no one

is going to insure in the future. And that may not just be for downtown Manhattan, although probably, we have the greatest liability

or risk. But it might be for any new, large project anywhere, unless

they can be assured of getting insurance.

And so, right now, as we sit probably in a recession, we do not

want to have it decline much further. To risk not doing anything

because we all cannot come together on an agreement, could really

push us much further down the economic ladder. So I think it is

important we do something.

I also think that we have to look at two issues—pricing, how do

we, as you say, ensure the dense economic centers get coverage, a

10

large project. This is in the future, and that is one thing that I

guess I would like to make clear to everybody.

We are not looking at any bail-out of the past. The insurance

industry is paying for everything that happened in downtown.

There are going to be disputes here and there. I hear there is one,

whether it is two incidents or one incident. But, overall, they are

stepping up to the plate and paying.

The issue is the future. And unlike hurricanes, you had the most

massive hurricane, but we had previous experience with hurricanes. And the day after the hurricane occurred, or a month or a

week after, there were not warnings from our Nation’s leaders—expect something else again, like the hurricane that occurred, the

largest ever.

And so, I am not sure the analogy exactly applies. We have more

pricing experience with hurricanes and we also had some experience with how regularly such a devastating hurricane over a populated area would occur. We have no experience here.

I think that we are playing with fire by saying, well, let us let

the market see if it can solve this problem, and then maybe next

year, we will come back. That is one issue. And the second issue

is duration.

The solution that I think seems to be gathering a little steam is

let the Government come in and pay an agreed-upon percentage for

a year to help the industry renew contracts that we know are coming up December 31.

The problem is, will anyone build anything if they do not know

what is going to happen a year later? Because these large projects

are not of 1 year duration.

I do agree that perhaps in 2 or 3 years, we will have a little more

experience and a little more market experience as to where to go.

But we do not have it now.

I think the analogy with the Florida hurricane, while we certainly can learn from it, and your wisdom is going to be really

needed by all of us because you have more experience with this

than anybody else, but it is inexact. It is not precise.

Senator NELSON. May I respond?

Senator SCHUMER. Yes, I do want you to respond. So I would just

like to know: Do you agree that the analysis is not precise? And

what do you say, not only to my constituents in Manhattan, but to

any large developer around the country?

The one other point that I would make is I think we have some

divergence of interest between the insurance companies, which are

very concerned, as they should be, with getting those policies renewed come January 1. That is for existing buildings.

But when I talk to real estate developers and entrepreneurs and

everybody like that, they say that without a longer-term solution,

they are not going to build a thing. That means rebuilding downtown Manhattan, but it might mean building a tall building in

Detroit, Atlanta, Indianapolis, or Trenton. Banks will not give

them the loan.

So that is the question I would like to ask you. Not so much to

do this for the sake of the industry, but to do it for the sake of the

economy of the country, which is hanging in the balance.

11

Senator NELSON. Senator Schumer, you, we, are under the gun.

Insurance contracts that are to start 21⁄2 months from now, less

than 21⁄2 months from now, they have to have notices sent out on

cancellation, whatever the contract calls for. Typically, it is 45 to

60 days.

We are under the gun right here to get something done for the

first of the year. And what my recommendation is to you, that you

just cannot get the long-term permanent solution done. It needs

more thought.

I have suggested to you that a potential solution is get insurance

companies’ ‘‘skin in the game.’’ They have a retention level that you

all set in law that up to that level that they pay, and above that,

that the Federal Government either pays or participates in whatever form you may—you will hear a proposal later on about loans

that would be paid back and loans that would be like guarantees

that have a direct pass-through to the consumer. Bob Hunter of the

Consumer Federation of America is going to make a proposal like

that to you. It certainly entitles your consideration of that proposal.

I do not equate this to the hurricane risk. I am just telling you

about the last big insurance catastrophe that we went through that

I happened to be in the middle of the storm and had the responsibility as the regulator of pulling us out of, and want to share with

you some of the things that I learned in the process and some of

the nature of the insurance industry, which it will try to dump that

risk if it can, when in fact, it is fairly robust in its health, and it

is in the business of insuring risk. And again, we can all say that

there is just never been a risk like this, and what is that unknown

out there in the future?

That is why you have to act quickly. But I am not sure that you

can act totally comprehensively in the next week and a half, is

what we are talking about.

Senator SCHUMER. Would you agree, though, if we did no solution or a 1 year solution, that it would create a significant damper

on economic growth next year?

Senator NELSON. Well, that is a consideration—we cannot do no

solution. I do not think we can do that. So let us find the delicate

balance.

Senator SCHUMER. Thank you, Mr. Chairman.

Chairman SARBANES. Senator Bunning.

COMMENT OF SENATOR JIM BUNNING

Senator BUNNING. No questions at this time. Thank you.

Chairman SARBANES. Senator Bayh.

STATEMENT OF SENATOR EVAN BAYH

Senator BAYH. Thank you, Mr. Chairman. I have one question.

Senator I agree with so much of what you said. You gave an excellent statement. Your endorsement of market-based solutions, I

think all of us would agree with that. I certainly do. And your concern with consumers and taxpayers being at the heart of our focus

here I think is on target.

My question, you also mentioned at the very end about the

unique nature of this risk and at the beginning of your statement,

you mentioned about the impossibility of pricing this risk at this

12

moment in time. Isn’t that at the heart of the question here, which

is, are we experiencing a market failure that puts the interests of

consumers and taxpayers at peril?

That, it seems to me, is really the issue, and for particularly

large risks, bet-the-company type risks. Won’t the companies, if you

go the consumer route, build in a risk premium, that if the Government acts to reduce some of that uncertainty, can be taken out,

thereby reducing the aggregate cost to society as a whole?

Because the American people are going to pay for this one way

or the other. You either pay for it through the consumer mechanism, which is spread through the economy in everything we buy,

or you pay for it through the tax mechanism, in which case the taxpayers pay.

The difference between consumers and taxpayers to me seems to

get blurred at the end of the day. So how do we reduce the aggregate amount of risk in an inherently unstable situation, it seems

to me, seems to be the question. And if they really cannot price the

risk, is not there a legitimate role for Government to step in a market failure and try and deal with that?

Senator NELSON. All very legitimate points, Senator. There is

good news and bad news.

The good news is that the insurance industry is clearly capable

of taking care of the losses that occurred on September 11. The bad

news is, as you have raised the question, on a going-forward basis,

how do you value that risk and how do you pay for it?

And nobody knows what that cost is going to be in the future.

And that is why I am suggesting that you have to create a formula

whereby, at the outset, the insurance companies have ‘‘skin in the

game,’’ so they will not walk away, and that they have to cover

that initial loss up to a certain level, called the retention level, and

then you can allow the Federal Government to participate either in

direct grants or in loan guarantees. And you will hear two of those

addressed by Mr. Hunter later on.

Senator BAYH. The final point I would make, Senator Nelson,

and thank you for your contribution here today, is it seems to me

we are trying to reduce as much as possible the inherent uncertainty in this unprecedented situation.

And the point Senator Schumer made I think is an excellent one.

We have economic decisions that need to be made in the short run

that are long-economic decisions, 6 to 7 year investments, bank

commitments, that kind of thing. And if that uncertainty is not reduced, these decisions simply will be deferred or cancelled outright.

Unfortunately, we are in the business, of having to make decisions

now to protect the long-term interests of the economy. Some of this

is unavoidable.

Senator NELSON. Well, said.

Chairman SARBANES. Senator Miller.

COMMENT OF SENATOR ZELL MILLER

Senator MILLER. I have no questions.

Chairman SARBANES. Senator Stabenow.

COMMENT OF SENATOR DEBBIE STABENOW

Senator STABENOW. No, thank you, Mr. Chairman.

13

Chairman SARBANES. Senator Corzine.

COMMENT OF SENATOR JON S. CORZINE

Senator CORZINE. Pass.

Chairman SARBANES. Senator Carper.

STATEMENT OF SENATOR THOMAS R. CARPER

Senator CARPER. There are two Senators in the U.S. Senate

whose names are Nelson. And they are both former insurance commissioners. I do not know if that has been pointed out here today.

[Laughter.]

And I like to refer, when we have one of them on hand, as the

half nelson. And when they are both present, as to what is referred

to as the full nelson. But the half nelson is better than no nelson.

So thank you for being here.

[Laughter.]

One quick question. You have referred a couple of times to the

financial health and strength, underlying the insurance industry. I

just want to ask you to expand on that, if you could, please.

Senator NELSON. Yes. In the aftermath of Hurricane Andrew, the

reinsurance markets of the world went haywire. It was hard to get

reinsurance and when you got it, you had to pay through the nose

to get it.

Over time, as the nurturing of the private marketplace came

back, as the hurricanes did not hit that were devastating in their

losses, that reinsurance market came back vigorously. And the insurance marketplace came back vigorously.

The surplus in the property and casualty lines is somewhere in the range of about $300 to $350 billion these days. The overall insurance industry surplus is in the range of about $550 billion. And

that is in an industry that has about $3 trillion worth of assets.

The insurance industry is strong. And that is why I say you have

to have some ‘‘skin in the game’’ as you devise what is going to be

the mechanism by which we offset these risks.

Senator BAYH. Thank you.

Chairman SARBANES. Senator Allard.

COMMENT OF SENATOR WANYE ALLARD

Senator ALLARD. Mr. Chairman, I do not have any questions.

Thank you.

Chairman SARBANES. Bill, thank you very much.

Senator NELSON. Thank you, Mr. Chairman.

Chairman SARBANES. It is very helpful.

Senator NELSON. Thank you.

Chairman SARBANES. Mr. Secretary, we would be happy to hear

from you and your colleagues.

Let me say to the Members of the Committee, given the nature

of the subject, its complexity, and the admission on the part of all

of us that we are searching for a solution and a consensus, I am

not going to rigorously hold witnesses to a highly limited time. I

think it is very important that they get the opportunity to lay out

their position because this is not only a situation in which the concept is important, but the details of the concept are in important

and interrelate to the judgment about what should be done.

14

Mr. Secretary, that is not a carte blanche to go on forever—— [Laughter.]

——but it is a partial carte blanche to go ahead and lay out your

position.

We very much appreciate your being here this morning. I might

note that the Secretary was originally scheduled to come before

this Committee. This had been arranged a long time back, to talk

about the Treasury report on currency manipulation and international trade and that complex of issues.

Given where we are, we thought we should change the nature of

the hearing. So we are pleased that you are here. We would be

happy to hear from you, sir.

STATEMENT OF PAUL H. O’NEILL

SECRETARY, U.S. DEPARTMENT OF THE TREASURY

Secretary O’NEILL. Senator, thank you very much. And with regard to the other—— Chairman SARBANES. We will bring you back on the other issue.

Secretary O’NEILL. I was going to say, with regard to that, I

know that we must deal with this issue today. But I look forward

very much to coming back and sharing with you the action the Administration is taking and thank you all very much for what you

are doing in strengthening our hand to deal with money laundering

and associated issues that we believe will permit us to achieve the

present objective of shutting down the financial means the terrorists have to support their activities.

So I look forward very much to coming back for that engagement.

Mr. Chairman, I do have what I would characterize as a long

statement for me. But I have an oral statement that is quite a bit

shorter that I think carries the essential points.

Normally, as you know, I would submit my statement for the

record. But this is a sufficiently complicated subject, that, if you do

not mind, I am going to work my way through what I think will

take maybe 10 minutes to lay down the terms.

Chairman SARBANES. Very good.

Secretary O’NEILL. It is a pleasure to be with you, Senator

Gramm, Members of the Committee. I appreciate the opportunity

to comment on terrorism risk insurance. We believe that there is

a real and pressing need for Congress to act on this issue now.

Market mechanisms to provide terrorism risk insurance coverage

have broken down in the wake of September 11. Such coverage is

now being dropped from property and casualty reinsurance contracts as they come up for renewal, with most policies renewing at

year-end. If we in Congress fail to Act, reinsurers have signaled

their intention to exclude such coverage, meaning that primary insurers may have to drop this coverage or institute dramatic price

increases. As a result, after January 1 the vast majority of businesses in this country are at risk for either losing their terrorism

risk insurance coverage or paying steep premiums for dramatically

curtailed coverage. If businesses cannot obtain terrorism risk insurance, they may be unable to obtain financing or financing may be

available only at a much higher cost. This would have widespread

effects as businesses of all types may, for instance, be unable to expand their facilities or build new facilities.

15

Let me state what I believe the problem to be. First, insurance

companies do not take risk. They knowingly accept and mutualize

risk. Because insurance companies do not know the upper bound

of terrorism risk exposure, they will protect themselves by charging enormous premiums, dramatically curtailing coverage or, as we

have already seen with terrorism risk exclusions, simply refuse to

offer the coverage. Whatever avenue they choose, the result is the

same—increased premiums and/or increased risk exposure for businesses that will be passed on to consumers in the form of higher

product prices, transportation costs, energy costs, and reduced

production.

Another way, any of the choices has the potential to cause severe

economic dislocations in the near-term, either through higher insurance costs or higher financing costs. Since September 11, the

uncertainty surrounding terrorism risk has disrupted the ability of

insurance companies to estimate price and insure risk.

Now to the question of what I believe our objectives should be.

In grappling with this problem, we have several objectives. First

and foremost, we want to dampen the shock to the economy of dramatic cost increases for insurance or curtailed coverage. We also

want to limit Federal intrusion into private economic activity as

much as possible, while still achieving the first objective, and we

want to rely on the existing State regulatory infrastructure as

much as it is practicable to do so.

I would like to talk briefly about a shared loss compensation program, which is what we are recommending that you consider. After

reviewing an array of options, we have developed an approach that

we believe best accomplishes these objectives. This approach reflects the current evolution of our thinking on this issue. But I also

want to say that we want to work with you and with the Congress

to achieve the best possible solution. This is such a new and novel

problem, that we think we need to evolve in our thinking. I must

say to you that the real test will not come in what we produce. We

will only know if we have succeeded if life goes on in insuring a

risk in the private market and businesses have the ability to

achieve financing, so that our economy can return to a much higher

rate of real growth than we are now experiencing. There is no

other test that makes any difference. The real test is does what we

do allow our economy to go forward in a good way?

When terrorists target symbols of our Nation’s political and military power, they are attacking the Nation as a whole, not the symbol. This argues for spreading the cost across all taxpayers. Yet,

there are also reasons to limit the Federal role. If property owners

do not face any liability from potential attacks, they may underinvest in security measures and backup facilities. In addition, the

insurance industry has sufficient experience and capacity to price

some portion of the risk associated with terrorism and has the infrastructure necessary to assess and process claims.

Under the approach we are suggesting, individual’s businesses

and other entities would continue to obtain property and casualty

insurance from insurance providers as they did before September

11. The terms of the terrorism risk coverage would be unchanged

and would be the same as that for other risks.

16

Any loss claims resulting from a future terrorist act would be

submitted by a policyholder to the insurance company. The insurance company would process the claims and then submit an invoice

to the Government for the payment of its share. In other words, we

would use the existing insurance claims process infrastructure to

deal with potential claims experience.

The Treasury would establish a general process by which insurance companies would submit their claims. The Treasury would

also institute a process for reviewing and auditing claims and for

insuring that the private/public loss-sharing arrangement is apportioned among all insurance companies in a consistent manner.

State insurance regulators would also play an important role in

monitoring the claims process and insuring the overall integrity of

the system.

Through the end of 2002, the Government would absorb 80 per- cent of the first $20 billion of insured losses resulting from terrorism, and 90 percent of insured losses above $20 billion. Thus,

the private sector would pay 20 percent of the first $20 billion in

losses and 10 percent of losses above that amount.

Let me say parenthetically here, when I say the private sector,

I mean the customers of insurance companies, not the insurance

companies, because if you understand how business works, then

you know there are no insurance companies who can survive if

they do not collect the loss values that they must pay out from the

people that they service in the form of premiums. I think it is a

very bad mistake of logic and understanding of how economics

works to believe in fact that insurance companies actually pay for

the losses that they cover. They are simply the transmission belt

that mutualizes risk among people with similar exposures.

Under this approach, the Federal Government is absorbing a portion, but only a portion, of the first dollar of losses, which we believe is important to do in the first year of the program. The key

problem faced by insurance companies right now is pricing the terrorism risk. We favor a first-dollar loss-sharing approach in the

first year because we are concerned about premium increases over

the next 12 months. We see this as the best way to mitigate

against premium increases, but it may not be the only approach.

And again, we want to work with you in finding an approach that

will work in the marketplace.

The role of the Federal Government would recede over time

under our proposal, with the expectation that the private sector

would further develop its capacity each year. In 2003, we would

have the private sector be responsible for 100 percent of the first

$10 billion of insured losses, 50 percent of the insured losses between $10 and $20 billion, and 10 percent of the insured losses

above $20 billion. The Government would be responsible for the remainder.

In 2004, the private sector would be responsible for 100 percent

of the first $20 billion of insured losses, 50 percent of the insured

losses between $20 and $40 billion, and 10 percent of the insured

losses above $40 billion. The Government would be responsible for

the remainder.

To preserve flexibility in an extraordinary attack, combined public/private liability for losses under the program would be capped

17

at $100 billion in any year and it would be left to the Congress to

determine payments above $100 billion.

The Federal Government’s involvement would sunset after 3

years. This approach would also provide certain legal procedures to

manage and structure litigation arising out of mass tort terrorism

incidents. This includes consolidation of claims into a single forum,

a prohibition on punitive damages, and provisions to insure that

defendants pay only for noneconomic damages for which they are

responsible. It is important to insure that any liability arising from

terrorist attacks results from culpable behavior rather than overzealous litigation. These procedures are important to mitigating

losses arising from any future terrorist attack on our Nation and

are an essential component of the program I have outlined.

In conclusion, Mr. Chairman, for the reasons I have set forth, the

Administration believes that the economy is facing a temporary but

critical market problem in the provision of terrorism risk insurance. Leaving this problem unresolved threatens our economic stability. The approach I have outlined limits the Government’s direct

involvement and retains all of those elements of our private insurance system that continue to operate well and provides a transition

period to allow the private sector to establish market mechanisms

to deal with this insidious new risk that confronts our Nation.

Mr. Chairman, I would be pleased to respond to questions that

you and the Members may have.

Chairman SARBANES. Well, thank you very much, Mr. Secretary.

Did you all examine the riot reinsurance program that was put

in place after the 1968 riots?

Secretary O’NEILL. Yes, I think we looked at what we consider

to be analogous kinds of situations and the staff looked at the riot

reinsurance. I think we did not find it to be a very compelling

equivalent to what we are facing with the terrorism risk that we

are now facing.

Chairman SARBANES. Why not?

Secretary O’NEILL. Sheila, come up here, would you?

You know Sheila Bair.

Chairman SARBANES. Certainly. Sheila’s nomination was approved by this Committee in record time.

[Laughter.]

That is how well we know her.

Secretary O’NEILL. And I must say that I greatly appreciated it.

[Laughter.]

Ms. BAIR. I must confess, that was one of the early suggestions

that we got. We looked at it. I think we thought it involved too

much of an infrastructure.

As I understand that program, the funds are set up on a Stateby-State basis. It looked like a more dramatic permanent fix to a

problem that we thought was very temporary. It has been several

weeks since we looked at it, but I would be happy to talk to your

staff later about more of our analysis.

Chairman SARBANES. I think it is probably worth looking at.

Mr. Secretary, how would you assure, if the Government is going

to take a significant part of the cost of some of this risk, if the premiums charged by the companies for the balance of the risk will

not be excessive, so that, in effect, the taxpayer is on the hook to

18

pay the responsibility that the Government is assuming, and then

the taxpayer as consumer is in effect overpaying on the premium

side for the risk that is retained by the company?

Secretary O’NEILL. In a way, I think your question goes to the

center of the problem.

If you walk around the problem from the point of view of the different participants, let us say, first of all, that you are a business

owner and you need to have terrorism risk insurance.

Why do you have to have it? Because your bank will not continue

to support you. They will not give you money, either for continuation for rollover loans or for a future investment, if you can prove

to them that you have protected them and have the ability to pay

back the money that they have loaned you in the event that you

suffer the loss associated with a terrorist catastrophe. And so, as

a business person, you are forced into a position where you must

find some coverage.

And under the proposal that we have made, if you saw this as

an economy with one insurance company and one business person

and you, the insurance company, now were at risk for $4 billion.

And let us say for purposes of illustration, that my business had

a $4 billion catastrophic loss potential. Then, as an intelligent business person, you would probably seek to charge me something close

to the value of me being the target of a terrorist event that costs

me $4 billion.

How do we keep that being the experience in the situation that

we are talking about through the competitive process of insurance

companies seeking to provide coverage, which is how they make

their money, after all, by charging premiums with an expectation

that, through the combination of premiums and investment, a flow

of funds, that they are going to be able to make a market rate of

return? That is what insurance companies do. Like all other business, they are out there trying to make a market rate of return.

And through the competitive process, multiple millions of business

owners will be approaching insurance companies and hundreds of

insurance companies will be trying to make sales, if you will. And

through that process, there will be a determination of what the

premium is that is required on an insurable basis.

And that is part of the reason that we have suggested that we

take a 3 year approach to this. We are facing a cliff on the first

of January. And since we have not really priced terrorist acts before, we are going to go through a learning process.

I guess I would say, in a succinct way, the response to your answer is the competitive process will not permit rapacious pricing by

the insurance companies because the competitive process will get

this down to a level that the general judgment says, at this premium rate and with reinvestment of funds, we are protected

against a $4 billion loss.

Chairman SARBANES. Well, I have other questions, but I will

defer to my colleagues.

Senator Gramm.

Senator GRAMM. Well, thank you, Mr. Chairman. Let me say,

Mr. Secretary, that I have sat in many hearings on this Committee

and others. I have never heard a better statement on the subject

than you gave today and I want to thank you for it.

19

Secretary O’NEILL. Thank you.

Senator GRAMM. Let me go through three principles and see if

you agree with them and then I want to just talk about your proposal and my own thinking on it. First of all, the question was

raised earlier about eliminating risk, other than through law enforcement, private security, restructuring physically potential targets, and the use of American military.

When we have used all of those vehicles, whatever risk remains,

I would say as a first principle, is that risk cannot be eliminated.

No bill that we could pass, no law that we could write could eliminate that risk, that all we can do is redistribute it, and ultimately,

redistribute it from the person paying insurance premiums to the

taxpayer. Do you agree with that principle?

Secretary O’NEILL. I think, generally, with this one caveat.

If you think about insurance, what it does is it mutualizes the

risk against people in like situations. If you think about the insurance industry taking this $4 billion worth of exposure in our firstyear proposal, there is an assumption basically that there are

enough people out there who are willing to pay premiums to have

their terrorist coverage, that we have effectively mutualized the

cost of the risk that is associated with their exposure to the people

who choose to buy or who, for financial reasons, are forced to buy

policies, and that population is a smaller subset than the general

population. But at the end of the day, you either have that subset

of the population that mutualizes and shares the cost and the risk,

or the taxpayers do, yes.

Senator GRAMM. The second principle would be that private insurance as the basic structure is the cheapest way to lay off this

risk and manage risk. And I do not know of any evidence that Government has ever been more efficient than private insurance.

Secretary O’NEILL. I would agree with you completely.

Senator GRAMM. The third is not a principle, but an objective. I

am sure you share my objective that nothing we do here would in

any way permanently get the Federal Government in the insurance

business.

Secretary O’NEILL. That is the last thing we should do.

Senator GRAMM. As I look at your proposal, let me first say that

I think your proposal is a good proposal. And I think if we adopted

your proposal, that it would be a dramatic improvement over the

status quo. Can anything be improved? I guess you can always debate that.

It seems to me that, as I look at it, the various proposals that

are being made—first of all, the proposal by the insurance industry, for us to sanction a monopoly reinsurance pool, is an absolute

nonstarter with me. I assume it is with you.

Secretary O’NEILL. You are right.

Senator GRAMM. It seems to me that the real question is, based

on our experience with reinsurance, could we, to use Bill Nelson’s

words, get the insurance—I do not want to use his words.

[Laughter.]

But the point is, it seems to me that if we are talking about a relatively small amount of risk given the size of the industry, $10

billion, for example, that if the Federal Government were backing

up a program where the first $10 billion was the liability of the

20

insurance industry—in other words, moving your proposal really 1

year forward—the disadvantage of that is you have a very compressed process whereby reinsurance would be marketed.

My guess is that in this interim, you would have a lot of insurance companies that would become the primary insurer and they

would line up partners individually, and then the reinsurance market would come in and say, well, we can really do that more efficiently if you will just simply contract with us. My guess is that

that is how it would happen.

That is the cost of skipping a year in your program. I think the

advantage of skipping a year in your program is you would put

pressure for the reinsurance market to develop. And one of my concerns is that the comforting effect of having the Federal Government there with the first dollar coverage, 80 cents on the dollar,

would be such that if I were in the insurance business, I might

want to come to Congress in 9 months and say, well, look, we have

not developed this reinsurance market and therefore, we want you

to extend this program. One of the advantages of skipping a year

would be to force the development of this market sooner.

I think also, from a political point of view, which is a relevant

factor here, is that Members would feel more comfortable if the

first exposure were private and the Federal Government were a

backup, part of the backup process, rather than the Federal Government being on the hook for the first dollar. Let me just get your

reaction to those alternatives and the trade-offs. It is not a question of right and wrong.

Secretary O’NEILL. No, I understand, Senator.

I believe we have what you are saying as a suggestion for the

second year of our program. Let me tell you why we did not end

up with it as the first year of our program. We do not have much

time, and I do not want to name them because I do not want television reporting that O’Neill said these are high-visibility targets.

But you all have in your own mind, there are places in our country

that are high-visibility targets that have a billion dollars’ worth of

value. If I own one of those places—let me be the owner first—and

I have to have insurance because my financing is going to walk

away with me if I do not have terrorist insurance.

So with the $10 billion, in effect, deductible that is out there for

the industry to absorb, I am one insurance company. So if I am

going to write insurance for one of these high-visibility, multibillion

dollar places, then I have to get a very big premium because the

Government does not do anything until I have had a $10 billion

loss. And it could be all my loss as an individual company unless

there is a reinsurance pool possibility for a mutualization of the

risk among insurance companies somehow. It is really that question of whether the market can develop quickly enough.

I have no doubt that there will be a reinsurance market developed for this kind of risk-in-kind. But there is uncertainty and in

the early days, my guess would be, because these are not fools who

put their money into reinsurance or into insurance companies, they

will insist in the early days on a higher risk premium than they

will likely need going forward. There is a counterpoint, which is

this, and it is directly related to what Senator Nelson said.

21

What the insurance companies had to do after they had huge catastrophic losses because of hurricanes is they had to raise the premiums going forward to put themselves on a sound financial basis.

Again, we are reminding ourselves, insurance companies do not

accept risk. They mutualize it. And they pay their losses out of premiums and earnings on premiums that have come in. And it is that

that provides the basis for our economy to operate in the way that

it does to absorb risk.

I do not have any trouble with your idea if we could quickly test

it. And if I may offer this. One thing is we have talked about this.

I do not think we are going to know whether the terms that you

all adopt in your legislative proposal are going to work until we

have had a real market test. And therefore, it may be useful for

you all to think about the possibility of giving the Executive the

ability to adjust these terms.

If, in the first instance, after you have drawn a line and it does

not work, and we find that we are in trouble because we do not

have a whole lot of time to go through an elaborate reconsideration

of the legislation.

So just a thought for you. Believe me, not a reach for power. We

could do without this. But we need a mechanism that is going to

be able to adjust the market conditions and work in the real world,

and we need it quickly.

Senator GRAMM. And my time is expired. But the problem is, the

fact that you have that power affects behavior.

Secretary O’NEILL. You are right. You are absolutely right.

Senator GRAMM. That is the problem.

Chairman SARBANES. I say to my colleagues, we are going to

hand everyone—because we do not have the lights here—after 5

minutes, we will hand you a piece of paper. We do not want to cut

anyone off in midstream. But then we would like you to start winding it up.

Senator Schumer.

Senator SCHUMER. Thank you, Mr. Chairman.

I want to thank you, Mr. Secretary. You have been out front on

this issue early, and that is really important, I think even in terms

of assuring the markets now that we are looking at a solution. Just

a quick question. There are some in the Congress who say we do

not need any solution at all next year. Do you strongly disagree

with that?

Secretary O’NEILL. I just do not think that we are in a workable

position because with the reinsurance companies pulling out, we

are going to face real-life situations out there where people will not

be able to get financing.

Senator SCHUMER. My two other questions relate to the specifics

of your proposal. I am worried about two things and I wish you

could address both.

One is what Bill Nelson referred to as ‘‘cherry-picking’’ or ‘‘failsafe’’ or whatever. Even if you do not do what Senator Gramm suggested, and do this very generous proposal in the first year, how

do we know that some very important existing entities, buildings

or just large physical entities, which is what is at the most risk,

a lot of value, economic value concentrated in a small space, I

guess, how do we know that they will get any insurance, that the

22

insurance companies will say, look, I will write with this 80 percent, I will write for this, this, this, this, and this, but I will not

write for 5 percent of the economy. And that would really create

unusual havoc.

Secretary O’NEILL. I think there is no doubt in my mind that the

market will eventually provide risk insurance or terrorism risk insurance for everyone.

But if we think about this problem in a way that we are all more

familiar with. If you are buying automobile insurance, it is experience rated, which means if you are over 25 and you have three

children and you do not drink and smoke and do other things, that

insurance companies will like you and you will get the preferred

premiums. If you are 15 years old and you have never been to driving school, your premiums are unbelievable.

Senator SCHUMER. And there are some people who no one will

insure.

Secretary O’NEILL. That is right.

Senator SCHUMER. The State government steps in and does it.

Secretary O’NEILL. All right. And what the insurance companies

do, though, effectively, and your example is the top-off case, what

they do is they create an experienced rate of premiums and assigned risk pools and that is going to happen in this case.

It is obvious that some of the high symbolic value things have

a higher risk associated with them than a suburban home in a

tract development.

Senator SCHUMER. Correct.

Secretary O’NEILL. And the insurance industry will work through

its market process with bid and ask on the part of buyers and sellers, and the premium rates will be established.

Senator SCHUMER. But how do we know—and I am going to ask

my second question now so you can answer both. But how do we

know that there are going to be some part of the economy, a valuable part, albeit, a small part, for which there will either be no insurance or the rate will be so high that, in effect, there will be no

insurance? And if you could answer that. And then let me ask my

second one.

Chairman SARBANES. You cannot do that.

Senator SCHUMER. Yes, I understand.

Chairman SARBANES. We have been through that before. I can

say, I have three questions.

[Laughter.]

Senator SCHUMER. I just want to hurry him up, so I get in my

second before you start singing, Mr. Chairman.

[Laughter.]

Secretary O’NEILL. I think we need to work this issue really

hard. I think there are arguments that can be made on your side

that we need to anticipate uninsurable companies or situations. We

do not have a magic bullet answer that I am going to throw my

body on the fire for. We should work with the Committee on this.

Senator SCHUMER. I would like to work with you on that.

My second question relates to my dialogue with Senator Nelson.

I have heard from numerous banks, that they will not insure longterm projects if they are only given 1 year or 2 years, or even 3

years, of some certainty that insurance will exist.

23

We are talking about prospective rather than retroactive. We are

talking about new projects rather than existing, although it might

apply to refinancing as well. And that worries me.

Now, the alternative proposal, the pool proposal, deals with that

issue better, although, admittedly, it deals with some issues worse.

Could you please address your view about how much dampening

will be placed on the economy unless we have some longer-term solution, a 1 to 3 year solution. I fear it is moving back away from

3 years to 1, that if we do not have such a thing in place, we are

going to prevent lots of lending and projects from being built. Even

if the entrepreneur wants to go ahead, the banks are cautious fellows and they do not lend unless they are assured of insurance for

the term of the project.

Secretary O’NEILL. Let me draw on my experience as an industrialist who had properties that were worth in excess of a billion dollars’ apiece. And recall in that incarnation, what I found is that the

insurance policies that I had that were full catastrophic coverage,

including explosions, but not as a self-initiated intentional act, but

as a catastrophic failure of a boiler or something, that all of my

policies had cancellation provisions in them and/or, and usually

and/or, provision for resetting the premium on an experience basis.

I think the idea that we have to provide 30 years’ worth of ironclad insurance protection to people is just wrong-headed. It seems

like a plausible thing. But I have not found that to be my experience that my financial backers insisted I had to have 30 years’

worth of iron-clad insurance coverage for a property that was at

risk.

It was at risk for cancellation and it was at risk for premium adjustment. But I never found a bank or that my equity investors

said we cannot invest in you or we are going to discount your value

because you do not have 30 years’ worth of protection.

Senator SCHUMER. But in this new world we are in, wouldn’t the

fact that we do not know what is going to happen create a real

dampening effect on the economy if we have a short-term plan?

Secretary O’NEILL. I think if we can do something and set the

terms down for a year, then we will have an experience base and

say to the American people, which I think we can all do in good

faith, if this does not work quite right, we are going to revisit it

and we will adjust the terms and conditions because we are all determined that we are not going to be set back by these people and

we will figure out a way to do it. I think we will be fine. As long

as we make a good-faith commitment to the American financial

community and the individual investors, we will be fine.

Senator SCHUMER. Thank you, Mr. Secretary. Thank you, Chairman Sarbanes.

Chairman SARBANES. Senator Bunning.

Senator BUNNING. Mr. Secretary, I have real problems with the

Federal Government guaranteeing profits for insurance and reinsurance companies.

Secretary O’NEILL. I would not ever suggest that we do that in

any way, shape, or form.

Senator BUNNING. Well, your proposal does—I mean, you are

guaranteeing whatever premium they charge, whatever risk and

investment they make, they cannot lose over a certain amount.

24

Secretary O’NEILL. And I am assuming that the competitive marketplace will bring them into a position where they will be able to

make a market rate of return on the risk that they are taking and

no more.

Senator BUNNING. That is a debatable question in your proposal.

Secretary O’NEILL. I agree with what Senator Nelson said about

insurance companies being flush and all the rest of that. I do not

know about the rest of you, but I know a lot about investment. I

do not know anybody who is rushing out because they think insurance companies are such a preferred investment vehicle, that they

prefer insurance companies over all the other investments.

My experience is that the markets grind very finely. And is anybody making a whole lot more than the market rate of return,

either competition or the process of competition and price competition grinds people down so that it is very hard on a sustainable

basis to make more than the market rate of return. I am assuming,

with the event of terrorism, we did not lose our ability to run a

capitalist society that produces that result.

Senator BUNNING. I am worried about the fact that if you have

first-dollar coverage on a terrorism act, why should I as a reinsurer

try to adjust to the market when the following year, you are going

to take a certain percentage also? And only at the end of 3 years,

I might want to change the way I approach my reinsurance company or my insurance company.

Somebody brought the economy up and I think that is really interesting, that this act, this hideous act that happened on September 11, is a disaster for the economy.

The economy was a disaster before September 11. This is just

adding to it. We had an even growth in the second quarter, a negative growth in the third, and a negative growth in the fourth. And

heaven help us, we had better not start out 2002 with a negative

growth in the first quarter then. Or else, these things will not

mean a thing, what you are trying to accomplish by your proposal.

We do have State insurance commissioners. They are capable of

dealing with this problem.

As Senator Nelson said, he had to deal with premiums and requiring premiums in law that required insurance companies to

write catastrophic insurance for hurricanes. Or else they could not

practice insurance or they could not do business in Florida. Well,

there is the same capability in New York, Illinois, or wherever that

we are capable of assuming there is major risk.

I believe insurance companies intend to make money. And I believe reinsurance companies intend to make money, or they ought

not be in business. What I am trying to say is, I like part of your

solution, but I do not like the first dollar coverage of that. I think

it is necessary we act quickly so that we insure and reinsure as

quickly as possible so there is no more negative effect on the economy. But the Federal Government does things so poorly, and writing insurance policies would just be another one of those things

that we do poorly.

Secretary O’NEILL. We do not want to write a single insurance

policy.

Senator BUNNING. You want to have what we call an assigned

risk pool——

25

Secretary O’NEILL. No.

Senator BUNNING. That is almost exactly what it is.

Secretary O’NEILL. No, no, no. We do not want to have an assigned risk pool at all. We do not want any pool. We do not want

any Federal insurance policywriting or rating.

Senator BUNNING. What is 80 percent of $20 billion, then? That

is your proposal for the first year.

Secretary O’NEILL. It is basically saying that is the part of a series of terrorist incident costs that we believe ought to be mutualized to the general taxpayer.

Senator BUNNING. In other words——

Secretary O’NEILL. In the first year.

Senator BUNNING. ——in the process of the insurance companies

doing that, and the reinsurance companies doing that, you do not

think that is possible?

Secretary O’NEILL. We think that there is a substantial risk if

we do not do something like what we have recommended, we will

have a significant dislocation in the economy on the first of January. And I can understand your view that maybe this is not right

and maybe it is the wish——

Senator BUNNING. I like the other part.

Secretary O’NEILL. Maybe it is the wish of the Congress to take

that risk. That certainly is a decision that you could make. And we

would find out. This is different from lots of things we do here in

Washington. This is going to either work or it is not going to work.

Senator BUNNING. I intend to work with the whole Committee to

see to it that we come up with a reasonable solution. I hope you

can work with us.

Secretary O’NEILL. Absolutely.

Chairman SARBANES. I am going to interject a question because

it flows from what Senator Bunning has said. Did you consider the

Government assuming the responsibility for all terrorist claims?

Secretary O’NEILL. Yes.

Chairman SARBANES. In effect, saying, it is the Government’s responsibility to protect the society against terrorism. And if we fall

short of that, the Government will pay these premiums. Therefore,

to the insurance business, you do not have to factor it in. You do

not have to take up the premiums. You do not have to have a

record on which to establish it. And we will assume it.

If there are no terrorist attacks, the Government does not pay

anything. If there are terrorist attacks, the Government has to certify the claims and then pay them. Did you consider that?

Secretary O’NEILL. I think, Senator, it is fair to say that, within

the economic team, and eventually, in a process of consultation

with the President, we looked at every conceivable way of thinking

about this problem, including 100 percent Federal role for costs directly associated with terrorism.

On balance, we came down with what we have recommended to

you, that we do this 3 year pilot process with the first year, 80/20.

And the reason we got to 80/20 is because we think there is a high

probability that it will be possible for the private industry to write

policies and be in the process for claims processing and working

with companies, for companies to take investment actions and the

26

management actions to reduce risks that otherwise might not be

tended to.

So, yes, we have worked this issue very hard, including everything that we thought was a logical possibility. And on balance, we

have come down with what I have said to you today.

Chairman SARBANES. Senator Bayh.

Senator BAYH. Thank you, Mr. Chairman.

Thank you, Mr. Secretary. I was interested in your answer to

Senator Schumer’s question. I would like to ask you, given the

state of the economy right now, the macroeconomic situation, it

seems to me this is a particularly inopportune time to have a significant amount of additional risk put into the marketplace.

We are trying to rebuild confidence on the part of consumers and

on the part of people who make investments and all that thing.

Now we are faced with a large, very difficult-to-quantify risk.

So it seems to me that something other than just a stop-gap

measure was in order. We needed something to allow the industry

to be able to quantify this risk and then we get out of any intervention and let them, assuming they have enough experience to do

what they do better than the Government possibly can.

But I took your response to Senator Schumer to be more of, not

along those lines. You mentioned the cancellation provisions and

the ability to increase premiums in light of experience and that

thing. Given that, why would we do anything? So I am having trouble reconciling my own sense that this is a particularly inopportune

time for this amount of additional risk, that we ought to do something, something more than just 6 months or 12 months. But I took

your comments to be to the contrary. Maybe I did not understand

you correctly.

Secretary O’NEILL. Well, what I said is I think we should put in

place, by our thought process, we should put in place a 3 year commitment from the Federal Government. But I am going to say to

you again, the real test of what we do here is whether it works in

the marketplace. And if someone has 100 percent certainty about

what is going to work in the marketplace, I have not yet found one.

I believe we have to proceed with a sense of flexibility and caution

and an expectation that we may have to make some adjustments.

Senator BAYH. I guess that gets to the heart of my question, Mr.

Secretary. At this moment, with the economy being in the shape

that it is, perhaps it is better to err on the side of caution rather

than additional risk-taking. Is that a fair way to characterize it?

Secretary O’NEILL. I am not sure how that translates into what

conclusion you would draw.

Senator BAYH. That is why you have a 3 year——

Secretary O’NEILL. On the side of caution, yes.

Senator BAYH. ——proposal rather than a 6 month proposal.

Secretary O’NEILL. Six months, I would say, would not work.

People need to be able to rely on at least a year’s worth of understanding of what they are going to face and make a contract.

Let me be a business person. And if you told me I have to face

this music every 3 months with great uncertainty, I would say you

are torturing me. Why are you doing this? It does not make any

sense. I need to get this out of my life after I have made a decision

for the next year and I will deal with it again maybe next year,

27

which I have to do anyway under conventional and catastrophic

provisions. You get revisited every year.

And believe me, if you think risk adjustment is not real, I can

tell you, if you have a boiler explosion, you know what the premium increase is going to be next year. It is going to be big enough

so that, in an expected value time of 3 years or so, the insurance

company got back the money it needed to pay off your claim.

Senator BAYH. Anybody who has reported an accident with their

automobile has gone through that, too.

Secretary O’NEILL. You know that.

Senator BAYH. Just two other points. Something that Senator

Gramm said and I think Senator Bunning touched upon it, too. The

risk is what the risk is. We take steps to reduce it as much as possible. But at the end of the day, it has to be dealt with and distributed throughout society. But what we are dealing with here is a

temporary market imperfection where the ability to quantify that

risk is in doubt because we do not have enough experience.

It seems to me that is what we are dealing with here. And we

are trying to get us through this period until the market is able

to perform the function it does much better than the Government

possibly could. It is just a temporary market imperfection that we

are attempting to address.

My final question, Mr. Secretary, what about the British experience? They have had to deal with acts of terror for some time. How

does your proposal differ from what they have instituted over

there? And what has their experience been?

Secretary O’NEILL. Basically, we think the UK decided to put

their national government into the insurance business. And we

have elected not to take that route. I think it is true both for the

UK and for Israel. They have both basically put the government

into the insurance business.

We just think it is a step way too far—in thinking about the logical possibilities, we did look at that possibility. But I think we

would have to have some huge additional, horrendous, ongoing experiences to get to the point where we said, this is a sensible thing

for us to do.

Senator BAYH. Let us all hope it does not come to that. Thank

you very much, Mr. Secretary.

Chairman SARBANES. Senator Allard.

Senator ALLARD. Mr. Secretary, I agree with you on the limited

role of Government. And I also agree with Senator Phil Gramm

that we need to be very careful, again, about how involved Government is in this whole process. I am searching for ways to see just

where that proper role might be. I would hope that, with time, we

can completely phase the Government out of this. Terrorist acts are

not anything new that happened with the attack on September 11.

There were terrorist acts before.

There is one question that comes to mind. Did you look at how

the industry had factored in that risk, because some of those terrorist acts, even prior to that, showed the possibility—for example,

in the bombing of the World Trade Center—of being huge in nature

and catastrophic in nature. It seems like up to that point, the private sector had been willing to respond, or did you find that at that

28

point in time, the private sector had not been willing to respond

to that potential type of accident?

Secretary O’NEILL. You have the experts here from the insurance

industry and I think your best qualified answer will come from

them. Let me tell you my view of it, and this is from talking with

high-level insurance executives around the country.

I think there had been the terrorist act provisions and insurance

policies and it was possible to have them as long as we did not

have terrorist acts. And what we are seeing now is the realization

that terrorist acts are not some unimaginable impossibility. They

are a reality in our society, hopefully, not again and again. And

therefore, the insurance companies are now having to think about

the possibility of having to deliver on their promises to pay in the

event of terrorist acts. And that means they have to address the

real issue of pricing for these things, instead of it being a freebie

that you would give some people comfort that they were covered for

terrorist acts, when you had no intention of ever actually having

to pay for a terrorist act.

Senator ALLARD. Subtly, you implied, but there is a lot in the

definition of a terrorist act.

Secretary O’NEILL. Yes.

Senator ALLARD. In your comments. Are you thinking about leaving it up to each individual policyholder to define this, or is this

going to be something that you are going to suggest? To me, that

is a real bucket of worms.

Secretary O’NEILL. I agree with you. But I think we need as tight

a definition as we can fashion of what a terrorist act is. If we are

going to put the Federal Government on the line, then we need to

know what it is that we are putting ourselves on the line for.

Senator ALLARD. The other question I have is on foreign assets.

In your proposal, I was not clear on how you would treat property owned by Americans. Are you putting them into that risk pool,

or are you holding them out separately from that? And how do you

do that?

Secretary O’NEILL. Well, what we fashioned is United States.

But, again, as a business person who has operations in 36 countries, now having seen this kind of issue up front and very clear,

businesses are going to face this issue and different countries will

sort the problem out in different ways. And equity-holders will pay

attention to whether or not our risk has been covered.

You know, I guess I can do this. There are lots of terrorist acts

in some other countries that we are very good friends with and

they have now incorporated these risks into their premiums in

some of these other countries. It is not as though we are alone in

the world. But businesses are going to have a much more complicated set of issues to deal with now. In fact, there is a different

premium structure. If you are an American company and you have

assets in places that are subject to lots of terrorist activity, you can

tell the difference in your insurance cost.

Senator ALLARD. I thought that was an important thing to think

about, the foreign coverage, because, like the Chairman said, the

question came to my mind, which government are you talking

about, foreign investments?

Secretary O’NEILL. Right.

29

Senator ALLARD. Some do a better job than others. And I would

hope that we will improve and do a better job in this country as

far as trying to keep terrorist acts to a minimum. I do not think

it is a practical goal to completely eliminate all terrorist acts. I

think we can take up organized terrorist acts perhaps that are

international in nature.

Secretary O’NEILL. Again, Senator, as a business person, how

you factor this in is important. Again, I do not want to name countries, but the financial premium of the intelligent business person

requires in places that have more fragile governments and less robust protections against terrorist acts than the rest, then the discount rate that you can earn on your money is 18 or 24 percent

instead of the 11 or 12 percent that is considered a reasonable rate

of return in our economy before September 11.

So there already is a risk adjustment mechanism in the capitalist system to take into account exactly what you are talking

about. And it shows up in the premium that business people require in order to deploy capital in other societies.

Senator ALLARD. Is my time up, Mr. Chairman?

Chairman SARBANES. Yes.

Senator ALLARD. Okay. Thank you.

Chairman SARBANES. Senator Corzine.

Senator CORZINE. Thank you, Mr. Chairman. Secretary O’Neill,

I appreciate the thoughtfulness of your presentation, even though

I might not totally agree on all aspects.

Let me just make a point that has been made and reinforced.

This is a real economic issue for the moment and, in my view, the

intermediate and long run. I might dispute a little bit about how

much these risks get adjusted. People who write bond issues for 7

years, 10 years, and we have already seen a very significant erosion of yield spreads, virtual shutdown of the high-yield market.

I saw where one of the great motor companies is paying almost

300 over Treasuries in intermediate and long-range, which is relatively unprecedented.

I think some of this risk is already there and I think it will be

an underminer of economic strength. So I think we need something, certainly in the short run, to address these issues. But I

want to go to a statement you made, and you are talking about insurance companies.

If we do not believe they can make money by underwriting a particular risk, they will not cover it. There will not be availability.

And there is an assumption in this testimony and from a number

of my colleagues that, somehow or another, we are going to be able

to quantify terrorist risk next year. We are going to get enough experience that we will be able to understand that risk and therefore,

people are going to want to accept that.

And in its particulars comes the ‘‘cherry-picking.’’ But there is no

reason to believe in my mind the reinsurers are going to say that

this is a great deal and we ought to step into it. As a matter of

fact, most business people do not put companies at risk on things

that they do not know.

We need a long-term solution that is not just completely dependent on the marketplace making a decision. I am actually troubled

that there is not an understanding that our national defense someVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 83472.TXT SBANK4 PsN: SBANK4
30

how slips into what we are talking about here with regard to the

insurance activity.

There are examples and we do not need to debate the merits and

the pool, but I have some sympathy for that. And we have actually

practiced that in some ways, in ways that we would not otherwise

have been able to have insurance and think about nuclear power

plants as a perfect example. And while it is not perfect, it is better

than if we did not have it.

So I hope that we are not so firm in believing that we understand how this risk is going to work its way through the system.

Are we going to be able to put a probability assessment on terrorist

risk in 4 years any better than we are today, strikes me as a huge

leap of intellectual view to be able to do that.

At least one business person who would like to make money, I

would not bet the ranch on something that I did not understand.

That leads me to believe that there may be a reason to think more

broadly about what the long-term solutions are. And since the

President has talked about this as a long-term situation, this is not

a 1 year or other type program.

That said, I am sympathetic with what Senator Nelson said— haste makes waste too often and there is a lot of reason to think

that we ought to analyze this in great detail before we come to a

long-term solution. And then I get to your suggestions, which are

some good ideas, and I actually like Year Two or Year Three better

because I do believe that the industry ought to be responsible for

managing a substantial amount of this risk. It is the catastrophic

risk that I am more concerned about.

It just strikes me that this first dollar exposure is very high. I

have heard your arguments about it. I would love to hear if there

is any greater element on that. And then I have one other question.

Do you have a feel for how much impact on the economy failure

to act would have? Do you have estimates, macroeconomic views,

about how much we would undermine the economy?

So, really, two questions. Do you think we could expand and protect the economy by having a much larger first-dollar exposure of

insurance companies?

And have you all done a lot of market testing on that? And what

do you think the impact of failing to do anything would have with

regard to the economy?

Secretary O’NEILL. R. Glenn Hubbard, Chairman of the CEA, is

here and I am going to let him answer the broader—and Glenn,

you can correct me.

[Laughter.]

Senator CORZINE. What would be the long-term impact?

Secretary O’NEILL. Absolutely. Again, Senator, if you think about

this, and I like working problems in a way that I can understand

them and think about them that reflects some experience.

If I received a notice where I was before, that my terrorism risk

coverage was cancelled next year, it would not have any immediate

effect on a company of the size of Alcoa with $36 billion worth of

market cap. But the S&P and Moody’s would probably take a new

look at my credit rating and because we were so terrific, they probably would not knock us down. But other companies that were not

so terrific would probably get an adjustment in their rating and

31

that would cause them in their next roll-over financing to pay more

money and, in effect, the risk value would be imposed through the

financial system indirectly instead of through a premium for insurance. And we do not really know what that is.

To return to your question to the broader issue of what happens

in the general economy, where you would expect to see the effect

is in new project proposals. That kind of wash-through effect that

I have described would happen for things that are already there.

Where you would see impact is in people not being able to get

financing at all because they were not able to get terrorism insurance even during the construction period. How does that translate?

I do not know. I will let Glenn give you a number for that.

[Laughter.]

Mr. HUBBARD. I could do it now if you want.

Secretary O’NEILL. I am going to say one more thing first, Glenn.

With regard to the proposal with the 80/20, I would argue that

the companies, the reinsurance companies, will arbitrage between

their aggregate exposure and the premiums that they are able to

collect. And the more coverage that is written, the more the premiums will come down.

The companies will make sure that whatever premiums they collect, their complete exposure is covered. Otherwise, they are not

running a business. They are running a lottery. And that is why

I would start with what you would say is first-dollar coverage, I

would say is still a considerable exposure for an individual company in the aggregate.

I expect that this competitive process will arbitrage between the

maximum exposure and they would collect all of the maximum exposure in premiums. It is a reason to start with a fairly

small number and develop some experience instead of making the

exposure big upfront because, at least I cannot imagine that the industry is going to collect less in premiums than what we say is

their first-line exposure.

Chairman SARBANES. Well, the Secretary I know has to leave at

12:15 p.m. We still have some Members and, Chairman Hubbard,

you will have a chance to go at some length.

Senator Bennett.

STATEMENT OF SENATOR ROBERT F. BENNETT

Senator BENNETT. Thank you, Mr. Chairman.

Mr. Secretary, I appreciate you being here and I agree with Senator Gramm that your opening statement was unusually clear. We

do not often get that. We appreciate the work that went into it.

Let me just see if I understand what we are saying here, because

this is not an area where I have a great deal of expertise or previous experience. I just paid the premiums and went on running

the business.

[Laughter.]

There is an assumption that in the uncertainty of what we face,

the initial premiums of the industry will be very high. Is that a

correct assumption?

Secretary O’NEILL. First of all, there is an assumption that if

there is no reinsurance pool, that individual insurance companies

32

will have to collect premiums that are large enough to cover all of

their potential exposure.

Senator BENNETT. I understand that. But even with the reinsurance pool, as the green eyeshade folks sit down and figure out what

the risk is going to be, they are going to err on the high side.

Secretary O’NEILL. That is right.

Senator BENNETT. Simply because they have no experience.

Secretary O’NEILL. That is right.

Senator BENNETT. And presumably, by the end of 3 years, you

will have had a track record of experience so that someone in reinsurance Company X, can say, we can come in under the market

with this kind of a premium because we now have enough experience to know that the exposure is not going to be as high as we

originally thought it would be and therefore, the competitive forces

will bring the premiums down. Is that a fair assumption?

Secretary O’NEILL. I believe so, although I want to go back to the

comment that Senator Corzine made about the difficulty of pricing

the risk of terrorism. I personally, and I am sure you all join me,

in not wanting to have enough actuarial experience that we can

price terrorism.

But if you know how insurance works, it is based on a set of actuarial judgments and experience base that gives one a basis for

making some judgment about what the premiums should be when

there is an event.

And even for hurricanes and tornadoes, we have enough weather

experience that it is now possible to do that. I hope we never have

enough experience to figure out what the costs should be, and that

should be our ultimate objective.

But I think part of the reason we have suggested this graded approach is because we think we need some learning. We need to

evolve our thinking. We have never really had to face this kind of

issue, and we honestly do not know if it is possible to proceed in

the way we have suggested and beyond to basically turn this over

to a private function and let it forever be a private function.

I am saying we can, if we do not have more terrorist experience.

If we have lots of additional terrorist experience, I do not know

what we do next.

Senator BENNETT. Well, you are going the same direction I am.

At the end of the 3 year period, we need to revisit this and see exactly what we are because, put in a slightly different context, we

are dependent upon the success of the Administration in conducting the war. And if the war goes badly, at the end of 3 years

we are going to be faced with an entirely different problem than

if the war goes well.

Now you talk about the British. Their principal source of terrorism has been the IRA. And that has been going on for long

enough that they do, unfortunately, as you say, have a base of experience on which to deal with it.

We are in a world where we do not know whether the attack on

the World Trade Center and the Pentagon was the ultimate gasp

of this group and the absolute most they could possibly do, or if

they have in the pipeline a whole series of attacks that could replicate that over the next 3 years.

33

So I think you have had a thoughtful approach here, but as I try

to get my arms around it, that is what I keep coming up against.

I do not really know what I can endorse because I do not know

what the risk is going to be, and presumably, nobody else does.

Maybe Secretary Rumsfeld does, but he is not telling us.

Senator GRAMM. Because we would leak it to the media.

[Laughter.]

Senator BENNETT. Not I.

[Laughter.]

Isn’t that what is driving your decision as to the first-year activity?

Secretary O’NEILL. Yes, it is, Senator. You said it very well.

Senator BENNETT. As I read the criticisms and listen to the criticisms, we say let’s wait for the second and third year. Aren’t you

telling us we cannot wait because we have a January 1 deadline

with many of these policies and we do not know? And given the

fact that the insurance company does not know, that means we hit

January 1 with no insurance at all.

Secretary O’NEILL. Exactly right.

Senator BENNETT. Is that——

Secretary O’NEILL. Yes, sir. You said it extremely well.

Senator BENNETT. Well, I am not trying to say it extremely well.

I am trying to get it in my own head so that I understand it when

we come along.

Thank you.

Secretary O’NEILL. Thank you.

Chairman SARBANES. Thank you, Senator Bennett.

Senator Carper.

Senator CARPER. Thanks, Mr. Chairman. And to the Secretary

we welcome you here. Thanks for joining us today.

You brought your written testimony and it has been entered into

the record. Everybody keeps saying how good your oral testimony

was. Who wrote your oral testimony?

Secretary O’NEILL. You know, I am really delighted you asked

me because it gives me an opportunity to say, I believe we have

assembled the finest team of people that have ever been at one

time at the Treasury. Sheila Bair, who you probably know, Peter

Fisher, and David Ockhauser. I could go on naming fabulous people

at the Treasury. I am proud to represent them and I am proud to

say that Sheila wrote the oral testimony.

Senator CARPER. I know because while you were speaking, her

lips were moving.

[Laughter.]

We are grateful for you and your team, for your presentation

today.

I want to go back to a question that I asked of Senator Nelson.

The question dealt with the underlying financial strength of the industry itself.

As I read the Administration’s proposal, and I add up the industry’s share of the potential cost, it looks like the industry’s share

in the first year could be as much as $12 billion. In the second

year, maybe $24 billion. And the third year, as I recall it, it was

$36 billion. That is a lot of money. But compare that, if you will,

34

to the reserves of the industry itself and whether or not those are

fair and reasonable numbers.

Secretary O’NEILL. I think the reserves are irrelevant. The reason I think they are irrelevant is this. Again, if you are a business

person and you understand how business works, then you know

that the reserves that they have there are there for a good reason.

And if they are excessive, then competition will grind them down

over time.

But the reserves are there because they are required to be there

so that the company can operate in the jurisdictions where it sells

policies in the event that there is a loss, the company can pay off

the claims that it has contractually agreed to pay off. And so, the

fact that companies have huge values in reserves has no relevance

whatsoever to the taking on of new risk.

Senator CARPER. The second question I want to ask is this.

There are others who are going to testify after you, some have

liked what you suggested and some will not. You have heard from

critics within the Administration, Executive Branch, Legislative

Branch, and the industry itself, and others. What are some of the

most valid criticisms that you have heard of the Administration

proposals? How would you rebut those criticisms?

Secretary O’NEILL. Well, since we are near perfect, I do not know

how to answer that question.

[Laughter.]

What do I think are valid criticisms? Senator Sarbanes asked me

earlier, did we look at the possibility of simply waving a wand and

saying, the American people are ultimately responsible for the cost

of terrorist acts?

I think that is a legitimate question. But there is a legitimate

question beside it which says, or a legitimate thought process beside it which says, we have demonstrated that insurance companies

are very good at assessing a risk and handling the claims process

and working with clients to assure that clients take reasonable and

necessary steps to reduce the risk that they have because they do

not have proper security, say for this instance, or they do not have

the structural integrity that is required to deal with terrorist risks,

and the rest of that.

Using the insurance companies as an intermediary to make sure

that the Nation presses harder on building in reasonable protections against terrorist acts seems to me to be an intelligent argument and a reason to keep the insurance companies out there

interfacing the rest of the world so that we do not have to create

a huge Federal bureaucracy to run a parallel insurance system.

But what this has the effect of doing by using the private industry sector to cover part of this risk is a way of spreading the cost

to people who have assets at risk instead of to the general taxpayer.

And there is an argument one can have about whether it is reasonable to spread the cost through our tax and redistribution system as compared to using an insurance vehicle to accomplish it. It

is an age-old argument. We will never be done with it. But I think

at the moment, one thing that is really clear to me, that we need

to take some action and we need to do it very soon, or we are going

to regret the implication that no action has for our economy.

35

Senator CARPER. Thank you very much.

Secretary O’NEILL. My pleasure.

Chairman SARBANES. Mr. Secretary, I just have a couple of

thoughts I want to leave with you. I know you have to get away.

First, presumably, whatever we do here becomes a precedent for

health and life insurance issues as well. Is that a fair concern?

Secretary O’NEILL. We would like for it not to be. We would like

to keep that off the table. But I can understand why you would

think that. For sure, I think we should talk with the Committee

about the reasons why we think it is not a good idea to include

those. But we can do that.

Second, the complexity of this issue is reflected in an article in

today’s Wall Street Journal. I do not know if you have seen it—‘‘Insurers Have Easy Time Raising Money.’’

For a business faced with pay-outs of $40 billion or more in the wake of September 11 terrorist attacks, the property casualty insurance industry is having a remarkably easy time raising money from investors.

Then it goes on and tells about what is at work in the market.

Behind the enthusiasm for the sector is the fact that property and liability insurers, after a decade of competing for business by lowering prices and thus squeezing

profit margins, now are in a position to increase the premiums they charge.

And an analyst says, ‘‘The pattern with catastrophic losses is

that the price increases are greater than the losses.’’

And then they do a track in the market. They say, sudden premium. And they show that the index for U.S. property and casualty

insurer stocks, which was trailing behind the S&P prior to September 11, has now jumped substantially above the S&P. I do not

quite know what to make of that, except that I believe that it is

pertinent to get that observation out on the table.

The final point, when we did the Chrysler guarantee, which was

done by this Committee, those of us who were Members of the

Committee then, we wrote in provisions of fee charges and compensation to the Government for the guarantee for Chrysler, which,

over time—actually, the Government came out more than whole in

the situation.

Now the airlines, we moved so quickly, we did not do that, although I think there is some discretionary authority in the panel

of which you were a member and which is chaired by Chairman

Greenspan who can place constraints of that sort on.

Now in this instance, I gather that there is no compensation to

the Government, is there, for taking on this risk that you are talking about in your plan?

Secretary O’NEILL. No.

Chairman SARBANES. I have no further questions.

Senator GRAMM. Mr. Chairman, let me just make the following

comment.

I think, first of all, I am not the least bit surprised that capital

is available to go into insurance and reinsurance. This is obviously

going to be a growth industry. We have had a cataclysmic event.

And clearly, this is going to be a new market for a new product

that, in essence, has not existed. People, at least, did not know

they were covering it. And that, clearly, this market is going to

come into existence.

36

I see this, what you read there, I am not surprised and I view

it as very good news because I think it is an indicator of two

things.

One, if I had to bet my life on whether or not the market would

not solve this problem if we did nothing, I would not be willing to

bet my life on it. My guess is they will solve it. My guess is if we

did absolutely zero, that this thing would sort itself out. I think we

are taking a risk that I am not willing to take by doing that. But

I am not convinced that the market would not solve the problem.

But what this says is that we can get the extra protection for the

taxpayer by having a threshold or retention, as they call it in the

insurance industry, of, say, $10 million. We can make that work.

And I think this cursory data indicates we could. And I think,

second, that this is something that at the end of 2 years or 3 years,

the market will be able to deal with.

I think it is good news. I think it encourages us that if we just

did nothing, that we might survive it. And if we do a bridge program, we probably will not have to do a permanent program. Also

I think it says to me, do as little as we can do to hedge the risk

for the economy, but do not do any more.

What I am fearful of, and I would just tell you, I would rather

have the Government come in and pay for every penny of terrorist

losses for the next 2 years, than to get the Federal Government in

the insurance business. That is the greatest fear I have, is that we

are going to step into this thing now and 20 years from now, we

are going to still be in the insurance business. That just scares the

hell out of me, much more than what is going to happen if we do

not take the first step.

Thank you, Mr. Chairman.

Chairman SARBANES. Thank you, Senator Gramm.

I also note that The Wall Street Journal, which you probably

saw——

Secretary O’NEILL. The cabbage article there.

Chairman SARBANES. They are eating cabbage now up at The

Wall Street Journal.

[Laughter.]

It says, ‘‘We loathe cabbage, so understand the sacrifice involved

when we say that we would rather eat cabbage for the next 20

years than have to suggest that the insurance industry needs some

government help.’’

And then they conclude, it needs some help, although they are

not very clear on exactly what that ought to be.

[Laughter.]

They do end up with this paragraph, ‘‘We will also admit to some

nagging doubts about whether or not the industry is bluffing about

shutting down on December 31. But we would rather eat cabbage

than find out.’’

[Laughter.]

Mr. Secretary, thank you very much. You have been very helpful.

We look forward to working closely with your people as we continue to address this issue.

Secretary O’NEILL. Thank you.

Chairman SARBANES. Chairman Hubbard, if you can come on up

to the table, we look forward to hearing from you.

37

If I could have the attention of the next panel for a moment, presumably, Ms. Sebelius, Mr. McCool, Mr. Hunter, and Professor

Froot are all in the audience.

We are considering doing Mr. Hubbard and then going over until

after lunch, say to 2:15 p.m. We will finish Mr. Hubbard here before we adjourn for lunch and then go over and come back to resume. But I need to know whether there are any of the four people

scheduled to appear on the concluding panel who would not be able

to accommodate that to their schedule.

[Pause.]

Well, not hearing anything to the contrary, I believe we will call

on Mr. Hubbard and then the Committee will recess until 2:15 p.m.

We will resume with the concluding panel.

We want to give that panel ample time because it has been put

together with—first of all, we very much appreciate the witnesses

being willing to come on short notice, and we think it is a very balanced panel. We think it would give us the benefit of a lot of points

of view, which the Committee is obviously trying to collect here this

morning and tomorrow morning.

Chairman Hubbard.

STATEMENT OF R. GLENN HUBBARD

CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS

Mr. HUBBARD. Thank you, Mr. Chairman. It was somewhat dangerous earlier when you suggested to a college professor little time

limits. But I will not abuse that.

In fact, I thought this morning’s Wall Street Journal editorial

that you quoted was a nice summary and actually, pretty supportive of what the Administration wants to do.

What I would like to do—— Chairman SARBANES. Senator Gramm used to be a college professor and he has gotten very good at controlling his time.

[Laughter.]

Senator GRAMM. Fifty minutes on Monday, Wednesday, and Friday, and it was a hour and 15 minutes on Tuesday and Thursday.

[Laughter.]

Mr. HUBBARD. Exactly. And I promise to be even more abbreviated than that.

What I wanted to do, since the Secretary ably walked through

the Administration’s proposal, was to spend some time with you on

the economic case of why we think this is so important and for the

areas where we find a lot of flexibility in hoping to work with you.

I would like to begin by echoing what the Secretary said, that we

are very grateful to the Committee for what it is done in the postSeptember 11 period and look forward to working with you on the

terrorism risk insurance problem. The timing of these hearings is

very significant, Mr. Chairman. Just to underscore what the Secretary said, it is not only important, but essential, that the Congress act on this issue before the end of the year.

In the simplest economic terms, one could think of the shocks to

the economy that we have seen since September 11 as a kind of

supply shock to the economy’s ability to supply goods and services.

It is in our interest as a Nation to contain the increase in transaction costs broadly that these attacks have raised.

38

A second feature that came up in discussion with Secretary

O’Neill, is that the attacks also raised the uncertainty in the economic environment, uncertainty about the state of where the economy is, uncertainty about demand for particular goods and services

like aviation to a myriad of other areas.

Commercial insurance, of course, lies directly at the intersection

of these two forces. Property and casualty insurance is one mechanism by which private economies respond efficiently to the risks

that are presented in the environment. Risks are spread, so that

for each business, a potentially large and perhaps even unknowable, cost, is turned into a stream of smaller known premium payments. The events of September 11 induced quite a large revision

in perceived risks. In normal circumstances, increased risks are

simply translated into higher premiums. That is a useful thing.

There is an often too quick criticism from an economic perspective

to criticize higher premiums. That is a useful economic function of

pricing risk. It leads the private sector toward those activities

where the risk is worth it, and away from foolhardy gambles.

At the moment, however, we are not in normal times. The entire

Nation is unsure about the likelihood of additional terrorist events.

For insurance markets, unfortunately, the distinction between

risk—that is, not knowing when an event will happen, but knowing

a great deal about the odds of occurrence—and genuine uncertainty—where we do not know about the frequency of an insured

event—is the key to being able to price efficiently. Experience with

this new security environment will doubtlessly mitigate this difficulty over time. In the near-term, however, what we were concerned with in the Administration and what you have been concerned with in the Committee’s efforts is the potential problem of

a disruption in the property and casualty market in the short run.

An interruption of coverage is a particular and extreme version

of this problem. It would be a very large potential increase in

transactions cost.

We are all familiar by now with what happened in the commercial aviation sector—the disproportionate rises in insurance coverage or potential withdrawals of insurance coverage that hinder

transitions to a new aviation operating environment. The phenomenon is more widespread. And here I want to walk through

essentially the question Senator Corzine raised with the Secretary.

Lenders typically require businesses of course to insure property

before securing loans. So one immediate manifestation of the problem is to diminish bank lending for new construction projects. More

important, perhaps, in the overall scheme of the economy is the impediment to transactions in existing commercial properties. That is,

the resale of skyscrapers, pipelines, power plants, and other large

assets. This changing hands, or recirculating assets, in the private

economy is an important economic function. It goes to the heart of

how we are able to reallocate capital in the economy.

From an economic perspective, then, there are really three

issues. One is this new projects issue. Second is the issue of capitalizing costs in existing projects. We know that the 1990’s were

a period where, loosely speaking, we were willing to pay a lot for

money in the future. Discount rates were low. The concern here is

that abrogation or interruption in the insurance markets would

39

raise discount rates capitalized into the value of existing assets, a

serious problem, indeed.

A specific numerical example is that about 3 percent of domestic income is MC&P premiums, about $155 billion a year. That was for

Year 2000 where, arguably, very little terrorism risk had been

priced. If one thinks, then, a substantial increase would have been

priced in the short run, you can get a sense of a very large flow

cost to inaction.

And third, a well-functioning private insurance market has to be

a core part of our financial infrastructure in the economy. And that

is precisely why the Administration put together an approach and

we look forward to working with the Committee and the Congress.

I think there are very important principles for any Federal Government involvement here. And the first I think received perhaps

not the full attention it deserved in the earlier discussion.

I think the key and perhaps the most important element is that

intervention should encourage and not discourage market incentives to expand the industry’s capacity to absorb and diversify risk.

A lot of the concern here has been expressed about problems in

pricing. I will come back to that. That is an important problem.

But perhaps the more compelling role for any government involvement at all would be in the issue of capacity in the short run. Toward that end, again, going to the article the Chairman noted in

the paper, it is precisely high short-term returns that induce investment in capacity and can be a positive thing.

A second principle is that any intervention should be temporary,

permitting us and you to review in the future the ability of the industry both to price risks and absorb losses.

Third, private market actors should face appropriate incentives

to encourage efforts to limit losses should such an event occur. And

if I might digress for a moment, one of the problems with socializing all the costs that were discussed a little bit is that it simply

provides no such incentive to the private sector, either to take responsible risks or for the insurance industry to process claims efficiently. I would submit that is a road down which you do not want

to go.

The fourth principle is that private sector uncertainty about liabilities that arise from litigation should be reduced, and I want

to come back to that in a few moments.

One thing that needs to be absolutely clear, and was missing

even from the otherwise well-done Wall Street Journal editorial

this morning, is that these principles do not imply providing government assistance to the property and casualty insurance industry. That is simply not the subject under discussion. The issue is

mitigating short-run cost increases for an insurance scheme in an

otherwise competitive market.

We believe that the Administration’s approach—and I am using

the word approach rather than proposal simply because we do want

to work with you on all the elements—match those four principles.

I am not going to go over the approach again in detail. The Secretary already did that.

But I will say again that the key element from an economic perspective is to mitigate short run, sudden increases in costs of insurance over the next year. The imposition of a deductible, Year Two

40

in the scheme we are proposing, Year One perhaps in some of the

proposals that the Committee is considering, and a subsequent increase in the deductible as we have proposed would permit the

Federal Government to recede gradually from the market as the insurance industry adapts the measuring and pricing terrorism risk.

I asserted a moment ago that the Administration’s proposal as

the Secretary outlined was consistent with the principles. Let me

just walk you through a quick economic argument as to why.

First, I think our approach is dead-centered on building privatesector capacity to absorb risk. It respects the insurance industry’s

proven ability to develop the capacity to price, to market, and to

service products for new types of risks. I think it is important to

keep some perspective here. In the past, there were naysayers who

said that the private sector would not figure out natural catastrophe reinsurance. There are important differences in these occurrences, as I will come back to, but also some similarities. And I

think experience has proven that the private sector has done very

well. By providing a temporary bridge—3 years in our suggestion;

we look forward to working with you on the length of that bridge— and steadily receding Federal presence and explicit sunset, we believe that the industry can grow, and it can grow well into this

market.

Second, and going back to a point that I made a few moments

ago, the Administration’s proposal is centered on the idea that a

key limitation in the industry—the primary insurance industry and

the reinsurance industry—is one of total capacity to absorb risk.

It is for this reason that we think the economic function here is

limiting maximum exposures in the event of very large catastrophes which would necessarily generate large transactional cost

increases for businesses. And let us be clear, that means prices for

consumers.

A third reason we feel our proposal is consistent with the basic

principles and economics outlined was that the industry is sharing

in the losses, or skin in the game, in Senator Nelson’s terms, up

to a maximum loss, and the share that it shoulders rises over time.

We can quibble whether it starts in Year One or Year Two, but I

think I sense a pretty broad-spirited agreement on that point. And

there will be an important profit motive for insurance companies

to begin now to refine pricing models. Again, I think that profit motive is both good and essential to making that private market work.

There are economic benefits to the efficient pricing of risks and

that needs to be left to the industry. Now, having said all of this,

the potential losses that face insurers, whether they are from a

natural disaster like Hurricane Andrew or from a man-made disaster like a terrorist act, depend not only on the security environment we have been talking about, but on the legal setting as well.

And let me give you a quick numerical example and walk you

through why we felt from the economics of the problem that some

tort issues were important. The initial physical costs from Hurricane Andrew in 1992 of $6 billion became more than $20 billion,

and still ticking, in part because of the cost of litigation.

The Administration wanted to include certain legal procedures

that were designed to manage mass tort cases that might arise out

of terrorism incidents. We believe very strongly that these proceVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 83472.TXT SBANK4 PsN: SBANK4
41

dures will bring damage claims closer to economic fundamentals

and more importantly, from an economic perspective, reduce the

uncertainty about the magnitude of potential claims. Much has

been made in the discussion thus far this morning of uncertainty

over costs of disasters, and that is an important problem. But go

back to the Andrew costs. The morphing from 6 to 20 was not uncertainty about the hurricane. It happened only once. It was uncertainty about the legal system. We believe that consolidation of

claims in a single Federal forum would help to ensure that the

claims would be treated in a consistent manner, reducing uncertainty in the private sector and eliminating redundancy costs of

litigating similar claims in multiple jurisdictions. We believe that

limitations on punitive damages, obviously other than those that

are directed literally against perpetrators and their betters, and

proportional liability for noneconomic harm, reduces the potential

for open-ended claims that would exhaust not only initial defendants’ resources, but potential collateral defendants. This is the kind

of uncertainty that we can work together to address, even while we

are working together on the larger concern of terrorism.

We believe these reforms are not just add-ons to an otherwise

good proposal. They are absolutely essential to getting a private

market and insurance up and running, and that appears to be not

only our goal, but I think the goal of all in the discussion thus far.

Let me say briefly a word about three roads not taken, at least

in our approach that came up this morning. One was the issue of

the monopoly pool model. Our concerns there were to—to put them

in economic terms. One was, while I characterized the insurance

business as, roughly speaking, competitive, we believe these pools

could generate the potential for significant monopoly power. Let

us be clear where that goes. It is a higher cost of doing business,

higher prices for consumers. We view that as unnecessary, while

still preserving a legitimate role for intervention you might take.

The second I referred to earlier—full government socialization.

While it is possible to make an argument in that direction, I do not

believe that argument holds much water upon closer inspection,

precisely because of the failure to grant incentives both to individuals as managers of buildings and properties, and to the insurance

industry as it processes claims.

The third that came up was the issue of charging premiums. One

of the things that I hope we all can agree, or I hope we can all

agree, is that we do not want the Federal Government in the longterm insurance business. We believe that the short-run issue of

cost-sharing that the Secretary outlined earlier is a way to get private-sector participation and some of the costs borne directly in the

P&C insurance base, without charging explicit premiums.

If we are all arguing among ourselves as to when we think the

private sector will be able to efficiently price risk, let us ask the

question when we think government officials would be able to do

that. I think that would be close to a nonstarter.

To conclude, I think it is our view that the economy as a whole

is very resilient. And we believe that the combined efforts not only

of what the Administration is doing, but, importantly, its work

with the Congress, can provide transitional public policies to make

sure that what might otherwise be temporary disruptions do not

42

become permanent. Again, I think the property and casualty industry raises important issues. These issues are not issues about the

industry. They are issues about consumers and the businesses that

provide goods and services for them.

Thank you, again, Mr. Chairman, for the opportunity and I look

forward to yours, Senator Gramm’s, or Members’ questions.

Chairman SARBANES. Thank you very much. Is it your view that

it is the cost of insurance that leads the insured to take steps

against terrorism?

Mr. HUBBARD. Well, one appropriate—people, of course, have incentives for a variety of reasons to take measures against terrorism. The larger the financial incentive, the greater the incentive

for hardening buildings, providing extra security systems, and so

on, much as you might in your own home if you were faced with

different pricing if you did different things.

Chairman SARBANES. It is your view that if the Government assumes the responsibility for paying the cost of terrorism, so that

was then not factored into the insurance cost, that the insured

would then be lax in guarding against terrorism. Is that your view?

Mr. HUBBARD. I think these are questions of degree.

You are painting them as poles. I think the question is, what are

the incentives for me to harden a building that I own or to make

sure that, if there is an act of terrorism, that the damage is not

any larger than——

Chairman SARBANES. I understand that. And you think you need

to put a cost into the insurance in order to get you to do that. Is

that right?

Mr. HUBBARD. That is correct. I think there are two reasons for

that cost.

One is for the private sector to face the right incentives. The

other is for the industry to face the efficient incentives in processing claims.

Chairman SARBANES. Well, that is a different issue, the processing of claims. I recognize that point about using the expertise.

Mr. HUBBARD. Keep in mind——

Chairman SARBANES. In order to process the claims. But I am

trying to get at apparently this view of yours that the really motivating factor to get building owners and managers to guard against

terrorism is that it is factored into the cost of their property in casualty insurance. Is that your view?

Mr. HUBBARD. No. Keep in mind, Senator, that the difference between what is the premise of your question of what is in the Administration’s proposal is 90/10 versus 100/0. So we are not talking

about polar extremes.

Chairman SARBANES. That is right, which only underscores the

thrust of the question.

Let me ask you this question. Why are you putting the Administration in on first-dollar damages? If you say that the problem the

industry has is limiting the maximum exposure, that is what creates the problem for them. So they do not know. They might have

some huge bill to pay and therefore, they have to guard against

that, some enormous amount of money.

43

And I understand that argument. But why does the resolution of

that argument require coming in for first-dollar damages on the

part of the Government?

Mr. HUBBARD. The question is one of timing, Mr. Chairman It

certainly is a long-run matter. If there were any role for government at all, it would be only on the back end, which is the premise

of your question. But the problem we are facing is in the short run,

in the market trying to figure out how to price things.

Our view was, particularly in the current economic situation,

we wanted to have as minimal a disruption, as minimal and necessary increase in property and casualty rates to move to that new

environment.

We have a deductible beginning in Year Two. You may well decide to do a deductible in Year One. But our philosophy was simply

to keep the first year of this as blunting cost increases as possible.

Chairman SARBANES. And to ask the question that I asked earlier, how are you assured the companies do not use the premium

boost in effect to overprice the risk to their pocket advantage?

Mr. HUBBARD. Well, I think the short answer to that is the single

word, competition.

The longer answer would be that, in the short run, it is quite

likely that an industry like this could underprice as well as overprice if the problem is uncertainty. And the increased premium——

Chairman SARBANES. How likely do you think it is that they will

underprice in this circumstance?

Mr. HUBBARD. One does not know until we put a specific policy

on the table. But I have no doubt that the industry in the long run

would not have significant competitive price discipline.

In the short run, if the behavior you indicated happened, you

would see a pretty rapid rebuilding of capacity in the industry precisely as the article that you referred to in The Journal suggests.

Chairman SARBANES. Well, the industry has very significant capacity now, does it not?

Mr. HUBBARD. Well, the P&C capital base is around $300 billion.

There are different lines and commitments of that. But that is a

pretty significant capital base.

Chairman SARBANES. Yes. Senator Gramm.

Senator GRAMM. Mr. Chairman, let me say that I do not know

that it is an extraordinarily relevant point, but I think the argument that you are making against just Government providing the

coverage——

Chairman SARBANES. I am not making that point.

Senator GRAMM. I know.

Chairman SARBANES. I am just trying to explore the parameters

here so we get some idea of where they are coming from.

Senator GRAMM. The point I made earlier, if I knew we were getting into the insurance business, I would take it as a preferable alternative for 3 years.

The problem is getting out of it once you have gotten in it. Second, it gives you no bridge to get out of it. And you had added what

I think is a very small factor in it, and that is, for example, as a

business, and in some case, homeowners, you get lower insurance

rates if you put in smoke and fire alarms.

44

You might say, well, your children are sleeping in this house.

Why didn’t you do that anyway? Well, the problem is, you figured,

well, it may not be essential, but if I am going to get an immediate

reward, I do it. People do respond to this. You get lower life insurance for not smoking. Only an idiot would smoke cigarettes, given

everything we know. I know many idiots.

[Laughter.]

And respect them on all other subjects.

[Laughter.]

On that subject, they act like idiots. But, anyway, so much for

antismoking.

[Laughter.]

Let me say that I strongly agree with you, Glenn, and I just

want to emphasize it, on this liability. The Federal Government is

stepping in—however we do this, there is going to be Federal Government exposure. And I think the taxpayer is going to want to be

sure that we are providing this assistance to keep the economy

going. And since we are giving this coverage, the idea that someone

could sue us for punitive damages or that we would be subject to

class-action lawsuits, or that a substantial amount of the cost could

end up being what at least a person like me calls frivolous lawsuits, is almost unthinkable.

I think that is an important component here. And since we are

backing up private money, if we do not give that coverage, at least

in this interim program, to that money, it ends up being eaten up

by those things and we end up being the payer sooner. So I think

that is the important ingredient in your proposal, and I want to

urge you to stand by it.

Let me just conclude, Mr. Chairman, by saying that I think that

the Administration’s proposal has a lot of good ingredients in it. I

think if you just throw away the first year of your program and

start with the second year the first year, you will be making a

major step in the right direction.

Based on having listened to my colleagues today, we are not

going on the hook for 80 cents out of the first dollar of loss. It may

very well be a logical place for us to get together—and I think we

can make it a bipartisan proposal, and if we can end up with something that the Administration supports, and we support it, it would

be helpful.

I think we do not want—whatever agendas we have that have

nothing to do with this, I think we all agree that we want to leave

it out of this. I think that is the way to do it.

But I just want to thank you and the Administration for putting

this, even though I do not support it, for putting together a very

thoughtful and a very helpful proposal, and one that I think we can

work on together, and I look forward to working with you on it.

Mr. HUBBARD. I think I will count you as a two-thirds supporter.

[Laughter.]

Senator GRAMM. Well, two-thirds is not bad.

[Laughter.]

You win a lot of elections with two-thirds. I have never achieved

that total.

[Laughter.]

Thank you very much.

45

Chairman SARBANES. Senator Corzine.

Senator CORZINE. Yes. Mr. Hubbard, I wonder if you have done

any economic analysis if we do not act with regard to this. You

talked about the categories of things that might be enacted in the

economy. But have you done any runs of economic models to see

how much it might actually cost the economy if we do not deal with

this issue?

Mr. HUBBARD. Well, the quickest thing that we did that is to look

again at the importance of premium domestic income and just

make a range of assumptions about what might happen to premiums. The total amount of the premium paid is $155 billion in

narrowest terms in the year 2000, a little over 3 percent of domestic income. So you can pick your favorite increase in that and get

a sense of the cost hit to industry.

I think perhaps the more serious concern is the capitalization

factor if discount rates in projects get changed because of a belief

in the lack of insurance. That changes the value of existing skyscrapers, power plants, and so on.

Senator CORZINE. I am not sure I fully understand the analysis,

but that sounds like you are pushing upward of 11⁄2, 2 percent of

GDP.

Mr. HUBBARD. I am not sure how you get to 11⁄2. Just because

the $155 billion——

Senator CORZINE. Knowing that is not going to be dollar for dollar translated through, and then you are going to have the secondary impacts with regard to the discounting numbers.

Mr. HUBBARD. Right.

Senator CORZINE. You are talking about a serious impact.

Mr. HUBBARD. That is a little too big. One hundred fifty-five billion dollars is what was actually paid before when arguing there

were pricing risks at zero.

So the question is, how much do you think that would go up if

you were pricing the terrorism risk? With 11⁄2 percent of GDP, that

is probably too extreme.

But that calculation misses, I think, the capitalization effects and

the value of assets, and that is probably what slows down development the most, the fear that lenders have that the projects would

be worth less.

Senator CORZINE. Even by that analysis, it is a very substantial

amount.

Mr. HUBBARD. Yes.

Senator CORZINE. How much of the $300 billion of the capital

base of P&C’s do you believe has been designated for terrorism

risk?

Mr. HUBBARD. You mean that is available to pay?

Senator CORZINE. No, no. We have other lines, as you suggested.

So there are all kinds of other calls on that surplus.

Mr. HUBBARD. My understanding from Sheila is that they have

not reserved.

Senator CORZINE. I think that is the point, when we talk about

how healthy the industry is with regard to surplus. And I am not

particularly in favor of no first dollar participation, the first dollar

position that we have here.

46

I think that people take false security in thinking about $300 billion worth of surplus when we still have natural disasters and fires

and other things that go on.

I also would like to know if your intent with regard to the legal

recommendations that you are making are designed only to fit to

the bridge proposal you have here, or are they intended to be longterm recommendations with regard to terrorism risk insurance?

Mr. HUBBARD. Well, that, of course, would be up to the Committee and the Congress. Our view is that they go hand-in-glove

with a reform in this area. We are only considering——

Senator CORZINE. When they are proposed, do you expect that

they would be proposed only limited to the proposal that you have

and not deal with the overall context of terrorism insurance?

Mr. HUBBARD. If your question is beyond 3 years, if you decided

to go the route of a more permanent program, I do not believe that

the private market will function in the way we want and hope it

will without these legal reforms.

Chairman SARBANES. So you are now reaching for permanent

tort reform. Is that right?

Mr. HUBBARD. The question was if there were a permanent proposal. We are asking for a 3 year in our proposal set of packages.

If you were designing a permanent system, it would be my advice

to you as an economist that that system would not take off very

well with private-market participation without these legal reforms.

Chairman SARBANES. You are complicating further a very complicated situation. I just want to make that observation. Tort reform is not a matter under the jurisdiction of this Committee, and

it is a highly controversial issue. Now, in a sense, you are

piggybacking it on here and we just have to take a look at that.

Mr. HUBBARD. If I might, Mr. Chairman, this is not a

piggybacking. This is absolutely essential. If you go back to the argument that I gave you about Hurricane Andrew——

Chairman SARBANES. Well, some aspects of it may be and some

may not be.

Mr. HUBBARD. No, that is right. What you need to do is take a

look at what——

Chairman SARBANES. You are going to have one venue for hearing all these cases?

Mr. HUBBARD. Yes, Mr. Chairman.

Chairman SARBANES. Where would that venue be?

Mr. HUBBARD. It would be a single Federal jurisdiction.

Chairman SARBANES. Where?

Ms. BAIR. It would be the multidistrict panel on tort litigation.

Chairman SARBANES. Which is located, where?

Ms. BAIR. Federal Government court structure.

Chairman SARBANES. I know, but where is it physically located?

Ms. BAIR. Well, they would make the determination about where.

Mr. HUBBARD. How about Maryland?

Ms. BAIR. It would be in Federal Court. And this panel would

make the determination depending on where the incident occurred.

Chairman SARBANES. You know, you all seem to assume that

witnesses and aggrieved parties can travel all over the country in

order to press their claims without experiencing great difficulties in

47

doing that. I find that a fantastic assumption, if that is the premise

of the system you are setting up.

Ms. BAIR. Senator, I think claims consolidation and punitive

damages limits are very important.

Chairman SARBANES. No, no, you are adding other things in

there. I am slicing this thing now.

Ms. BAIR. Right.

Chairman SARBANES. I am slicing it now to the venue. And as

I understand it, you are going to have one venue nationwide. I am

raising a very simple question, it seems to me; What does that do

to litigants who would have to travel great distances at great expense and inconvenience in order to assert their legal claims? That

is the question. What is the answer to that question?

Mr. HUBBARD. I am not an attorney. So the economic key to this

is that you have a single jurisdiction. You can have different single

jurisdictions, but there needs to be a single jurisdiction. The

counter-argument to your claim is the venue shopping.

Chairman SARBANES. No, no. You suffer a terrorist problem and

you live in Los Angeles, where it happened. And you have to go to

Washington, DC or New York City in order to assert your claim.

Do you see a problem connected with that?

Mr. HUBBARD. Well, again, you have a single jurisdiction per

incident——

Chairman SARBANES. Do you think that has no problems connected with it?

Mr. HUBBARD. As opposed to the lack of consolidation of claims,

then we are in an empirical argument, Mr. Chairman. The important thing is to reduce the transactions costs in the process so that

the litigation costs do not wind up dwarfing the physical costs.

Chairman SARBANES. If you suffered the damage and you had to

come all the way from Los Angeles to Washington in order to assert your claim, it would be an imposition on you, would it not?

Ms. BAIR. Senator, I just want to clarify. I do not think the Administration is talking about a single Federal district court to hear

all terrorism claims. It would be per-incident, just the way consolidated claims in the Southern District of New York for the attacks

in Manhattan.

On a per-incident basis, we would envision going forward that

those claims would be consolidated, presumably, in the Federal district court where the incident occurred. But I think that is the kind

of thing that we are talking about.

Chairman SARBANES. Well, that is a more sensitive and rational

response to what I have been getting.

Do you have anything else, Senator Corzine?

Senator CORZINE. I am troubled by this context because if we

think that this program is necessary to deal with a short-run problem by the industry and its inability to price this risk and, somehow or another, we are going to get greater comfort 2 years and

3 years from now, which I am not certain that I accept that assumption, but let us just do that for conversational purposes, and

we are going to change the tort structure for the period of time

while it is on, and then it is going to come off, how is the insurance

industry going to learn anything?

48

Again, I am not arguing that we should do anything with regard

to tort activities, but you are changing the whole rationale when

you come back to go to the private market solution, pure private

market solution, for the operation of this bridge.

That does not make sense to me. You say we want this so that

we will be able to have the price discovery mechanism have enough

time to go through it, but we are not going to allow for any discovery with regard to litigation that might come from personal liability, culpability, or other issues.

I do not think that the insurance companies are going to develop

a book that allows them to be able to do that in that timeframe,

unless you are arguing that we are basically for broad tort reform

that goes beyond the timeframe of the bridge.

Mr. HUBBARD. I do not think that is any different from any other

major element of the proposal. The theory is that you would review

this in 3 years or whatever horizon you choose. That would include

not only the legal process issues, but every other element.

I accept that uncertainty, but precisely for the reason that the

Chairman indicated, we did not want to use this as an occasion to

look for an entirely different permanent piece of legislation. We

wanted to focus this on the property and casualty problem.

Chairman SARBANES. Well, obviously we will have to continue to

explore this. I think we have to simplify this so that we have a better feel for what the ramifications or consequences are, and so that

it is more easily explainable in terms of the public understanding.

But we will hear from the next panel, which I assume the Treasury will monitor. I certainly hope so, because I think the views expressed there will need to be taken into account. And we will hear

from our two panels tomorrow and then see what we can sort out

in terms of what is a reasonable and rational way to deal with the

situation.

I want to say to the Chairman of the Council of Economic Advisers because I am looking here at an article by John Sweeney in

this morning’s paper, which you have probably seen. The essential

thrust of it is that there is an inadequate consideration of the question of emergency jobless benefits for workers and emergency

health care coverage for workers.

I think there is a growing danger that we are responding to this

crisis and challenge in an unbalanced way. As someone said, actually, right at the witness table earlier today, the airline companies

got help, but the airline workers did not get help. We are looking

at trying to address a problem confronting the insurance industry,

but there are other things that are not being done.

They are less directly related than the airline situation where

they did one side and not the other. But, nevertheless, I think the

Administration needs to give some additional and careful thought

to having a more balanced response to this challenge, so that there

is a sense in the country that it is equitable in how it is seeking

to deal with the situation.

This is obviously bringing in a lot of issues that are not the focus

of this hearing, and some that are well beyond the jurisdiction of

this Committee. But I simply want to make that point to you, and

I think the Administration needs to be thinking more broadly in

those terms, in terms of having a balance in what they are putting

49

forward and seeking that provides an assurance to the country that

this is being done in a fair and equitable fashion. And I would

leave you with that thought.

Mr. HUBBARD. Well, if I might just offer a quick thought in return, Mr. Chairman. The President proposed the displaced worker

package that did indeed offer an expansion of unemployment insurance and increased the funding for national emergency grants,

which would have provided a great deal of flexibility for Governors,

not only in the jobless problem that we are now facing, but also in

health insurance.

Chairman SARBANES. You are taking the CHIP money for health

care for children and shifting it over, and a lot of us—it is not the

purpose of this hearing to engage in that. But a lot of us think that

that is just playing shell games.

We have some CHIP money out there that has been provided to

the States to get health care for children. That is the approach.

Some of that money has not yet been spent by the States because

we are still gearing up to it, and so forth. And you are proposing

to take that money and move it over here to get health insurance

to unemployed people. Now we want to get health insurance to unemployed people, but I do not think we want to do it at the expense

of taking it away from children.

Mr. HUBBARD. I am afraid I could not just let that comment

stand, Senator. That is not really the intent at all. The CHIP program, for reasons we do not have to go into here, has a lot of inflexibility in it and does not well cover populations it is designed

to cover. And this would improve that flexibility greatly.

Chairman SARBANES. Mr. Hubbard, look. We could go at this all

day long. Let me just say this to you. I think there is a perception in the country on the part of a substantial number of people,

and a perception in the Congress on the part of a substantial number of people, that what is being done does not have a full equity

component.

I am just putting that to you in a sense, hopefully, of some

friendly advice. Now you may choose not to act on it, and if so, I

think this impression will continue to grow.

But this Committee has certainly tried very hard in order to do

that, if you witness the speed, and I think the care as well, in

which we acted on the money-laundering issue. I am just passing

this along to you. You may simply consider it as gratuitous advice

and proceed to ignore it.

Mr. HUBBARD. No, I appreciate it very much, Senator. Again, we

are very grateful for the work the Committee did on the moneylaundering front.

The one closing thought I would leave you with is, again, in your

reference to the insurance industry, I would submit that is not why

you wisely held this hearing. I think you wisely held this hearing

about the cost of doing business in the country. And that is the

problem that you are working toward and we hope to work with

you.

Chairman SARBANES. We are trying to address this issue, otherwise, we would not have scheduled 2 days of hearings.

Thank you very much.

Mr. HUBBARD. Thank you, Senator.

50

Chairman SARBANES. The Committee stands in recess until 2:15

p.m., at which point we will take the panel that I indicated earlier

that had been scheduled.

[Whereupon, at 1:05 p.m., the Committee was recessed, to reconvene at 2:15 p.m., of the same day.]

Chairman SARBANES. The Committee will reconvene.

I apologize to the witnesses. There are a lot of things happening

all over the place here, as you can well appreciate.

I see we have some time constraints here. Professor Froot, you

have to leave, I gather, at 3:30 p.m.

Mr. FROOT. 3:30 p.m. or 3:45 p.m.

Chairman SARBANES. Why don’t we go ahead and hear from you

first, and then we will pick up with the others.

And you, Ms. Sebelius, have to leave at 4:30 p.m. And we should

be all right on that. Why don’t we hear from you because then we

will take the rest of the panel. And by that time, you may have to

excuse yourself.

So why don’t you go ahead?

STATEMENT OF KENNETH FROOT

ANDRE ́ R. JAKURSKI PROFESSOR OF FINANCE

HARVARD UNIVERSITY

Mr. FROOT. Mr. Chairman, Senator Gramm, and Members of the

Committee, I appreciate the opportunity to appear before you and

discuss the insurance and reinsurance markets in the aftermath of

the events of September 11.

I come to this issue really as an academic economist, which I

think of as a person who is good with numbers, but lacks the charisma of an actuary.

[Laughter.]

I am also very pleased to share with you this after-lunch session

and note that it is an established fact that auto accidents peak between 1 p.m. and 3 p.m., after lunch each day.

[Laughter.]

What I would like to do is give you a little bit of a background

on my own impression of the events surrounding Hurricane Andrew and Northridge and pull that forward to today.

I think we run the risk of considerable dislocation in these markets going forward, given especially the annual nature of reinsurance renewals. However, at the same time, we need to preserve the

benefits of a vibrant insurance marketplace, high quality, evaluation, pricing, allocation, and mitigation of risk.

In the early 1990’s, the United States experienced two very large

natural disasters—Hurricane Andrew and the Northridge earthquake. The losses from these events were a shock to an industry

that had rarely considered and had never seen losses of these magnitudes from natural perils. Firms were obviously stressed, along

with their capital.

Let me spend a second of my testimony here tracing out the industry response. First, as one might expect, insurance and reinsurance prices rose spectacularly immediately following Andrew, doubling between 1992 and 1993.

The second point to make is that after these events, prices then

fell steadily between 1994 and 1999, as the effect dissipated to

51

about half of their level. Additional risk-bearing capital and new

firms entered the reinsurance industry, increasing competitiveness,

and approximately $10 billion of additional capital flowed into new

reinsurers, much of which was the result of the attractive postevent prices.

I should comment that, in fact, as the stock prices we have seen

in The Wall Street Journal today have increased, so, too, it has

been regularly with natural catastrophes in the past, as the opportunities for insurers to write and as the demand increases following

events. We see stock prices rise and capital then wanting to flow

into that sector.

The third point I take from this is that the growth that has occurred through the creation of a variety of new instruments and

new institutional reinsurance mechanisms. For example, there

have been new prototypes for reinsurers domiciled in tax- and regulation-favorable countries. These have been developed and highly

streamlined over this time period.

Fourth, additional sources of capital outside the reinsurance sector have become quite active. Cat bonds, and related financial

instruments which could be purchased by investors became viable

alternatives to reinsurance treaties as a way of transferring risk.

Even though relatively few cat bonds have been issued, they have

nevertheless promoted competition substantially in the industry.

Fifth, while this is hard to summarize in numbers, the entire discourse surrounding natural catastrophe events changed during the

post-event period. Insurers, reinsurers, commissioners, regulators,

rating agencies, brokers, consultants, third-party risk assessment

firms, all of them became much more aware of the possibility of

these events, where they might occur, what kinds of buildings were

at risk, how construction techniques can be approved, et cetera.

The language and vocabulary surrounding these events grew enormously, and that led, of course, to better pricing in the reinsurance

and insurance markets and a better awareness, not just for risk allocation, but also for risk mitigation.

These changes have helped reduce the post-event price of reinsurance. But I think perhaps more importantly, they have also increased the amount of reinsurance protection that is commonly

purchased today. If you look at the second graph of those color pictures, the ones down at the bottom labelled 4–D, it shows the fraction of reinsured losses covered at different levels of losses for the

industry in 2000. The results are striking here. Before Andrew and

Northridge, the most common layer of protection purchased against

industry-wide events covered events of about $4 billion. As of 2000,

the most popular level of loss protection had about tripled, to $12

billion. In addition, today substantial coverage has been extended

to much larger levels. Protection against natural catastrophe losses

of $25 billion or more is not uncommon. This is the legacy of Andrew and Northridge, and it is a permanent one, given the changes

discussed above. What do I take from this little bit of retrospective

for policy pointers for today?

First, I think it is very clear from this evidence that the reinsurance industry is efficient over the medium term. The industry can

and does respond to large disasters. High prices certainly occur,

but these motivate the response. Figure 4b shows prices have reVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00055 Fmt 6633 Sfmt 6633 83472.TXT SBANK4 PsN: SBANK4
52

turned to their pre-Andrew levels, even as the lower Figure 4d

shows that demand today for reinsurance has increased enormously. This is the sign of an economically efficient industry, one

that can expand capacity, have financial innovation, and accommodate a large increase in demand with virtually no increase in price.

Second, there is evidence that this medium-term response time

has grown shorter today. Following Andrew, the post-event spike

in prices took several years to undo. But there are a number of reasons to believe that the response would be much faster now.

First of all, we built what I like to call hardware, institutions,

Bermudan reinsurers, transformers, other financial institutional

forms, including capital-market instruments, that can rapidly and

smoothly incorporate new capital.

Second, there is the software around that hardware. The expertise and knowledge of the brokers, the investment bankers, the reinsurers, insurers, rating agencies, investors, regulators, all of

whom are much more familiar and fluent in the activities of risk

transfer in these areas.

I think there is plenty of direct evidence now that this hardware

and software is at work. In just a month after these terrible events

of September 11, one is aware of billions of dollars—to be precise, around $5 or $6 billion of committed funds already moving into the

reinsurance sector.

We have alluded already to The Wall Street Journal article in

the paper today that cites another billion dollars from AIG, Goldman Sachs, and one other firm. And I am aware of at least another

billion and a half of funds that are in the process of being raised. That would come to about $6 or $7 billion worth of funds, which

is fully half of the entire industry requirement under the Administration proposal for the first year, all done, or not completely done,

but all certainly moving very rapidly, and much of which is done

in the first 6 weeks after these events, the first 6 weeks being of

course the most shocking.

Third, I would say that any form of sustained provision of reinsurance by the Government will impede the kind of progress we

have made in developing the software and hardware and the ability

to process these kinds of issues. The decisions that need to be made

throughout the economy affect exposure in real ways. What types

of steel and concrete reinforcements help reinforce buildings of various heights? What kinds of physical barriers around buildings

shall we have? What kinds of equipment for checking, opening, or

possibly sterilizing mail would we expect? I think it is not really

a question, as we heard earlier this morning, of whether we will

rebuild downtown New York. The question is how will we rebuild

it? What kinds of coverage will be available for specific types of

buildings? I think that is going to lead, in the end, to more rational

mitigation of risk and better risk allocation.

Fourth, the sheer level of uncertainty about the likelihood of terrorist attacks is not in itself a reason to replace market functions

with Government programs. Critics of catastrophe modeling, of

which there are many, including some of the most important reinsurance underwriters, argue that models provide false precision

about the probabilities of disasters and that they are unknowable.

The uncertainty surrounding the one-time potential impact of the

53

Year 2000 computer bug was certainly extreme. Yet, this did not

stop the creation of private insurance dedicated to protecting

against Y2K damages.

And in that event, of course, with respect to Y2K, one might expect as an insurer that the firm’s purchasing insurance might

know a good deal more and have considerable more control over

their exposure to that bug than the insurer would know about.

That certainly is not the case with respect to terrorist events.

In terms of the Administration’s proposal, I support in a qualified way this approach of a limited, temporary, Federal intervention in the insurance market. A measured response is appropriate

to assure continuity in the insurance markets and to support renewed economic growth. I agree with three of the basic principles

of intervention that were discussed earlier, that intervention

should generate appropriate price incentives, that it needs to encourage private market incentives to expand capacity as needed,

and that it needs to help produce uncertainty about liabilities that

are associated with litigation. In addition, I believe that if these

three principles are to be satisfied, the sunset feature of the program is absolutely essential.

In that spirit, I would also strengthen the second principle of this

program that deals directly with the sunset feature. In my view,

it should read that the intervention shall be absolutely temporary

and primarily intended to resolve severe, short-term dislocations of

the market due to a sudden shift in risk and coverage perceptions.

I believe that is what we have and I believe that is a concern, indeed, for January 1, but I believe that these concerns die away considerably over time. I do concur with Senators Gramm and Nelson

that a greater participation by the industry in the first-year losses

is, at least for the first dollar claims, is probably appropriate.

Over 1 or 2 years, however, I believe the market is fully capable

of evaluating pricing and designing exposure to large risks. The existence of anything more than a targeted, highly temporary, Federal program is likely to forestall development of better insurance

markets and pricing, better risk allocation, and mitigation decisions by the private sector.

Thank you, again, Mr. Chairman.

Chairman SARBANES. Well, thank you very much. We appreciate

your statement and the effort that went into preparing it. And we

very much appreciate your being with us.

Ms. Sebelius, we would be happy to hear from you.

STATEMENT OF KATHLEEN SEBELIUS

PRESIDENT, NATIONAL ASSOCIATION

OF INSURANCE COMMISSIONERS

COMMISSIONER OF INSURANCE, THE STATE OF KANSAS

Ms. SEBELIUS. Thank you, Mr. Chairman.

I am Kathleen Sebelius. I am the elected Insurance Commissioner from Kansas and serve this year as the President of the National Association of Insurance Commissioners. We appreciate the

opportunity to be with the Committee Members today.

Today, I really want to focus on three basic points. First, the

NAIC and our members believe there is presently a need for the

Federal Government, working with the State regulatory system, to

54

provide appropriate financial backup to the private insurance market in order to ensure that the Nation’s economy does not falter

due to a lack of insurance coverage for terrorism. Although we have

not endorsed any specific proposal for Federal assistance, we have

adopted a set of 19 principles that are attached to my testimony

that we believe should form the basis of a sound program of the

Federal Government.

Second, we believe Federal assistance should be a short-term solution to stabilize the commercial marketplace, while it regains the

risk assessment and pricing equilibrium needed for private insurers to underwrite terrorism exposures. Any Federal terrorism insurance program should be limited in scope and duration.

And third, a Federal insurance program should maximize the use

of market forces to add efficiency and reduce the risk of losses from

terrorism and the potential cost to Federal taxpayers.

Let me just start by saying that we really do believe that the insurance industry is well capitalized and financially able to withstand the pressures created by the September 11 terrorist attacks,

which right now are estimated to be upward of $30 billion. The industry is a $1 trillion business with assets of more than $3 trillion.

And the preliminary loss estimates of $30 to $40 billion represents

just 3 to 4 percent of the premiums written in the Year 2000.

As regulators, my colleagues and I will continue monitoring the

process to make sure that insurance promises are kept. To do our

job, we have an array of human and technical resources, including

our center office, the NAIC, of 51 State insurance departments that

collectively employ more than 10,000 people and spend about $900

million annually on insurance supervision. In addition, the State

insurance guarantee funds have the capacity to provide up to $10

billion to compensate American consumers in the event of insuring

insolvencies.

We would urge Congress to structure any Federal assistance program to take full advantage of the existing regulatory system. We

have mechanisms in place to monitor solvency and to handle claims

payment issues.

The business of insurance is about measuring risks and selling

promises to cover them with a reasonable profit. Over time, insurance experts have demonstrated a remarkable ability to adapt to

unforeseen circumstances, while making available the insurance

products that are essential to the growth and productivity of American business. As expected in a free competitive market, individual

companies may stumble, falter, and even fail when substantial adversity strikes. However, the industry as a whole has a long and

proud record of finding ways to overcome new obstacles, while advancing its business goals and serving the interests of the insurance-buying public.

Thus, the NAIC believes Congress should begin its consideration

of Federal assistance to the industry by recognizing the strength

and adaptability of the private markets. Federal actions that disrupt or interfere with private market forces are likely to end up

causing more harm than good for both consumers and taxpayers.

State regulators know from their own experiences that Government action can help the market recover when it becomes overwhelmed by changing risk factors or catastrophic losses. We found

55

successful Government assistance involves tailoring actions to fix

specific problems and keeping the program as narrow as possible.

State insurance regulators believe the current situation affecting

the availability of insurance for active terrorism is similar in nature to other catastrophic events. Enacting a very temporary Federal solution will provide the necessary time to craft a more

thoughtful, long-term solution.

Here are three market factors that we would like to keep in

mind. First, following the September 11 attack, Government and

commercial facilities across America have begun to add security

measures to prevent acts of terrorism and limit potential damages.

As commercial risk managers review these new precautions, it is

likely that they will become more inclined to offer terrorism insurance because the possibility and extent of potential losses will be

reduced. At that point, we expect market forces will start filling the

gap by making terrorism insurance available through the private

industry.

Second, the private market instills policyholder discipline to

avoid insurance claims through the concept of coinsurance. Coinsurance means that policyholders are liable to pay part of any

losses covered by insurance before expecting recovery from an insurer. It is a common concept known by everybody who buys car

insurance or health insurance as a deductible, which you pay before receiving payment from the insurance company. And we think

coinsurance should be considered by Congress as an important

market discipline tool that works equally well with Government

programs.

Third, the scope and duration of any Federal assistance program

will itself become a factor in the private market. Even though Congress is considering special Government assistance intended to operate as a supplement to normal business channels, the very fact

that you will pay certain costs of a commercial business becomes

a factor to be taken into account when the private market decisions

are made.

We think that it is appropriate in the short-term to have the

Congress involved, but basically feel that it is appropriate to have

that very short-term and very strategic and not disrupt the private

market forces. We look forward to working with Congress, with insurers, with the Administration, so that the needs of individual

Americans and our Nation’s economy are met in a timely way.

Thank you.

Chairman SARBANES. Thank you very much.

Mr. Hunter, why do not we hear from you, and then we will conclude by hearing from the GAO.

STATEMENT OF J. ROBERT HUNTER

DIRECTOR OF INSURANCE

CONSUMER FEDERATION OF AMERICA

Mr. HUNTER. Thank you, Mr. Chairman. And thank you for holding this important hearing and I particularly thank you for doing

the Nation’s business in these hard days. We appreciate it.

This hearing seems very familiar to me since, when I was young

man and starting out as Chief Actuary of the Federal Insurance

Administration back in the early 1970’s, I was asked to calculate

56

actuarially sound rates for the riot reinsurance program that Congress enacted to keep insurance available and affordable in the

inner cities of America in the riot era of the late 1960’s. There is

a lot to fear in uncertainty then, as now. We were very concerned

about whether there would be markets for insurance.

Further, it is very familiar because the Banking Committee was

where we held all the hearings where we developed the plan and

implemented the plan. And Senator Proxmire, who was Chairman

at the time, and others, were doing all of our oversight work. And

so, here we go again together, Mr. Chairman, on another similar

venture.

I would like to start off by saying that CFA supports a Federal

backup of the insurance business for the peril of terrorism. We

think that there is need. In the testimony that I provided for the

record, was a list of the principles that consumer groups will use

to measure the acceptability of any plan for terrorism coverage

from the perspective of the consumer.

Chairman SARBANES. Let me say that all of the statements will

be included in the record in full. I know that people are now in the

process of summarizing prepared statements. But the entire prepared statements will be included in the record.

Mr. HUNTER. Key among our principles that you will see that the

taxpayers as well as insurers should be protected. By this we mean

that actuarial rates should be charged for any Federal backup coverage. ‘‘Cherry-picking’’ by insurers should not be allowed. And the

claims presented for Federal payment should be subject to Federal

audit. The second principle is that State consumer protection

should be maintained. The third principle is that consumers should

be protected by making sure affordable and available insurance for

terrorism is maintained. Fourth, insurance prices must reflect security-enhancing incentives so that free Government reinsurance

would undermine that goal. Fifth, terrorism must be clearly defined and national in application.

There are several serious flaws in both the industry approach

and the Administration approach. Clearly, neither bill requires actuarial soundness. Indeed, insurers pay nothing for reinsurance in

the first year of the industry program and never under the Treasury approach. Apparently, free Government reinsurance would

even cover policies already in force for which insurers have been

paid premium and are fully at risk today. This is a grossly improper use of taxpayer dollars. Neither approach is simple enough

to be up and running on January 1, 2002, when the bulk of private

reinsurance against the peril of terrorism expires.

That is another serious problem. The insurer plan is worse than

the Administration plan in that it provides an end of rate regulation and overrides any remnant of State or Federal antitrust law

and sweeps in tort reform and is basically a Christmas tree.

Unfortunately, the Administration plan shows that they do not

really understand insurance, and if there are questions, I can explain at least two areas of what I mean. It is in my testimony that

neither plan assures affordability or availability of coverage to reasonably secure risks. Congress should not rush to pass either of

these severely flawed plans or a combination of such flawed plans.

57

CFA proposes a plan that is simple and is constructed so that

Congress can easily have it up and running on January 1, 2002.

In the written statement, I call it an interim plan, but since I put

it forth at the NAIC yesterday and talked to a lot of experts, I

think I am going to go bolder and say that maybe you could make

it the plan. Here is the idea. The industry today has $300 billion of surplus which could be applied to any risk. Surplus is nondivisible. It is available for any

risk. Considerably more than is needed for an efficient market.

That is why premiums have been falling. It is overcapitalized the

insurance industry. Even after September 11, the vast majority of

insurers could withstand easily another event of the magnitude of

September 11. So we are sure that the plan need not cover firstdollar losses.

CFA proposes that a retention for each insurer of 5 percent of its

surplus as of December 31, 2001, the end of this year, when the

program starts, be used as a retention for each company group.

This protects weaker insurers from insolvency risk and minimizes

interference with insurance pricing decisions.

Terrorism must be defined clearly and a Federal official will determine the availability of the rest of the program, which is loans

by the Government to insurers if losses exceed the 5 percent.

If a terrorist attack occurs and an insurer suffers claims greater

than 5 percent of its surplus, the insurer would be eligible for Federal low- or no-interest loans—that is up to you all—the term of

which would be negotiated for up to 30 years. This would spread

the cost over time, an important goal.

For each insurer, the discounted value of the loan would be limited to an additional 5 percent of that insurer’s surplus. This is

needed, this limit, in order to make sure that individual company

balance sheets are not impacted by very large losses and the companies become technically insolvent.

Amounts of money loaned in excess of the 10 percent of the surplus by a company would be repaid to the U.S. Treasury through

a property casualty insurance industry-wide loan repayment mechanism. This loan repayment would be collected over a number of

years sufficient to minimize the rate impact on consumers who

would ultimately pay the cost of the coverage.

Let me give you an example. If there was a $100 billion loss,

next year, the first 5 percent would roughly produce $15 billion

that the industry would have to pay out of pocket. The next 5 percent, where the individual companies would come in, would

produce another $15 billion. That would leave $70 billion for the

spreading mechanism.

Seventy billion dollars happens to be about 20 percent of the premium charged last year. If you capped it at 21⁄2 percent, then the

loan would have to be repaid over an 8 year period and that would

be passed through to consumers.

The loan would be repaid by the industry. It would be based on

premium. And it would be piggy-backed. The States could collect it

piggy-backed on the State premium tax mechanism, which is based

on premium.

This plan leaves the regulation of insurance fully in the State

hands. The States should be required by the bill to assure availVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00061 Fmt 6633 Sfmt 6633 83472.TXT SBANK4 PsN: SBANK4
58

ability and affordability of the terrorism risk, using their usual regulatory methods, including pooling by State, if necessary. Such

pools are actually in place in about 30 States.

Further, the States should be asked to assure that the plans enhance security through discounts or other incentives. Congress

should set goals for the States in this regulatory effort, but the

States should do it. This requires little, if any, new bureaucracy at

the State level since much of the work is already part of the State

insurance department responsibility.

And as to the Federal bureaucracy, the plan would require only

a handful of people to monitor the request for loans, write up loan

documents, advise the States on the amount of monies needed if

the losses exceeded the 10 percent level, and monitor claims, which

you must do under any, to make sure that they really meet the definition of terrorism.

If there is no terrorist attack after January 1, 2002, the program

never becomes operative. But you have given surety to the insurance companies that they know exactly what their maximum annual loss is.

Congress should enact this plan, which protects the insurance industry, the consumer, and the taxpayer. It is certain, it has actuarially sound basis, it is simple, there is no hand-out, there is no

bail-out, it works, and, more importantly, it can be fully operational

on January 1, 2002.

Chairman SARBANES. Thank you very much. A very interesting

statement.

Mr. McCool.

STATEMENT OF THOMAS J. McCOOL

U.S. GENERAL ACCOUNTING OFFICE

Mr. MCCOOL. Mr. Chairman, Members of the Committee, we appreciate the opportunity to discuss the response of the insurance

industry to the losses resulting from potential terrorist attacks and

the extent to which the Government should play a role in addressing these risks.

My testimony today presents features of selected insurance programs covering catastrophic or terrorist events, information on alternative mechanisms for funding insured losses, and outlines some

broad principles or guidance that the Congress may wish to consider as it reviews possible ways to support the insurance industry

in case of future catastrophic losses due to terrorist attacks.

Regarding the first point, my full statement has fairly elaborate

discussion of existing insurance programs. But in my short statement, I will just say that a number of the programs exist in the

United States and other countries to help insure that insurance

will be available to cover risks that the private sector has been unable or unwilling to cover by itself, including losses from catastrophic events and terrorism. Certain insurance programs are

completely controlled and managed by the Government, while others have little or no explicit Government involvement. Likewise, in

many programs, the public and private sector share risks and go

in several different ways.

With respect to the different mechanisms, funding mechanisms

for funding insured losses, clearly one of the major issues that has

59

been discussed in most of the testimonies today has to do with

pricing. And again, I am restating something that was stated this

morning, pricing for a program like this will be as difficult for

the Government as it will be for the private sector, and maybe

more so.

In any case, you must try to balance concerns about underpricing

and potential issues of insolvency for the private sector or oversubsidy for the Government sector if the Government sector is doing

the pricing versus concerns about overpricing and the potential distortions in the market that could result.

Part of the discussion that has come up in many of these programs is the extent that you engage in a pooling arrangement.

Again, pooling arrangements can be pooled amongst private-sector

parties or shared with the Government. And there is again a number of examples in some of the programs that exist currently

throughout the world where the pooling arrangements are an important part of the program.

Another issue that has to be determined by any program will be

whether you try to prefund losses or try to do after-the-fact assessment. And even within the option of after-the-fact assessments, one

of the issues is whether you pay as claims come in or whether the

Government provides when the initial claims come in and then the

firms would pay these assessments over time through some type of

a loan program.

So there are a number of different ways in which such a program

could be set up, again, with or without pools and with or without

prefunding, and all of these are options for consideration.

The Government could also fund any contingent liability in a variety of ways. It could charge a premium for the reinsurance protection it provides, accumulate a fund it could use to pay for losses.

Alternatively, the Government could provide loans to the industry

or fund its losses out of tax revenues, either with or without repayment requirements.

In conclusion, a financially secure insurance industry is essential

to the smooth functioning of the economy. There have been reports

that without insurance coverage against potential catastrophic consequences of a terrorist act, investors and providers of finance may

not be willing to provide capital or may impose very stringent

terms. Any mechanism established by the Federal Government to

support the ability of individuals and businesses to get insurance

for terrorist attacks should address many significant concerns.

First, the program should not displace the private market. It

should create an environment in which the private market can displace the Government program. As a result, any program should be

temporary. I think, again, these are principles that have been stated by others. And the third principle, which is one that GAO always supports, and again, it has been mentioned earlier, any program should be designed to ensure private market incentives for

prudent and efficient behavior are not replaced by an attitude that

says, do not worry about it. The Government is paying.

So, Mr. Chairman, that is my prepared remarks and I would be

happy to respond to any questions you or the Members of the Committee may have.

60

Chairman SARBANES. Well, thank you very much, sir. First, let

me ask, I want to ask each member of the panel what they think

would happen if nothing were done. And why do not we take you

in the order in which you delivered your testimony.

Mr. FROOT. If nothing was done at all, I think there would be a

substantial dislocation because of the calendar effects associated

with the January 1 renewals. My guess is that that would be resolved within a year. But that, in the first year—again, this is back

to something we said earlier—I would not want to bet that we

would not end up in a situation with extreme exposure in a few financial intermediaries or insurers, and perhaps some reinsurers,

that was unable to be spread and therefore, in the event of a crisis,

actually led to a severe collapse.

Chairman SARBANES. Do you think the people seeking insurance

would be able to get it?

Mr. FROOT. I think in some circumstances, it would be very expensive. And, yes, I believe it would be hard to assure that insurance would be available in all cases.

Chairman SARBANES. So it would be expensive and it might not

be obtainable? Is that what you are saying? Or it would be obtainable, but only at a very high cost?

Mr. FROOT. I do not think there is any guarantee that it would

be unobtainable.

Chairman SARBANES. Ms. Sebelius.

Ms. SEBELIUS. Senator, In the short term, we have a real crisis

in the commercial marketplace because I do not think that money

is going to be available for the development or financing of large

commercial properties without insurance.

We are already as regulators getting notices from companies who

would like immediately to institute restrictions on terrorism coverage. Those are being filed across the country as we speak.

And if this were a different timing, I think if we were having this

hearing in February or March, and we had gone through the renewal period, it is conceivable that the private market could figure

out a solution by the renewals the following January. What we are

faced with here is a calendar problem because the renewals are imminent. And I really think it is highly likely that it would be very

difficult, if not impossible, to get any kind of coverage at any price

for this risk in the short run without some program.

Chairman SARBANES. Both for existing buildings and for new

development?

Ms. SEBELIUS. I am not the capital market expert. But we have

been told that the real problem is not initially with the insurance

itself. It is really without the guarantee that you could insure an

attack in the future in the short run. Nobody is going to put substantial amounts of money down for ongoing financing or for new

developments. So it would dry up the capital market. And I think

that could happen very quickly.

Chairman SARBANES. Mr. Hunter.

Mr. HUNTER. It does hinge on what type of policy you are talking

about. A company like State Farm, which is insuring homes and

cars, many of them all over the country, a big spread of risk, probably would not have much of a problem dealing with not having

61

terrorism reinsurance. It does not buy much reinsurance anyway

because it effectively reinsures itself with the spread, and so on.

But when you get into the commercial accounts, that is where

you would have the crunch, big accounts that this morning Senator

Nelson called target risks, would have trouble getting insurance.

There would be applications made to the State insurance departments to allow the exclusion of terrorism. Now some States might

disapprove those filings and therefore, then companies would have

to make a decision whether to cancel the whole policy or not cancel,

but nonrenew the whole policy. But that is a potential that—how

do you put a number on it? I believe it is severe enough that Congress should worry about it.

Chairman SARBANES. Mr. McCool.

Mr. MCCOOL. Well, again, I think that the problem would exist,

clearly. The question of how large it would be and how it would

show up, there is a number of different ways it could show up.

Clearly, you could have cases of—there would be no doubt that

there would be much higher premiums applied to commercial insurance in particular, and possibly there is going to be nonavailability of insurance.

I guess the next question would be, if someone did not have insurance, either it was not available to them or the price was so

high that they would think about opting out, what would be the

impact on someone providing financing to them?

And again, there would be ways for the financiers to adjust by

asking for more upfront equity, by lower loan-to-value ratio, by

asking for higher returns. But there would be a lot of different

ways in which this could show up. And it would clearly have a potential significant impact.

Chairman SARBANES. I want to repeat the question I asked and

get two of you to answer. Is there a divide or difference between

getting the insurance for existing buildings and getting the insurance for new development, new buildings?

Mr. HUNTER. Again, it depends on the building. If you are talking about big target-type buildings, I think they would have trouble

keeping the insurance they had and the new buildings would be

even more problematic because they do not have the history of

insurance.

Now, obviously, these big accounts also have some ability to selfinsure and so on. So they may have some ways to get through that

and find some kind of reinsurance at very high levels. But until the

reinsurance market is assured, I think you would have trouble with

those big accounts.

Mr. MCCOOL. Again, I would agree that new construction would

probably be more affected. But I do not think that you could ignore

the effects on existing structures.

Chairman SARBANES. I see my time is up and I yield to Senator

Miller.

Senator MILLER. Just a couple of things, Mr. Hunter, help us to

understand this better. What kind of distortions would there be in

the insurance market if we created the Administration proposal? In

other words, what happens to a market when you give away a Federal guarantee that does not cost the industry anything?

62

Mr. HUNTER. Well, it means that the rates can be much lower

obviously than they might otherwise because the insurance companies do not have to find actuarially priced reinsurance protection.

They know they have free reinsurance for 80 percent from dollar

one, and a $12 billion maximum loss in a year.

That is a lot of assurance and it means the pricing of things like

security would be less enhanced. There would be less reason for

people to toughen their buildings and put security guards out there

and spend that kind of money, whereas, if insurance was fully

priced, there would be that additional incentive, besides saving

lives and the other good things that happen. The financial incentive to do those, that would be weakened.

Senator MILLER. Thank you. Let me ask this question of everyone on the panel, except Mr. Hunter.

[Laughter.]

What do you think of Mr. Hunter’s proposal?

[Laughter.]

Mr. FROOT. Let’s see. I like it to the extent that allegations that

parts of the insurance industry are over-capitalized are true.

That is, that, in certain sectors, mutuals in particular, it may be

very difficult to reduce the amount of capital, even as risks decline.

And so, therefore, putting that capital to work, in a sense, directly

through this kind of program would make a lot of sense.

For companies that are not overcapitalized, it would be a mistake

because, in the end, after the event, they would be burdened going

forward with a substantial liability, additional liability, which

would place them in a financially inflexible and relatively fragile

position compared to where, judiciously, they would believe they

should be.

Ms. SEBELIUS. Senator, I am not sure I can make a terribly well

qualified review of Mr. Hunter’s program. I have heard the basic

outlines now twice. But there is a bit of misconception. Regulators

want companies to build reserves. You want companies to build reserves as a policy program because without those reserves, they

may end up not being able to pay the claim.

So I do think that we want to be careful about assuming that if

they have assets in reserve, that somehow, that is extra money.

That is there to back up the policies that are in force in the marketplace.

I think the concepts are interesting about the notion that there

would be some repayment scheme at some level and probably is

one that should be looked at by the Congress.

Some of these issues really are kind of insurance-related principles. Some of them are really public policy decisions. And I am

not sure that, as an insurance regulator, I am very well qualified

to suggest what your public policy decisions may be. And I believe

a lot of what Mr. Hunter has outlined really falls into more the

public policy area.

Is it a good idea that taxpayers should expect this money to be

repaid? How much should the industry count on? We certainly support the notion that dollar one involvement from the Federal Government may not be the best way to approach this, a deductible

system, setting a level that gets some insurance capital involved

before there would be any kind of Government involvement may be

63

a more appropriate approach, and that is part of what Mr. Hunter

has talked about. So I do not know if that is helpful, but I do not

know a lot about the plan.

Chairman SARBANES. Could I just ask a simple question? It is

possible that if the reserves are built up too much, that they have

been charging too much on the premium side, is not it?

Ms. SEBELIUS. That is something that regulators look at on a

fairly regular basis when companies apply to us, that certainly

more of that regulatory oversight is exercised in the personal lines

market less than in the commercial market because we assume in

a competitive market that the sophisticated buyer will essentially

use the marketplace to drive rates down. And markets are pretty

competitive at that level and they have the ability to do that.

Chairman SARBANES. Thank you. Senator Miller.

Senator MILLER. Let me ask Ms. Sebelius a question while she

has the microphone. The industry’s concern about the Administration’s proposal is that they will not be able to price risk. Do you

agree with this concern about their ability to price risk?

Ms. SEBELIUS. We have had this discussion, all the regulators in

the country, frankly, who have been in town for the last couple of

days, to look at the aftermath of September 11 events on the industry. We have talked a lot about the industry’s really amazing ability to price anything. I mean, not that anyone would have foreseen

September 11, but they have had lots of unforeseen issues in the

past and have relatively quickly, as the Professor suggested, figured out a pricing mechanism. It may tend to be very conservative

initially, over-reserving, charging too high, and then the market

drives that down.

I think the issue here is how quickly can that happen? And our

concern is that the timetable of the January 1 policy renewals are

such that we do not have a lot of faith that can happen in that

kind of timespan. But I am very optimistic that within the course

of the next year, they can begin to appropriately price this risk,

they will price it, and they will sell it.

Senator MILLER. Thank you. My time has run out.

Chairman SARBANES. No, go ahead, Senator.

Senator MILLER. Mr. McCool, do you have a statement on Mr.

Hunter’s proposal?

Mr. MCCOOL. Well, again, we do not endorse or die.

[Laughter.]

I think it has some interesting features. It does have first-dollar

coverage, which again we think is something that is a good idea.

It has a formula for allocating the first-dollar coverage on a firmby-firm basis, which again is an attractive feature. Whether capital

is the right basis or some other basis could be used, the fact that

it does have an allocation formula on a firm-by-firm basis I think

is a useful feature. Again, the fact that it repays the Government

over time is something that the GAO would never be against.

[Laughter.]

And again, at what rate is up to you to decide.

Senator MILLER. That is an attractive feature. Thank you.

Thank you, Mr. Chairman.

Chairman SARBANES. Senator Schumer.

64

Senator SCHUMER. Thank you. I appreciate the panel being here.

I have looked at the testimony and I am sorry I could not be here

the whole time.

Let me ask each of you, and particularly those who seem to like

the Administration’s proposal, how do we prevent ‘‘cherry-picking?’’

How do we prevent 5 percent of the most vulnerable, or at least

as perceived, the most vulnerable properties from just being excluded and not getting insurance?

Professor Froot.

Mr. FROOT. I would have said that ‘‘cherry-picking’’ is a great

problem when it comes to someone trying to buy for you life insurance or for themselves more extensive medical coverage, or any of

those things. I think those are examples where, in those markets,

the individuals have some control over the risk and they have some

knowledge about the risk that the insurer would not have. That is

where we tend to see ‘‘cherry-picking’’ most severely.

I do not think that is the case here. I do not think there is much

risk that a particular building owner knows more about the risks

of terrorist attack than can be easily established by someone looking to write a policy for that building.

Senator SCHUMER. I do not follow you. I do not understand. The

Empire State Building, Disney World, the Hoover Dam might be

places that might be much riskier.

Mr. FROOT. Much riskier.

Senator SCHUMER. To insure after September 11. And if we just

say that the Government will pick up 80 percent of the costs of

whatever insurance you write, some might say, well, 20 percent is

still too much to be dangling out there for these type risky things.

We are not going to insure them any more.

Mr. FROOT. But I tend to agree with Ms. Sebelius, that, basically,

that there will be competition, there will be a desire to write that

policy, and there will not be a concern that one is being adversely

selected in writing that.

That is to say, that because you come to me and are willing to

pay a very high premium, that means an even higher risk than I

would have ever guessed.

Senator SCHUMER. Again, we are talking past each other. I am

not worried about competition between the two. I am saying, if

everybody comes to the conclusion that $10 a square foot to rent

the Empire State Building in insurance, the owners will not be able

to make any money and the building will go under, the building

will not be insured. That is what I worry about. I worry about a

significant portion of properties not being insured.

Ms. Sebelius.

Ms. SEBELIUS. One of the features that you may want to look at,

as a possibility in partnership in this Government involvement,

would be to disallow exclusions for terrorism coverage, which forces

the risk to be spread, essentially, and tie that or tie any opportunity to participate in the Federal program to not having the exclusions. The issue we are dealing with right now State-by-State is

really holding those to see what is going to happen.

Senator SCHUMER. That is a pool of a sort, but a pool you could

live with.

65

Ms. SEBELIUS. But one of the issues may be spreading that risk

so that every company is in the game from the outset and then you

have a realistic possibility. If you let people begin to exclude out

of the pool the price against the pool to, as you say, cherry-pick the

properties, I think then you really have the potential of a very distorted marketplace very quickly.

Chairman SARBANES. Could I ask on that very point? You say in

your statement, and I am now quoting, ‘‘Many people in Congress

apparently think that States require private businesses to carry insurance against terrorism, and that failure of the private insurance

market to offer terrorism coverage will result in violating State

laws and regulations. We believe there is a misunderstanding of

what State laws require and what State insurance regulators do.’’

And then you say you did an electronic search of State laws and

regulations with references to terrorism and you found nothing.

Now, maybe I have a misunderstanding. It was not my premise

that the current law and regulations require terrorism coverage because, in a sense, it is not been at the forefront of our concerns.

But I thought that you could require that the State insurance

regulators have the authority to require that the policies cover terrorism. Is that correct?

Ms. SEBELIUS. I do not think that is accurate, Mr. Chairman,

without legislative intervention. For instance, legislators in some

States have said health care policies must have the following features in it.

At the State office level—some of us have and all of us do not

even have this authority, is actually to deny exclusions. We do it

in reverse. When exclusions are filed with our office, there are statutes right now in some States that have deemer provisions. Unless

you take some action and that could be administratively overruled,

they go into effect. So it is really the reverse.

The issues that come as exclusions are looked at by our office,

but there is really not an affirmative requirement that policies

must have a variety of features in them unless that is something

that the legislature has actually taken on as a legislative initiative.

Chairman SARBANES. But if you did not give the exclusion,

wouldn’t terrorism be covered?

Ms. SEBELIUS. At this point, that is the likelihood, that as a

State insurance commissioner—most of us either could deny the exclusion or take some emergency rule to not allow the exclusion to

exist. Now having said that, they do not have to offer the policy at

all. I mean, that is step two. You could deny the exclusion, but that

does not mean the company has to write the policy.

Chairman SARBANES. Well, I understand that.

Senator Schumer.

Senator SCHUMER. Just one other question. I think earlier, Senator Gramm said that he might consider supporting 100 percent insurance for 2 years, Federal, 100 percent coverage Federally—did

he say this? Yes? I am surprised—to avoid the Federal Government

being involved permanently.

Now, of course, if we had a series of terrorist incidents even at

the end of Year 2, or after Year 3, we would have to come back,

is my guess, of great magnitude. So I do not quite get it because

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that really depends on what happens post-September 11. But

would any of you want to comment on that idea?

Mr. HUNTER. That is a terrible idea. Part of the reason it is bad

to have no premium is it would undermine all the various normal

market workings and incentives for more secure risks. You really

want to have safer places out there.

Senator SCHUMER. Hunter says Gramm ignores free market.

[Laughter.]

Ms. SEBELIUS. Senator, I also think that we, at least, believe you

really want the private market forces to get back in the game as

quickly as possible and to begin to figure this out.

A 2 year hiatus with no risk, no capital, no anything, may really

be exactly the wrong message to send. I believe very limited, very

strategic backup help, but urging the private-market forces, essentially, to regroup quickly, recapitalize quickly, and sell the policies.

Senator SCHUMER. Could I ask each of you one final question?

First, in writing, if any of you have ideas on how you deal with

this ‘‘cherry-picking’’ issue beyond what we have discussed today

because, to me, it is a very vexing issue, could you send them?

Would that be okay, Mr. Chairman?

Chairman SARBANES. Sure. Certainly.

Senator SCHUMER. For a week. It is not mandatory, but if you

have some good idea, I would love to hear it and I bet the Committee would as well.

My final question is, as you may have heard, if you were here

earlier, I am very worried that people will not endeavor to begin

large new projects if they are worried even if they know that in the

first year there will be insurance, if they worry that there will not

be in subsequent years. Is that a valid worry? And should that play

a role in what we pass here, if we were to pass something?

Do any of the witnesses—— Mr. HUNTER. It is a valid worry. But you could set up a program

that said, if you enter into a multiyear project, requiring multiyear

insurance, you have to notify the Government, and perhaps you

could even have a multiyear policy, even if the program ended. You

still might be able to do something.

Senator SCHUMER. The policy could be backed up in Year One.

Mr. HUNTER. Either a policy or a loan guarantee, or however you

do it, you could have a multiyear basis for that.

Senator SCHUMER. Right. Any other comments? Ms. Sebelius.

Ms. SEBELIUS. I did hear or was able to watch some of the hearing this morning and heard that concern voiced. I guess we are

fairly confident and, again, it is based on looking at what happened

after Northridge and Hurricane Andrew, what happened in various

situations, that the multiyear funding issue is probably less a problem, assuming that we do not have a series of attacks, less of a

problem than this strategic issue right now. I am fairly confident

the market would rebound and be issuing policies in the future.

Chairman SARBANES. I take it it’s your view that if this had happened next February, that the private sector might have been able

to work it out by the end of the year, given the 9 or 10 month period within which to do it. Is that right?

Ms. SEBELIUS. Well, there has been some discussion that certainly the problem is really exacerbated by the timing, given the

67

proximity to the January 1 expiration of virtually all—not all, but

a large portion of the reinsurance treaties. We are in a particularly

difficult time. I think what you would have had in a different timetable is at least several months to see how much capital came back

in, what the market solutions were. We just do not have that luxury at this point.

Chairman SARBANES. Of course, one could then, carrying the

logic of that out, say, well, we have a situation where we have to

get over this hurdle or this hump that is facing us, and enough

time to see how it works. If it does not work out, it could be revisited, I guess, would be the argument.

Ms. SEBELIUS. Well, that is certainly why we would support a

firm sunset, a very short timetable, and the opportunity certainly

is there to revisit or renew. But we think having a time certain

where the program ceases of fairly short duration makes very good

sense and it keeps pressure on everybody to figure out the solution.

Chairman SARBANES. Now, Mr. Hunter, let me try to take your

proposal and see if I—and Mr. Froot, I know you have a time problem. So any time you have to go, just excuse yourself. We understand your situation and we very much appreciate that you came.

Not that these are minor differences, but is it accurate to say

that you differ from the Administration in that you would require

the industry, in effect, bear the burden upfront up to a certain

amount? As I understand your testimony, your figure was I think

$35 billion. Is that right?

Mr. HUNTER. That is what I said in my testimony. In the plan that I just outlined, it would probably be more like $30.

But, yes.

Chairman SARBANES. And then beyond that, the Government

would come in to cover the loss, but it would do it on a loan rather

than a grant basis. Is that right?

Mr. HUNTER. That is correct.

Chairman SARBANES. And then the industry would repay the

loan over whatever terms you have worked out over an extended

period of time.

Mr. HUNTER. Yes.

Chairman SARBANES. They would have to keep the premiums up

in order to do that.

Mr. HUNTER. Yes. You could put a cap on how much that could

be per year, like 2, 3, or 4 percent per year, so that the premiums

would be maintained at a relatively low level for the loan repayment period.

For a typical homeowner’s policy, you are talking maybe between $16 and $24 a year additional. Obviously, for a big target risk, it

might be several thousand dollars a year.

Chairman SARBANES. What is your reaction, Ms. Sebelius, to that

scheme—plan, I guess.

[Laughter.]

Ms. SEBELIUS. I guess, Senator, I do not know quite what my reaction is. I do think that it shifts a lot of the burden for terrorism

coverage in the short-run particularly on to those Americans who

are buying insurance policies and away from, if you accept the notion that, somehow, this is a public policy issue and the Government has some legitimate role, then I think having the taxpayers

68

at large bear some of this burden as opposed to just the insuring

consumers bearing it through the higher premiums they are paying, I think a lot of Mr. Hunter’s concept really assumes that consumers who are buying insurance products over a longer period of

time would be paying off the loans as opposed to the taxpayers at

large paying them. That may be too narrow a focus for that to bear

all that risk.

The insured public are also taxpayers. But, essentially, they

would be picking up more of a burden than the average person who

may not be buying car insurance, homeowner’s insurance, having

to develop property, whatever.

So I guess I do not find a great deal of—I do not have a real

problem looking at the issues of public policy issues, saying a portion of this rightfully may belong to the Government, may be

spread among taxpayers at large, and not require the repayment,

which essentially gets transferred through higher premiums over a

longer period of time just to insure the public.

Chairman SARBANES. Mr. McCool, do you have an analysis?

Mr. MCCOOL. In most of these issues, the GAO would prefer that

the Government not be—I agree with Ms. Sebelius. You really are

to some extent talking about over what base you are spreading the

increase. There is probably a fairly large overlap between the taxpayers and the people who pay for insurance. It is not 100 percent,

but it is probably fairly high.

Mr. HUNTER. But there is also a question of equity, of course.

And that is, the people with the higher risks pay higher premiums

and particularly will pay higher terrorism premiums in the future.

And they will then bear the 2 percent per year burden more heavily than the average taxpayer. And that is fairer because they are

the ones with the exposure.

Senator MILLER. One more question, Mr. Hunter. Let us say that

the plan, as you put it, is not adopted. And instead, what is passed

is something like what the Administration has offered. In your

opinion, what kind of oversight capacities would be necessary for

the Federal Government to engage in that kind of temporary reinsurance commitment with the private sector?

Mr. HUNTER. Well, first of all, you would have to write reinsurance contracts with the insurance companies because they would

not certainly—they would want to have certainties, so they would

want a policy. Even though there was no premium, I guess, you

would still have to have some kind of a legal document that you

would work with them that would define terrorism and explain

who decides what. You would have to have a system of auditing the

claims. You would have to have a bureaucracy. Claims is fairly

complex. And of course, you would not ever get the taxpayer reimbursed, is my key problem with that system.

But I do think that—

Senator MILLER. There are no oversight provisions that you

would propose that we write in there?

Mr. HUNTER. I still think that you could rely a lot on the States,

although there is a lot of preemption in the insurance proposal of

State regulations, so you would need some Federal thing to take

the place of that in the insurance industry proposal.

69

But in the Administration proposal, there seems to be less override of the States. So you could still task the States with various

things like assuring affordability, availability, making sure that

there are surcharges or discounts that would enhance security. I

think some of those things could be added to the Administration

proposal.

Senator MILLER. Are you saying they should be added or could

be added?

Mr. HUNTER. Should be.

Chairman SARBANES. Well, now, the Administration’s own proposal has them withdrawing after 3 years, apparently on the

premise that reinsurance would then be available to the primary

carriers. Is that how you understand it?

Mr. HUNTER. Yes.

Chairman SARBANES. If you got through that period without a

major terrorism attack, then the whole thing would be back in the

private market and there would have been no Government cost.

Correct?

Mr. HUNTER. Right. You still have to have the administrative

costs of running the program.

Chairman SARBANES. Those would be relatively inconsequential.

Mr. HUNTER. Right. Yes.

Chairman SARBANES. Now what do you all think, if you read

about this proposal that the insurance companies put forward.

Mr. HUNTER. I will start. It is terrible. I have a long list of complaints about it in my written testimony, including the fact that it

is not an actuarially sound program because it has no premium the

first year. Additionally, it allows ‘‘cherry-picking’’ of the worst sort.

That is, individual companies can opt in or out of the plan. And the

individual companies within a group can individually opt in and

out of the plan.

So if you have these target risks that we have been talking

about, you can put one company, reinsure that one with the Federal Government, and leave all your good business not for the Federal Government. And I do not believe the Federal Government

should be put in a position of the taxpayers only picking up the bad

risks and having the good risks left for the private sector.

The selection of Illinois as the sole regulator and creating, in effect, a cartel at the front end in Illinois, and overriding the bill, not

only would there be no rate regulation, but there will be no residual Federal or State antitrust law enforcement against it. So it

waives all those. There is no guarantee of affordability or availability and so on, and it is a very large overreach by the industry

with a lot of their wish list in it.

Chairman SARBANES. Mr. McCool.

Mr. MCCOOL. Well, again, we have——

Chairman SARBANES. What does your analysis show? I know you

have to frame it in terms of analysis.

Mr. MCCOOL. I was going to say, our list of concerns is not quite

as long. But we are concerned about the pooling arrangement being

in one State. Again, there is a certain monopolistic element to that.

There are again concerns about, in this case, what I guess would

be ‘‘cherry-picking’’ as opposed to some other arrangement that we

were talking about earlier. It is a problem, but it is a different one,

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that you could end up with the better risks in the pool and the

worst risks outside the pool.

Chairman SARBANES. Ms. Sebelius.

Ms. SEBELIUS. Well, I think Mr. Hunter outlined a number of the

key issues that would be of grave concern to regulators, ‘‘cherrypicking’’ not the least among them. The antitrust provision, there

is fairly broad preemption of State laws and regulations.

We think it would abdicate a lot of consumer protection initiatives that are currently in place and they would cease to exist.

And I think the mandating of the pooling arrangement—I do

think the industry has a keen interest in pooling risk, but it is

something that we feel could be accomplished voluntarily. That is

part of the kind of regrouping mechanism that they could go

through. And I am not sure that you need a Federal law or a kind

of bureaucratic structure to have that done and create a new company. I think that is very much a private market phenomenon that

will happen.

Chairman SARBANES. Well, one of the issues that is raised here

in the backdrop, so to speak, is, as you say, the preemption of various State requirements that have heretofore applied to the insurance industry.

Now, if that is going to happen, it seems to me, particularly if

you are asking for a major contribution of resources from the Federal Government, there is going to have to be monitoring and oversight and, indeed, regulation at the Federal level. So I think one

of the issues here is whether we are going to start down this path

of altering the Federalism arrangement with respect to insurance.

Now I am prompted to say that because there are people moving

around the halls of the Congress who want to do Federal insurance

charters and so on. That is an issue, it seems to me, with far-ranging implications, which would need to be addressed on their own

terms. I do not think we want to do it through the back door on

a terrorism bill. So, presumably, the Association of Insurance Commissioners has some concern about that issue. Am I correct?

Ms. SEBELIUS. I think that is safe to say.

[Laughter.]

That we do have concern. We think, Senator, that the ability of

the industry to pay the September 11 events is a strong testimony

to the fact that the regulatory system in place works. The reserves

are there. The companies are capitalized. They are monitored. The

claims are going to be paid.

We think what you are looking at at this instant is a short-term

problem dealing with recapitalization and availability of what is a

bit of an unknown risk up until September 11. Hopefully, we will

not know a lot more about it, but we can price it more accurately

going forward.

A lot of the monitoring and oversight I think that would be required for any kind of Federal involvement frankly is in place right

now around the country and could be detailed to the States to go

ahead and do, following up on claims payments, auditing. Those

are things that we have experts doing as we speak. We have actuaries. We have a variety of technical staff, both at the national office and locally.

71

We think it is appropriate in terms of preemption issues that you

look at things like, one, uniform definition of terrorism. You clearly

could not have 50 different definitions floating around. In fact, we

have a group working on that very issue because we think we are

going to need that one way or the other.

The issue about whether or not all companies would be required

to, or would be disallowed from having terrorism coverage, is an

issue that may appropriately rest with you.

So there are some issues that we would be very supportive of

having uniform definitions across the country put in place very

quickly. But in terms of a long-term need to either duplicate or preempt the State system that functions very well, we would urge you

not to use this opportunity as a way to sweep away what is a 100-

plus year-old regulatory system that actually functions pretty well.

Totally unforeseen loss, nobody could have predicted it. They are

up at the table paying the claims, and I think that is testimony to

the fact that it actually works.

Chairman SARBANES. Does anyone else have any observation on

that issue?

[No response.]

Now let me ask this question.

Mr. HUNTER. Let me just say, there is no question that if you

adopt something like the industry approach, I think you have to

get in there because, otherwise, there is going to be nobody checking the rates or anything. And you had better get in there because,

otherwise, you are going to be handing away all this free insurance

by taxpayers and you are not going to have any guarantee that the

prices are affordable or anything. You need, it seems to me, some

way of assuring that.

Chairman SARBANES. I take it all three of you would rate the Administration’s proposal above the insurance industry’s proposal, as

you know those proposals. Is that correct?

Ms. SEBELIUS. Yes.

Mr. MCCOOL. [Nods in the affirmative.]

Mr. HUNTER. [Nods in the affirmative.]

Chairman SARBANES. And I take it that all three of you would

also—there are modifications you feel can be made to the Administration’s proposal which would make it better than it is. Is that correct as well?

Ms. SEBELIUS. Yes.

Mr. MCCOOL. [Nods in the affirmative.]

Mr. HUNTER. [Nods in the affirmative.]

Chairman SARBANES. Well, this has been a very helpful panel. I

hope we can continue to call on you for your counsel and advice as

we wrestle with this issue. You can be very helpful to the Committee. And, of course, the State insurance commissioners have a

tremendous amount of expertise built up over the years. And Mr.

McCool, we always look to the GAO around here. And Mr. Hunter,

you have actually come in with some very imaginative and helpful

suggestions. And so, we will continue to work with this issue.

Ms. SEBELIUS. Senator, we look forward to working with the

Committee, with the Administration, on moving this issue forward.

We think it is a high priority and we do think it is appropriate that

the Federal Government play a role, and it is probably got to be

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done pretty quickly, given our timetable issue. But we look forward

to helping in any way we can. We do have a lot of technical expertise that we would be happy to lend to the process.

Chairman SARBANES. I think, as we think about it, we need to

try to—well, you can never deal with a complex issue necessarily

in a simple way. I understand that complexity has to be met to

some extent with complexity.

On the other hand, we need to get this thing down to the essentials and deal with the essentials. We need to push back overreaching, if that is, in fact, occurring.

And I do not know that we can take on other agendas that people

of one sort or another that have been hanging around here and

have not been acted upon, and then they fasten upon this vehicle

to move that agenda. That is not what we are about. We are willing to try to address what everyone has said needs to be addressed

on the problem. But if people start piling in on this, either with

some long-standing agenda or seeking to overreach on the relevant

agenda, we are going to have difficulty. We have to work through

this toward a consensus we can close ranks on and move ahead.

But your testimony has been very helpful. And again, I want to

express my appreciation. I know that people were given a lot of

time to prepare and obviously, a great deal of care and thought has

gone into these statements.

The Committee will resume its session. We will reconvene tomorrow morning at 10 a.m. in this room. The Dirksen Building where

the Committee’s hearing room is has not yet been opened. It may

be opened by the end of the week or the first of next week. The

Russell Building has been opened and the Hart Building apparently, which is where the Daschle office was and so forth, will remain closed while they continue to carry through on the environmental check-out.

Tomorrow, we have two panels. Panel One is: Robert Vagley,

President of the American Insurance Association; Ron Ferguson,

the CEO of General Ray, representing the Reinsurance Association

of America; and John T. Sinnott, the CEO of Marsh, Inc., representing the Council of Insurance Agents and Brokers. That will

the first panel.

And the second panel will be: Tom Donohue, President and CEO

of the Chamber of Commerce; Ellen Baker, Chairman of Wacovia

Corporation, who will be speaking for the Financial Services

Roundtable; and Thomas Carr, President and CEO of Carr America

Realty Corporation, representing the National Association of Realty

Investment Trust.

And that will obviously give us an opportunity to hear from both

the insurance industry itself and then the second panel, from

broader representatives of the business community. I know it has

been a long day for you. We very much appreciate your staying

with us.

The Committee is adjourned until tomorrow at 10 a.m.

[Whereupon, at 4 p.m., the hearing was adjourned.]

[Prepared statements and additional materials supplied for the

record follow:]

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PREPARED STATEMENT OF SENATOR JIM BUNNING

I would like to thank you, Mr. Chairman, for holding this important hearing, and

I would like to thank Secretary O’Neill and Chairman Hubbard for testifying today.

The tragic events of September 11 have had many repercussions. In addition to the

obvious losses to those directly affected, the attacks wreaked havoc throughout our

economy. One critical part of the economy the attacks have affected is the insurance

industry. I am very grateful that Secretary O’Neill and Chairman Hubbard were

able to come before this Committee and explain the Administration’s insurance proposal. I believe there is a serious problem facing us that must be addressed by January 1. As my colleagues know, many insurance policies will be up for renewal on

January 1.

If Congress does nothing, many of these policies will not be renewed, and many

businesses and properties will not be able to purchase insurance. The Administration has a proposal that frankly gives me some heartburn. However, something

needs to be done and done quickly and I have not seen a better plan. Hopefully

today we can start to come up with some better ideas. However, I do agree with

the Administration that there must be a sunset on assistance we give the insurance

and reinsurance industry. This is absolutely critical. We must allow the market to

figure out how to price this new risk.

We can help give the industry time to sort this out and collect data, but we can

not set the market. We also must make sure this is not a way to create a backdoor federalization of insurance. I know there are many in Congress who would like

a Federal insurance charter and a greater Federal involvement in insurance, but

this is neither the time nor the place. It is also crucial that we make sure the industry assumes some of the risk. We cannot ask the taxpayer to pick up the entire bill.

I believe it is crucial that we act thoughtfully and we act quickly. We must do

what we can to avoid the unintended consequences that could harm our vibrant insurance industry but we must also assist the industry so they can figure out how

to price this new risk before the end of the year. If we do not, not only will we have

businesses failing because of a lack of insurance, we may have the taxpayer completely on the hook if another catastrophic event hits our county, be it act of God

or act of evil.

Thank you, Mr. Chairman.

—————

PREPARED STATEMENT OF BILL NELSON

A U.S. SENATOR FROM THE STATE OF FLORIDA

Chairman Sarbanes, Members of the Committee, thank you for inviting me to address one of the many challenges facing us in the wake of the terrorist attacks on

September 11, and the bioterrorism attacks since then. I hope my prior experience

as Florida’s insurance commissioner will be helpful as we grapple with the challenge

ahead, which is to protect all of America’s insurance consumers by making sure coverage remains available and affordable to protect them against such despicable acts.

We all know that insurance is one of the crucial engines of our economy. Without

it, banks will not make loans for real estate or other ventures, and businesses will

not invest or expand. Millions of jobs would be lost as the impact rippled through

our economy. We cannot let that happen. Neither can we allow the insurance industry to use the September attacks as an excuse to shirk its rightful role and responsibilities. Already, reinsurance and insurance companies are saying they no longer

will cover terrorist attacks after December 31 . . . when about 70 percent of the

commercial insurance contracts in the United States are scheduled to expire.

I do not doubt that the industry’s problem is genuine. In the immediate aftermath

of September 11, it is virtually impossible for insurers to calculate their potential

liability in the face of possible future terrorist attacks. But we cannot allow ourselves to be held hostage by high-pressure tactics of any industry.

Nor can we make the same mistakes we made with the airline industry. In that

legislation we did not hold the industry’s feet to the fire and make sure that they

took care of their employees and the consumers.

I know from our experience in Florida that the insurance industry is more than

willing to walk away from its biggest risks and turn them over to somebody else.

Companies paid out $16 billion in claims after Hurricane Andrew slammed across

South Florida in 1992—the costliest natural disaster ever. Then major players in

the industry spent the rest of the decade trying to slip through State legislation that

would shift responsibility for hurricane coverage to Florida’s government and its

taxpayers. We headed off every one of those efforts. And we fought the industry’s

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attempts, since Andrew, to force unconscionable, ever-increasing rates on Florida’s

homeowners.

Homeowner insurance rates are now stabilized in Florida, and competition has returned—because we worked out a solution that will back up the industry if and

when another mega-storm hits. But the emergency fund created by the State requires companies to pay for most hurricanes and to shoulder their share of cost of

major storms. And it spreads the risk by building up reserves with premium dollars—not taxpayers’ dollars.

Whatever solution we come up with at the Federal level on terrorist coverage, I

believe the same principles of private enterprise must be applied. Government can

play an important role in helping to resolve the immediate crisis—whose impact

would be felt far beyond the insurance industry. For the most part, however, we

should leave the business of insurance to the insurance business.

As you know, there are two basic plans so far—the White House proposal and another plan that seems to have broad support from the insurance industry. They are

still being fleshed out, so we do not have the details needed to fully and fairly judge

them. But, based on the information that has emerged so far, I have some major

concerns. For example, what safeguards would be provided to prohibit insurers from

doing what the industry calls ‘‘cherry-picking?’’ In other words, once Federal help

is provided, what is to stop the companies from covering only those properties or

businesses that are relatively safe from terrorism and leaving the bigger risks for

someone else? And, what is to stop them from simply passing on any terrorism

losses they might suffer in the form of sudden and steep surcharges against their

customers? Or from finding ways, in the complex array of State regulations, of excluding acts of terrorism from the coverage consumers buy on their homes, their

automobiles, or their lives?

I say that anything we do here, at the Federal level, must assume and require

that companies cover the peril of terrorism—a peril that looms so much larger since

September 11. Simply put, if taxpayer’s help foot the bill, then the terrorism peril

cannot be dumped by the insurance industry.

As I understand it, the Administration’s plan would make the Federal Government responsible for paying 80 percent of the first $20 billion in claims, and 90

percent of the next $80 billion, resulting from any terrorist attacks in 2002. This

proposal would increase the industry’s liability from terrorist claims in the next 2

years, but still cap it at $23 billion in 2003, and $36 billion in 2004, with the Federal Government covering all remaining claims. I have strong concerns about requiring the taxpayers to assume, even on a temporary basis, such a large percentage

of the cost—especially at the front end.

A more responsible approach, in my view, would be to require the companies to,

cover terrorist-related losses up to a certain level before any Federal help would

kick in. The primary insurer would cover up to a certain dollar retention level, and

above that level, the risk could shift to the Federal Government. We should not support any proposal involving the use of taxpayer dollars unless we are convinced that

the insurance companies have ample ‘‘skin in the game.’’

Under the separate, industry-backed proposal, insurers would pool their premiums through creation of a new Government-backed insurance company called the

Homeland Security Mutual Reinsurance Company. Each participating company

would retain 5 percent of terrorism and 5 percent of workers’ compensation war

risk, and leave the remaining 95 percent of each to the insurance pool.

I hold true to the belief that private market solutions are more desirable than

Federal intervention. But—if I understand this plan correctly—the Federal Government would be responsible for covering 100 percent of any claims resulting from terrorism next year, while the new insurance pool begins building its capital.

As this debate progresses, we must constantly keep in mind that insurance companies are well equipped to handle most large-scale disasters. The industry is recognized by many financial rating agencies, institutional investors, and economists as

one of the strongest in the global economy.

• Between them, the property-and-casualty and life-and-health insurance industries

count nearly $3 trillion in invested assets.

• The National Association of Insurance Commissioners estimates that the industry

has a capital cushion of more $550 billion to absorb unexpected downturns in the

financial markets and adverse loss experience on its policies.

In other words, the industry is flush right now with huge surpluses. And, whatever our solution to this aspect of the terrorist crisis, we must require insurers to

pay their fair share. As we consider the public policy implications of terrorism reinsurance, I believe we must proceed in a deliberative fashion. In my view, that

means reaching agreement in the coming weeks on a short-term, interim solution—

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no more than 1 year—to ensure that insurance protection against terrorist attacks

remains available in 2002. And then resuming our work after January 1 to develop

a more permanent plan.

That approach also would enable us to consider reform of the current system of

insuring against natural catastrophic disasters. Despite our progress in Florida in

dealing with the hurricane threat, the fact remains that no single State, nor any

single industry, could cope with the kind of mega catastrophe we now know Mother

Nature could bring our way.

In lieu of the perennial debate over establishing a Federally backed insurance

pool, I am personally intrigued by proposals that would require insurers to set aside

part of their profits for a rainy day. The idea is to let companies develop tax-deferred reserves and thereby increase their capacity to respond to catastrophic losses.

I know this Committee takes a keen interest in these problems, as does the Commerce Committee.

I look forward to working with you on legislation—both short- and long-range solutions—that not only will keep our economic engines running but also protect the

consumers we all serve.

—————

PREPARED STATEMENT OF PAUL H. O’NEILL

SECRETARY, U.S. DEPARTMENT OF THE TREASURY

OCTOBER 24, 2001

Mr. Chairman, Senator Gramm and Members of the Committee, I appreciate the

opportunity to comment on terrorism risk insurance. These hearings are extremely

important. We believe that there is a real and pressing need for Congress to act on

this issue now. As I will discuss in more detail, market mechanisms to provide terrorism risk insurance coverage have broken down in the wake of September 11.

Such coverage is now being dropped from property and casualty reinsurance contracts as they come up for renewal, with most policies renewing at year-end. If Congress fails to act, reinsurers have signaled their intention to exclude such coverage

meaning that primary insurers may have to drop this coverage or institute dramatic

price increases. As a result, after January 1 the vast majority of businesses in this

country are at risk for either losing their terrorism risk insurance coverage or paying steep premiums for dramatically curtailed coverage. This dynamic can, in turn,

be expected to cause dislocations throughout our economy, particularly in the real

estate, transportation, and energy sectors.

The Problem

The terrorist attacks of September 11 created widespread uncertainty about the

risk and potential costs of future terrorist acts. Since September 11, we have endured this uncertainty every day as a country. It has permeated every sector of our

economy.

A key part of the Federal Government’s response to the events of September 11

is to ensure that our economic stability is not undermined by terrorist acts. Continued economic activity is dependent on well functioning financial markets—where

the lifeblood of capital is provided to business enterprises. Financial markets allocate capital based on the potential success of a business. In doing so, financial markets rely on the insurance sector to mitigate certain types of risk that are not directly related to the plans or operations of a business.

Insurance companies manage risk in economic activity and facilitate the efficient

deployment of capital in our economy by estimating probabilities of possible adverse

outcomes and pooling risk across a large group. Since September 11 the uncertainty

surrounding terrorism risk has disrupted the ability of insurance companies to estimate, price, and insure the risk.

We learned on September 11 that, while perhaps highly improbable, terrorists are

capable of enormous destruction. Could such an event be repeated? As a country

and a Government, we are doing everything in our power to prevent a repetition

of anything like the events of September 11. But how does an insurance company

assess this uncertainty? How does an insurance company price for it? At the moment, there are no models, no meaningful experience, no reasonable upper bound

on what an individual company’s risk exposure may be.

Insurance companies do not ‘‘take’’ risks. They knowingly accept and mutualize

risks. They are private, for-profit enterprises. If they do not believe they can make

money by underwriting a particular risk, they will not cover it. Because insurance

companies do not know the upper bound of terrorism risk exposure, they will protect

themselves by charging enormous premiums, dramatically curtailing coverage, or—

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as we have already seen with terrorism risk exclusions—simply refusing to offer the

coverage. Whatever avenue they choose, the result is the same increased premiums

and/or increased risk exposure for businesses that will be passed on to consumers

in the form of higher product prices, transportation costs, energy costs, and reduced

production.

The consequences of uncertainties surrounding terrorism risk are already evident

in the airline sector. The Department of Transportation’s initial projection is that,

as a result of the September 11 attacks, airlines will pay nearly $1 billion in premium increases for terrorism risk insurance in the next year despite a congressionally imposed cap on third-party liability. Within the next few months, similar

increases can be expected for other forms of economic activity deemed ‘‘high risk’’—

if coverage is available at all. Higher premiums will divert capital away from other

forms of business investment.

The need for action is urgent. From our conversations with insurance company

representatives, State insurance regulators, policyholders, banks, and other entities

which provide financing for property transactions, the next 2 months are critical.

The insurance industry relies on a complicated structure of risk sharing. Risk is

shared among primary insurers, reinsurers, and retrocessionairs (that is, providing

reinsurance to the reinsurers). This structure has worked well in the past and

greatly contributed to widely spreading losses associated with the events of September 11 across the insurance industry.

However, in light of the uncertainty created by September 11, reinsurers have

told us that they will no longer cover acts of terrorism in their reinsurance contracts

with primary insurers. And as I have said, most property and casualty insurance

contracts are up for renewal at year end. This will create the following choices for

insurers: assume all of the risk of terrorism coverage and raise prices to cover all

of the associated, unshared costs; reduce coverage levels; or cancel coverage. Any of

these choices has the potential to cause severe economic dislocations in the nearterm either through higher insurance costs or higher financing costs.

Objectives

In grappling with this problem, we have had several objectives. First and foremost, we want to dampen the shock to the economy of dramatic cost increases for

insurance or curtailed coverage. We also want to limit Federal intrusion into private

economic activity as much as possible while still achieving the first objective. And

we want to rely on the existing State regulatory infrastructure as much as practicable. Note that none of these objectives are directed at providing Government assistance to the insurance industry. The industry is absorbing the financial losses it

contracted for as a result of the September 11 attacks, and is fully capable of making good on those losses. The industry is also capable of continuing to provide insurance for nonterrorist hazards. The problem, as I have said, is one of uncertainty

about future terrorist risk. At the moment, there is no basis upon which to price

terrorism risk and no sense of the upper bound on the risk exposure.

Options

Over the past few weeks, a variety of proposals have emerged to deal with the

problem I have outlined. Before turning to the approach we have developed, I will

briefly discuss a few of the alternatives we considered and some of the shortcomings

we identified with each.

A case could be made to treat terrorism risk insurance like war risk insurance.

During World War II, the Federal Government provided property owners with insurance protection against loss from attack. Similarly, the Israeli Government provides insurance for terrorism risk. This approach would recognize the terrorist

threat as one made against all Americans and would establish the broadest possible

risk pool for insuring against this risk. At the same time, such an approach implies

a permanent Federal intrusion in the market so long as any terrorism risk remains.

A second approach, one suggested, in various forms by insurance industry representatives, involves the creation of a reinsurance company to pool terrorism risk.

This model follows an approach developed in the United Kingdom in response to

IRA terrorist activities. This approach has some appeal, especially in providing a vehicle for pooling the industry’s risk while providing an upper bound on industry

losses through a Government backstop. With more time, or in different circumstances, this approach may have been desirable.

In our judgement it has several significant shortcomings. First, the approach ultimately leads to the Federal Government setting premium rates by establishing the

rate charged to the pool for the Government’s backstop. If the basic problem is that

the insurance industry whose business it is to measure and price risk—cannot curVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00080 Fmt 6633 Sfmt 6621 83472.TXT SBANK4 PsN: SBANK4
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rently price terrorism risk without distorting markets, why would we think the Government can do a better job?

Establishing a pool would also take time, and time is very limited since most policies expire at year-end. It is unclear how long it would take industry to capitalize

the pool. In the interim, the Government’s exposure could be substantial, insofar as

it would be liable for 100 percent of losses that exceeded the pool’s capitalization.

In addition, we question whether the Government could move quickly enough on its

end to establish the contracts, the pricing structure, and the regulatory structure

needed to make the proposal work.

Finally, the pool approach creates a Federal insurance regulatory apparatus with

some presumption of permanence and a potentially enormous pool of captive capital

that we may never need to use. We believe that there will be less uncertainty about

terrorism risk a few years from now and that uncertainty will be more manageable

by the private sector than is the case today. Given that, why undertake the effort

to create a monopoly reinsurer and give a new Federal regulator the power to both

set prices and regulate insurance companies and their activities?

A third option would be to simply set a large industry deductible and let the Federal Government cover all losses from acts of terrorism past that point. For instance, the Federal Government could require the insurance industry to cover all

losses up to, say, $40 billion in a given year and the Federal Government would

pay all losses above that amount.

This approach has two substantial drawbacks. First, it does not address the fundamental problem: the industry has no basis for knowing—and hence pricing—terrorism risk. A large deductible would require them to assess premiums large enough

to cover a large potential loss. In the absence of better information, we might well

expect companies to price insurance as if they fully expected losses up to the deductible amount. Second, this approach makes it difficult to control losses above the deductible as insurance companies would have no incentive to limit costs once their

deductible has been paid.

A Shared Loss Compensation Program

After reviewing these and other options, and discussing these issues with Congressional and industry leadership and the State insurance regulatory community,

we developed an approach that we believe best accomplishes the objectives I set

forth. Let me say at the outset that this approach reflects the current evolution of

our thinking on this issue. We want to work with Congress to achieve the best possible solution. As I have said, the insurance industry can easily protect itself by

eliminating coverage or charging very high premiums. What we are trying to do is

craft a plan that will prevent the economic dislocations that will otherwise take

place if private insurers follow the course they are now on. It is imperative that we

find a solution that works in the marketplace. We must get it right, and we must

get it right now.

When terrorists target symbols of our Nation’s economic, political, and military

power, they are attacking the Nation as a whole, not the symbol. This argues for

spreading the cost across all taxpayers. Yet there are also reasons to limit the Federal role. If property owners do not face any liability from potential attacks, they

may underinvest in security measures and backup facilities. In addition, the insurance industry has sufficient experience and capacity to price some portion of the

risk associated with terrorism and has the infrastructure necessary to assess and

process claims.

Under the approach we are suggesting, individuals, businesses, and other entities

would continue to obtain property and casualty insurance from insurance providers

as they did before September 11. The terms of the terrorism risk coverage would

be unchanged and would be the same as that for other risks.

Any loss claims resulting from a future terrorist act would be submitted by the

policyholder to the insurance company. The insurance company would process the

claims, and then submit an invoice to the Government for payment of its share.

The Treasury would establish a general process by which insurance companies

submit claims. The Treasury would also institute a process for reviewing and auditing claims and for ensuring that the private/public loss sharing arrangement is apportioned among all insurance companies in a consistent manner. State insurance

regulators would also play an important role in monitoring the claims process and

ensuring the overall integrity of the insurance system.

Through the end of 2002, the Government would absorb 80 percent of the first

$20 billion of insured losses resulting from terrorism and 90 percent of insured

losses above $20 billion. Thus, the private sector would pay 20 percent of the first

$20 billion in losses and 10 percent of losses above that amount.

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Under this approach the Federal Government is absorbing a portion—but only a

portion—of the first dollar of losses, which we believe is important to do in the first

year of the program. The key problem faced by insurance companies right now is

pricing for terrorism risk. While this type of loss sharing approach does not completely alleviate that problem, it does provide insurance companies with the ability

to evaluate potential losses on a policy-by-policy basis, with clearly defined maximum exposures. For example, on a $100 million commercial policy the insurance

company’s maximum exposure would be $20 million. If industry losses were greater than $20 billion that exposure would be reduced even further.

More importantly, price increases to policyholders should be lower under this approach than under an approach that requires companies to absorb 100 percent of

losses up to a large, aggregate industry loss deductible. Under this approach, if an

insurance company’s maximum exposure was defined at $20 million on a $100 mil- lion policy, the insurance company could then price that $20 million exposure on the

probability of a complete loss event occurring. Suppose instead that the insurance industry had to absorb $20 billion in losses

before any Government loss sharing began. Then, in our example, the insurance

company’s maximum loss exposure would be $100 million on that policy, not $20

million. Pricing to this maximum loss would create the economic dislocation we are

trying to avoid.

The role of the Federal Government would recede over time, with the expectation

that the private sector would further develop its capacity each year. As private sector capacity increases, the nature of the Government’s loss sharing agreement would

also change. Given more time and experience, we believe that the insurance industry could reestablish robust risk-sharing arrangements such as reinsurance that

would enable the private sector to insure losses from terrorism before the Government loss sharing commenced.

Thus, in 2003, we would have the private sector be responsible for 100 percent

of the first $10 billion of insured losses, 50 percent of the insured losses between

$10 and $20 billion, and 10 percent of the insured losses above $20 billion. The Government would be responsible for the remainder.

In 2004, the private sector would be responsible for 100 percent of the first $20

billion of insured losses, 50 percent of the insured losses between $20 and $40 billion, and 10 percent of the insured losses above $40 billion. The Government would

be responsible for the remainder.

To preserve flexibility in an extraordinary attack, combined private/public liability

for losses under the program would be capped at $100 billion in any year. It would

be left to Congress to determine payments above $100 billion.

The Federal Government’s involvement would sunset after 3 years. It is our hope,

indeed our expectation, that the market problem we face today will have been corrected by then so that the private sector will be able to effectively price and manage

terrorism risk insurance going forward. Of course, should that prove not to be the

case, Congress and the President can reevaluate the program in place and decide

at that time on an extension of the program or establishment of another approach.

This approach would also provide certain legal procedures to manage and structure litigation arising out of mass tort terrorism incidents. This includes consolidation of claims into a single forum, a prohibition on punitive damages, and provisions

to ensure that defendants pay only for noneconomic damages for which they are responsible. It is important to ensure that any liability arising from terrorist attacks

results from culpable behavior rather than overzealous litigation. These procedures

are important to mitigating losses arising from any future terrorist attack on our

Nation, and are an absolutely essential component of the program I have outlined.

Finally, this approach requires a clear definition of an ‘‘act of terrorism.’’ We suggest that the Secretary of the Treasury, with the concurrence of the Attorney General, and in consultation with other members of the Cabinet, be given authority to

certify that a terrorist act had taken place for purposes of activating the shared loss

compensation arrangement.

We believe that this approach dampens any adverse economic impact from a sudden increase in the cost from terrorism risk insurance over the next 12 months. The

imposition of a deductible in the second year, and an increase in the deductible in

the third year, permits the Federal Government to gradually withdraw from the

market as the private sector adapts to measuring and pricing terrorism risk.

Conclusion

Mr. Chairman, for the reasons I have set forth, the Administration believes that

the economy is facing a temporary, but critical, market problem in the provision of

terrorism risk insurance. Keeping our economy moving must be our overriding concern. Leaving this problem unresolved threatens our economic stability. The apVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00082 Fmt 6633 Sfmt 6621 83472.TXT SBANK4 PsN: SBANK4
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proach I have outlined limits the Government’s direct involvement, retains all those

elements of our private insurance system that continue to operate well, and provides

a transition period to allow the private sector to establish market mechanisms to

deal with this insidious new risk that confronts our Nation.

There are no perfect solutions to this problem. We have developed what we believe is a sound approach. As I explained earlier, we do not believe that creation

of a reinsurance pool can be accomplished under the time constraints we face, but

we would be glad to explore modifications to our approach with the Committee.

I would be pleased to answer any questions the Committee may have.

—————

PREPARED STATEMENT OF R. GLENN HUBBARD

CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS

OCTOBER 24, 2001

Mr. Chairman, Senator Gramm, and Members of the Committee, I appreciate the

opportunity to appear before you today to discuss the situation facing insurance

markets in the context of the current terrorist threat. In a very real sense, the timing of these hearings is significant; it is important that Congress act on the issue

of terrorism risk insurance before the end of the year.

The terrible tragedy associated with the terrorist attacks on New York and Washington exacted an economic toll on the United States as well as a human toll, and

the Administration is working with Congress to address both losses. Among the direct repercussions of these attacks has been an increased appreciation of the need

to focus public policy on security, including efforts toward defending American economic activity against terrorist intrusions. The need for security in economic activity—whether in such visible forms as Federal Air Marshals or more mundane needs

like additional backup computer systems raises the overall cost of transacting business. In this sense, the attacks acted as a shock to the costs of supplying goods and

services in the economy. It is in our economic interest to contain these transactions

costs as much as possible.

The attacks also raised the degree of uncertainty in the economic environment—

from the state of aggregate demand, to the demand for particular goods and services

(air travel, for example), to a myriad of other areas. Commercial insurance lies at

the intersection of these two forces. Property and casualty insurance is one mechanism by which economies respond efficiently to risks in the environment. Risks are

spread, converting for each business a potential cost of unknowable size and timing

into a set of smaller, known premium payments. The events of September 11 induced a dramatic revision in perceived risks. In normal circumstances, increased

risks are translated into higher premiums. This serves the useful economic function

of pricing risk, leading the private sector toward those activities where the risk is

‘‘worth it’’—there might be losses now and then, but on average society will benefit—and away from foolhardy gambles.

At the moment, however, the entire Nation is unsure of the genuine likelihood

of additional terrorist events. For insurance markets, unfortunately, the distinction

between risk not knowing when an event will happen, but having solid knowledge

of the odds of an occurrence—and genuine uncertainty about the frequency of an

insured event is the key to being able to price efficiently. Experience with our new

security environment will mitigate this difficulty over time. In the near term, however, it would not be terribly surprising to experience disruption of the property and

casualty market. In the extreme, customers may not be able to renew policies until

the market resolves pricing difficulties. That is, reinsurers may no longer cover acts

of terrorism in their reinsurance contracts with primary insurers.

An interruption of coverage is a particular, and extreme, version of an increase

in transactions costs as a result of terrorist-associated risks. Still, there is the possibility that existing lines of coverage will be renewed only with quite substantial increases in premiums. I believe we are all now familiar with the difficulties facing

aviation; disproportionate rises in insurance coverage or, in the extreme, withdrawal

of insurance coverage, would hinder transition to a new operating environment. This

phenomenon is more widespread, however. Lenders usually require businesses to insure any property they use to secure loans. The terms of terrorism coverage could

diminish bank lending for new construction projects. It could as well act as a sharp

impediment to transactions that permit existing, commercial properties—skyscrapers, pipelines, power plants, and so forth—to change hands. It is important to

point out that this ‘‘changing hands’’ is an important economic function. The relative

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efficiency with which our economy reallocates capital from less productive to more

productive uses sets it apart from many other nations.

In short, a well-functioning insurance market is part of the financial infrastructure that underpins our economy. The Administration and Congress worked together to restore the institutional underpinnings of the financial markets in the

week after September 11. In the same way, the Administration looks forward to

working with the Congress to bolster the capacity of private insurance markets to

provide the risk-sharing services that benefit commerce and consumers.

Principles for Government Involvement

To this end, the Administration believes that any Federal intervention in the insurance market should adhere to four key principles:

1. Intervention should encourage, not discourage, private market incentives to expand the industry’s capacity to absorb and diversify risk.

2. Intervention should be temporary, permitting us to review in the future the

ability of the insurance industry to price these risks and absorb losses.

3. Private market actors should face appropriate price incentives to encourage efforts to minimize the probability of a terrorist event and to limit losses should such

an event occur.

4. Private sector uncertainty about liabilities that arise from litigation should be

reduced.

Importantly, these principles do not imply an objective of providing Government

assistance to the property and casualty insurance industry; rather, the principles

address implementation of the objective of mitigating short-run cost increases for insurance. The Administration’s approach to terrorism risk insurance adheres to each

of these four principles. In order to see this, please allow me to first explain the

basic outlines of how this approach would work.

The Administration’s Approach

After reviewing several options and discussing terrorism risk insurance with industry lenders, insurance regulators, and academics, the Administration developed

an approach, one with which we look forward to working with Congress. Upon enactment of this legislation, if the United States were the victim of a terrorist attack

before the end of 2002, the Federal Government would pay for 80 percent of the first

$20 billion of insured losses, and 90 percent of insured losses in excess of this

amount. The private insurance industry would pay for the remaining insured losses.

In 2003, the industry would be responsible for the first $10 billion in insured

losses, and 50 percent of insured losses between $10 billion and $20 billion. Above

$20 billion, the Federal Government would continue to pay 90 percent of all losses.

In 2004, the third and final year of this program, the industry would be responsible for 100 percent of the first $20 billion in losses, and 50 percent of insured

losses between $20 billion and $40 billion. Above $40 billion, the Federal Government would continue to pay 90 percent of all losses. In the event that total insured

losses exceed $100 billion in any calendar year, Congress would determine the procedures for and source of any such payments.

In addition to this insurance component, the Administration approach would also

consolidate all claims arising from a terrorist incident in a single Federal forum. In

addition, it would prohibit claims for punitive damages (other than those directed

at the perpetrators), and require that noneconomic damages be proportional to a defendant’s responsibility (for economic losses, ordinary rules of joint and several liability would apply).

This approach is designed to mitigate economic consequences from sudden increases in the cost of terrorism insurance over the next year. The imposition of a

deductible (in the second year) and a subsequent increase in the deductible (in the

third year) permits the Federal Government to recede gradually from the market

as the insurance industry adapts to measuring and pricing terrorism risk.

Consistency of Approach With Principles

The approach I outlined is consistent with the Administration principles outlined

above. This proposal encourages private sector capacity building in several ways.

First, it is forward-looking. It respects the insurance industry’s proven ability to develop the capacity to price, market, and service products for new types of risks. In

the past, naysayers deemed reinsurance against the risks of natural catastrophes

such as hurricanes as beyond the reach of private insurance markets. Experience

has proven them wrong. By providing a temporary bridge of 3 years, a steadily receding Federal presence, and an explicit sunset, we will permit the industry to grow

into this new market.

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Second, the Administration’s proposal recognizes that a limitation facing the insurance and reinsurance industry is its total capacity to absorb risk. For this reason, we provide the economic function of limiting its maximum exposure in order

to provide a backstop against catastrophic losses, which could generate large increases in transactions costs for businesses and, ultimately, for consumers.

Third, because the industry shares in the losses—up to a maximum loss—and the

share it shoulders rises over time, there will be a profit motive for insurance companies—and actuaries and economists—to begin now to refine pricing models. As I

noted earlier, there are economic benefits to the efficient pricing of risks. While no

covered individual company can control whether terrorists strike, efficient pricing

can lead every covered company to take actions lessen the damage that results from

terrorist incidents. After the approach sunsets, the industry will have made progress

toward efficient pricing of risks. At that time, issues of pricing and the industry’s capacity to absorb losses can be revisited.

In addition, having the industry participate will control costs after any event. If

the Government agrees to pick up 100 percent of all claims, the insurance industry

has no incentive to do careful claims adjustments.

The potential losses facing insurers depend not only upon the security and economic environment, but on the legal setting as well. That is why the Administration

approach would also include certain legal procedures designed to manage mass tort

cases arising out of terrorism incidents. These procedures will bring damage claims

closer to their economic foundation and reduce the uncertainty about the magnitude

of potential claims. The consolidation of claims in a single Federal forum, for example, helps to ensure that the claims will be treated in a consistent manner and

eliminates the redundancy costs of litigating similar claims in multiple courts. In

addition, consolidation tends to expedite the claims process, reducing the uncertainty about the length of the litigation. Limitations on punitive damages (other

than those directed at perpetrators or abettors) and proportional liability for noneconomic harms (except those caused by perpetrators or abettors) reduces the potential for open-ended claims that would exhaust the defendants’ resources in mass tort

cases. Such reforms are essential for economically enhancing the efficiency of the

insurance market by increasing the ability of the insurance industry to price and

absorb the risks associated with terrorism.

Conclusion

To conclude, the U.S. economy is very resilient, and, through the combined efforts

of the Administration and Congress it is possible to provide transitional public policy to support the needs of purchasers of property and casualty insurance. Thank

you again, Mr. Chairman, for the opportunity to appear before you today. I am

happy to answer your questions.

—————

PREPARED STATEMENT OF KENNETH A. FROOT

ANDRE ́ R. JAKURSKI PROFESSOR OF FINANCE, HARVARD UNIVERSITY

OCTOBER 24, 2001

Mr. Chairman, Senator Graham, and Members of the Committee, I appreciate the

chance to appear before you today to discuss the insurance and reinsurance markets

in the aftermath of the tragic events of September 11. We run the risk of considerable short-term dislocation in these markets going forward, given especially the annual nature of reinsurance renewals. At the same time, we need to preserve the

benefits of a vibrant insurance marketplace: the high-quality evaluation, pricing, allocation, and mitigation of risk. So the issue before the Committee is extremely important as well as timely.

Some Useful Background

This is not the first important upset in insurance and reinsurance markets. In

the mid-1980’s, as the U.S. courts entered new territory, large insurer and reinsurer

exposure to product and environmental liability became apparent. Insurance prices

rose rapidly. Some firms failed, and insurance and reinsurance capital was stressed

by the additional liabilities. The industry responded by developing specialized contracts, and treaties to cover these liabilities. They developed schemes for pricing

that, especially in the early years, proved remunerative. Major financial intermediaries came together to sponsor the creation of new major reinsurers to write

new liability coverage.

In the early 1990’s, the United States experienced two very large natural disasters, Hurricane Andrew and the Northridge Earthquake. The losses from these

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events (currently estimated at approximately $20 billion and $17 billion, respectively) were a shock to an industry that rarely considered, and have never before

seen, such losses from natural perils. Once again, some firms were bankrupted and

risk capital was stressed.

Let me trace out the industry response. First, as one might expect, insurance and

reinsurance prices rose spectacularly immediately after Andrew, doubling between

1992 and 1993. Figure 4b shows an index of Rate on Line (ROL), the ratio of premiums to policy limits, for catastrophe reinsurance. ROL rose strongly in 1993.

However, ROL actually understates the change in the cost of reinsurance. When the

price of reinsurance goes up, buyers tend to purchase less, specifically by using

higher deductibles. The expected claim against the policy goes down relative to the

limit, thus making the protection more expensive than ROL makes apparent. The

line labeled ‘‘price’’ adjusts for this effect. Price is the ratio of the premium paid to

the expected loss. This is a much truer index of reinsurance cost. The event impact

on price is considerably greater using this measure of price.

Second, after these very large post-event increases, prices fell steadily between

1994 and 1999. The effect of Andrew and Northridge dissipated. By 2000 prices

were at half of their earlier values. Why did this occur? Additional risk-bearing capital and new firms entered the reinsurance industry, increasing competitiveness.

Approximately $10 billion of additional capital flowed into these reinsurers, much

of which is a result of the attractive post-event prices.

Third, this growth occurred through the creation of a variety of new institutional

reinsurance mechanisms. For example, the basic prototypes for reinsurers domiciled

in tax- and regulation-favorable countries—Bermuda in particular—were developed

and streamlined. These tax and regulatory advantages benefit the U.S. insurance

industry by providing more competitive reinsurance products.

Fourth, during this same period, additional sources of capital outside of the reinsurance sector became active. ‘‘Cat’’ bonds and related financial instruments, which

could be purchased by investors, became viable alternatives to reinsurance treaties

as a way of transferring risk. Even though relatively few ‘‘cat’’ bonds have been

issued, they have promoted competition in the industry. Over the past 3 or 4 years

there have been a number of episodes where major reinsurers have succeeded in undercutting the price of ‘‘cat’’ bonds. While it is unclear whether the motives have

been tactical or predatory, what is clear is that competition has been enhanced.

Fifth, while hard to summarize in numbers, the entire discourse surrounding natural catastrophe events changed during this post-event period. Third-party firms

specializing in building objective models of potential natural disaster losses grew

and, unlike before, became popular with insurers, reinsurers, investors, and intermediaries. Critics of the objective models engaged them. Conferences and specialist

groups began to discuss catastrophe risk both qualitatively and quantitatively. Insurers, reinsurers, commissioners, regulators, rating agencies, and even the general

public became far more aware of the possibilities of these events, where they might

occur, what kinds of buildings are at risk, how construction techniques can be improved, how damage can be contained, etc. Insurance and reinsurance prices increasingly impounded this information. The increase in awareness and planning has

resulted in significant risk mitigation, better decisions about risk exposure and financial capital, and corporate, financial, and household sectors that are more stable.

These changes have helped reduce the post-event price of reinsurance. But, perhaps more importantly, they have increased the amount of reinsurance protection

that is commonly purchased today. To see this, Figure 4d shows the reinsurance

buying patterns of insurers who purchase reinsurance. Specifically, it shows the

fraction of reinsurer losses covered at different levels of industry losses (in 2000 dollars). Because this chart covers only insurers who purchase protection, it is not representative of the entire insurance industry. Nevertheless, it is representative of the

level of industry losses for which protection is purchased. And the results are striking. Before Andrew and Northridge, the most common layer of protection helped

protect against events generating industry-wide losses of about $4 billion. As of

2000, the most popular level of loss protection had about tripled, to about $12 billion. In addition, today substantial coverage has been extended to much larger

events. Protection against natural catastrophe losses of $20–$25 billion and more is

not uncommon. This is the legacy of Andrew and Northridge, and it is a permanent

one, given the changes discussed above.

Some Implications for Today

This brief retrospective provides context for policymaking in the aftermath of the

latest, largest ever losses from September 11. First, it is clear that reinsurance industry is efficient over the medium term. The industry can and does respond to

large disasters. High prices occur, but these motivate the response. Figure 4b shows

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that prices have fully returned to their pre-Andrew levels, even as Figure 4d shows

that demand today for reinsurance has increased enormously. This is the sign of an

economically efficient industry: financial innovation and capacity expansion have accommodated a large increase in demand with virtually no increase in price.

Second, there is evidence that the ‘‘medium term’’ has today grown shorter. Following Andrew, the post-event spike in prices took several years to undo. With the

losses of September 11 following so closely thereafter, there are a number of reasons

to believe that the response will be considerably quicker going forward.

• Bermudan reinsurers, transformers, and other financial institutional forms including capital-markets instruments can rapidly and smoothly impound new capital. A variety of vehicles allow investors to participate in the reinsurance function

through equity in new or existing reinsurance companies, closed-end mutual

funds, convertible close-end funds, bonds, convertible bonds, etc. • In addition to the ‘‘hardware’’—meaning explicit organizational forms, contractual

and financial instruments—for transferring risk, much ‘‘software’’ has also been

built. This includes the expertise and knowledge of brokers, investment bankers,

reinsurers, insurers, rating agencies, investors, and regulators, who are much

more fluent in the activities of risk transfer in property/casualty lines. • There is direct evidence that the combination of this ‘‘hardware’’ and ‘‘software’’ works effectively today. As I write, I am aware of approximately $3.0 billion that

has already been newly committed to reinsurance capacity directly as a result of

the September 11 events. These additional capital infusions involve the expansion

or creation of Marsh Axis Specialty Re, AIG, GE, Renaissance Re, Hartford Financial, QBE, Zenith National, Da Vinci Re. These are committed fund raising efforts,

fully in place in less than 6 weeks.

At the end of the post-Andrew price cycle, prices had returned to where they

began. However, durable progress had been made. The ‘‘hardware’’ and ‘‘software’’ create a kind of infrastructure. As a result, the catastrophe marketplace today has

become more flexible and responsive. The risk associated with natural disasters is

better mitigated and better spread as a result.

Third, any form of sustained provision of reinsurance by the Government will impede this kind of progress. Many decisions throughout the economy need to be made

that affect exposure to terrorist actions. What types of steel and concrete reinforcements help reduce risk in buildings of various heights? What kinds of physical barriers around tall buildings, stadiums, public works projects are appropriate? What

kinds of equipment for checking, opening, or possibly sterilizing mail should employees reasonably expect? What kinds of security is it appropriate for the travel and

other industries to provide their employees and customers? Insurance and reinsurance markets help provide answers to these questions by evaluating and pricing

risk, and formulating detailed policy requirements. The result is that risk is both

mitigated and better spread throughout the economy.

Fourth, the sheer level of uncertainty about the likelihood of terrorist attacks is

not itself a reason to replace market functions with Government programs. Critics

of catastrophe modeling including some of the most important reinsurance underwriters—argue that the models provide false provision and that the probabilities of

natural disasters are unknowable. The uncertainty surrounding the potential onetime impact of the Year 2000 computer bug was certainly extreme, yet this did not

stop the creation of private insurance dedicated to protecting against Y2K damages.

The history of the last 5 years strongly suggests that market can and does function

even when risk is hard to evaluate.

The Administration’s Proposal

I support and applaud the Administration’s proposal of a limited, temporary Federal intervention in the insurance market. A measured response is appropriate at

this time to assure continuity in insurance markets and support renewed economic

growth. I am comfortable with all but one of the four key principles articulated by

Chairman Hubbard in his earlier testimony. The intervention should encourage private market incentives to expand capacity as needed and diversify risk. It should

generate appropriate price incentives to encourage the private sector to mitigate the

losses and risk of a terrorist event. And it should help reduce uncertainty about liabilities that arise from associated litigation. In addition, I believe that if these

three principles are to be satisfied, the short sunset feature of the program is absolutely essential.

In that spirit, I would strengthen the second of the Administration’s principles,

which deals with the sunset feature. In my view, it should read, ‘‘The intervention

should be absolutely temporary, and primarily intended to resolve short-term dislocations in the market due to a sudden shift in risk and coverage perceptions.’’

Given the magnitude of the change in expectations that we have just experienced,

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and the very tight calendar before year-end, I believe that an intervention is justified. The risk profile of major firms—both financial and nonfinancial—would be otherwise unbalanced and a deterrent to economic growth.

Over 2 or 3 years, I believe the market is fully capable of evaluating, pricing and

designing exposure to large risks. If we experience losses beyond what the markets

are willing and able to tolerate, then Government involvement is, at that point, virtually assured. This is, and has been, the case for natural disasters. There, private

market policies are not open-ended; they extend to losses that are only so great.

Since the largest events are often unknowable beforehand, the sensible approach is

to define the intervention ex post, based on the then-existing circumstances. The existence of a Federal program ex ante is unlikely to forestall Federal actions after

another event should that program then be considered inadequate. As I have argued, the existence of anything more than a targeted, highly temporary, Federal

program is likely to forestall development of better insurance markets and pricing,

and better risk allocation and mitigation decisions by the private sector.

Thank you again, Mr. Chairman, for the opportunity to express my views.

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PREPARED STATEMENT OF KATHLEEN SEBELIUS

PRESIDENT, NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS

COMMISSIONER OF INSURANCE, THE STATE OF KANSAS

OCTOBER 24, 2001

Introduction

My name is Kathleen Sebelius. I am the Commissioner of Insurance for the State

of Kansas, and this year I am serving as President of the National Association of

Insurance Commissioners (NAIC). Speaking for myself and my fellow insurance

commissioners, we appreciate the opportunity to testify regarding the potential role

of the Federal Government in making sure that insurance against acts of terrorism

remains available to American consumers and businesses.

Today, I want to make three basic points:

• First, NAIC and its members believe there is presently a need for the Federal

Government, working with the State regulatory system, to provide appropriate financial backup to the private insurance market in order to assure that our Nation’s economy does not falter due to a lack of insurance coverage for terrorism.

Although NAIC has not endorsed a specific proposal for Federal assistance at this

time, we have adopted a set of 19 guiding principles that we believe should form

the basis of any successful Federal program. A copy of the NAIC’s guiding principles is attached at the end of my testimony. • Second, we believe Federal assistance should be a relatively short-term solution

to stabilize the commercial marketplace while it regains the risk assessment and

pricing equilibrium needed for private insurers to underwrite terrorism exposures.

Thus, any Federal terrorism insurance program should be limited in scope and

duration. • Third, a Federal assistance program should maximize the use of market forces to

add efficiency and reduce the risk of losses from terrorism and the potential costs

to Federal taxpayers.

The U.S. Insurance System Remains Fundamentally Sound

Let me start by saying that NAIC believes the insurance industry is well-capitalized and financially able to withstand the pressures created by the September 11

terrorist attacks, despite losses projected to exceed $30 billion. The U.S. insurance

industry is a $1 trillion business with assets of more than $3 trillion. Preliminary

loss estimates of $30 billion to $40 billion represent just 3 to 4 percent of the premiums written in 2000.

America’s insurance companies have time and again shown their ability to respond to huge disasters and successfully recover. Adjusted for inflation, Hurricane

Andrew in 1992 caused $19.7 billion in insured losses, and California’s Northridge Earthquake in 1994 cost $16.3 billion in insured losses. As with previous disasters,

we believe insurers affected by the recent terrorist attacks will be able to pay their

projected claims, as they themselves have said.

Insurance is the sale of a promise to pay claims when losses occur. As regulators,

my colleagues and I will continue monitoring the process to make sure that insurance promises are kept. To do our job, we are backed by an impressive array of

human and technical resources, including the NAIC and 51 State insurance departments that collectively employ more than 10,400 people and spend $910 million annually on insurance supervision. In addition, at this time State insurance guaranty

funds have the capacity to provide up to $10 billion to compensate American consumers in the event of insurer insolvencies.

We would urge Congress to structure any Federal assistance program to take full

advantage of the existing State regulatory system. We have the mechanisms in

place to monitor insurer solvency and handle claims payment issues.

Congress Should Not Disrupt the Power of Private Market Competition

The international commercial property/casualty insurance market is very powerful, dynamic, and competitive. As a free market, it responds to new information

quickly, and sometimes with great volatility. Like the stock exchanges, insurance

market participants often react in unison to reach the same conclusion at the same

time with regard to what products are viable and profitable, meaning that the price

and availability of specific products will rise and fall in conjunction with the industry’s collective willingness to sell them. Substantially negative information, such as

the September 11 terrorist attacks, can disrupt the entire market until new information becomes available that makes insuring terrorist risks acceptable.

Given sufficient time to adjust, however, the commercial insurance market has

found ways in the past to assess and insure extremely large and difficult risks that

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were initially considered uninsurable. During the 1980’s and 1990’s, the insurance

industry weathered enormous financial losses from asbestos, medical malpractice,

and environmental pollution claims against corporate policyholders that were not

foreseen by insurers. In those instances, insurers said they had not reasonably expected to be held responsible for such colossal claims, and therefore had not collected sufficient premiums or established sufficient loss reserves to cover them.

In the short term, the insurance market responded to huge environmental exposures with policy cancellations, coverage limitations, exclusions, and increased

prices, as is being threatened now with regard to terrorism risk coverage. In the

longer term, coverage for these risks became available through a combination of aggressive risk management, self-insurance, captive insurance pools, other alternative

risk-sharing mechanisms, and renewed interest by commercial insurers as they

gained confidence in their abilities to adapt their policies and pricing to a level

where they could underwrite the business profitably. Ultimately, the creativity and

competitive discipline of the market overcame its initial period of contraction and

volatility to provide viable insurance solutions for enormous risks that were previously considered uninsurable.

The business of insurance is about measuring risks and selling promises to cover

them at a reasonable profit. Insurance experts who perform these tasks are exceptionally talented. Over time, they have demonstrated a remarkable ability to adapt

to unforeseen circumstances, while making available the insurance products that

are essential to the growth and productivity of American business. As expected in

a free competitive market, individual companies may stumble, falter, and even fail

when substantial adversity strikes, but the U.S. insurance industry as a whole has

a long and proud record of finding ways to overcome new obstacles while advancing

its business goals and serving the interests of the insurance-buying public.

Thus, the NAIC believes Congress should begin its consideration of Federal assistance to the insurance industry by recognizing the strength and adaptability of the

private insurance markets. Federal actions that unduly disrupt or interfere with

private market forces are likely to end up causing more harm than good for American consumers and Federal taxpayers.

Appropriate Government Action Can Help the Private Market Recover

State regulators know from their own experiences that Government action can

help the insurance market recover when it becomes overwhelmed by changing risk

factors or catastrophic losses. When the psychology of the market results in industry

reactions that harm the public, Government has unique powers to alter the insurance marketplace for the benefit of consumers. We have found that successful Government assistance involves tailoring actions to fix specific problems and keeping

the program as narrow as possible.

Hurricane Andrew provides a useful example of limited Government intervention

that works. Following the tremendous losses from this hurricane in 1992, commercial reinsurers restricted their coverage for windstorms and raised prices. This

caused a corresponding reaction from primary insurers, who moved to raise prices,

cancel coverage for coastal properties, and increase deductible amounts for consumers having significant hurricane exposure. Within a couple of years, normalcy

returned to the reinsurance market, and then to the primary market. The Florida

Insurance Department assisted with the recovery of the industry by introducing a

moratorium on policy cancellations and beginning the discussion of the need for a

State catastrophe pool. The Florida legislature later adopted a Hurricane Catastrophe Insurance Pool that provides a State-based backstop for catastrophic windstorms in Florida. These collective actions have resulted in a robust and competitive

market for homeowners insurance in the State of Florida.

State insurance regulators believe the current situation affecting the availability

of insurance for acts of terrorism is similar in nature to other catastrophic events.

Due to the magnitude and unpredictable nature of terrorism as it is currently perceived by insurers, a temporary level of Federal assistance to spread risk appropriately should provide time for the marketplace to adjust its thinking about how

insurance coverage for terrorist acts should be handled. If the Federal Government

and business customers make quick progress in lessening exposure from acts of terrorism, the insurance industry may start providing the coverage American businesses and families demand. Enacting a temporary Federal solution will provide the

necessary time to craft a more thoughtful long-term solution.

Three Important Market Factors for Congress to Keep in Mind

As Congress considers what type of Federal assistance may be appropriate to

steady the commercial market while it adjusts to new demands, the NAIC recommends that you keep in mind three very important factors. These factors will

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greatly affect the costs of any Federal program, as well as its lasting impact on

America’s consumers and private insurance markets.

First, risk management precautions that reduce the likelihood of losses from terrorist attacks will have a large impact on the willingness of private insurers to offer

terrorism insurance coverage to customers. Risk management—the implementation

of safety and security measures to prevent harm—is a standard part of insuring

commercial and Government facilities that are most susceptible to terrorist attacks.

Large firms have professional risk management departments whose mission is to reduce a company’s exposure to potential accidents and intentional harm, thereby improving the company’s chances to get insurance at the lowest rates possible.

Following the September 11 attacks, Government and commercial facilities across

America have added security measures to prevent acts of terrorism and limit potential damages. As commercial risk managers review these new precautions, it seems

likely they will become more inclined to offer terrorism insurance because the possibility and extent of potential insured losses occurring will be greatly reduced. At

that point, we expect market forces will start working to fill the gap by making terrorism insurance available through private industry.

The NAIC recommends that Congress build-in strong incentives for insurers or

companies receiving Federal assistance to implement and maintain effective risk

management measures to prevent acts of terrorism from occurring. In that way, the

Federal Government will be building upon standard risk-reducing steps that are

well accepted in the private marketplace for insurance products.

Second, the private market instills policyholder discipline to avoid insurance

claims through the concept of co-insurance. Co-insurance means that policyholders

are liable to pay part of any losses covered by insurance before expecting a recovery

from an insurer. Obviously, the higher the dollar amount covered by the policyholder himself, the greater will be his incentive to take steps to avoid losses. This

concept is commonly understood by everyone owning a car or a home who agrees

to bear the cost of a ‘‘deductible’’ before receiving payment from an insurance company. Co-insurance should be considered by Congress as an important market discipline tool that works equally well with Government programs.

Third, the scope and duration of any Federal assistance program will itself become a factor in the private insurance market. Even though Congress is considering

special Government assistance intended to operate as a supplement to normal business channels, the very fact that Government will pay certain costs of a commercial

business becomes a factor to be taken into account when private market decisions

on terrorism insurance are made.

The NAIC urges you to keep in mind that Federal Government policy regarding

terrorism insurance assistance will not occur in a vacuum. It will become a private

market consideration affecting prices and availability of insurance, and it may impact insurance products having nothing to do with terrorism. The extent of the Federal influence on private market insurance products can be expected to be directly

commensurate with the size, details, and length of the Federal assistance program.

State Actions Are Not Driving the Market Demand for

Terrorism Insurance

The NAIC and its members have recently been asked to explain how requirements

of State law impact the market demand for terrorism insurance. Many people in

Congress apparently think that States require private businesses to carry insurance

against terrorism, and that failure of the private insurance market to offer terrorism coverage will result in violating State laws and regulations. We believe there

is a misunderstanding of what State laws require and what State insurance regulators actually do.

Let me say that States do not drive the private market for terrorism insurance.

To our knowledge, no State currently requires that business entities maintain insurance against acts of terrorism. In fact, the NAIC recently performed an electronic

search of State laws and regulation for references to ‘‘terrorism.’’ We found nothing.

Furthermore, it is important to understand that State insurance regulators do not

normally get involved in the details of property/casualty insurance policies for large

business operations. These are considered to be the product of free market negotiations among sophisticated insurance underwriters, brokers, and professional corporate risk managers who rely upon the traditional powers of buyers and sellers to

bargain for the best deal they can get. The State regulatory interest in such large

transactions is mainly that they not impair the overall financial health of an insurer, since monitoring insurer solvency is a major responsibility of regulators.

Banks and investors typically use their private market influence to require that

large business and Government entities maintain adequate property/casualty insurance coverage against foreseeable harm. As a result of September 11, foreseeable

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harm may now start to include possible terrorist acts in addition to normal hazards.

However, terrorism coverage would usually be just one part of a comprehensive insurance package that insurers want to sell. Their desire to avoid terrorist risk exposures may be offset by their need to include it in order to sell a package of insurance

coverage judged to be profitable overall.

State Actions Having a Limited and Indirect Impact on

Terrorism Insurance

What, then, is the impact of State laws on terrorism insurance? Primarily, it falls

into three areas—workers’ compensation requirements, policy form regulations, and

rate regulations. We believe these areas have a limited and indirect effect upon the

price and availability of terrorism coverage in commercial property/casualty policies

for large business projects that significantly affect the American economy. It is important to recognize that States are not initiating market requirements in these

areas, but only reacting to market forces that threaten to deny consumers fair insurance coverage.

Workers’ Compensation Requirements

State workers’ compensation laws were developed early in the 20th Century. In

the late 1800’s and early 1900’s, the number of occupational injuries and illnesses

occurring in the American workplace was hindering the Industrial Revolution. Businesses were asking how they could assure that working men and women who are

injured on the job get the care they need, while protecting industry and commerce

from the financially crippling and demoralizing prospect of employees suing their

bosses for every work-related injury. The question was answered with the State

Workers’ Compensation System, which covers employees’ medical expenses and lost

wages for work-related injuries and disease, regardless of who was at fault. In return, employees are limited to the benefits provided by the workers’ compensation

system as their exclusive remedy.

State workers’ compensation laws require a set of benefits that are guaranteed

by employers to their employees who are injured on the job. Insurers play a key

role in the delivery of the benefits promised by employers. Typically, insurers assume by contract the obligation to provide the employer’s share of medical benefits,

rehabilitation benefits, and survivor’s benefits in exchange for premiums the employer pays the insurer. Since State law obligates the employer—and therefore the

insurer that has assumed the employer’s obligations—to provide the benefits specified in a State’s Workers’ Compensation Act, the insurer cannot introduce either an

exclusion for war or an exclusion for terrorist acts.

As a no-fault safety net for workers’ injuries on the job, State workers’ compensation laws do not permit coverage exclusions as a matter of public policy. Workers’ compensation insurance is one part of the commercial coverage maintained by significant employers.

State Policy Form Regulations

Many States have statutory authority over insurance contract language through

general policy form regulations. These requirements typically prohibit contract language that is misleading, illusory, inconsistent, ambiguous, deceptive, or contrary to

public policy. Since no currently enacted State laws specifically prohibit an insurer’s request to exclude coverage for terrorist acts, States would have to rely upon the

general provisions above if they seek to deny an insurer’s request to exclude terrorism coverage. Under State law, an adverse regulatory decision can be challenged

by an insurer through the State insurance department’s administrative process,

with the right of appeal to State courts.

State insurance regulators are also charged with solvency oversight of insurers.

Thus, an action to deny an exclusion of terrorist activities under general policy form

provisions could cause financial difficulties for insurance companies. However, it is

ultimately the insurer’s choice whether to provide coverage for a specific business

event or peril. Primary insurers may be hesitant to exclude coverage for terrorist

acts because they know their business and individual customers will want assurances the coverage is provided. Reinsurers do not directly deal with businesses and

families, and therefore do not face the same pressures to provide terrorism coverage.

State Rate Regulations

State rate regulations are primarily focused on protecting small businesses and

individual policyholders. For commercial lines insurance products, only 13 States

still require that the insurance department exercise prior approval requirement for

most rate changes. The remaining 38 jurisdictions have some form of competitive

rating mechanism that allows insurers to file and use rates, or use them even before

they are filed with insurance regulators. Moreover, in recent years insurers have

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been successful in convincing State legislatures to create rate regulation exemptions

for large commercial policyholders. The NAIC does not believe State rate regulations

are preventing insurers from charging adequate rates for terrorism insurance.

Conclusion

The NAIC and State regulators believe the insurance industry remains strong,

and that it retains tremendous strength to recover from the September 11 attacks

and adjust its business practices to new conditions in the marketplace. State insurance regulators are working together to help assure that any glitches which occur

do not disrupt the process of getting people’s lives back in order and America’s businesses back to work. The NAIC and its members plan to work closely with Congress

and fellow regulators, as set forth in the Gramm–Leach–Bliley Act, so that the

needs of individual Americans and our Nation’s economy are met in a timely way.

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1This testimony relates to property/casualty insurance. The life insurance industry has requested a Commission to study if they need backup. CFA believes that a Commission is not

needed. The life insurance industry should make its case for when they might need help and

Congress should call hearings to critique that analysis. CFA looks forward to participating in

that separate process.

PREPARED STATEMENT OF J. ROBERT HUNTER

DIRECTOR OF INSURANCE, CONSUMER FEDERATION OF AMERICA

OCTOBER 24, 2001

Good day Mr. Chairman and Members of the Committee. My name is Bob Hunter.

I am Director of Insurance for CFA. I previously served as Texas Insurance Commissioner and, of particular relevance to today’s subject, as Federal Insurance Administrator under Presidents Ford and Carter.

I served at FIA between 1971 and 1980. My first task was to assist in establishing

the Riot Reinsurance Program under the provisions of the Urban Property Protection Act. I encourage you to look at the Riot Reinsurance Program for guidance in

your current important effort for reasons I will cover in the next few minutes.

In the late 1960’s, the Nation faced great uncertainty from a form of terror from

within. There were an awful series of riots in the land. If this were not bad enough

for the people in the inner cities who were at the equivalent of what we now call

‘‘ground zero,’’ the reinsurers panicked and began to cut off reinsurance protection

from the American primary insurance market. The primary insurers, without their

layoff arrangements were poised to pull out of the inner cities. Then lenders would

have to call mortgages . . . the set up for a true crisis.

Congress, wisely, stepped in, creating the riot reinsurance program. The program

adhered to good insurance principles, requiring the Government to charge full actuarial rates for the reinsurance and making sure that claims were appropriate for

payment.

I was tasked with the job of coming up with actuarially sound rates for the Riot

Reinsurance Program. This was about as fearful a job as I ever faced. There was

great uncertainty. But actuarial soundness is not defined as precise prices. It relates

to procedures such as using the best information available, making reasoned judgements and basically doing your best. We did that, full well expecting to be too high

or too low since future events such as riots are hard to predict.

I met with insurers, actuaries from the actuarial societies and other interested

parties and came up with prices. Insurers thought they were OK since they bought

the reinsurance. The taxpayer was protected and, indeed, profited from the transaction. Sound insurance principles require proper prices and require adequate supervision of the claims payment process.

CFA Supports a Federal Reinsurance Program for Terrorism

CFA supports a sound program of reinsurance for the terrorism risk underwritten

by the Federal Government.1 I attached a list of principles CFA developed for Congress to consider when developing the program. Foremost among the principles are

that the insurance industry must be able to purchase affordable reinsurance and

that the taxpayer be protected.

Interim Terrorism Insurance Proposal

CFA understands that creation of the permanent plan we espouse below might

take more time than we have to protect insurers as of January 1, 2002, when most

reinsurance runs out. We, therefore, suggest that an interim, actuarially sound plan

be developed.

Simply, we believe that most insurers could withstand at least another event of

the magnitude of the September 11 tragedy. So we do not think that the interim

plan should cover first dollar losses. CFA proposes that a retention be used for each

insurer of 5 percent of surplus, as of December 31, 2001. ‘‘Terrorism’’ must be defined for this interim plan and should be determined by a Federal official.

If a terrorist attack occurs and an insurer suffers claims greater than the retention amount, the insurer would be eligible for Federal low or no interest loans, the

term of which would be negotiated up to 30 years. This would spread the cost over

time, an important goal. For each insurer, the discounted value of the loan would

be limited to an additional 5 percent of surplus.

Amounts of money loaned in excess of the 5 percent of surplus by company would

be repaid to the U.S. Treasury through a property/casualty insurance industry-wide

loan repayment mechanism. This loan repayment would be collected over a number

of that years are sufficient to minimize the rate impact on consumers (Congress

should set the maximum surcharge, perhaps at about 2.5 percent per year, until the

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2 At year-end 2000, the property/casualty industry had surplus of $321 billion and net pre- mium written of $303 billion. The rule of thumb for a very safe industry is a ratio of $1 of surplus for each $2 of net premium written. Thus, the industry had ‘‘excess’’ surplus of $170 Billion.

($321¥$303/2). So, even if the industry has another WTC event they can afford it. 3Some have maintained that this is difficult to do since some who suffered loss early would

be more exposed than those with later claims. This is a red herring. What you should do, I

think, is to allocate the deductible by insurer based on the sorts of risks they have and their

surplus level. Then a smaller insurer might be paid even if a terrorist loss was relatively small

but in the locus of the exposure that that insurer wrote.

loan is repaid). The surcharge would be collected by the States as a piggyback on

their State premium tax mechanism and forwarded on to the U.S. Treasury. This

step is needed in order to make sure that individual company balance sheets are

not impacted by very large losses due to terrorist activity.

This plan leaves the regulation of insurance fully in State hands. The States

should be required to assure availability and affordability of the terrorism risk,

using their usual regulatory methods, including pooling by State, if necessary. Further, the States should be asked to assure that the plans enhance security through

discounts or other incentives. Congress could set goals for the States in this effort.

This requires little, if any, new bureaucracy since much of this work is already part

of the State insurance department responsibility.

Needed Protections for the Taxpayer

Any longer term plan should protect consumers and taxpayers in the following

manner: First, insurance companies should pay full actuarially sound rates for any

reinsurance protection they enjoy. Any plan that requires no premium is not actuarially sound. The insurers need a plan to protect their interests—they do not need

a hand out. Insurers should be loathe to set a precedent where inadequate premiums are acceptable when they are paying the premium, if they do not expect consumers to press for inadequately priced home, auto, life, and other coverages. When

the insurers offer free insurance to us, we will consider free reinsurance for them.

Free insurance is particularly galling in Year One of the coverage. Do not forget

the insurers made contracts with Americans to cover terrorism fully. These contracts are being entered into even as we speak. So, for a year for policies being written today and for an average of about 6 months for policies already in force, there

would be terrorism coverage even if Congress did nothing. To come in after-the-fact

and give away insurance to the industry, which is a very healthy industry 2 even

after September 11, would be foolish.

Actuarial soundness is possible. The taxpayer can be assured that, over time, the

program would, at worst, cost the taxpayer nothing. Here is how to do it:

• Congress should require actuarially sound reinsurance premiums. That does not

mean precision, it means doing the best you can to set a price you think is based

on reason.

• The plan should include assessments against the industry if terrorism reinsurance

claims exceed certain dollar thresholds. During the riot reinsurance days, the industry had to agree to a 2.5 percent of their total premium assessment provision

in the reinsurance contract.

• The plan should have a provision stating that if the taxpayer has paid more into

the plan than the premiums and investment of premiums, the premium collection

aspects of the plan will stay in effect until the taxpayer is made whole. Just as

in the Riot Reinsurance Program, the plan can be self-sustaining over time. Uncertainty will end and the costs shifted to taxpayers during the uncertain times

can be recouped as certainty returns.

• The plan should include a wise payout plan that minimizes taxpayer exposure.

The second year of the White House proposal is a good start. That should be the

first year of the program. The industry can easily afford a first layer of coverage

where they are 100 percent at risk for tens of billions. I would set it at $35 billion 3 for Year One. The industry could easily afford three such events even today.

• The Federal Government should have a claims audit role to assure that only

claims that meet the definition of terrorism and are within the contractual provisions of the reinsurance policy are paid.

Second, private insurers should not be able to ‘‘cherry-pick’’ against the taxpayer.

By ‘‘cherry-picking’’ I mean sending bad risks to the Federal reinsurance program

and keeping good risks for the industry accounts. Thus, all primary insurance companies should be required to participate in the reinsurance program. At the very

least, groups of insurers should not be allowed to reinsure one company with ‘‘target’’ risks (for example the Empire State Building) but not reinsure another company in the group (say, insuring farm risks).

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State Consumer Protections Should NOT Be Impacted by Any

Reinsurance Plan

One of the beauties of reinsurance by the Federal Government is that it is simply

a contractual arrangement with the insurer, it does nothing to interfere with the

carefully constructed system of State regulation in place.

There Must Be a Degree of Bureaucracy To Administer the Program

While it can be minimized, you need staff to develop the contract and administer

the claims payment process. You cannot just pay claims. If you do, the taxpayer will

be ripped off. You need a small but not insignificant staff (maybe 50) to do this job.

The setting of the premium charge and the collection of the reinsurance premium

requires very few staff (maybe 5).

Availability and Affordability of Insurance Must Be Assured

The reason for Congress to step into this situation with Federal backup is to make

sure that the economy is not frozen by lack of insurance for the terrorism risk. To

write a plan that does not do the necessary to assure that insurance is written and

the price is reasonable would be foolish.

This means that the plan should include a requirement of continuation of direct

provision of terrorism coverage by insurers as part of the ‘‘deal’’ for taxpayer backup

for those risks that meet minimum security standards. Further it means that the

rate charged for primary insurance should be correlated with the reinsurance

charges so that there is no gouging by insurance companies at this time of national

emergency. Congress should not infringe on the ability of State regulators to assure

that price gouging for primary insurance does not occur.

Critique of Industry Proposal

The Consumer Federation of America strongly opposes the industry drafted ‘‘Insurance Stabilization and Availability Act of 2001.’’ This proposal is a massive overreach that unnecessarily exposes taxpayers to billions of dollars in risk. There are

several serious problems with the industry approach:

• The bill does not require actuarial soundness. Indeed, insurers would pay nothing

for reinsurance for the first year of the program, until the mutual insurance company created under the bill builds up a $10 billion net asset base. Apparently, this

free Government reinsurance would even cover policies already in force for which

insurers are fully at risk today. This is a grossly improper use of taxpayer monies.

• Insurers can ‘‘cherry-pick’’ risks since they could opt in or out of the reinsurance

program at will. One insurer of a group of companies could be set up to take all

of the ‘‘bad’’ risks and buy the reinsurance, effectively adversely selecting against

the taxpayer. Further, ‘‘cherry-picking’’ is allowed in that the insurers can decide

whether to reinsure personal risks and commercial risks separately.

• The selection of Illinois as the sole regulator of the new Federally backed mutual

insurer puts consumers at risk. Illinois, unlike most other States, does not control

prices. Congress should not interfere with normal insurance protections afforded

business and personal consumers. If Congress decides to interfere, a Federal

agency should be empowered to regulate the insurers, including the rates charged

for the reinsured coverages, to assure that no price gouging occurs. (Why enact

a terrorism reinsurance program to make insurance affordable and then let insurers charge whatever they want for the coverage?) If one State were to be used

to regulate the rates and policies offered (something CFA does not favor), the most

advantageous for consumers would be the largest State, California. Studies show

that California insurance oversight has been the best in the country over the last

decade.

• The bill would cover war events only for workers’ compensation. The bill should

cover war for all lines of insurance and the reinsurance program should be so constructed.

• The bill waives the application of all Federal and State antitrust laws. This is unnecessary and inappropriate.

• The bill allows territorial differences in pricing, which means that New York City

will likely pay much higher rates than other cities, particularly if there is no Government review of insurer pricing decisions, as the bill proposes.

• There is no guarantee of affordability or availability of coverage to reasonably secure risks.

We urge you to reject the insurance industry proposal and, instead, use the very

successful Urban Property Protection Act of 1969 as the precedent for this program,

as reflected in the principles developed by CFA (printed below).

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Critique of the White House Proposal

The White House proposal is flawed for several reasons. First, it is actuarially unsound. The taxpayer should not give away reinsurance.

Second, the first year payout plan shows a fundamental misunderstanding of insurance. The 80/20 percent split starting at the first dollar of terrorism loss will actually leave the taxpayer exposed to 100 percent of the risk. This is because the

plan will reinsure the reinsurers. So, the primary insurers will reinsure the 20 percent the taxpayer is not on the hook for with the reinsurers. The reinsurers will

then ‘‘buy’’ (for no premium) the 80/20 percent cover. This will increase the taxpayer

share to 96 percent (100 percent¥[20 percent*20 percent]). But that is not the end

of the reinsurance process. The reinsurers will again reinsure (called ‘‘retrocession’’)

with other reinsurers (possibly including the primary carriers themselves). The taxpayer share will then go to 99.2 percent (100 percent¥[20 percent*20 percent*20

percent]). If they reinsure again (there is no limit on how many times the risk can

be ping-ponged to lay off risk on the taxpayer) the taxpayer share would be 99.8

percent. And so on. This could be corrected by not exposing the taxpayer to private

reinsurance payouts.

A better approach would be to change the plan to have a large deductible. As indicated earlier, I think that amount should be $35 billion. Over that, there should be

sharing as in Year Two of the White House plan . . . but no reinsurance should

be allowed on private reinsurance claims even in that scenario. The White House

plan also does not guarantee affordability or availability of coverage to reasonably

secure risks.

Conclusion

Congress can and should backup the private insurance market with reinsurance

for the peril of terrorism. It can and should do it in a wise way that protects the

taxpayer and, over time, assures that the taxpayer is reimbursed for the costs of

the program so that the cost goes to ratepayers rather than to taxpayers.

CFA looks forward to working with the Congress on this most important effort.

Guiding Principles for Insurance

Legislation Related to War and Terrorism

1. CFA supports the concept of Federal backup of the private insurance industry

for the perils of war and terrorism. We suggest the riot reinsurance program as a

precedent for this backup.

2. Legislation should supplement but not replace other private and public insurance mechanisms where those mechanisms can provide coverage more efficiently.

However, all insurers should be required to reinsure against the perils of war and

terrorism through the Federal Government at the outset of the program. In time,

as conditions warrant, private reinsurance should be encouraged. To avoid undue

taxpayer exposure, however, the program should include a requirement of minimum

extended terms for reinsured insurers with claims paid to allow taxpayers to recoup

some of the losses.

3. There should be a reasonable coordination and structuring of State and Federal

regulatory responsibilities with respect to a Federal terrorism reinsurance program

that achieves the objectives of the program without unnecessarily compromising or

preempting State regulatory authority and consumer protections. Necessary preemption of or limits on State regulatory authority should be compensated by requisite Federal oversight.

4. There should be an appropriate balance of different private and public interests

in the governance of regulatory oversight over the program. Consumers (business

and personal), insurers, reinsurers, and State regulators of insurance should be on

the board of advisers for such program.

5. All records relating to the program, including the records of the reinsured insurance companies should be available for Federal audit and, to the maximum extent possible, made public.

6. Rates for the war and terrorism perils charged for the Government reinsurance

should be actuarially sound and should consider all reasonable factors that can be

feasibly measured and supported by theoretical and empirical analysis.

7. The Federal Government should assure that the cost of terrorism/war coverage

charged by reinsured insurance companies to the consumer is actuarially based and

correlated in price with the reinsurance offered by the Government.

8. The legislation must clearly define ‘‘terrorism’’ and ‘‘war’’ and exclude any coverage beyond those definitions. A top Federal official should determine if a specific

event falls into either of those definitions.

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9. Anti ‘‘cherry-picking’’ provisions such as the following should be included: Legislation should recognize that many war or terrorism exposures subject the Government to potential adverse selection as insurers with less catastrophe risk are less

likely to voluntarily purchase coverage, while those with greater risk are more likely

to purchase coverage. If legislation were to create a Government reinsurance program, the program should encourage the inclusion of both low-risk and high-risk insureds to promote greater risk spreading in a way that does not subject the Government to adverse selection.

10. Legislation should promote or encourage coverage that is available to any

property that meets reasonable standards of insurability. Federal security requirements should be met within reasonable time periods by insured risks and policed

by inspection by reinsured insurers.

11. State residual market mechanisms and other pooling mechanisms for insurance should be allowed to participate in the entity established by legislation to

provide war and terrorism insurance, in such a way as to not create incentives for

business to be placed in the residual market. To the extent that a risk meets the

minimum security requirements, it should be able to get war and terrorism coverage

through some source . . . a residual market if necessary.

12. Jurisdiction over claim settlement practices should remain with the States.

13. Tax law changes should be encouraged to avoid penalties on and encourage

the accumulation of reserves for war and terrorism losses.

14. Legislation should encourage loss reduction and hazard mitigation efforts

through enhanced security.

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(131)

TERRORISM RISK INSURANCE

THURSDAY, OCTOBER 25, 2001

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, DC.

The Committee met at 10 a.m. in room SC–5 of the Capitol

Building, Senator Paul S. Sarbanes (Chairman of the Committee)

presiding.

OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

Chairman SARBANES. If the witnesses will take their seats, we

can get the hearing underway. Mr. Baker, I understand you have

a time constraint so why don’t we move you up from the second

panel to this panel, and that will give us an opportunity to hear

from you. By what time do you have to leave?

Mr. BAKER. Around noon.

Chairman SARBANES. Oh, well, we are in good shape here. I

might even have kept you on the second panel.

[Laughter.]

But we will not want to take that chance. Today we continue our

consideration of the question of terrorism insurance in light of the

attacks of September 11. We began our examination of this issue

on yesterday, both morning and afternoon as you are probably

aware, and we had a very informative hearing and the opportunity

to explore a variety of views, including hearing from the Administration and in particular Secretary O’Neill.

I believe we gained a number of valuable insights as the Committee seeks to deal with this issue. And, of course, we have been

exploring the extent to which the events of September 11 threaten

the availability of terrorism coverage for commercial property owners. If such coverage should be unavailable, what impact that

would have on the functioning of the economy. And, is Federal

intervention necessary to prevent any such disruption? If so, what

form should that intervention take? We are increasingly focusing

on the last question there, but we would appreciate the witnesses

helping to build a record by walking us through the other issues

as well.

We have been looking forward to hearing from this panel. I want

to assure the witnesses at the table that we are here to hear you

with a very open mind, so this headline here in the Financial

Times ought not to set you back or dissuade you, which says, ‘‘Industry plan to aid insurance groups labeled nonstarter.’’ That was

not a statement by me, and I do not think—we have a more open

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mind than that. So we are happy to hear any plan that you might

want to put forth.

We will have two panels this morning. The first panel will

include Robert Vagley, President of the American Insurance Association; Ron Ferguson, CEO of General Re Corporation, representing the Reinsurance Association of America; and John

Sinnott, CEO of Marsh, Inc., representing the Council of Insurance

Agents and Brokers. And they have been joined on this panel by

Leslie M. Baker, the Chairman of Wachovia.

The second panel, which will follow immediately after we conclude with this one, will include Tom Donohue, President and CEO

of the U.S. Chamber of Commerce; Tom O’Brien, Chief Financial

Officer of LCOR, who is representing the Real Estate Roundtable;

and Walter Knorr, Chief Financial Officer of the City of Chicago.

I just want to take a moment before we go into this panel to express my very deep appreciation to my colleagues on the Committee and even more so to the Committee staff on both sides,

Members’ staff, for the extraordinary work that has been done with

respect to the Committee’s agenda over the last few weeks.

This afternoon we are scheduled to vote on and presumably—not

only presumably, but certainly pass the antiterrorism legislation

which will contain within it a title on money laundering, which was

the work product of this Committee and our colleagues over on the

House side. And that represented an incredible concentrated effort

on the part of the staff working through the night on a number of

occasions over a 2 week period in order to complete that legislation

and resolve the differences with the House and move it forward.

We think that is an important piece in the fight against terrorism.

We believe it is carefully worked out and considered legislation.

We sought to consult with all interested parties. All interested parties did not get exactly what they wanted. That is never possible.

But we do think it will provide an effective framework for our authorities to crack down on money laundering and do it in a way in

which the banking industry will be able to work in a cooperative

fashion. They will have to assume some additional burdens, but the

whole country is assuming additional burdens at this point. And so

I want to thank the staff for this terrific work.

And we have also, of course, tried to move ahead on the issue

that we are considering this morning. Hearings are now being held

elsewhere on the Hill as well. But, of course, we launched these

hearings yesterday. We are carrying them on today. We seek to distill out of all of what we are hearing hopefully a consensus position.

We need to work out something that commands the general support or at least acceptance if we are to move forward on this issue

in the time period that is remaining.

Having said that, Mr. Baker, why don’t we go with you first? We

are really moving you up.

[Laughter.]

Chairman SARBANES. We moved from your panel, and now we

are going to move you to the front of this panel. And we would be

happy to hear from you, sir, and then we will go to Mr. Vagley. Am

I pronouncing it correctly?

Mr. VAGLEY. Right.

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Chairman SARBANES. We would be happy to hear from you, Mr

Baker.

STATEMENT OF LESLIE M. (BUD) BAKER, JR.

CHAIRMAN, WACHOVIA CORPORATION

REPRESENTING

THE FINANCIAL SERVICES ROUNDTABLE

Mr. BAKER. Mr. Chairman and Members of the Committee,

thank you for the opportunity to testify on a critical matter. My

name is Bud Baker, Chairman of Wachovia, here on behalf of the

Financial Services Roundtable.

I am also here today to tell you that without cooperation between

our Government and America’s private industry in support of insurance activities, there could be major disruption in the marketplace and potential harm to the economy.

On October 10, thirty chief executive officers from Roundtable

member companies signed a letter to the Congress expressing concern over the impending lack of terrorism coverage and urging

Congress to act this year. It is important to note that 22 of those

30 signatories are bankers, including Wachovia.

The President of the United States, the Chairman of the Federal

Reserve, the Secretary of the Treasury, and many Members of Congress have recognized that our economy needs an economic stimulus package. Without Congressional action to provide a Federal

backstop for terrorism insurance, efforts to provide an economic

stimulus could be rendered ineffective. This is an issue about the

ability of the United States to recovery from the terrorist attacks

of September 11 and the ongoing issues of uncertainty which now

weigh upon the economy.

Without insurance coverage for terrorist acts, it will be much

more difficult for bankers to extend or renew commercial loans or

lines of credit for business purposes, construction, or development.

If the insurance industry cannot offer adequate insurance to a borrower or a bank because it cannot properly price or reinsure the

risk, the bank is faced with a serious risk assessment problem. Is

it prudent to make a loan to construct a pipeline or a power plant,

a large shopping center or office building when the potential for the

borrower to repay is diminished by inadequate insurance coverage?

For most banks, the answer will be ‘‘no.’’ In many cases such a loan

most assuredly would be considered unsound.

Wachovia is one of the five largest commercial real estate lenders

in the United States. Our company has total commercial exposure

of approximately $252 billion, including real estate and small business loans. I am particularly concerned about the impact on small

business customers who are already experiencing wide disparity in

quoted premiums due to insurers’ inability to price products consistent with standard actuarial analysis. In the case of large or

small business, only the Federal Government can provide the insurance industry with the breathing room it needs to return to a

stable, rational market. Without a Federal backstop, businesses

will have to self-insure, putting their capital and ours at risk. Magnify that potential loss of capital across the domestic banking

sector to gain an appreciation for the dramatic impact a loss of insurance could have on our economy.

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Mr. Chairman, it is impossible to determine if, when or where a

terrorist might strike. But it is quite clear what the business ramifications can be. We are certain, however, that the lack of insurance coverage for terrorism will mean fewer loans, and that will

mean constriction of the economic activity across the country.

When a loan is not made, the jobs that build the plant or run an

office cannot be created. With appropriate support and assistance

from the Federal Government, the insurance industry can be in a

position to accept the risk associated with terrorist attack, and our

economy can continue its march to recovery.

The Roundtable is familiar with the various proposals that have

been developed. We have deliberately not stated a preference for

any particular one. From my perspective, any proposal must pass

a simple test: It must return predictability to the market. I am certain that given the close collaboration between the Congress, the

Administration, and the industries affected, we can work together

to develop a fine solution.

Thank you very much, Mr. Chairman. I would be pleased to answer any questions.

Chairman SARBANES. Thank you very much.

Mr. Vagley.

STATEMENT OF ROBERT E. VAGLEY

PRESIDENT, AMERICAN INSURANCE ASSOCIATION

Mr. VAGLEY. Thank you very much, Mr. Chairman. My name is

Robert Vagley and I am President of the American Insurance Association, a leading property and casualty trade association in the

United States. Before beginning my formal remarks, Mr. Chairman, I would like to thank you so much for your willingness to consider this matter and to thank you and Senators Gramm, Dodd,

and Schumer for your leadership on this issue.

Mr. Chairman, the tragic events of September 11 forever

changed our collective understanding of and concern about terrorism. We lost many valued business colleagues and dear friends

in the attacks on the World Trade Center and the Pentagon, and

no discussion of this subject should proceed without a heartfelt remembrance of them. Mr. Chairman, the new post-September 11

world is fundamentally different than that which existed before,

surely for Americans in general, and very specifically for property/

casualty insurers and our customers.

Current estimates of total insured losses resulting from the September 11 attacks are between $30 billion and $60 billion, although

the final number could end up being higher. The September 11 attack is by far the most costly insured event in history. The amount

of losses from September 11 may well exceed the entire U.S. property/casualty industry’s net income for the past 3 years.

Notwithstanding the enormity of this loss, the insurance industry is committed to meeting our promises to policyholders affected

by the events of September 11. We are paying claims quickly and

fully, and have received in excess of $20 billion in declared claims

to date. We are not seeking any financial assistance to meet these

obligations.

Looking ahead, however, we are very concerned about what will

happen if, heaven forbid, there are additional terrorist attacks on

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our country. The financial capacity of our industry, while sizable,

is limited and finite. Unfortunately, the potential harm the terrorist can inflict is both totally unpredictable in frequency and

almost infinite in severity. These two factors combined make terrorism risks uninsurable.

There is another important aspect to this issue. Over two-thirds

of annual reinsurance contracts are renewed each January 1. Reinsurers already have notified primary carriers that they intend to

exclude or dramatically scale back terrorism coverage in the reinsurance contracts coming up for renewal. They are not to blame for

this. These risks are no more insurable for them than for us.

Primary carriers do not have the same flexibility as reinsurers

with respect to our own products, because we are subject to tighter

regulatory controls. Any terrorism exclusions we might choose to

introduce must be approved by individual State insurance departments. If approved, our customers could find themselves bearing

100 percent of the risks associated with terrorism. Certainly the repercussions of this are clear. However, if exclusions were denied,

the insurers would be left to shoulder 100 percent of future terrorist losses, which we simply cannot afford to do. Our only

remaining option, and one we would prefer not to consider, is to

simply withdraw from certain markets and/or lines of coverage.

So we face a very difficult dilemma. How can we remain solvent

and still serve the real needs of our customers for financial protection against terrorism? We believe that the only course of action is

enactment of legislation to create a Federal financial backstop for

losses that result from future terrorist attacks. This backstop could

be temporary, but must be enacted before Congress recesses in

order to avert the market crisis that will occur on January 1.

This is not—repeat, not—a bailout for the insurance industry. In

fact, the primary beneficiaries of such legislation would be our customers and the U.S. economy. The purpose of the legislation would

be to ensure that adequate insurance coverage remains available to

American businesses. There are a few ways in which this can be

done. One is the British-style reinsurance pool concept which we

have advanced. Another is the quota share approach recently offered by the Administration. A third could involve some industrywide deductible or retention. We are not wedded to the details of

any particular proposal, not even our own, though we do believe it

offers the best hope for restoring this market. However, in order for

any legislative plan to be successful in averting the looming economic crisis, it must be drafted in a way that improves predictability, stabilizes the market, and preserves insurer solvency.

We understand that in all likelihood, any new risk-sharing mechanism for terrorism coverage will include some significant retention

of future losses by private insurers. On that point, I would like to

note that the more risk insurers are forced to retain, the less stability there will be in the marketplace, and the higher the retention, the higher premiums will have to be.

Mr. Chairman, terrorism has become uninsurable in the private

marketplace as currently structured. Appreciating that an immediate stopgap solution may be somewhat imperfect, we expect that

dislocations will still occur as insurers may cautiously reenter the

marketplace. It is our hope that with time and experience, we will

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be able to craft longer-term, more complete solutions that avoid

such disruptions.

In the absence of Federal legislation to prevent the complete collapse of the commercial insurance market, entire sectors of the

U.S. economy could be left wholly exposed and unable to continue

the normal course of business. I urge you to act quickly and decisively to ensure that all businesses are able to obtain much needed

protection against future losses.

Thank you for your attention.

Chairman SARBANES. Thank you very much, sir. Before I turn to

Mr. Ferguson, what percent of the property and casualty insurance

companies belong to the AIA?

Mr. VAGLEY. Of the affected losses, probably about 70 percent of

the affected companies.

Chairman SARBANES. And just as a general picture, the total

coverage?

Mr. VAGLEY. The total coverage, including personal lines and

lines that are unaffected, probably about 35 percent.

Chairman SARBANES. Okay. Mr. Ferguson, we will be happy to

hear from you.

STATEMENT OF RONALD E. FERGUSON

CHAIRMAN, GENERAL RE CORPORATION

REPRESENTING

THE REINSURANCE ASSOCIATION OF AMERICA

Mr. FERGUSON. Thank you. Mr. Chairman, Senator Gramm, good

morning. I am Ron Ferguson. I am one of the 2,400,000 people that

work in the insurance business in the United States. I am proud

of our industry. I am proud of the role we play in our society and

our economy.

As you well know, the insurance business was front and center

in the tragedy of September 11 in terms of claim dollars, which we

will talk about, but also in terms of lives lost. We will individually

and collectively as a Nation recover from this and move forward.

We will get back on our feet. We are all working to do that under

the leadership of President Bush, Congress, the heroes on the

ground and now overseas, we are assured of doing that.

I have five main messages here this morning, Mr. Chairman:

One, the September 11 claims will be paid. Two, there is a crisis

brewing right now, today, on the availability of terrorist coverage.

Three, I believe that in time we will win the war on terrorism and

we will see a return to a normal private sector insurance market

for these coverages. Four, we do need a transition period that, in

my humble opinion, will inevitably involve the Federal Government

in a backstop role. Five, as we go down this path, I believe there

are a few principles that we need to articulate and follow. If I may,

Mr. Chairman, I would like to elaborate just a bit on each of those

five headlines.

Chairman SARBANES. Certainly.

Mr. FERGUSON. Thank you. As for the September 11 claims,

there is no way to measure or dimension the grief, but we can tote

up the insurance dollars. As Mr. Vagley said, analysts indicate that

the range of insured losses for all lines, including life insurance, is

likely to be between $25 billion and $40 billion. A lot of guesswork,

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but that is the best guess. My own personal opinion, which should

be accorded no special weight or credibility, is that we are going

to be at the high end of that range.

How will these losses be paid? First, there was never a nickel of

premium collected for these coverages because no one expected

them to happen. That is the plain and simple truth. Second, there

are no assets on insurance company balance sheets or reserves that

are earmarked for this coverage. Third, there are no hidden reserves in the balance sheet of the insurance industry. These losses

will be paid out of the capital account, out of the shareholder, or

in case of mutuals, policyholder funds.

Let us talk about those funds for a moment. Broadly speaking,

the entire insurance industry—life, health, casualty and all lines— has policyholder surplus or net worth of about $500 billion. The

property/casualty industry, which bears the great bulk of these

claims in this instance, has a policyholder surplus of about $300

billion at June 30. But we need to narrow the focus and analysis

a little more, and we have to talk about, as Mr. Vagley did, the affected companies—those companies that write the commercial lines

business, the workers’ compensation, the property that indeed generated these losses.

If you then go down from the $300 billion to the affected companies and lines of business, I believe that the capital account that

supports that business is about $125 billion. So we quickly have to

go from the $500 billion headline down to the surplus that is directly supporting these lines of business, and that is about $125

billion. Tillinghast, which is a very well respected actuarial firm,

has actually come up with an even lower number than I did, and

they estimated it at $80 to $100 billion capital that is supporting

these lines of business.

In any event, numerically, you can certainly make the argument, and I am here to do that, that the losses of $25 to $40 billion can

be funded out of that capital account. But that capital account, it

must be understood, also supports other operating risks, other investment risks. And so now it has been reduced or impaired and

we have to collectively ask the question, ‘‘and then what?’’ What

happens after this? What if there are multiple events?

All of the normal actuarial pricing and predictive models do not

hold up here. We have one horrific data point. That is all we have

to go on. The rational response for individual companies, Mr.

Chairman, is likely to be that they will either restrict the amount

of terrorism coverage they write or they may not offer it at all in

certain cases, or they may try to simply underwrite around it and

not provide insurance in certain targeted areas. And different companies will choose different paths, and it is very hard if not impossible for me to dimension that for you. But I think absent some

backstop and plan to go forward, it is inevitable that will happen

and it is starting to happen today.

Chairman SARBANES. Mr. Ferguson, have you ever been at a

stoplight when it was red and wished you could go on through?

[Laughter.]

Mr. FERGUSON. Yes. That is the way I feel right now.

Chairman SARBANES. Well, I am telling you here we can give dispensation. So just ignore that red light.

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Mr. FERGUSON. No ticket?

Chairman SARBANES. No ticket.

Senator GRAMM. But do not forget it is there.

[Laughter.]

Mr. FERGUSON. And it can come back at a moment’s notice.

Chairman SARBANES. Yes. Do not get carried away, but we are

really very anxious to get the benefit of what you gentlemen have

to tell us.

Mr. FERGUSON. I will try to move along. I understand. I appreciate it. Thank you, sir.

So we do have an availability crisis in the making. It is not just

a January 1 problem. It is easy to slip into that thinking. It is a

today problem. All those policies that were out there on September

10 and exposed on September 11 still exist today. It could happen

again this afternoon.

Steve Bartlett from the Financial Services Roundtable said it in

the shortest possible way. He said, ‘‘No insurance, no lending; no

lending, no economy.’’ I could not improve on that short statement.

Chairman SARBANES. Steve is pretty good.

[Laughter.]

Mr. FERGUSON. In time we are going to win this war. We are

going to win the war on terrorism and the markets are going to return to normal. They always do. We have the examples of the nuclear energy business which in the late 1950’s had to set up some

special pools and a Government backstop. We had the urban riots

in 1965. But it takes time. It takes time to run these transitions.

But with a Federal backstop program, it can be done. The nuclear

risk matter was handled successfully in the 1950’s. The urban riot

insurance was handled successfully. And today, there is little or no

Federal involvement in either of those areas, because the private

market has come back in.

Now we have several models in play today, as Mr. Vagley said.

I am not wedded to any one particular model. I am only wedded

to the idea of going forward from here. I do have a couple of principles I would like to articulate very quickly before the red light

comes on again.

Chairman SARBANES. No, no. Do not worry about that. You take

your time.

Mr. FERGUSON. You are very kind. I would like to offer a few

principles that need to be agreed on, I think and followed.

One, we need to very clearly define the problem and the objectives lest we get into objective creep and unintended consequences.

Two, we need to make sure that all the interests—the insurance

companies, the insureds, the policyholders, the State regulators,

and the Government—that we have a plan that aligns all of those

interests. We need a plan that is workable at the micro level. What

I mean by that is, it is companies and it is underwriters and companies that make the decisions every day. It is not the industry as

a whole. And we need to provide for the people at the companies,

the underwriters that price this risk and make the go/no-go decisions every day have reasonable certainty as to what they are signing onto, that they have an agreed definition of what terrorism is

so we do not end up with 51 different definitions, 52 counting the

Federal Government. We need to have consistency there.

139

Three, we need some latitude in the ratemaking from the traditional rate regulatory system that is applied at the State level.

Four, I believe any plan must allow for current and future private sector response. It will come back. It is just a question of time.

Five, any plan—this is the tricky part—it has to be long enough

to restore the confidence and the predictability Mr. Baker was talking about but short enough to avoid being institutionalized. And

that is the hard part of this.

My boss is Warren Buffett. And Warren Buffett has a truly remarkable way of cutting through complex issues and putting them

into common sense, everyday words. He did that the other day in

The New York Times on this issue. He said two things I would like

to share with you. He said, number one, ‘‘We do not want to write

coverages. We do not want to make promises as an insurance company, as Berkshire Hathaway, unless we are absolutely certain we

can fulfill those promises. Otherwise, it is a cruel hoax.’’ Number two, he said that, ‘‘This is not a bailout of the insurance

industry, it is a bail-in. Let’s find out how we can get together and

bail-in and find the way forward.’’ I wish I could turn phrases the

way he does. I cannot, so I can only quote them. Mr. Chairman,

we can do the job, but we need your help for now. Thank you for

your time and thank you for the dispensation on the traffic ticket.

Chairman SARBANES. Thank you very much, sir.

Mr. Sinnott.

STATEMENT OF JOHN T. SINNOTT

CHAIRMAN AND CEO, MARSH, INC.

REPRESENTING

THE COUNCIL OF INSURANCE AGENTS AND BROKERS

Mr. SINNOTT. Thank you, Mr. Chairman. I would like to explain

what Marsh, Inc. is because some people cast us as an insurance

company. We are not. We are the largest risk advisor and insurance broker in the world with 35,000 employees with offices in

about 100 countries around the world.

We represent and advise clients, the consumers of insurance. We

represent all aspects of all levels of business clients, from the

smallest business client up to the Global 1,000 if you will. We also

serve private clients. And finally, we also serve as a reinsurance

broker and service provider for insurance companies.

So I am speaking today from a different perspective that my colleague is. I am speaking from the consumer standpoint, both the

insurance consumer and the reinsurance consumer, who needs the

reinsurance. And we have a very good perspective as to what the

current conditions are in the world today. And we think we have

a very good perspective as to the immediate future.

I should also say that I speak today not just representing Marsh,

Inc., but I also speak as a member firm of the Council of Insurance

Agents and Brokers. That is our national industry association. It

represents about 245 of the larger firms which comprise somewhere

in the neighborhood of 75 to 80 percent of the commercial insurance transacted in the United States.

I will not repeat some of the points already made. However,

there are really two problems as we see it. First of all is the size

of the event that took place on September 11. I might disagree with

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Ron. I would say that our best estimates are that, yes, it will be

at the top end, and maybe even more because of the uncertainty

that still exists. That is twice as large as the next largest catastrophe event that ever occurred, more than twice.

Looked at another way, if we added to Andrew, which was the

next largest, the next five largest catastrophe claims that took

place in the last 10 years and we aggregate those together, that in

my estimation will equal September 11. So we have a very significant severity problem.

Second, the problem is uncertainty. And insurance is an important social instrument, and it is used to dealing with uncertainty.

That is the nature of its business. But if the uncertainty gets to

such size and the probability of losses becomes so large, then it creates a situation where the instrument does not respond. And that

is what we have today.

And January 1 is a very key date. But I can tell you that right

now, working for our clients in putting together their insurance

programs, some of which renew prior to January 1, we are already

faced with exclusions for terrorism.

So what we see here is that the primary insurers will not be able

to provide our clients with what they need if the reinsurers that

back them, that provide the spread of risk, feel that they cannot

underwrite this particular risk. Simply stated, without sufficient

insurance coverages, businesses and other entities will be handcuffed at a time when they are already wrestling with a slowdown

in the economy.

My message is fairly simple. When there is a cure for the current

environment, and that cure will only take place if there is a partnership between the Government and the private industry, business doing its best to better secure its environment, Government

working to secure the country’s environment, I am convinced, we

will be back to where what we are talking about today will not be

needed.

I will make one final comment. Marsh was in the World Trade

Center in 1993 when the first terrorist attack took place. Fortunately, we did not lose a single employee. And the insured loss—

because we are also an insurance consumer, and quite a large insurance consumer—the insured loss that we collected was less than

$5 million on our property and business interruption.

On September 11, we lost almost 300 colleagues. I mean, that is

the real tragedy, and that is what we carry as we walk through our

office and all my colleagues around the world, that is what we are

carrying today.

But in addition, the insured claim that we will have to submit

to our insurers will not be measured in a few millions, it will be

measured in the hundreds of millions, and that is not the type of

exposure or occupancy that the market would ever have expected

from our type of business. We are an office occupancy.

So I think that best explains the change of environment that was

created on September 11. Whatever is done here, we believe must

be a partnership between the Government and private industry. It

should be short-term. We need something that gets us beyond January 1. And as my colleagues have said already, the devil is in the

details. But our view is that we do not like Government involved

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in our business. That is not good for us because we are in the risk

advisory business. And when the Government takes over part of

that, that gets into our advice piece. The same thing is true with

the risk-bearing part. If they constantly give off risk to the Government, they are losing part of their business. This has to be temporary, but right now, for the consumer, we need a partnership

between the Government and private industry.

Thank you, Mr. Chairman.

Chairman SARBANES. Well, thank you very much. I thank all of

the panel. And Mr. Sinnott, we understand, of course, that the first

plane that hit the towers hit directly into your offices.

Mr. SINNOTT. That is right.

Chairman SARBANES. And we certainly extend our sympathies to

your corporate family. I understand that you lost 295 people out of

1,900. You had offices in both towers?

Mr. SINNOTT. In both. Everyone got out of the south tower. We

had about 900 there, which was where the second plane hit. But

anyone who was on our floor in the north tower, no one got out.

Chairman SARBANES. I am going to ask a few questions just to

try to get some sense of the parameters of this. What percent of

the loss that you are estimate—you say 25 to 40, you took the high

figure. I mean, who knows, in a sense, but in any event—is property and casualty and what percent would be life and health? Do

you have any idea?

Mr. VAGLEY. Yes. We have estimates, Mr. Chairman. Let us stick

with the 40 for the minute, and I certainly take Mr. Sinnott’s point

of view, it could be higher. But let us stick with that for the moment. The estimate would be about $5 billion of that 40 would be

life and health.

Chairman SARBANES. Is what we would do here set a precedent

for what we might have to do for life and health? Since we are now

worried about bioterrorism, chemical, things of that sort. Do we

have to keep that in mind as we work on this problem?

Mr. VAGLEY. My opinion would be yes.

Mr. SINNOTT. I am less sure. Because even with the life insurance industry which is a vast industry with individuals—let’s face

it, it happens every day. We have not to date had the same issues

raised on the life side that we have had on the property/casualty

side.

Chairman SARBANES. Yes, I know. But this event, this terrorist

event was one that by its nature impacted financially at least more

greatly I think on the property and casualty side. But you could

have a terrorist event, as we are now seeing as we deal with anthrax. If you refer back to the chemicals in the Tokyo subway and

things of that sort, which would come down heavy on the life and

health problem.

Mr. FERGUSON. May I add that I think the key phrase that Mr.

Sinnott used is ‘‘to date.’’ And the life industry will handle this one

just fine. But you are absolutely right, Mr. Chairman. I think we

have to think beyond this particular event. And I almost hate to

say it, we have to think about nuclear terrorism where then the life

insurance industry could be very seriously affected.

We all tend to think about the life insurance industry as being

huge, which by some measures it is. But I must tell you that the

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capital base of the life insurance industry in round numbers is

about $200 billion. It is not the behemoth that many of us might

think it is. And you can imagine, as you have just started to, terrorism scenarios where it would affect the life insurance industry.

Chairman SARBANES. Mr. Vagley, you said in your—and I am

just trying to get a sense of the parameters here. We have to understand the lay of the land. You say on in your testimony, ‘‘Our

only remaining option—this is if something were not done here

...’’ and ‘‘. . . one we would not prefer to consider would be to

simply withdraw from certain markets, and/or lines of coverage.’’

What markets would you anticipate insurers would withdraw from?

Mr. VAGLEY. Again, Mr. Chairman, with the same reluctance

that Mr. Ferguson shared, because you almost hate to identify

these areas for fear that somebody will act on them. But certainly

there are a number of American companies that are icons, that are

very visible targets. There are a number of American industries

that it would not require a great stretch of the imagination to believe would be exposed. Certainly large office buildings in major cities, transportation networks, electric utilities, petroleum facilities.

There are a number of businesses that would seem to be more at

risk than others.

Chairman SARBANES. And lines of coverage?

Mr. VAGLEY. Well, lines of coverage, some of the most exposed

here, workers’ compensation would be a very precarious line of coverage. I think the losses coming out of the World Trade Center for

workers’ compensation could indeed be staggering and could even

reach or exceed some of the commercial property losses. And some

of these markets, Mr. Chairman, already are firming up and are

considered hard markets.

Chairman SARBANES. Yesterday the NAIC President, Kathleen

Sebelius, who is the Insurance Commissioner in Kansas—this goes

to the duration issue that someone raised at the table—she said,

‘‘Well, you know, if this had been February instead of September,

that there might have been enough time for the industry to have

sorted it out before the renewal questions came up.’’ What is your

reaction to that?

Mr. FERGUSON. In a very narrow sense, you can make that argument. But I would have to broaden it and say that it is a problem

today. You know, all those policies, as I mentioned a moment ago,

that were in existence on September 10 are still affording this coverage today. And if we have a couple of more events like September

11, you are going to have a serious impairment of the capital of the

property/casualty business. That could be February, that could be

October. It would not matter.

So in the narrow sense, I agree with her. There is a little broader

issue here, the financial solidity of the industry which is exposed

every day of the year.

Mr. SINNOTT. I would add to that. I would say that 10 extra

months would help because there would be the opportunity to develop more capacity and capital in the market. By the same token,

the environment is still the same today as if this had happened in

February. And we are no more secure in that regard. So there is

two parts to this. There is the environment and the ability to seVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00146 Fmt 6601 Sfmt 6601 83472.TXT SBANK4 PsN: SBANK4
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cure. I do not think we will ever get back to the way we were before September 11.

Remember in 1993 when we had the terrorist attack, no one was

sitting here saying we needed help, because there was not a perception that the environment had changed that radically. So that

is an important issue as well in the timing.

Chairman SARBANES. I am going to impose on my colleagues and

go on with just a couple of more questions. Mr. Baker, I wanted

to ask you, from the banker’s point of view, is there a difference

on the insurance question between existing structures and new development as you would evaluate the insurance issue?

Mr. BAKER. Mr. Chairman, we will look at all of our customers

the same way. In other words, we will go forward with existing customers. The question I suppose that is apparent right now is the

need to renew policies as we go forward and the changing of the

risk structure for these people, not just because of their loans from

us but because of their position and their own risk evaluation in

the marketplace.

So our view of them will not change. I think as we look forward,

this becomes an economic issue as we try to think about what can

be done for our customers. So I do not believe there will be any disparity in how we treat existing customers or new ones. We do have

this renewal issue coming up where we have a lot of policies that

will come up for renewal between now and the end of the year, and

that is what gives some urgency to this.

Chairman SARBANES. There is some discussion about whether

the Government should share upfront. That was discussed here

yesterday and has been debated by others.

I take it from the industry point of view, of course you do not

want the figure to be large—you would rather it be smaller than

larger—but it is important to you to have a figure that would represent your exposure. Then you could calculate. Is that correct?

Mr. FERGUSON. In a word, yes.

Chairman SARBANES. I mean, whether it was $20, $30, $40 billion, whatever. If you knew that and whatever the formulas were

that the balance then would go off on the Government, at least you

could calculate where you are. Is that correct?

Mr. FERGUSON. Yes. You begin to have some certainty and you

could begin with admittedly crude pricing and underwriting tools

to try to do it.

Chairman SARBANES. Now on the question of certainty, the

Treasury’s proposal, if you get over $100 billion says—and I am

looking at their chart—‘‘discretion of Congress.’’ Now that is not a

lot of certainty I would think.

[Laughter.]

Chairman SARBANES. On the other hand, the figure is very

large—very large. Now how would you handle that? Essentially figure, one, we may never get there? And two, if we do get there, Congress will, in fact, do something, and therefore it is taken out of

the pricing equation?

Mr. FERGUSON. Well, you have correctly framed the bet that you

as a company would have to make. And I cannot predict how individual companies would react. You have framed the argument exactly. Some companies would look at it and say the $100 billion is

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sufficiently large. The risk of a frequency, a number of events is

sufficiently remote that we feel we can underwrite and accept risk

in this environment. Other companies may look at it and say it is

not enough. It does not give me enough certainty.

So we cannot, Mr. Chairman, in advance predict how individual

companies would react. Sorry to give you kind of a wishy-washy

answer.

Chairman SARBANES. This may be an admission against interest,

but if I were trying to calculate how much of a burden I think the

industry should carry, given its financial position, what figures

would I look at? What indices would I look at in order to make

some calculation in that regard?

Mr. FERGUSON. I would start, respectfully, with Exhibit A in my

attachment to the prepared testimony where I make the case that

the capital base on September 10 for the affected lines of business

is about $125 billion. And as I say, some experts think my number

is a little high, but let us stick with it for discussion purposes.

So we need to look at that. You know, that capital base is supporting all of the commercial business, commercial lines insurance

business in the United States. All the operating risks that attend

that business, investment risks that attend that business. So it is

not a huge capital base. It is big, but it is not huge. So that would

be one of the indices that I would look at.

Another statistic to look at is the amount of premiums in the

commercial lines insurance sector and in round numbers—this is

workers’ compensation, property, general liability, and so on, business interruption insurance, add it all up—in round numbers, it is

about $145 billion of premium annually. So that is another factoid

or another statistic that enters the equation.

But to me, the important one is the first one. What is the capital

base that is supporting this business? And how many September

11’s can we handle? And the answer is, we can do this one, but I

do not know what happens after that on the existing capital base.

Mr. SINNOTT. I might——

Senator DODD. You ought to review these numbers, by the way.

The first number on the capital is very important.

Mr. SINNOTT. Did that number, represent just U.S. companies?

Mr. FERGUSON. Oh, yes. U.S.-licensed companies.

Mr. SINNOTT. Okay. Therefore, it does not include capital outside

the United States?

Mr. FERGUSON. That is correct.

Mr. SINNOTT. I would add to that, the fact that our business is

a global business. Reinsurance carriers, alien carriers who provide

capital need to be included. So if I calculated it, I think my number

might be up. The United States has at least half of the surplus

that exists in the world, about half is what it is.

So you could make a calculation. I might come up with something higher, but it is still not some of the numbers that have been

thrown out as to the assets and such that the industry has.

Mr. VAGLEY. Mr. Chairman, if I could add further, clearly a part

of the calculation could be, should be, how much more pain can the

industry bear? But the focus really ought to be on what will it take

to restore the marketplace. And simple economics will suggest that

the higher the amount the industry is required to retain, the more

145

reluctance the industry will have to move comfortably back into

this market, even uncomfortably back into this market, and the

greater the retention levels, the greater will have to be the price

of that coverage to the policyholders. I mean, there is no way to

escape those fundamental economic principles.

Chairman SARBANES. Well, if you knew what your exposure was,

you could calculate what the premium level had to be to cover that

exposure, could you not?

Mr. VAGLEY. Well right now the exposure is infinite.

Chairman SARBANES. No, no. I understand that. If you are dealing with an infinite.

Mr. VAGLEY. Just some plan to be sure. And the more that retention is constrained and made definite and comprehensible, the

greater will be the ability of the industry to move back into those

markets and to take on those risks.

Chairman SARBANES. Now are you suggesting—well, I will wait

and do it on the next round. I yield to Senator Gramm.

STATEMENT OF SENATOR PHIL GRAMM

Senator GRAMM. Thank you, Mr. Chairman. Let me just say in

terms of capital levels, we have to be very careful. A witness at

these hearings yesterday suggested that the existing capital level

of the industry told us something about our ability to extract that

as part of some kind of mandatory process. The bottom line is, no

matter what your capital is, you are not going to invest it unless

you believe that ultimately you can end up selling a viable product.

It is always tempting to say, well, let us pool the assets of this

industry and then I will be able to afford these things. The problem

is, it is other people’s money.

I do not expect any insurance company to put its capital at risk

in an enterprise that has no hope of being successful. We had better be sure we organize what we do based on that thesis.

Let me make a couple of comments and then I want to pose a

question or two since I missed the opening statement. First of all,

I would like to say that I think the insurance industry has been

about as responsible as any industry in America. And people often

accuse me of being pro-business. Actually, I am pro-free enterprise,

and I agree with Adam Smith’s observation that, ‘‘Never do two

merchants meet even for merriment lest the topic turn to conspiracy and restraint of trade.’’

[Laughter.]

Senator GRAMM. So I am not free with my compliments to

businesspeople, and I just want to say that I think the position of

the insurance industry and the people who run it has been about

as admirable as any business that has dealt with this crisis. You

are not at the heart of it like firemen and policemen in New York,

but in terms of the secondary effect, pretty substantially affected.

We had a talk this morning with Jose Montemayor, who is our

Insurance Commissioner in Texas. And in our State, you can cancel

a policy with 7 days’ notice. We are already beginning to see some

terrorism policies canceled with regard to private aviation, which

makes it very difficult for these charter companies to fly into big

airports. So we are already beginning to see an effect. I do think

146

it is interesting. My State is about as proud of its rights as any

State in the Union. We were a country at one time.

[Laughter.]

Senator GRAMM. But here are the points that our insurance commissioner made about the whole State sovereignty issue. That as

long as whatever we are doing is limited to terrorism, he is not

worried about infringements on States’ insurance powers. And as

long as it is limited to 2 or 3 years, he is not worried about it. And

I think that is pretty important. I am not saying he speaks for

every insurance commissioner in the country, but I think that is

relevant. That if it is very narrowly defined terrorism where we are

going to define it in law and perhaps have a panel—the Secretary

of the Treasury, the Attorney General and the head of the Federal

Reserve Bank—based on that law, make a determination when an

act occurs, is this terrorism, and we are not going to let the media

decide whether it is terrorism or not, on that basis, what we do

there is going to be a lot more acceptable within those narrow limits than if we were talking about a Federal action in insurance that

was going to have a profound and lasting effect on the States. And,

if we are talking about a 2 or 3 year emergency program, I think

people understand and they do not see it as a precedent for the

Federal Government taking powers away from States.

It is clear from our hearings we had yesterday that on a bipartisan basis that for us to do a bill—and I think The Wall Street

Journal article says it correctly. In fact, I said a similar thing before I read it and I totally agree with what they said. And that is,

my guess is that we might be able to get through this thing without a Federal program. I just think the risk of doing that is too

great. And I am not willing to take the risk.

I think listening to the people we listened to yesterday on this

Committee on a bipartisan basis, we are going to have to have

some degree of retention so that the Federal Government is not the

first dollar payor. We could debate as to what that was going to

be. The Administration has a proposal where that is the case in the

second year, not the first. And a simple way of bringing us together

with the Administration would be just to make their second year

program the first year program.

The President’s proposal, other than the first year, has a lot of

good features and it is a very good start for us to work with. And

for us to do something in 2 weeks, there is no way we are going

to write a program and get into a debate with the Administration

or get involved in any partisanship and get that job done. It is distinctly possible we might not get it done. And that it is important

that everybody make an effort to make it happen. I just want to

assure you of my best faith effort to see that we do get it done.

Let me ask you a question. In 1993, we had a group of terrorists

try to blow up the World Trade Center. What happened to insurance property and casualty rates after that? What happened to

them in 1994 and 1995?

Mr. SINNOTT. I do not recall a great impact. I mean, it was a catastrophe, but, you know, it was not as big as Hurricane Andrew

or some of the other catastrophes like Northridge Earthquake. In

total, it was less than $1 billion.

147

Senator GRAMM. No, I am not talking about the cost in paying

out of your reserves. I am talking about changing expectations. I

mean, we had had a terrorist attack. People had tried to blow up

the World Trade Center. Did anybody reevaluate—is there any evidence that anybody reevaluated and said, well, if we are going to

provide terrorist insurance, maybe there should be a change in the

rates that we charge? I am just trying to see how sensitive the

market was to that.

Mr. SINNOTT. From a broker’s standpoint, we did not see a

change. The result of terrorist acts has been covered in the United

States under insurance policies. That is not necessarily the standard in all parts of the world, but here it has been. And I think the

World Trade Center at that time, as I recall, was viewed as, okay.

That is what insurance is all about.

Senator GRAMM. So you did not see any change in premiums?

Mr. FERGUSON. That is my recollection as well. It did not create

much of a ripple in the market. It should have been a wake-up call,

but it was not. And to take Mr. Sinnott’s point, it was regarded as

a discrepancy, and it was not of such a magnitude that it caused

huge problems for the industry. What we are facing now, of course,

is a whole different category where we see a systematic aura of terrorism. No one thought that in 1993. Maybe we should have, but

we did not. The short answer to your question is, it did not really

create much of a ripple in the industry.

Mr. BAKER. Senator, I think it is important to remember that in

that incident also the system worked. The industry kept going. Insurance was available. We did not have any problems.

Senator GRAMM. Let me say, Mr. Chairman, that I think again

what we are going to have to decide is are we willing to take the

risk that we are going to have a huge spike in insurance rates and

generate an economic ripple in the economy of some substantial

size? Or can we come up with a workable, short-term program to

help us build a bridge to where hopefully we will eliminate much

of the threat, and that ultimately this can be built into the structure of the system, and the Federal Government can get out? I

think that is everybody’s goal. I had not heard anybody on this

Committee or in Congress or anybody I am talking to talking about

getting the Federal Government permanently into the insurance

business.

STATEMENT OF SENATOR CHRISTOPHER J. DODD

Senator DODD. [Presiding.] Thank you. Senator Sarbanes will be

back. Let me again apologize to my colleagues for not being here

yesterday. But I had a staff member who had been with me a long

time who lost her mother, so I was at a funeral in upstate New

York all morning and afternoon yesterday. So I apologize.

I think for us not to act is too high a risk in my opinion. What

we do has to be done carefully because we are dealing with 100

Members of this body and 435 in the other. And apparently there

is some reluctance on the part of the House to move on some legislation here. I hope that mood is changing a bit. I know that people

have been talking to them.

I worked with Bob Bennett of Utah on the Y2K Committee. We

spent 2 years urging business and industry, Governmental entities

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to make corrections and to get up to speed. And when the clock

turned, the world did not collapse. And there were some who

looked around and said, well, what did we waste our time doing

that for? It is always hard to prove a negative I suppose, except

that I can tell you the other day I was in Ground Zero in New York

at the operations center there.

The fellow who took me around had no idea that I had been involved in the Y2K issue but volunteered and said, you know, I do

not know who was responsible for it, but had it not been for that

effort made on this Y2K stuff, this operation center would not exist.

Because the Federal Government pushed us to modernize, to update, to correct our systems, we were able to put in place a system

here that has allowed us to respond to this savage attack in ways

we could not have even imagined without the Y2K effort.

And so my hope would be we will act, and in doing so, will avoid

the kind of problems that have occurred. I am sure there will be

those who then say, well, you did not need to act. So I agree with

Phil Gramm that for us not do something here would be highly irresponsible. We are talking about stimulus packages that are going

to be passed to try and shore up a weak economy. And in my view,

it would be a huge mistake if we were to take some sensible action

there and not do something here.

Ron, it was in your statement—I believe it was in yours. No, Les

Baker. There you are right there. You said this. I think it is true.

Is it prudent to make a loan to construct a pipeline, a power plant,

an airplane, or a ship, a large shopping center, or an office building

when the potential for the borrower to repay the loan is diminished

by inadequate insurance coverage? For most banks, the answer will

be no. And that is the real danger we face here.

So this is really—we have insurance here. We are going to hear

from Tom Donohue and others—but this is far more of an economic

issue than an insurance issue. And there is a tendency to talk

about this in insurance terms, which is obviously important, because the industry is involved directly. But the people who are

going to be adversely affected here if the insurance does not show

up in January with 70 percent of these contracts are up for renewal in about 8 weeks, and if they are not renewed, the insurance

industry will be here. The question is, is whether or not those other

industries out there that depend upon that insurance are going to

be able to survive.

So when we have our hearings about the effects of all of this, we

will have a very viable insurance industry at the end of all of this,

but we may not have a viable economy or economic interests as a

result of our failure to act.

So my hope is that we will. There is no perfect plan, and it ought

to be relatively short-term in my view if we are going to do something in a way that we can come back and during that period of

time review maybe on a longer-term basis what steps need to be

taken to improve the potential for the damage to be caused by terrorist acts.

So the question of capacity I was going to raise with you which

you have already indicated where we stand with the capacity

issues, but let me ask this panel if I can, first of all just quickly,

two questions. One is, I mentioned short duration. We have been

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talking about 2 years with a possible third year with the President

giving that authority. I would like you to comment on whether or

not that is adequate or too long. And then second, I would like you

just to mention and respond if you could to the effects on the economy, what your own thoughts would be in terms of what this could

mean if we do not act here and come up with a plan that works.

And then last let me just say, my view is the economic interests

always are important, but I worry deeply. This economy begins to

crater more. You are going to watch a public reaction that is going

to have an impact on policy setting in dealing with September 11

and other events. You have unemployment rates going up. You

have interest rates and all of these problems that are going to create tremendous pressures on our society, and that is we have to be

very mindful of. And we do not want to make the perfect enemy

of the good here, and we realize we are sailing in some uncharted

waters, but it is my hope we would be willing to take a chance and

do something that I think would protect against a far greater tragedy occurring if we did not act.

So with that, Mr. Chairman, I thank you immensely for holding

these hearings. They have been very worthwhile. And my hope is

that we will move very quickly now and come up with a proposal

here that we can present to our colleagues, and hopefully one that

will enjoy broad-based support. All of us who have been around

here any length of time will tell you, at this stage of the year,

the clock is the 101st Senator and a tiny group of people could be

highly disruptive in terms of stopping something from happening.

And my hope is that our colleagues will recognize the potential

dangers here of not acting and will help us construct a plan here

that will provide the needed assurance and help. And I again want

to compliment the industry for acting so responsibly. Just those

two questions if you want to comment on duration and economic

impact.

Mr. VAGLEY. Senator Dodd, thank you very much. And in your

absence and Senator Gramm’s absence, I really thank you and

would like to do so again for your extraordinary leadership, your

joint leadership on this very important issue.

I certainly agree with the sentiments that you both have expressed in the last several minutes and the challenges to restore

some stability in the commercial insurance marketplace. It is not

about saving insurance companies. We do not need to be saved in

that respect. The consequences really fall more broadly on the

American economy.

With respect to your two questions, I think from our standpoint,

longer is better than shorter because it does correlate with stability. But the kind of architecture that you and Senator Gramm

have described is perfectly adequate in light of the business and

the political circumstances and would provide a sufficient bridge to

get us through this period, and perhaps in the calm of the fullness

of time, the industry could get more comfortable with this, the marketplace could settle down, and private mechanisms could begin to

move in, or there might be a determination made that some additional support needs to be provided.

I think with respect to the economic dislocations, there are others

on the panel who are better suited to speak to that than me. But

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without engaging in too much hyperbole, we are on the frontlines

of a growing economic crisis. We are seeing it already in the lack

of reinsurance availability, which is washing back on us, and that

is translating currently into the lack of insurance availability, and

that message is beginning to impact the business community at

large. But there may be a lag time there in terms of the kinds of

communications you are hearing from businesses generally, but I

promise you it is there and it is going to wash over that community

very soon.

Mr. FERGUSON. Senator Dodd, as to the period, my personal opinion is, 2 to 3 years is the minimum. I hope and think that can

work. If we look for historical precedent and look back at the nuclear energy reinsurance program and the urban riot reinsurance

program, it did take longer. I am not saying that is a perfect precedent, but it did take about 10 years for those things to settle down.

I certainly hope that is not the case here. We as citizens cannot afford to wait that long. So I think 2 to 3 years is the minimum is

the short answer.

As for the economy, obviously the frontline where you are going

to see it first, as Mr. Baker indicated and Mr. Bartlett has indicated in comments, is going to be in lending. Quickly behind that,

the real estate industry. And then you get into kind of the confidence factor, and then the second and third order effects that I

do not know how to judge any better than anyone else, but it really

gets to the confidence and predictability factor that Mr. Baker was

talking about before.

Mr. SINNOTT. On the duration question, I have two answers to

that. If the environment does not change, let us say we are sitting

here a year from now and there is no change in the environment,

in my view, will there be more private capacity available? Yes,

there will be more capital. There is more capital coming in now in

general across the board. And that will include, the ability to mitigate the withdrawal that is taking place. That will be very slow.

And as I said earlier, if there is no change in the environment,

however, a year from now, it is a matter of degree. There will still

need to be Government involvement.

If however the environment is secure, and we no longer see on

television the ‘‘Attack on America’’ and we are some way able to

get back anywhere close to the way we were before, then, we can

accelerate the withdrawal of the Government. But, you know, there

are two issues there.

And on the investment side, Mr. Baker probably has the best answer on this or the best information, but I can think of one, and

that is large construction projects, which involve not just physical

assets but significant numbers of workers, so you have both workers’ comp and you have big asset values. If there is not adequate

insurance for those particular projects, they will not go forward.

Senator DODD. Mr. Baker.

Mr. BAKER. Mr. Chairman, I would make a brief comment on the

duration issue from a banking standpoint simply to say that a

great deal of our financing is in the 2 to 3 year range, and so when

we look at projects, it could be a big project, a large office building

or a power plant, typically things take a while to get built. So you

have to begin to think of this link to projects. That is the best guidVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00154 Fmt 6601 Sfmt 6601 83472.TXT SBANK4 PsN: SBANK4
151

ance I can give you on duration that you are trying to bring stability to the market over time.

On the economy, I would like to address this, because I think it

is critically important at this time. I would like to say first that I

am an absolute optimist on the American economy. I believe that

when you look at the demographics, for example of North America,

the population will increase about 40 percent over the next 50

years. It virtually assures us of a growing, sound economy over the

first half of this century. So put me in the optimist column.

Right now the weakness that we are seeing is a global weakness

in the economy. It is lower nominal growth within our domestic

economy, and now it is very severe employment pressure. We lost

something on the order of 77,000 jobs out of the economy in the

last week alone. So my sense of this is, it is a very critical point

right now, because I believe the American consumer is in the process of making up his or her mind about where this economy is

going to grow. And so stability is important. And what we do not

want to see happen is to see the economy lapse back into a selfdefeating proposition. We do have this global weakness in Europe,

Latin America, and Asia.

I would like to finish my comments by saying that I think particularly this is a small business issue. We tend to focus on large

power plants and things like that, but I think this is particularly

difficult for small business. I think you should consider the business interruption insurance. That is a small business issue if there

ever was one. So that is the critical thing on the economy. The

economy is going to grow. It is going to be good, but it is a very

critical point right now.

Chairman SARBANES. [Presiding.] Thank you very much.

Senator Corzine.

STATEMENT OF SENATOR JON S. CORZINE

Senator CORZINE. Thank you very much, Mr. Chairman. I apologize to the panel for being late. I was at another hearing, but I too

would like to give my congratulations and laud you for how the industry has reacted in the post-September 11 time. It has been very

responsible.

I have a question with respect to the knowledge base that you

think you will have gained over the next 2 or 3 years in this exercise of bridging which we are about. Is this the kind of activity that

we can bring actuarial knowledge and applications to in a way that

you might be able to deal with natural disasters? I am very much

of the view that the long-run solution may have to wait so that we

can be careful about the short-run. I am troubled with the assumption that somehow or another we are going to have actuarial

knowledge with regard to crazy behavior that comes from terrorism. I would love to hear your propositions on that.

Mr. Baker, you talked about 2 or 3 year financing programs

through the banking industry, but as you know, there are other

capital markets that have longer duration, and what kind of impact

do you think a short duration program may have with regard to

the free flow of capital? And have we seen any indication that that

may be drying or at least dampening down? I do believe this is a

serious economic dislocation issue that needs to be addressed, and

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the business interruption issue with regard to small business, I

would love to hear your comments.

And I would love to be respectful to my colleague, Senator

Stabenow, who had to leave, but she was very interested in understanding whether if we implemented this bridge program for 2 or

3 years, do you anticipate insurance rates for consumers in particular would stay the same or go up? Would you be withdrawing

from lines? I ask any and all of you to take on any piece of that.

Mr. BAKER. Senator, you are the expert on debt markets, and so

I will not try to—— Senator DODD. He would like you to bring that microphone and

say that again.

[Laughter.]

Mr. BAKER. I think there are markets where financing is of

longer term, but the point should be made that these markets are

very sensitive. And when we have issues that come up, we see debt

markets that have cracked almost immediately. We see difficulties

in risk assessment. So what plea I would make here this morning

is as we are looking for continuity and stability in the underlying

economy, that is what keeps debt markets going.

Senator CORZINE. The commitment committee process that you

have at a bank on an interim financing basis is not unlike what

you would have in putting together a prospectus of investors.

Mr. BAKER. I was just trying to logically think about the kind of

project time that you have when you build a building or a power

plant. On your point, if I may say so, about risk assessment, there

are pretty startling things going on in that field, so my guess is we

will learn a lot from this and other events as we go forward.

Mr. SINNOTT. I will comment on the rates and the actuarial question. Ron would probably have good ideas on this. We do it through

our reinsurance broking operation. We do modeling, and that is catastrophe modeling for earthquakes, hurricanes. And to do that

modeling, you do need some frequency. So I will have to go back

and ask some of my modeling experts. But I am a bit skeptical. We

do not want frequency, that is for sure here.

I think that they would probably say if we do not have that frequency, which we hope we do not, it is very difficult to model something like this, and if you cannot model it, it is difficult to come

up with any actuarial precision.

The second part as to the consumer, the business consumer in

this particular case, what will happen with rates? Rates have gone

up very significantly already. Since September 11, we have seen

property rates go up on average, that includes business interruptions, 65 percent sometimes 100 percent, sometimes 150 percent.

Do I expect if I were sitting here a year from now that will have

moderated? No, I do not think it will have moderated.

We went through 13 years of a very soft market from 1987 on

to 2000, and if you look at the loss experience, and again, my colleagues here can speak to that directly since they were impacted,

but if you look at the loss record for the industry up to that point

absent September 11, particularly in property, it was not good to

say the least.

So I would have said I do not expect that we are going to see

another 65 percent, but I am just saying I do not think we are

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going to see a moderation of rate increases. And I guess the question is, are we dealing with that with our clients? Yes, we are dealing with that.

Three aspects: There is capacity, the scope of coverage, and there

is cost. We do not play loosely with our clients’ money. But scope

of coverage is the thing that can really be extremely harmful to the

security that insurance is supposed to provide. And what we are

talking about here is scope of coverage.

There is capacity loss as well. The capacity issue we can deal

with, capacity across the board, not just for terrorism. There is a

reduction in capacity. So that is my view, Mr. Chairman.

Mr. FERGUSON. Senator Corzine, first with respect to your colleague’s question, I agree with Mr. Sinnott. It is important that we

realize there are two things going on here. We are coming off a sustained period of poor returns in the insurance business that has

nothing to do with the tragic events of September 11. If it had

never happened rates would still be going up for that fact.

It is awfully hard, as you would note, to break that envelope

apart. You know, which part is going to be attributable to the September 11, and which part is attributable to the fact that the industry was earning subpar returns?

With respect to the actuarial point, if I may, you are absolutely

right. There is no actuarial technique. There is no statistical extrapolative process that allows you to deal with one horrible data

point. We can try to take the Bayesian approach, and if we get two

data points maybe we will make something of it, but we all hope

that we only have one data point. So my real answer to your question is this. As long as the actuaries and the underwriters can put

this in a box—by that, I mean know with reasonable certainty

what they are signing up for when they write a risk—they will be

willing to exercise their collective judgment. It will not be actuarially based. It will not be statistically based. It will be the judgment

of underwriters and pricers who have been doing this, admittedly

not terrorist coverage, for decades.

The insurance business kind of lives by its wits in that there is

not a nice black box. You do not know the cost of goods sold, let

us put it that way, beforehand. But if we know what the box is,

you are going to find underwriters that are willing to step up to

the challenge, even though it will not be actuarially based.

Mr. VAGLEY. There is little I can add to the views of the

businesspeople, Senator. In terms of actuarial experience, I am reminded by something I read recently which was, in the light of the

IRA attacks in Central London, it took the London market about

5 years to get comfortable with doing that business again. So there

is a period of experience that will promote stability if here, assuming, again, and the important assumption of no additional terrorist

acts, which could create even further angst and anxiety.

And in terms of rates, maybe juxtaposing what might happen on

January 1, which is commercial insurance for some risks simply

will not be available is a way of making the comparison. There may

well be in the absence of support no rate which is acceptable to an

underwriter to write that risk.

Chairman SARBANES. Senator Reed.

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COMMENT OF SENATOR JACK REED

Senator REED. Thank you very much, Mr. Chairman. Gentlemen,

thank you for your testimony. This is a critical issue that is in need

of your attention and your testimony today. Let me just ask a few

questions. Unlike my colleagues, I am not an expert in debt.

[Laughter.]

Senator DODD. We are all involved in debt.

Senator REED. But I cannot make money on my debt.

[Laughter.]

Chairman SARBANES. He is an expert on other people’s debt.

Senator REED. Let us talk about other people’s insurance for the

moment. Both proposals are on the table. You have a proposal from

the White House and you have a proposal from the industry. I

apologize if I am covering ground that has already been trodded,

but is there any way that if either of these proposals is adopted we

can guarantee affordable, available coverage to reasonably secure

risk?

Mr. Sinnott.

Mr. SINNOTT. Yes. In my view, if there is coverage in the broadest sense as there has been, as I said a moment ago, yes, prices

have gone up, but I deem that to be something that can be dealt

with by the business consumers.

Senator REED. So your view is that if we enact either one of

these points that we can create a climate where it might be more

expensive but only marginally so, that we effectively could secure

in a reasonable way the risk we face going forward?

Mr. SINNOTT. Yes. Because particularly where you are looking at

a situation that maintains competition, and there still is competition out there amongst the insurance companies, and they are looking at their rates, yes, I think we can.

Senator REED. Now again, these plans are rather complicated,

but the industry plan as I understand it would set up initially a

pool which would take the risk, and if the pool is exhausted, the

Government would step in. So in a sense, the first industry proposal has the industry absorbing risk to a certain limit and not the

Government. The White House plan, and again, I stand to be corrected if necessary, would have the first dollar of risk paid for by

the Government. Is that a fair——

Mr. FERGUSON. In a word, yes. It is an 80/20 quota share, yes.

Mr. REED. Again, this goes to the notion which is common of

someone paying a deductible first before the Government steps in

or the insurance company steps in. Could you elaborate the industry’s rationale for your proposal and why it might be better, different, or more effective than the White House proposal?

Mr. VAGLEY. There are a number of proposals, Senator. The industry proposal was really advanced, it was really based on the

British model and the British experience and the experience of

other nations after they became unfortunate members of the terrorism-at-home club. Our model is predicated on their concept,

which is called Pool Re. It simply is a way of taking risks that

would be unfathomable for any particular company, a tall office

building in a major metropolitan area, and in the absence of reinsurance, available commercial reinsurance coverage, in effect

spreading that risk through a pooling mechanism, in effect creating

155

a mutual insurance company into which all primary insurers would

pool their risks, and that would be reinsured by the Government,

acting itself as a reinsurer.

That proposal has been effective in the United Kingdom. To my

knowledge, the British government has not paid out a pound in liabilities. The Administration’s proposal, which Ron described as a

quota share, would provide at least in the initial year an 80/20

sharing of risk, Government and industry. In that proposal, although in our view perhaps not as efficient as the pool proposal,

would also be effective because it would allow underwriters in a

real sense to get their arms around the defined liability.

Then there is a third proposal which has been discussed but not

reduced to legislative form, which is in effect the deductible approach. That may be a little more difficult. And the industry may

have to determine and create some mechanisms to deal with the

retention level underneath it, because it does in a way present the

same kinds of difficult underwriting risks that the status quo presents in terms of a real reluctance to write those big risks upfront

because you could be eating 100 percent of it instead of just 20 percent of it, say, in the Administration’s proposal. But it can be made

to work.

And I guess our view, and this picks up on Senator Dodd’s and

Senator Gramm’s statements is, there are the business imperatives

which we understand very well, and then there are the political imperatives, which you understand far better than we do, and the

challenge for us and I think the challenge for all of us is to find

the common ground there. It may be that the proposals we think

are the most efficient are simply indigestible in terms of the remaining time and the body politic.

Senator REED. Let me ask one final question or two if the time

allows, certainly one. In essence, I know this is not designed to be

a bailout of the industry. I know the purpose here is to allow

ranges of business from small drycleaners to large office complexes

to buy insurance at reasonable rates. But essentially, from a business perspective, you all will be laying off risk to other people.

Typically, you pay for that in your industry. You pay a fee, you

take your risk. In any of these proposals, would the industry be essentially paying a fee or paying anything to the Government to absorb risk?

Mr. VAGLEY. The pool proposal does provide for payments by the

industry to the Government for reinsurance.

Mr. REED. Mr. Ferguson.

Mr. FERGUSON. Just as a footnote on that, interestingly enough,

the Pool Re in the United Kingdom, they had a different twist on

it. Once the Pool Re accumulated assets of $1 billion I believe, then

they were going to start to pay the reinsurance they were getting

from the U.K. government. It was a slight twist on it.

Mr. REED. Thank you, Mr. Chairman.

Chairman SARBANES. Thank you.

Senator Carper.

COMMENTS OF SENATOR THOMAS R. CARPER

Senator CARPER. They gave us two microphones so we can talk

out of either side of our mouths.

156

[Laughter.]

Senator CARPER. Maybe you do not do that in Connecticut, I do

not know. But I think they do.

[Laughter.]

Senator CARPER. To our panelists, welcome. I have just come

from another hearing. We all serve on a bunch of different committees, and as former Congressman Bartlett knows, you cannot be

present at all of them, and I am going to ask you if I can just cover

some ground that you have already covered that, but to the extent

if you could do and do it quickly, I would be most grateful.

Secretary O’Neill was here yesterday and laid out the Administration’s proposal, which I thought had a fair amount of merit.

They had obviously given it a good deal of consideration. If each

of you could just take 30 seconds to add briefly to it please, what

you like about it and what you do not.

Mr. BAKER. Senator, I am here representing the banking industry. From the standpoint that the economy is dangerously weakening, and this is a time when we probably need to work together

to resolve that, we really have no view on the particular programs

themselves or the merits of them, other than we probably need to

do something sooner rather than later. And our own recommendation would be it should have a time limit and certain constraints

put on it, as all these programs should.

Senator CARPER. In your testimony, did you lay out a number of

principles? Someone did.

Okay. Please.

Chairman SARBANES. We moved Mr. Baker up from the next

panel. In fact, Mr. Baker, if you need to excuse yourself, you ought

to go ahead.

Mr. SINNOTT. Our reaction to the Treasury proposal is favorable

for these reasons. It can be enacted quickly. It is the least intrusive

from a Government standpoint, the easiest to unwind. You do not

need to staff up on the Government side to do this, and it is the

least complex.

The others are complex. Anytime you have an industry aggregate, there is questions as to who gets what and how the aggregate

is accumulated. Having said that looking at it from the consumer

standpoint, it should be seamless. As long as the industry and the

Government are in partnership on this and it provides the ability

for the insurance policy to not be restricted, then it becomes an internal seamless issue.

I would say, though, that the one thing we would want to look

at it again, because we also act as a reinsurance broker to the insurance companies, is how this mechanism would work. To make

sure that it maximizes the amount of private industry you can get

back into the market.

Senator CARPER. Thank you. Thirty seconds.

Mr. FERGUSON. First, I thought Secretary O’Neill just did a fantastic job of laying out the issues. I really applaud him. Second,

any of the three proposals that are in play and being discussed

could in theory work. Third, the devil is in the details. You might

want to arm wrestle about whether the 80/20 and the way it goes

in the second year and the third year is the right parameters, but

in theory, can it work? Yes, it can work.

157

Senator CARPER. Thank you. Twenty-nine seconds. That was

good.

Mr. VAGLEY. Senator, I thought what was perhaps most important about the Administration’s proposal was clearly the recognition of the need that this was not a trivial or frivolous subject and

another in a succession of industries seeking relief from the events

of September 11. That was an important recognition. I think in

terms of its basic structure, it is workable, it is relatively straightforward. In our view, the retention levels in the outyears are high.

It would not necessarily promote the objectives of the legislation.

Having said all that, however, I would like to indicate again, lest

we seem to be preferring one plan over another, though perhaps we

do, that we are for any plan that will help stabilize this market

and that is politically feasible and are not wedded to the details of

any particular proposal.

Senator CARPER. Thank you. I have been wrestling with a couple

of different terms looking at a statement of Mr. Ferguson where

you talk about adjusted commercial U.S. insurance property and

casualty, possibility of a surplus of $126 billion. We have a staff

briefing that was given to us where they talk about that surplus

number is close to $300 billion. I have a hard time reconciling that.

Chairman SARBANES. He has a table. He has worked that down.

Mr. FERGUSON. I can reconcile it very quickly. The $300 billion

is a correct number. Fire and life plus property and casualty, it is

$300 billion. If you take the surplus that goes along with the companies that predominately write personal lines of business, your

personal automobile, your homeowners and so on, and make a couple of other adjustments—I will not go through them, but you come

down to the $125 billion. I can reconcile them.

Senator CARPER. Thanks. I would just observe in closing that we

do not have a whole lot of time before the end of the year in terms

of oversight and things. We need to move forward with some dispatch. And I will not quibble with what the Administration has

proposed. It probably will change it to some extent. But it does

have simplicity. And if I can understand it, it is a pretty good sign

that others could as well. And to the extent that we can agree on

something that is fairly simple and straightforward, we might actually be able to pass it to the House through the Senate and work

it out with the White House and get it done in a timely matter.

Thank you very much.

Chairman SARBANES. Well, gentlemen, thank you very much. Mr.

Baker, you had better go. I am worried about you.

[Laughter.]

Chairman SARBANES. I want to put a couple of questions to the

others, so if you want to slip away. I want to ask a couple of very

simplistic questions. If you have a major property or casualty loss

in some geographic area of some sort which is in the ambit of the

industry handling it on its own, do you then raise rates across the

country to all your clients in order to make up for that hit, or do

you localize the rate increase?

Mr. SINNOTT. A combination really. The individual policy that

has sustained the loss at renewal, that is going to be recognized,

just as good loss experience is recognized. But if the overall loss exVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00161 Fmt 6601 Sfmt 6601 83472.TXT SBANK4 PsN: SBANK4
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perience, as it has been, as we mentioned in the property area, is

across the board, then everyone will have some degree of increase.

Chairman SARBANES. All right. I want to get a handle on the

magnitude of this problem. What is the premium flow into the

property and casualty business?

Mr. FERGUSON. For the commercial lines business, which would

be the relevant base here, sir, that would be about $145 billion.

That is for everything.

Chairman SARBANES. One hundred forty-five billion dollars. Well,

now the Treasury’s proposal in Year Three would have the industry exposed for $36 billion.

Mr. FERGUSON. Correct.

Chairman SARBANES. Leaving aside for the moment the problem

of in excess of $100 billion, which we discussed before, putting that

to one side, and that was left in this black hole called the discretion

of Congress.

[Laughter.]

Chairman SARBANES. But putting that to one side, now, an increase as I calculate here of about 23 percent uniformly in your

premium flow would cover that exposure. Is that correct? Do you

cover it 100 percent or do you cover it a factor of 100 percent?

Mr. FERGUSON. Your mathematics are impeccable. That is correct. The problem—— Chairman SARBANES. I know you have the problem that that is

not exactly how you do it, but I am just trying to get a sense of—— Mr. FERGUSON. Your math is correct, but in practice, it would not

work out that way because, of course, in some States and in some

classes of business, it would be thought that they are not particularly targeted for terrorism and so they would have much less increases and others would have more. But I do not mean to quibble

with your arithmetic.

Chairman SARBANES. The 150 is not homeowners.

Mr. FERGUSON. Correct. The 145 to 150 is commercial lines only.

My best guess, Senator Gramm. Commercial lines only, workers’ comp, property, general liability, roll it all up, about $145 billion.

Chairman SARBANES. All right. Now one other question. I did not

understand Mr. Vagley. On the one hand, you say we should preserve rate review by appropriate State regulators. On the other

hand, you seem to want to alter their process. Is that correct?

Mr. VAGLEY. I think we would like to alter the process with respect to terrorism and rate review. However, there are State regulators who disagree with that.

Chairman SARBANES. Let me just say this just as observation. I

have not discussed this with my colleagues. I am frank to tell you

the simpler you keep this and the less you seek to change current

arrangements, whatever they may be, I mean, the NAIC yesterday

talked about consumer protection provisions. If this is envisioned

as a vehicle for getting other type changes, it is going to significantly complicate it. You have a problem on the tort issue in my

opinion. First of all, we do not have jurisdiction over that. We may

run into a serious problem in that regard.

Senator DODD. That has never stopped the Committee up here

before.

[Laughter.]

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Senator DODD. We claim the whole world as jurisdiction.

Chairman SARBANES. I understand, but it is highly relevant as

we consider this, since we may have to assert jurisdictional lines

in order to keep moving forward so we do not undercut our own

case, if I may say so. But in any event, I just wanted to make that

observation. People who have things up on the shelf they have been

wanting to get and then they want to take them off the shelf and

put them into this pot, that greatly complicates the stew.

Senator DODD. Let me just say that I agree with Senator Sarbanes on that point, too. That is something all of us feel. If we are

going to get something done here, it has to be done very tightly.

But I would put on the rate issue, we talked about this already,

with the exception of some 12 States, and I may be wrong on that

number, writing commercial insurance, that you set the rates and

then the States-by-State law determine whether or not that rate is

justifiable. And I do not know why you would want to change that.

Mr. VAGLEY. We do not. As a matter of fact, it really was in recognition of precisely what you described; that this should be narrowly focused on terrorism risks and not seek to advance any other

legislative agenda. That the proposal that we advanced was in compliance with that.

And with respect to the two areas of potential State regulatory

interference, even the State regulators are in agreement that it is

necessary in the one instance to have a common definition of terrorism, for instance, where States cannot require greater coverage,

so that in the worst of all worlds, there is incongruent coverage.

And my understanding is even the States agree that a pricing

mechanism such as we have advanced which does kind of cut the

baby in half, it is a final use system consistent with what Senator

Dodd said is understandable and agreeable, and we are not seeking

any additional leverage or advantage even though we might prefer

to do so. Our understanding, Senator, Mr. Chairman, is that this

bill, if it is to advance, with all the difficulties of the remaining

time available and all the circumstances surrounding the issue,

must really be laser-like and focused on this principal issue.

Chairman SARBANES. Let me ask one other question just for my

own enlightenment. What is your reaction if someone says why

doesn’t the Government just assume the responsibility for terrorism on the premise that one of the things the Government ought

to be able to do is protect the society against terrorism, so we are

not going to put this in the private sector. And if we have a terrorism attack and a loss, the Government will pay for it and the

industry will go on about its business of ensuring the other kinds

of risks that do not relate so directly to, in a sense, our national

security.

Mr. FERGUSON. Senator, that argument can be advanced. I think

it comes down to the philosophical issues. My own answer would

be let us construct a plan where the private sector has the opportunity to return to normal and not put the Government permanently in the insurance business. But I recognize others will have

different viewpoints.

Mr. SINNOTT. If I can add to that, there are other perils called

riots, civil commotion, that governmental bodies, whether it is the

local police force, are responsible for securing. I think that they are

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all manageable. They can all be dealt with in the private sector.

Terrorism is another part of that. It can be dealt with so long as

we are not in the situation that we are currently in.

Senator GRAMM. Mr. Chairman, first let me say that in terms of

a Government program, We could do that, and there is some programs that could be adopted that would be, in my opinion, worse

than a Government program. The problem is transitioning, the

problem is how do you get out of it, and I know you are not proposing a Government program.

Chairman SARBANES. I am just trying to feel for the parameters

of this.

Senator GRAMM. I think having tried to think through that in

terms of my own preferences, the problem is not that the world

would come to an end if the Federal Government said, in these narrowly defined areas, we are just going to cover it directly. The problem is how do we get out of it and how do we get the private sector

into it. And then over time how do we keep it from growing where

people want to broaden the definition of terrorism. So, at least, in

my own mind, that is why I have rejected that.

I would like to say that I think your point you made is the key

to us getting this bill written, and that is if somebody wants to put

something in here, the heavy burden of proof on them is you have

to prove that it will not work or work well without it. I think if

we begin with that premise, writing this bill will be doable, and

there is not any other way to do it. I think Senator Dodd and I

have felt for several years now that we had a real problem, if we

had a major hurricane and we had an earthquake in the same

year, and at some point, we have to come to grips with that. And

I would prefer to do it by changing tax policy and letting you build

up reserves rather than the Federal Government getting permanently into protecting against cataclysms. But on the other hand,

if we bring any extraneous issue into this, we are lost.

Mr. SINNOTT. Mr. Chairman, can I bring up one issue on that

that was mentioned earlier that I do not think is extraneous. At

the hearing I was at yesterday, I was not aware of the fact that

the Treasury or the Administration, which is of course the Treasury proposal, covered property insurance but somehow did not include business interruption. That is a very serious impediment.

Senator GRAMM. They are very concerned about the potential

cost of it, the open-ended nature of it, and that is why I am not

saying I agree with them, but that is why they did it.

Mr. SINNOTT. Business interruption is important and I can give

you a list of corporations that do not purchase it. There are some

very large corporations that do not purchase this coverage.

Senator DODD. Here is the problem you get into with that. We

talked about it. There is an easier one. Where the car service, because it serves a particular industry that was hit, it goes out of

business because it does not have the capital to sustain it. The

other business interruption is where some of us on the plane have

some place to go and sign a contract. Then you get into that business interruption. You have a broad definition of that and boy, it

becomes a nightmare.

Mr. SINNOTT. I agree but I think that the definitions are fair

under the policy. There is an insurance policy with terms and conVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00164 Fmt 6601 Sfmt 6601 83472.TXT SBANK4 PsN: SBANK4
161

ditions and that coverage has been there for as long as I have been

around, and it is adjustable. So I do not know why, if the insurance

industry has been able to deal with that, via it’s accounting, the

Government could not deal with it too. It would create a serious

defect to excuse business interruption.

Senator DODD. It is a challenge, just by the way—— Chairman SARBANES. Actually, you are making a very important

point.

Senator GRAMM. If you can narrow it, you can make the point,

but you are going to have to do that.

Chairman SARBANES. If you leave it out, then you have left out

an important aspect of the coverage, or leave it out altogether.

Senator DODD. Let me ask you two other quick questions. We are

talking property and casualty here but you know the questions

come up about life and health. It seems to me I do not know how

you are going to avoid particularly the health area, the life. There

may be some other argument you can make, but the health insurance issues are going to be hard to exclude from this calculation.

That is one question.

The second, how do you define an act of war as it is usually defined and terrorism. When does an act of terrorism become an act

of war or not an act of war? Do you think we can draw that distinction well enough?

Mr. SINNOTT. It is most of the definition. When you have an

agent acting in concert with a government, a foreign government,

in other words, acting at the direction of that government, that can

be construed as a war risk rather than a terrorist risk. On the

other hand, in most cases, it is up to the government. The government is the one who really declares whether a state of war exists.

Chairman SARBANES. We have another panel. Unless there is

anyone who has a question, this has been an extremely helpful

panel. And we really appreciate your coming. Thank you.

If the other panel will come forward.

[Pause.]

Chairman SARBANES. We are very pleased to have this panel. I

know we held you a bit but you can tell we were having a pretty

interesting and helpful session. We will just go straight across the

panel. Mr. Donohue, it is nice to see you again. We are pleased to

have you back with us and we will be very happy to hear from you.

STATEMENT OF THOMAS J. DONOHUE

PRESIDENT AND CEO, U.S. CHAMBER OF COMMERCE

Mr. DONOHUE. Thank you, Senator. I am here because the American consumers and businesses require the financial security provided by terrorism insurance to get the economy moving again. I

am not an expert in insurance the way many of you are, but I do

understand the challenges facing American businesses.

The problem is the recent events are making adequate terrorism

insurance hard to come by, and the Government temporarily needs

to be part of the solution in whichever way you think is appropriate. September 11 will result in the largest one day insured loss

in U.S. history. My understanding is the industry will lose $30 to

$60 billion in claims, easily surpassing the previous record of $30

billion from Hurricane Andrew.

162

And, without adding any of my other views about the role of the

class action and trial lawyers, let me say that depending on the activities of the Government, some of which have been very positive

in locating where these matters will be resolved and who gets involved in it, that number could be significantly higher, and it is a

matter to be concerned about, but I am sure not resolved in this

legislation.

The insurance industry is committed to meeting its obligations

and I think they were very forthcoming. The Administration was

talking about war. These people walked in and said we are going

to pay our bills. No one was asking the Government to bail out the

industry, or to take care of its established obligations.

The problem, however, is in the wake of our events of September

11, insurers and reinsurers feel compelled, as you have heard, to

reduce terrorism coverage or not to offer it at all, and that is where

you get the complication. If you do not have it, whose crawling all

over your circumstances? And they are bankers and they are investors and they are partners and everyone else that wants to know

what happened if I put my money on the line and we either have

an activity or we create one, how are we going to be sure that if

there is an overt act of terrorism that we are going to be paid?

This market disruption caused by a lack of terrorism insurance

coverage, if it is not provided, could have deep and potentially devastating effects. Let me list them quickly. First, businesses that

cannot get the coverage may have to cut back their operations or

stop what they are doing in a particular business area; trucking

firms, railroads, airlines, ships, may all be compelled to say, I am

not going to carry this, I am not going to go there, I am going to

limit my business activities to protect my interests or to meet the

requirements of my bank or my other financial partners.

Second, the lack of such coverage could prevent many businesses

from obtaining financing. Or it could accelerate in what happens

with existing financing, in that people are going to come to them

and say, okay, you don’t have the insurance, you have to pay me

in a certain amount of time, or I have to increase your costs, or I

am going to close down your line, and this is a real serious problem. A lot of loans require evidence of terrorism insurance. If you

do not have it, the loan is not a performing loan.

Finally, businesses that are left with no choice but to self-insure

against this risk are going to have to really think very hard. They

are going to find it very difficult. But I want to pass a thought on

to the Committee. Let us assume we do not do this. Let us assume

people go bear or people deal with all these issues. If we have another major terrorist incident, I mean something of the magnitude

we have had, you are going to pay for it anyway.

It is very clear that if we are sitting here a year from now and

some terrible, horrific thing happens, and the people sitting up and

down this table say, every single one of the major casualty insurance companies in this country are going to go bankrupt, you are

going to take care of it. So what you are really doing is like the

guy with the oil filter. You are going to cover me now or you are

going to cover me later.

Senator GRAMM. You are buying insurance.

[Laughter.]

163

Mr. DONOHUE. You are buying insurance and what you are doing

is you are keeping the private sector in this right up to their necks

about as far as they can go, so the water does not get where they

are drowning. And what this is, and by the way, I am a private

sector guy, and I am opposed to creating some massive, new Federal deal that covers this thing for now and forever. What we are

talking about is a bridge and we would better make it a bridge that

damn well finds a way to get to the other end of it, or as Senator

Dodd said, and you said as well, Senator Gramm, we are going to

be adding more and more ornaments to this Christmas tree in a

big hurry.

Anyway, I came up here with a very simple message. I am not

an expert on the insurance issue and not an advocate for one solution or the other, other than it ought to be as much private as we

can so that the private sector does all of the background work, carries all of the administrative work; we do not need another Government agency. We need the Government to insure itself from what

it is eventually going to do if it has to.

And I want to congratulate the Committee. It has been extraordinary for me in the last couple of weeks to see how people have

said, wait a minute, we have a political agenda, but let us sit down

and figure out how we are going to handle these things. I just came

back, for just a half a second, I just came back from the APEC

meetings in China, and I was with business leaders and government leaders all around the country and around the world. It is a

very simple thing over there. Everybody figured out they made a

big mistake. Those guys just got their act together, they are all

playing the same music, they are walking the same step, and I give

you great credit for what you are doing.

But I will tell you this is something else you have to do and you

need to find a way to do it so that it is done in the private sector.

You take the least amount of risk, but you understand if you do

not do it, you are going to do it anyway.

Thank you very much.

Chairman SARBANES. Mr. O’Brien.

Senator DODD. We have Donohue, O’Brien, and Knorr. Are you

Irish?

Chairman SARBANES. He is from the City of Chicago.

Senator DODD. It sounds like a Dublin law firm up there.

[Laughter.]

STATEMENT OF THOMAS J. O’BRIEN

SENIOR VICE PRESIDENT OF FINANCE AND

CHIEF FINANCIAL OFFICER, LCOR, INC.

REPRESENTING

THE REAL ESTATE ROUNDTABLE

Mr. O’BRIEN. Thank you, Mr. Chairman. My name is Tom

O’Brien. I am Chief Financial Officer of LCOR Inc. As such I am

responsible for companywide oversight of LCOR’s finances, risk

management and insurance activities which includes the $700 million U.S. Patent and Trademark Office’s new headquarters in Alexandria, Virginia; the JFK Airport terminal port facility in New

York, a $1.2 billion airport terminal developed and operated by a

private consortium, and various other offices and multifamily

164

homes located throughout the country but primarily from New

York to Washington.

I am what Mr. Sinnott earlier referred to as an insurance consumer. LCOR is a national real estate development, management

company. We specialize in structuring and implementing public,

private development. We have completed projects in 15 States and

the District of Columbia including one for 16 million square feet of

space and 18,000 residential units.

The company has completed developments or has under construc- tion projects totaling $4.4 billion and over $1.6 trillion in predevelopment. LCOR is and has been involved in some of the

Nation’s largest most complex and most creative developments. We

are currently active throughout the United States as well as Pennsylvania, where we are headquartered. I feel well-represented by

the Senators on this Committee based on that.

But I am here today as a longstanding member of the Real Estate Roundtable and on behalf of a number of real estate agencies

and trade groups that are submitting to this Committee written

testimony. As many of you are aware, the tragic events of September 11 triggered the withdrawal of virtually all new insurance

on property and casualty. This is caused by the insurance industry’s inability to predict future man-made catastrophic insurance

losses. This will be increasingly apparent throughout the industry

on January 1 when approximately 70 percent of the policies are up

for renewal.

I am personally involved in transactions of more than $2 billion

that have been impacted by the eliminating of terrorism coverage.

By way of example, since September 11, our JFK Terminal Four

Project has already had its liability coverage for terrorism revoked.

We are told that we will lose our properties’ terrorism coverage and

that our current policy limit will be pushed upward 50 percent.

Our premiums will be doubling and our revenues have been drastically affected due to reduced capacity in volume.

As CFO of a commercial and residential real estate development

and a property owner, I know from my 20 years of experience that

it is not possible to buy, sell, or finance a property unless it is adequately covered by insurance. A significant percentage of privately

owned properties are open to the public including shopping centers,

offices, hotels, and they will need to renew their insurance coverage

on or before January 1. Many of these owners have been advised

that the policies may not be renewed or that the new policies will

exclude exposures currently insured, including terrorism. These

owners have also been advised that they will all likely have to absorb significant increases in premiums. They have also been advised that there are greatly expanded uninsured exposures due to

policy exclusions. Without adequate insurance, it would be difficult,

if not impossible, to develop, operate, or acquire properties, refinance loans, and sell commercial mortgaged-backed securities.

Since real estate transactions are primarily based on prudent

risk-taking, the disappearance of coverage for terrorism acts will

affect the underwriting of real estate and other businesses which

could severely disrupt the economy. It will not only effect real estate owners and lenders, but also their tenants, who lease facilities,

their employees and customers, and lenders and also anyone who

165

rents an apartment or buys a new car. I am very concerned about

the short- and long-term future of the real estate industry, unless

the Federal Government creates some type of mechanism to help

provide this coverage. The scale of the industry is immense. Estimates are $4.6 billion

of real estate and as the current policies expire, there is tremendous uncertainty about the status of debt in this sector. Mr. Baker

spoke to some of those concerns on the banking side. But obviously

it goes well beyond that. Before September 11, property and general liability policies typically covered losses including business

interruption costs from terrorism and similar acts. However, as

other testimony has shown, future policies will likely exclude coverage for terrorism and sabotage in addition to the current exclusion practices of war.

As Secretary O’Neill and others have stated already, the Federal

Government needs to help insure the commercial property owners

and other businesses that cannot continue to obtain insurance coverage for losses related to terrorism in the future. I must also add

that action needs to be taken as soon as possible, because there are

policies expiring every day and new transactions pending which are

being heavily impacted by the lack of resolution.

I am not really familiar with the traffic signals, but I know red

means stop. May I go on?

Chairman SARBANES. For a little bit.

[Laughter.]

Mr. O’BRIEN. We have already said that 70 percent of the policies

terminate on January 1.

Chairman SARBANES. The light gets less waivable the more we

move through.

Mr. O’BRIEN. That is fine. I am almost through. I think it is key

that we talk about some of the necessary characteristics of a workable plan. From a real estate perspective, we believe they include

the following duration. Real estate is a long-lived asset and is generally financed over a long period of time, generally 10 to 30 years.

Thus, if a program is created of insufficient length that may not

be able to provide the stability in the long term, so any program

created must be of sufficient duration to provide reasonable certainty of the future availability of this coverage.

The second point is the definition of terrorism. The line between

terrorism and acts of war has certainly been blurred since September 11. The President, as well as the media, have focused on

our current war against terrorism. We believe any program created

must cover an expansive notion of terrorism so that future events

along the lines of September 11 and similar acts are covered, are

not excluded from coverage in the future.

The third point is development of deductibles and limits of coverage. The real estate industry is concerned about what could be

dramatic increases in deductibles to property owners, which could

be tantamount to no insurance coverage at all. And accordingly,

any program must carefully apportion loss exposure between property owners, lenders, insurers, and the Federal Government.

One last thing in terms of premium cost disclosure. You may

have heard earlier that property and casualty rates have already

been predicted to skyrocket prior to the attack on America. We beVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00169 Fmt 6601 Sfmt 6601 83472.TXT SBANK4 PsN: SBANK4
166

lieve insurers should be required to separately disclose the cost of

comparison coverage and impact on the overall insurance rates;

otherwise it will be impossible for insurance consumers to discern

the actual increase in the policy as a result of the difficulty in writing the terrorism coverage versus the increase as a result of normal

market conditions.

Finally, our Congress must not fail to act. The real estate industry welcomes the opportunity to work with the Administration and

Congress to achieve a workable solution to this immediate problem

and help our company get back to its core mission of creating better places to live, learn, work, and play.

Thank you for the opportunity.

Chairman SARBANES. Thank you very much, Mr. O’Brien. That

was a helpful statement. I think you actually made a couple of important points toward the end. Afterwards, you might consult with

Mr. Donohue. He is a pro. You notice he came in right on the mark.

[Laughter.]

Chairman SARBANES. When the light turned he was right there,

but he has had a lot of experience in doing this.

Mr. O’BRIEN. Yes, Mr. Chairman. This is my first Committee

meeting, much less appearance, so I apologize.

Chairman SARBANES. You did a good job. We appreciate your

comments. Mr. Knorr, the Chief Financial Officer of the City of

Chicago. We are very pleased to hear that you want to get this perspective. I also have a statement for the record sent to us by Marc

Morial, the Mayor of New Orleans, who is President of the U.S.

Conference of Mayors.

Without objection, we will include that in the record, and the

Mayor is urging us to take immediate legislative action.

Chairman SARBANES. Mr. Knorr.

STATEMENT OF WALTER K. KNORR

CHIEF FINANCIAL OFFICER, CITY OF CHICAGO, ILLINOIS

Mr. KNORR. Thank you, Mr. Chairman, for inviting me to testify

today. My name is Walter Knorr. I am the Chief Financial Officer

of the City of Chicago. I appreciate the opportunity to present to

the Committee a matter of great concern to the City of Chicago,

and I am sure to other cities throughout America. The price of war

and terrorism liability insurance, as a result of the tragic acts of

September 11, has escalated to incredible levels, if available at all.

The insurance industry is uncertain about the risk of terrorism and

therefore appears unable to assess and price that risk.

In Chicago, our insurance carrier recently cancelled our war and

terrorism liability insurance coverage for Chicago O’Hare International Airport and Chicago Midway Airport. Prior to September

11, we paid an annual premium of $125,000 for $750 million of war

and terrorism liability coverage. If we want to renew our coverage,

it will cost us $6,950,000 for $150 million of war and terrorism liability coverage. I will repeat those figures to you. Our premium

has risen from $125,000 to $6,950,000. Our coverage has dropped

by $600 million. That is a premium increase of over 5,000 percent

for substantially less coverage.

Putting it another way, the cost of $1,000 of coverage has risen

from 16 cents to $46.33 per $1,000. This is an astronomical inVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00170 Fmt 6601 Sfmt 6601 83472.TXT SBANK4 PsN: SBANK4
167

crease, almost 29,000 percent. This extraordinary cost increase

would be passed along primary to our tenants at O’Hare and Midway airports, namely the airlines operating out of those airports.

The financial problems of most airlines have been well publicized. A cost increase of this magnitude would negate the city’s

efforts to cut costs of airport operations to benefit the airlines and

keep them viable. It would also undue the efforts of this Congress

to assist the airlines financially during these uncertain times.

Chicago is not alone in this. We are aware of a number of other

major airports across the country that have received equally exorbitant quotes for war and terrorism liability coverage. In addition,

the Chicago airports have been warned that their premiums for

property and liability insurance may double, triple, or even quadruple and deductibles will increase significantly.

The problem extends beyond the airports. It includes infrastructure. The City of Chicago insures a toll bridge that connects Interstate 94 to the Indiana Tollway. Our most recent annual premium

was $406,000 for $386 million of coverage. In mid-September, the

city received a nonrenewal notice for this bridge with the ominous

indication that the insurance carrier could not quote a new rate but

that the rate will increase by more than 30 percent and potentially

much higher. One would expect insurance costs associated with terrorism to increase substantially for many other public and private

structures, existing buildings, buildings under construction, public

meeting areas like sports stadiums and convention centers and

other prominent infrastructure.

The increased insurance costs will undoubtedly be passed along

to the tenants and users of these assets. If those costs were significant, and I think they could be, they could have an extremely negative economic impact. Tenants would have to decide whether to pay

those higher costs or leave the city and take jobs with them.

The insurance crisis hits major cities the hardest because cities

would appear to be the most likely targets for terrorist attacks.

While terrorists may pick out individual targets, the attacks are directed at the Nation as a whole, and the risk should be spread to

the Nation as a whole. In these uncertain times, the Federal Government should act as an insurer for future terrorist attacks and

catastrophic losses. There are two proposals before this Committee

and the City of Chicago is not taking a formal position on the two

proposals. The City does believe it is imperative that the Federal

Government act on the insurance problem to provide certainty of

insurance at reasonable rates, and hopefully mitigate the cost to

Government and business.

Thank you again for this opportunity. I will be available for questions that you may wish.

Chairman SARBANES. Thank you very much for these statements.

When do these policies whose figures you quoted come up for

renewal?

Mr. KNORR. We received a 7 day cancellation after September 11

on war and terrorism. So as I mentioned, I know of nine other

major airports across the country that are in the process of examining these quotes for these levels of coverage to substantially reduce levels of coverage. We are all in the same position.

168

Chairman SARBANES. Do you have coverage at the moment under

the old terms?

Mr. KNORR. Under the old terms.

Chairman SARBANES. When do you lose that coverage?

Mr. KNORR. We lost it with a cancellation so right now we are

in a position where we will have to rely on sovereign immunity or

we basically would be in a position to have to piggyback onto the

war risk insurance that is attached to airlines as vendors.

Chairman SARBANES. In other words, you are not covered?

Mr. KNORR. With this terrorism insurance, yes.

Chairman SARBANES. They also said you could keep it at these

figures?

Mr. KNORR. These are the quotes we have given back in exchange for $750 million for $150 million.

Chairman SARBANES. So you are examining the implications of

that?

Mr. KNORR. I would say so.

Chairman SARBANES. Senator Dodd.

Senator DODD. I thank you as well. It has been very helpful testimony. It makes the case that maybe we should have had you on

first in a way because this really is an economic issue.

As someone pointed out earlier, here they come again, this

crowd, always showing up at the trough taking advantage of tragedy on September 11 to raid the Treasury. I do not believe that is

occurring. I do not believe it occurred in the airline industry, but

you have heard that from certain quarters.

What we are talking about here is not providing any assistance

at all to the insurance industry. What we are trying to do is to encourage the industry to stay in the business, to see to it they are

going to provide the insurance to public and private entities around

the country so that they can borrow money, they can do the things

that are necessary for the economy to continue to operate. So the

testimony here is very important so the case can be made.

I can see already the words they are using, the word bailout. I

know what a bailout is. I have seen them around here. This does

not even come close to falling into that category. But the mantra

has developed somehow, it becomes almost a cliche, and I think

your testimony about the implications here, and I will make the

point, I probably did not make as well as I would like to, but I get

very worried. I am very worried about the condition of our economy

anyway. When you add the events of September 11 and the events

of the last several weeks, I worry that we are going to be able to

hopefully sustain the level of public support for what needs to be

done in order for us to successfully deal with the issue of terrorism.

That will require a population that is willing to support the kind

of expenditures and efforts that are going to be necessary over a

long period of time.

I believe the President is absolutely correct. This is not a conflict

that is going to be resolved quickly. You can only resolve it if its

representatives have the support of their people for continuing to

invest in that effort. And if you have a weakened economy, if you

have high unemployment rates, if you have people worried about

those conditions, it will be harder to sustain the kind of effort that

will be necessary.

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I suspect that those who are responsible for the attacks on September 11 in some small way will count on an eroding public support, and the quickest way that happens is a weakening economy.

So I am not convinced that everything we are going to do in this

area is right.

Grover Norquist, who I do not necessarily associate with on too

many occasions——

[Laughter.]

Senator DODD. ——but he had the best piece of advice I have

heard given by anybody. He was asked 2 or 3 weeks ago what advice he would give a Member of the Senate these days. I thought,

oh, boy, here it comes. I can just imagine what this advice is going

to be. And he said, if I were a U.S. Senator, I would read every

bill. And that is pretty good advice. It is good advice at any time

anyway, but we are legislating quickly here and maybe we ought

to be careful about what gets included. But I think that this is a

very critical element for us to have on the table and done. It may

not be everything everyone would want, but it is a very needed

piece in this puzzle or this pattern we are putting together here,

to try and prosecute successfully the war on terrorism but also see

to it that our own country is going to remain strong.

I thank you. And, Mr. Chairman, I do not really have any specific questions. I just want to thank you for your testimony.

Chairman SARBANES. Senator Corzine.

Senator CORZINE. I very much appreciate the real world look at

what the cost of this is and what implications it would have for

business or the public sector. I would like to ask Mr. O’Brien again,

because I am troubled by our focus on a limited duration program,

do you believe that you will have access, do you think your industry will have access to credit if we come up with a 1 or 2 year program with cancellation clauses and other kinds of options that

insurance carriers undoubtedly will write here. How do you feel

that is going to impact your ability to finance some of the kinds of

projects you have talked about?

Then let me compliment you. I think the concept of making sure

that the terrorism premium is disclosed so that we are not mixing

apples and oranges in here is a very insightful and responsible

point. And then I would love to hear your comments on the business interruption issue as well.

Mr. O’BRIEN. Thank you, Senator.

I have had some first-hand discussions this week with longerterm lenders and bond underwriters and bond insurers because

many of our larger public-oriented projects end up being in bond

financing. And on Monday of this week, I was asked that specific

question. Okay, talk to me about the next 12 months, or talk to me

then about the next 28 years, because that is what I am underwriting. I am agreeing to accept the exposure to today’s bondholders. This is the underwriter saying to me, how do I know that

there is going to be availability of some product that is going to

protect me from this unknown, unquantifable risk, and it clearly focuses much more on the fact we have a 3 year development cycle.

In cases at patent and trademark headquarters, we actually fixed

the rental rate for the Government 2 years ago.

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So 2 years ago, the Government asked for bids, we gave our final

best offer, we fixed the rental rate. This month or probably next

month we will hopefully go forward on starting construction. Some

31⁄2 years later, the Government will pay the first dollar of rent to

us and they will pay rent during the next 20 years. Throughout

that 5 year period, 2 years back and 3 years forward, we are bearing tremendous uncertainty in terms of construction costs, interest

rates, but now suddenly, in the last month-and-a-half, the cost of

insurance availability and terms has become predominant. And

what you could say, some might look at it as a mundane area of

the business in terms of insurance, at least from a real estate developer’s perspective. Suddenly, it has become front and center.

So I certainly am concerned about a reasonable certainty as to

future availability. I am not proposing by any means that the program would last 20 plus years, but there is certainly a need to look

beyond the 12 month time horizon. Many of the insurers have the

luxury of deciding every 12 months whether they are going to

renew the coverage. But investment decisions are made on a much

longer period of time, and I cannot look back 12 months, 24 months

from now, it is too late. So it is definitely a concern of ours.

As far as the premium side, I said we clearly were already aware

that premiums were rising quite dramatically and Mr. Knorr’s comments I can share. The percentages may vary but all premiums are

really skyrocketing, and to the extent there is a way to quantify

the portion of the increased cost that ultimately is passed on to us

and the buyers, the insurer does not bear the ultimate cost. He is

the balance sheet in between the loss and the ultimate recipient or

beneficiary being us, the insurance buyer. So ultimately they are

going to pass the cost along to us in one form or another, and we

would at least like to know that it is a fair, calculable sum, so I

appreciate the question because it did come up in the first panel,

and I really think it is an important one.

Senator DODD. Jon, let me just interrupt. You made this point.

In your previous life you know how quickly these questions do

come up. Putting this aside, just going back in your earlier incarnation, how quickly these issues arose.

Senator CORZINE. Nobody is going to write a prospectus now

without the question of terrorism being one of the risk characteristics that you have to address. And it is going to, it is either addressed because we have insurance and that is going to impact the

bottom line of the company, so it is going to end up impacting stock

valuations, or if you do not have insurance, then you are going to

pay a spread that is dramatically broader for getting access and

credit, if you can get it at all. And by the way, it is just as true

for Mr. Knorr and the City of Chicago with regard to bridge financing or any—I do not mean bridge in the financial context, but between Indiana and Illinois. I do not think people get how big a

problem this is with regard to the financial interlacing, and I could

not agree with you more. We are going to need to have a sustainable economic environment to fight this broader terrorism, and if

we do not address these kinds of issues, I do not want the perfect

to be the enemy of the good, but I think somehow or another we

are not thinking about the duration issue.

171

Chairman SARBANES. I think it is an important point. The Pool

Re approach, which the insurers put together, he knows what that

problem is. I understand it because you have this pool and it can

go on. You know, the one in England has gone on now for a number

of years. The Government’s never actually had to pay anything.

Senator DODD. It is a million dollars. It is a rather very small

program.

Senator CORZINE. But the Government is the backstop for the

insurance.

Senator DODD. And the actuarial efforts are much easier under

that scenario.

Chairman SARBANES. That approach takes care of Mr. O’Brien’s

problem as I understand it.

Mr. O’BRIEN. To the extent I understand it, Mr. Chairman I

think it really comes back to no one has all the answers but we

cannot look at this as a 12 month issue or even a 2 month issue.

I disagree with the statement this morning that if this had happened in March it would not be a problem. That is just not the real

world. It is a problem. That is because the industry is really not

able to quantify and charge for what is an unquantifiable risk.

Senator you had asked a second question about business interruption and it was something that I had given some thought to

over the last few days. Because, as we have all seen, in New York

in particular, the recovery and the acts of private and Governmental parties have been phenomenal, but on the private side,

none of that would have been possible without business interruption and some of the property coverages that are currently in effect.

If it would happen without any type of terrorism coverage, things

would just stop because there would be no funds from the private

sector to do any of the kinds of things like reopen some of the

neighboring buildings and restore the economy in that part of New

York City.

Senator CORZINE. Senator Clinton, at a Budget Committee hearing this morning, and I wish I had the sheet, I wrote it down, but

said that the businesses that were interrupted in the immediate

area were like 300 but if you take south of Canal Street, which has

been completely interrupted by the process, it is over 1,200 and

most of that is small business and it is a devastating concept to

think we leave business interruption out of these kind of packages.

Chairman SARBANES. Anything else, Jon.

[No response.]

Senator DODD. I think while Jon was asking that question, Mr.

O’Brien, you had a very clear good example of how this can get way

out of hand very quickly.

Mr. O’BRIEN. Thank you, Senator.

Chairman SARBANES. Gentlemen, than you very much. Mr.

O’Brien, for your first time you made a very substantial contribution. We appreciate it very much.

Mr. Knorr, do not tell the mayor about this Irish problem.

[Laughter.]

Chairman SARBANES. This hearing stands adjourned.

[Whereupon, at 12:30 p.m., the hearing was adjourned.]

[Prepared statements and additional material supplied for the

record follow:]

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PREPARED STATEMENT OF LESLIE M. (BUD) BAKER, JR.

CHAIRMAN, WACHOVIA CORPORATION

REPRESENTING

THE FINANCIAL SERVICES ROUNDTABLE

OCTOBER 25, 2001

Mr. Chairman and Members of the Committee, thank you for the opportunity to

testify on this critical matter. My name is Leslie M. Baker, Jr., Chairman of the

Wachovia Corporation, here on behalf of the Financial Services Roundtable, of

which I am the Immediate Past Chairman. The Financial Services Roundtable is a

trade association for the Nation’s largest integrated financial services companies.

Our 100 members are drawn from the ranks of the banking, insurance, and securities companies.

I am here today to tell you that without full cooperation between our Government

and America’s private industries in support of insurance activities there could be

major disruption in the marketplace and harm to the economy.

On October 10, 2001, 30 chief executives from Roundtable member companies

signed a letter to the Congress expressing concern over the impending lack of terrorism coverage and urging Congress to act this year. It is important to note that

22 of those 30 signatories are bankers, including Wachovia. This makes the point

further that this is not an issue solely about the insurance industry. Mr. Chairman,

I ask your consent to have the letter entered into the record.

The President of the United States, Chairman of the Federal Reserve, Secretary

of the Treasury and many Members of Congress have recognized that our economy

needs an economic stimulus package. Without Congressional action to provide a

Federal backstop for terrorism insurance, efforts to provide an economic stimulus

could be ineffective. This is an issue about the ability of the United States to recover

from the terrorist attacks of September 11 and the ongoing issues of uncertainty,

which now weigh upon the economy.

The possibility of further terrorist acts in the United States places uncertainty

into many sectors of our economy. Without adequate insurance coverage, our Nation

could face economic, market, and employment disruption. To assist in revitalization

and to avoid an economic downturn in the United States, the Financial Services

Roundtable urges this Committee to create some form of Federal assistance for insurance losses due to acts of terrorism.

The Nature of the Problem

Property and casualty insurance coverage is one of those subjects that normally

attracts little public attention. However, it is a vital part of our economy and affects

large and small companies in industries from banking to real estate, and beyond.

Insurers assume risks that other parties cannot. For example, insurers shield developers from the risks associated with major construction; they protect shippers transporting goods and commodities; they cover losses associated with homes and cars;

they protect employees through workers’ compensation programs and disability coverage; and they protect businesses from legitimate claims arising from business

interruption.

The property and casualty insurance industry has announced that it is paying all

private sector claims associated with the September 11 attacks. These costs apparently could reach $50 billion or more. Additional acts of terrorism are unpredictable

and, as the attack on the World Trade Center illustrates, the losses from such attacks can be massive. Acts of terrorism are ‘‘human acts’’ rather than acts of nature.

As such, there is no existing actuarial analysis available to evaluate such risk. Risk

that cannot be priced or managed translates into the inability of primary insurers

to offer policies or get reinsurance. Thus, if primary carriers cannot transfer risk

for acts of terrorism through the reinsurance market then they cannot sell polices

that include coverage for such acts. If they are unable to sell polices that include

terrorism coverage; a lender may be precluded from making loans due to increased

exposure to uninsured risk.

A Banker’s Perspective

As I stated earlier, without insurance coverage for terrorist acts, it will be much

more difficult, for bankers to extend or renew commercial loans or lines of credit

for business purposes, construction, or development. To assess the viability of a particular loan, a bank must carefully assess the risk of the loan and price it commensurate with that risk. Obviously if the risk is too great, the bank cannot grant the

loan at all. One way borrowers reduce risk to themselves and the bank is to acquire

insurance protection against a number of risks. Purchasing appropriate insurance

173

is standard business practice for anyone attempting to obtain financing in the

United States.

If the insurance industry cannot offer adequate insurance to a borrower or a bank

because it cannot properly price or reinsure the risk, the bank is faced with a serious risk assessment problem. Is it prudent to make a loan to construct a pipeline,

or a power plant, or an airplane, or a ship, or a large shopping center or office building when the potential for the borrower to repay the loan is diminished by inadequate insurance coverage? For most banks, the answer will be no. Indeed in many

cases such a loan, most assuredly, would be considered unsound.

As part of the underwriting process a bank must gain understanding of likely

sources of repayment in the normal course of events and under catastrophic circumstances. A normal part of the underwriting process is to make certain that appropriate insurance coverage is available. This risk protection is good for the customer as well. In the absence of insurance there must be adequate cash reserves

in place to provide for the retirement of debt. Without insurance, however, such

cash reserves would lock up capital that our customers need to grow their business

and create jobs. Either way, a loan may not be approved without one of these provisions in place and this is not an acceptable outcome for an economy already dangerously slowed.

Wachovia is one of the five largest commercial real estate lenders in the United States. Our company has total commercial exposure of approximately $252 billion

including real estate and small business loans. Specifically, Wachovia’s exposure to commercial loans secured by real estate is $49 billion and our exposure to small

business is $12 billion. It is important that we continue to serve our customers. In

particular, I am concerned about the impact on small business customers who are

already experiencing wide disparity in quoted premiums due to insurers’ inability

to price products consistent with standard actuarial analysis. In the case of large

or small business, only the Federal Government can provide the insurance industry

with the breathing room it needs to return to a stable, rational market. Without a

Federal backstop, businesses will have to self-insure putting their capital—and ours—at risk. Magnify that potential loss of capital across the domestic banking sector to gain an appreciation for the dramatic impact a loss of insurance could have

on our economy.

Mr. Chairman, it is impossible to determine if, when or where a terrorist might

strike, but it is quite clear what the business ramifications can be. I am certain,

however, that the lack of insurance coverage for terrorism will mean fewer loans

and that will mean constriction of economic activity throughout the country. When

a loan is not made, the jobs that would have been created to build a plant or run

an office will not occur.

The Solution

Mr. Chairman, these economic problems need not arise. With appropriate support

and assistance from the Federal Government, the insurance industry can be in a

position to accept the risk associated with terrorist attack, and our economy can

continue its march to recovery. However, something must be done immediately before reinsurance contracts expire at the end of the year.

The Financial Services Roundtable is familiar with the various proposals that

have been developed. As an organization, we have deliberately not stated a preference for any particular one. There are insurance experts in the private and public

sector working to develop details of a plan that can best address the problem. From

my perspective, any proposal must pass a simple test: it must return certainty to

the market. As such, the program must be in place for an adequate amount of time,

and must give primary insurers a chance to understand changes in the marketplace

and explore adequate alternatives for reinsurance. I am certain, given the close collaboration between the Congress, the Administration, and the industries affected we

can develop a workable solution.

Thank you Mr. Chairman. I would be pleased to answer any questions.

—————

PREPARED STATEMENT OF ROBERT E. VAGLEY

PRESIDENT, AMERICAN INSURANCE ASSOCIATION

OCTOBER 25, 2001

Chairman Sarbanes, Senator Gramm, and other Members of the Committee, my

name is Robert E. Vagley, and I am President of the American Insurance Association, the leading property and casualty insurance trade organization in the United

States, representing more than 410 insurers that write over $87 billion in premiums

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each year. AIA member companies offer all types of property and casualty insurance, including those most impacted by the horrific events of September 11: commercial liability, commercial property, and workers’ compensation. Before I begin

my formal remarks, I would like to thank you for the outstanding leadership you

have shown on this issue, and for this opportunity to testify before the Banking

Committee at this crucial time.

The tragic events of September 11, 2001, forever changed our collective understanding of, and concern about, terrorism on our own shores. The scope and nature

of those attacks were unprecedented in world history. None of us—neither private

nor public sector interests—had made accommodations for this type of occurrence,

because such things were simply beyond our conception. Unfortunately, we are now

presented with a new view of the very real risks and potentially infinite costs associated with terrorist acts. The new, post-September 11 world in which we find ourselves is fundamentally different than that which existed before, for Americans in

general, and very specifically for property/casualty insurers and our customers.

Today, I would like to address two topics. First, I would like to briefly describe

how our industry has responded to the tragic events of September 11. Then, I would

like to share our thoughts on how we can make certain that insurers are able to

continue meeting the expectations and future needs of our policyholders with respect to terrorism and the wide range of other risks which we insure.

Current estimates of total insured losses resulting from the September 11 attacks stand at between $30 and $60 billion, although the final number will not be known

for some time, and could end up being much higher. This makes the September 11

attacks, by far, the most costly insured event in history. Although no natural disaster or man-made catastrophe even comes close, for the sake of some reference, I

would note that Hurricane Andrew, which devastated south Florida in 1992, caused

approximately $19 billion in insured losses, perhaps half to one-third of the September 11 losses. Put another way, the September 11 losses will exceed the entire

property/casualty industry’s net income for the past 3 years (1999, 2000, and 2001).

On that single day, 3 years of industry profits, including investment income, were

wiped out.

I want to be very clear about our response to the horrific attack on the World

Trade Center. Notwithstanding the enormity of this loss, the insurance industry has

been publicly and steadfastly committed to meeting our promises to policyholders

affected by the events of September 11. We have not attempted to invoke war exclusions, despite the militaristic nature of, and rhetoric surrounding, the attacks. We

are paying our claims quickly and fully. We have received claims in excess of $20

billion to date. And, unlike other industries who were directly affected by the attacks, we are not asking for any financial assistance from legislators or regulators

to meet our obligations.

Recognizing that the American people and our economy will recover and move onward, we also are looking ahead. Although the property/casualty insurance industry

can deal with the incredible losses from September 11, we are very concerned about

what will happen if there are additional, large-scale terrorist attacks in the future.

It is critical that you, as public policymakers, share our recognition that terrorism

currently presents core challenges to the insurance market that we cannot meet.

The financial capacity of our industry, while sizeable, is limited. Unfortunately,

the potential harm that terrorists can inflict is both totally unpredictable in frequency and unlimited in severity. As Warren Buffet, CEO of Berkshire Hathaway,

recently stated, ‘‘Terrorism today is not at all like terrorism 25 years ago. And now

you have something where the nature of the risk, the power to inflict damage, has

gone up a factor of—who knows what—10, 50 . . . you cannot price for that.’’ Put

simply, that which is not quantifiable is not insurable in the traditional sense.

As you probably are aware, more than two-thirds of annual reinsurance contracts

agreements by which primary insurance companies purchase their own insurance

to adequately spread the risk of large-scale losses—are renewed each January 1. Reinsurers already have notified primary carriers that they intend to exclude or dramatically scale back terrorism coverage in the reinsurance contracts coming up for

renewal. Although the primary insurance sector of the industry is adversely affected

by such decisions, we recognize that this may well be the reinsurers’ only way to

protect their own solvency.

Primary carriers, however, do not have the same flexibility as reinsurers with respect to our own products because we are subject to tighter regulatory controls. Any

terrorism exclusions we might choose to introduce must be approved by individual

State insurance departments. If approved, our customers could find themselves

bearing 100 percent of the risks associated with terrorism. Certainly, the repercussions of this are clear. However, if exclusions were not approved, primary insurers

would be left to shoulder 100 percent of future terrorist losses, which we simply canVerDate 11-MAY-2000 07:13 Jan 08, 2003 Jkt 000000 PO 00000 Frm 00178 Fmt 6601 Sfmt 6621 83472.TXT SBANK4 PsN: SBANK4
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not afford to do. Our only remaining option—one we would prefer not to consider— would be to simply withdraw from certain markets, and/or lines of coverage.

So we face a very difficult challenge: how can we remain solvent, and still serve

the real needs of our customers for financial protection against terrorism? I am

proud to say that insurers are working hard with you, your colleagues in the House,

with the Bush Administration, to come up with a public policy solution that will

allow us to continue providing this much-needed coverage to our policyholders.

We believe that the only course of action is immediate enactment of legislation

to create a Federal financial backstop for losses that result from future terrorist attacks. This backstop could be temporary, existing only for as long as it is needed.

The legislation must be enacted before Congress recesses for the year, since so many

reinsurance contracts which cover this risk will expire on January 1.

The legislation we are seeking is not, repeat not, a ‘‘bailout’’ for the insurance industry. In fact, the primary beneficiaries of such legislation would be our customers,

and the U.S. economy. Ultimately, the costs of risk must be borne by the policyholders who seek protection through insurance. Given the unprecedented nature of

the terrorism threat, the best way for this to be done is through a public/private

partnership that allows us to service the coverage needs of our policyholders while

remaining financially strong enough to pay all potential claims, whether from terrorism acts or the other ordinary and extraordinary events that affect our business.

The goal of needed legislation is to ensure that adequate insurance coverage remains available to American businesses. Federal Reserve Chairman Alan Greenspan recognized this when he testified before Congress last week, coming to what

he termed the ‘‘very unusual conclusion that the viability of free markets may, on

occasion, when you are dealing with a degree of violence, require that the costs of

insurance are basically reinsured by the taxpayer, as indeed they are, for example,

in Great Britain and in Israel and in other countries which have run into problems

quite similar to ours.’’ There are a number of ways in which this could be done. One is the British-style

reinsurance pool concept, and another is the quota share approach recently suggested by the Administration. A third would involve some industry-wide deductible

or retention. We are not wedded to the details of any particular proposal; not even

our own. However, in order for any legislative plan to be successful in averting the

looming economic crisis, it must be drafted in a way that improves predictability,

stabilizes the market, and preserves insurer solvency.

No proposal can make the risk of terrorism go away, nor can it make the cost

of insurance against terrorism risk go away. However, the right legislation can provide a way for the public and private sectors, on a short-term basis, to comanage

this risk—a risk whose dimensions changed fundamentally and exponentially on

September 11.

What must be in the legislation from our perspective to make it workable? First,

rather than 51 possible separate definitions of ‘‘terrorist act,’’ there must be a uniform national definition that will constitute the terrorism coverage provided by insurance policies all across America. A broad national definition of terrorism is essential to avoid nonconcurrence of coverages among primary insurers, reinsurers, and

the Federal backstop. Such uniformity cannot be achieved if States retain the authority to approve or disapprove policy forms in this narrow area.

Second, insurers must be able to quickly include the price for terrorism coverage

in their insurance policies, rather than be required to go to every State insurance

regulator and seek that regulator’s approval for the terrorism rate in every property/

casualty line. Even with a Federal terrorism reinsurance program that provides a

partial backstop, individual insurers’ retention for terrorism risk will be expensive,

given the huge uncertainties and potentially large losses we collectively face as a

Nation. States cannot take the attitude that ‘‘terrorism cannot happen in our particular backyard,’’ and therefore suppress rates. Mindful of the general prerogatives

of State insurance regulators in the rate-setting arena, there must be language in

place that preserves rate review by the appropriate State regulator, but does not

subject the rates to any review or approval prior to or in connection with the timely

introduction of those rates into the marketplace.

Third, we recognize that any Federal terrorism reinsurance program will include

a number of important details with respect to the mechanics of reimbursement and

other issues. These details must be drafted and implemented in a way that is workable for insurance companies and our regulators.

We understand that, in all likelihood, any new risk-sharing mechanism for terrorism coverage will include some significant retention of future losses by private

insurers. On that point, I would like to note that the more risk insurers are forced

to retain, the less stability there will be in the marketplace. Also, the higher the

retention, the higher prices will have to be.

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Terrorism has become uninsurable in the private marketplace as currently structured. Period. Appreciating that an immediate, stopgap solution may be somewhat

imperfect, we expect that dislocations will still occur as insurers cautiously re-enter

the marketplace. It is our hope that, with time and experience, we will be able to

craft longer-term, more complete solutions that avoid such disruptions.

In the absence of Federal legislation to prevent the complete collapse of the commercial insurance market, entire sectors of the U.S. economy could be left wholly

exposed and unable to continue the normal course of business. I urge you to act

quickly and decisively to ensure that all businesses are able to obtain much-needed

protection against future losses.

I thank you for your attention and look forward to responding to your questions.

—————

PREPARED STATEMENT OF RONALD E. FERGUSON

CHAIRMAN, GENERAL RE CORPORATION

REPRESENTING

THE REISSURANCE ASSOCIATION OF AMERICA

OCTOBER 25, 2001

I am one of the 2,400,000 people that work in the American insurance industry—

life and health, property, and casualty—day in and day out. I am proud of our industry. I am proud of the role we play in our society and in our economy. I am

proud of our team, the 2,400,000 people who are working hard, along with every

other American, to get this great country back on its feet. And I am proud of the

way we have stepped up to the losses of September 11 without complaint.

Our sympathy and condolences go to the families and friends of all who have suffered tragic losses in the September 11 terrorist attacks on our country. We also

express our deep gratitude and respect for the courageous emergency services, military personnel, and volunteers for their heroic efforts in this time of national pain.

I might add that for a lot of us in the insurance industry this is not just about

business, it is personal. We lost a lot of friends. People who worked in the insurance

industry accounted for at least 490 of those killed in the World Trade Center. My

family was fortunate—our son-in-law was among those who escaped unharmed.

General Re, a wholly owned subsidiary of Berkshire Hathaway Inc., is among the

four largest reinsurers in the world, and a market leader in the United States.

While General Re is also in the life reinsurance business, I am here today to talk

mainly about the property and casualty insurance and reinsurance business.

Let me first say that I believe that the U.S. insurance and reinsurance industry

will be able to meet its policy and contract obligations, and to pay the losses arising

out of the September 11 terrorist attacks. Insurers and reinsurers do not need a

bailout for those losses from the Federal Government, and are not asking for one.

We all know that the terrorist attacks of September 11, 2001 resulted in unprecedented losses of life, personal injury, and property damage. It is difficult to estimate

the total insured losses that the U.S. property and casualty insurance and reinsurance industry will ultimately pay as a result of those terrorist attacks. In addition

to the normal problems involved in estimating large or catastrophic losses, in this

case there may be liability issues that may take years to fully resolve.

Some recent analysts’ reports have suggested that $25 billion to $40 billion is a

reasonable range of estimated total insured losses (property, casualty, life, and

health) from the September 11 terrorist attacks. Some analysts have even suggested

that the total insured losses could exceed the range of numbers I just mentioned.

My own view is that total insured losses (property, casualty, life, and health) will

be at the high end of the $25 billion to $40 billion range.

Before September 11 the threat of terrorism within our borders seemed remote.

Because of that, no insurance or reinsurance premiums were collected for terrorism

coverages, and no assets or reserves were allocated to terrorism exposures. That

means that the September 11 terrorism losses must be paid from the industry’s capital account. The total capital and surplus of the U.S. property and casualty insurance and reinsurance industry at June 30, 2001—including both personal lines and

commercial lines writers was $298 billion. That figure includes $26.6 billion of capital in separately capitalized U.S. domestic professional reinsurers. That total industry capital consists of required regulatory risk-based capital, as well as the additional capital needed to support operating and investment risks and to meet the reasonable expectations of policyholders and claimants, rating agencies, stockholders,

and others.

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The exposure to loss from the September 11 terrorist attacks is not spread evenly

across the total insurance industry capital base. The great bulk of those losses will

fall on the capital base of the commercial lines insurers and reinsurers.

One way of looking at the commercial lines capital base is set out in Exhibit A.

It shows that—after subtracting personal lines capital, the Berkshire Hathaway

capital that is not allocated to the affected lines, and the pre-September 11 third

quarter declines in common stock values—the affected property and casualty commercial lines insurers and reinsurers (U.S. and non-U.S.) had a September 10 estimated combined total capital base of $126 billion. That $126 billion capital base has

now been reduced by $25 billion to $40 billion of losses—pre-tax and gross of nondomestic reinsurance.

Tillinghast, in a just-released study for the American Insurance Association, noted

that the September 11 losses might rest on an even smaller capital base—perhaps

$80 billion to $100 billion.

Three things stand out as being very clear to me:

First, the commercial lines capital base can obviously fund a total September 11

insured loss of $25 billion to $40 billion—or an even larger loss from that event.

Second, many actuarial and underwriting principles and practices will have to

change. While not a complete list, here are five things that will change:

• We will have new and different notions about the size, shape, and trends of insured losses and the required risk loads

• Most lines of business will require a greater capital allocation

• Risk-based capital standards will be revised by regulators and rating agencies to

incorporate terrorism risk

• The cost of capital for the insurance business will, other things being equal,

go up

• We need to rethink risk diversification or its opposite, the correlation of risk

And there will be other actuarial and underwriting changes.

Third, the commercial lines capital base cannot take the hit from another sizeable

terrorist event without seriously compromising the ability of the property and casualty commercial lines industry to meet its commitments for losses arising from

other underwriting and balance sheet risks.

The simple fact is that, on its own, the U.S. insurance and reinsurance industry

cannot afford to take on the potentially unlimited exposure to loss arising from insuring against terrorist acts. The commercial lines capital base I have described,

while able to absorb the losses from the September 11 attacks, simply will not be

able to sustain multiple events like those attacks. No one at present can reasonably

predict either the number or scale of future terrorist attacks we might face before

our war on terrorism is won.

We support and applaud the steps that the Federal Government is taking to combat terrorism. But until those efforts have borne the fruit of significant reduction

in the potential for terrorist attacks, it is close to impossible for many insurers and

reinsurers to responsibly underwrite or assume terrorism risk. We simply cannot

evaluate the frequency and severity of terrorism losses using traditional underwriting and actuarial techniques. There are no models that would let us price the

risk with confidence, and the consequence of error is ruin. That is why as an industry we need to explore alternative ways to cover losses arising from terrorism.

The September 24, 2001 edition of The Wall Street Journal featured this quote

from Warren Buffett, Berkshire’s Chairman:

I think in the future, the Government is going to have to be the ultimate

insurer for acts of terrorism . . . An industry with very large, but finite,

resources is not equipped to handle infinite losses.

In some very important ways, insurance is the grease that lubricates the American economic machine. Insurance and reinsurance coverage for terrorism risks is

necessary for our economic recovery—so that lenders will lend, and builders will

build, and employers will hire. It is that simple.

Going forward, we need to find a way to provide insurance against terrorist acts

that assures both the continued financial viability of the U.S. insurance and reinsurance industry, and the continued availability and affordability of the wide range

of products and services provided by that industry.

In a rare—if not unique—show of unity, the property and casualty insurance and

reinsurance industries universally agree that the best way to do that is to have the

Federal Government act as the ‘‘reinsurer of last resort’’ for terrorism insurance and

reinsurance coverage, similar to the plan used in the United Kingdom.

Federal Reserve Chairman Alan Greenspan appears to agree. On October 17,

2001, he said:

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What hostile environments do is induce people to withdraw, to disengage,

to pull back. It is quite conceivable you could get a level of general hostility

that would make viable market functioning very difficult, . . . I can conceive of situations [where] the premiums that would be necessary to enable

a private insurance company to insure against all those risks and still get

a rate of return on their capital would be so large as to inhibit people from

actually taking out that insurance, . . .

Therefore you are led to what is an unusual conclusion that the viability

of free markets on unusual occasions, when you are dealing with violence,

. . . [that it is necessary that] the costs of insurance are reinsured by the

taxpayers, . . .

Free markets and Government reinsurance, in this very unusual circumstance they are indeed compatible . . .

(Source: Bloomberg)

It is increasingly clear that State regulators, the Administration, Members of Congress, and a broad swath of Americans and American businesses also agree that we

need a solution.

All of these interests may not currently agree on the right way to structure that

Federal reinsurer role—we have all heard the several proposals that have been advanced. But there is nearly universal agreement on the fact that this is a significant

and urgent problem that needs to be solved before Congress recesses.

While the size and scale of the September 11 terrorist attacks are unprecedented,

there are precedents for Government involvement—here and abroad—in the solution of temporary insurance market disruptions. The Federal Government ran an

insurance program during World War II. FAIR plans were developed to deal with

insurance scarcity in the wake of the 1960’s urban riots. More recently, the United

Kingdom and other countries have developed government-backed solutions to terrorism insurance.

When the need for these kinds of programs abates, they tend to fade away. When

we are successful in our war against terrorism, we fully expect that any Federal terrorism insurance solution also fade away as normal market solutions return.

We are eager to work with this Committee, other Members of Congress, the Administration, State insurance regulators, and others to find a solution that makes

sense for the country and for the faltering economy, which badly needs an injection

of confidence. The solution must also make sense for frustrated and injured policyholders and claimants, for the insurance industry and its regulators, and for you.

Insurance is, after all, a critical part of the central nervous system of this economy

and this society.

We are not looking for a bailout for the insured losses flowing from the tragic

events of September 11. We are looking for a way forward to serve our clients and

fulfill our role in the economy.

I am reminded of a quote from Winston Spencer Churchill, one of my personal

heroes. Slightly more than 60 years ago, as Britain was engaged in the early stages

of World War II, Churchill said, ‘‘Give us the tools. We will do the job.’’

As we face a different kind of war, and as we find the way forward for the insurance industry, I could not possibly say it any better to you and to the Congress: give

us the tools.

I am grateful for the opportunity to speak to you today, and would be pleased to

answer any questions you may have.

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—————

PREPARED STATEMENT OF JOHN T. SINNOTT

CHAIRMAN AND CEO, MARSH, INC.

REPRESENTING

THE COUNCIL OF INSURANCE AGENTS AND BROKERS

OCTOBER 25, 2001

Mr. Chairman and Members of the Committee, I am John T. Sinnott, Chairman

and CEO of Marsh, Inc, headquartered in New York City. Marsh is the world’s largest risk management and insurance brokerage firm. We have 35,000 employees and

serve clients in over 100 countries around the world. We also serve virtually all of

the major insurance firms with reinsurance broking and related services through

our Guy Carpenter unit. My testimony is on behalf of my firm as well as the member firms of the Council of Insurance Agents and Brokers.

I would like to thank you, Mr. Chairman, for giving me this opportunity to testify

today on the topic of burgeoning terror insurance availability crisis in the wake of

the September 11 attacks. While it has been said many times before, I think it bears

repeating that the events of that day have changed the United States, and that life

and business as we once knew it will never be the same. The events of that day

were singularly devastating on one industry—the financial services industry—not

only in business terms, but also in human terms.

The World Trade Center housed several companies from the banking, securities,

and insurance industries that must now deal not only with the new business challenges facing them as a result of the attacks but also with the loss of colleagues

and employees. Within the insurance industry, the brokerage community was hit

particularly hard. Marsh maintained offices in both of the World Trade Center towers and the space that we occupied in the North Tower comprised the floors directly

struck by the first aircraft. No one in those offices at the time escaped. In fact, of

the 1,900 members of the Marsh & McLennan Companies working in both towers,

and who were visiting that day, 294 were lost. Another colleague was a passenger

aboard one of the aircraft. The world’s second largest brokerage firm, Aon, also had

a large presence in Tower 2. They lost 200 of their colleagues. While our first response was to focus on our people and the families of those lost, we also realized

that we had to begin the job of our affected clients in resuming their usual business

operations.

The events of September 11 have changed the landscape of commercial insurance

in a way that I have not seen in my 36 years in the business. To be sure, there

have been trying times in the past—the liability crisis in the mid-1980’s, the property catastrophe coverage problems in the early 1990’s following Hurricane Andrew,

to name a couple. Marsh rose to the occasion during both those crises to help our

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clients secure the coverage that they needed to adequately protect their businesses.

This is a function that is quite common in the brokerage community—not merely

selling insurance products, but identifying client needs and developing new and innovative products or programs to address coverage shortfalls and to make our clients more successful.

In response to the mid-1980’s liability crisis, Marsh played a leading role in the

creation of the insurance and reinsurance companies ACE Limited in 1985 and XL

Capital in 1986. These companies were formed to provide excess liability and directors’ and officers’ liability coverages at a time when the market could not provide

the necessary capacity. These companies were very successful in providing muchneeded market capacity. They exist as major insurers today. Similarly, Marsh

played a role in the creation of Mid Ocean Limited during the property catastrophe

reinsurance crisis following Hurricane Andrew in 1992. This company has also done

very well in meeting the needs voiced by our clients.

It was in this same spirit of responding to customer needs that MMC Capital, our

sister company, recently announced the formation of AXIS Specialty Limited, a new

insurance and reinsurance company formed to provide capacity needed in the wake

of the September 11 attacks. AXIS has an initial capitalization in excess of $1 billion, and will begin underwriting later on this quarter.

Our firm is proud to be able to continue our tradition of responding to supply and

demand imbalances in the insurance and reinsurance markets. But I must tell you

in all candor that what your Committee heard has been hearing over the past 3

weeks is true—there is an immediate crisis that demands your attention. In the current unique, and hopefully short-term, environment of uncertainty, the private sector alone will not be able to provide the insurance capacity America’s businesses

need to conduct their operations. Government involvement is needed until the environment becomes secure and returns to a state of more normalcy.

The problem with what happened on September 11 is that it presented a risk that

no one had could conceive would happen. When the buildings were built, loss scenarios did contemplate the impact of one Boeing 707, the largest commercial aircraft

at the time, however the idea of two, fully fueled 767’s hitting both towers was unimaginable. Thus, we arrive at the problem presented by terrorism: the magnitude

and severity of potential future events.

There has been considerable discussion about the scale of the World Trade Center

and associated losses of September 11. While it will be some time before the total

costs of the tragedies are computed, we all know that they represent the largestever losses in the insurance industry, by far. The previous largest insured loss was

Hurricane Andrew at nearly $20 billion—or less than half of the losses of September

11. Some further context—the most recent catastrophic losses for the insurance industry—including Hurricane’s Andrew and Hugo, the Northridge and Kobe earthquakes and the Lothar and Martin windstorms in Europe—totaled $53 billion in

losses. Chances are that the losses stemming from the attacks at the World Trade

Center will exceed that number—perhaps significantly.

The true cost of these events will not be known for years, because some types of

insurance, such as business interruption and workers’ compensation, do not constitute one-time payments but are rather ongoing for longer periods of time. While

the industry has stated it can cover the severity of losses from this event, it is very

unclear that the industry will be able to meet any frequency of future losses that

may occur. We are told by Federal authorities to expect retaliatory strikes against

America and that it is virtually impossible to completely shield ourselves from the

assaults of those who disregard their own lives.

We have already seen massive and virtually unanimous signs of the unwillingness

to take on such risks that are unquantifiable. As our commercial clients’ policies

have come up for renewals, we have seen a majority of insurers add terrorism exclusions to their policies. Of the top 25 property insurers with whom we trade, 17 have

stated that terrorism exclusions will apply effective immediately and most of the

others can also be expected to apply exclusions.

While most insurers will be unwilling to underwrite terrorism risks going forward,

there may be a few companies who will be willing to take on those risks. However,

even if they are willing to provide the coverage, it is not clear that they will do so

at prices which are affordable by most businesses. And clearly, such efforts will

involve adverse selection, in that many businesses that are considered most vulnerable probably will not be able to secure coverage at any price from any insurer, absent Federal intervention.

Similarly, there is now a new definition of what a maximum insured loss may be.

There are not many people who would have ever believed that the Twin Towers of

the World Trade Center could or would be completely destroyed, turned into a pile

of dust and rubble, with nothing of value left, and with thousands of deaths and

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injuries. We know now that it is possible, and that the concept of a maximum insured loss post-September 11 does not in any way resemble the concept we had before that date. Threats can come from anywhere in the world, not just from one’s

business partners or from Mother Nature. The scope of risks we must plan for has

changed as well.

This change in the perception of risk will have great repercussions in the pricing

of policies going forward. Before September 11, the insurance industry was already

experiencing what is known as a ‘‘hard market,’’ meaning that premium rates were

rising. That trend has now accelerated significantly. We are now seeing average rate

increases in the area of 65 percent to 75 percent coupled with dramatically increased deductibles, and a contraction of available limits and coverages. Some price

increases exceed 100 percent.

It is for this reason that I would urge the Congress to address the market contraction that we are facing before it adjourns for this year. We are facing a deadline

at the end of the year for reinsurance contract renewals that will begin to exclude

terrorism coverage. If insurers cannot cede this risk to a reinsurer, they will be unwilling to take it on themselves and will refuse to offer the coverage. That is why

I am delighted that proposals to address the insurance problems we face are being

advanced.

We all are familiar with the two major proposals—the 80/20 plan and the pooling

arrangement. There are others as well. Until there is a cure for the current environment of uncertainty created by the prospect of terrorism, the insurance coverage our

clients need cannot be obtained from the private sector solely. In this somewhat

unique—and hopefully short-term environment, it is critical that the public and private sectors collaborate. Then, once the environment has stabilized, and we achieve

a state of greater normalcy in the environment, it should be practical for Government involvement to decline and ultimately be withdrawn.

As mentioned above, my firm has been severely affected by the events of September 11. The first aircraft directly struck our offices in the World Trade Center

and we lost 295 members of our corporate family. That was the real tragedy and

is still with us in our offices and hallways.

We also incurred huge losses of property and equipment. So I speak here today

from painful personal experience—and perhaps with a deeper understanding of

what our clients face as they look to an uncertain future.

Mr. Chairman, let me restate that we are on the brink of an availability/affordability crisis insurance caused by the terrorist events. I commend you for holding

this hearing, for your efforts to create a solution that restores and strengthens the

private marketplace, and I urge you to work with your colleagues in Congress and

the Administration and within our industry to find workable answers.

—————

PREPARED STATEMENT OF THOMAS J. DONOHUE

PRESIDENT AND CEO, U.S. CHAMBER OF COMMERCE

OCTOBER 25, 2001

Good morning, Mr. Chairman and Members of the Committee. I am Thomas J.

Donohue, President and Chief Executive Officer of the U.S. Chamber of Commerce

and Chief Executive Officer of the U.S. Chamber Institute for Legal Reform. The

U.S. Chamber is the world’s largest business federation, representing more than

three million businesses and professional organizations of every size, in every business sector, and in every region of the country. The central mission of the Chamber

is to zealously represent the interests of the entire business community before Congress, the Administration, the independent agencies of the Federal Government, and

the courts. The mission of the Institute for Legal Reform is to reform the Nation’s

State and Federal civil justice systems to make them simpler, fairer, and faster

while maintaining access to our courts for legitimate lawsuits.

I welcome this opportunity to testify before you on the urgent need for prompt

Congressional action to help make sure that insurance coverage for terrorism is

available. I also ask that my full statement be inserted into the record.

The terrorists who attacked our Nation September 11 deliberately struck at the

center of U.S. finance and commerce. Congress has acted promptly to help address

a number of the immediate needs raised by the September 11 attacks by passing

the Air Transportation Safety and System Stabilization Act as well as providing

much needed emergency funding to help with the immediate recovery. Unfortunately, more work is needed to help shore up our economy, and passage of Trade

Promotion Authority and an adequate economic stimulus package would represent

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significant steps. But even those efforts will be inadequate if American business is

unable to move forward secure in the knowledge that the potential risks associated

with future terrorist attacks will not cripple them beyond the point of recovery.

The attacks have had a significant impact on the insurance industry. September

11 will result in the largest insured loss in U.S. history. It has been estimated that

the insurance industry will pay between $30 and $58 billion in claims, and some

estimates are even higher. To put the magnitude of this event in perspective, it easily surpasses the $30 billion, without adjusting for inflation, paid for claims because

of Hurricane Andrew. The insurance industry has indicated that it remains committed to meeting its obligations to policyholders for the events of September 11.

These claims for terrorist losses will be paid directly by the primary insurers operating in the United States, with a major portion of the costs ultimately shared

throughout the global insurance and reinsurance community.

The problem, however, is that in the wake of these events, insurers and reinsurers are examining how to manage the heightened level of terrorism risk they are

facing and are reevaluating what coverage, if any, they may provide for it. The September 11 attacks fundamentally changed assumptions about the scope of risks and

losses associated with terrorism. It now seems that any commercial enterprise, from

Main Street-type small businesses to multinational American ‘‘icon’’ corporations,

could become targets of or affected by the next terrorist attack on American soil.

As a result of the potentially astronomical increase in liability, the insurance industry has begun to indicate that it cannot cover losses associated with future terrorist

attacks.

A single-day event of the magnitude experienced on September 11 is a substantial

hit to the capital base of many companies as well as the worldwide insurance industry as a whole. While the attack may strain many insurance companies, current indications are that the majority of companies will be able to meet their obligations.

However, in the short run, the United States and global reinsurance industry does

not have the capacity to provide protection against another major incident, or a continuing series of incidents. Companies with significant losses stemming from the

terrorist attack will need to raise fresh capital in order to maintain their capacity

to insure against all other risks covered by their contracts. Uncertainties regarding

losses from future terrorist attacks will likely make raising fresh capital problematic. As a result, because of the unprecedented scope and nature of the losses sustained last month and the unpredictability of future liabilities, insurance coverage

against future acts of terrorism will become virtually unobtainable for the vast

majority of policyholders.

Major reinsurers have already alerted their clients that they intend to sharply reduce or eliminate their coverage for terrorist attacks, particularly policies on large

commercial risks such as office towers, transportation hubs, sports arenas, and the

aviation industry. The lack of reinsurance would leave primary insurance companies

on the hook for all of the risk of a terrorist attack, a position they cannot assume.

This, in turn, will force primary insurers to eliminate the availability of such coverage. Therefore, because the majority of American businesses traditionally renew

their insurance contracts each January 1, businesses of all sizes and kinds could be

left without insurance against terrorist acts.

What does that mean? If not corrected, this market disruption in insurance coverage will have deep, widespread, and potentially devastating ripple effects throughout the entire U.S. economy. Businesses that cannot secure full insurance coverage,

including coverage for terrorist acts, may decide that risks from a lack of complete

coverage leave them too vulnerable thus forcing them to reduce operations that

would be considered too likely to be terrorist targets. This would result in layoffs

and the elimination or decreased availability of a variety of products and services.

For example, without adequate coverage, trucking firms, railroads, airlines, and

ships may be unable to transport many types of cargo or limit their destinations.

In addition, a lack of terrorism insurance coverage could significantly harm the

ability of many businesses to obtain financing or otherwise buy or sell properties,

businesses, or projects. Furthermore, it is important to note that this is not only

a prospective problem. For example, the terms of most loans require evidence of adequate insurance. If adequate insurance is no longer available, borrowers may find

themselves in technical default of their loan terms. As a result, lenders would be

in the position of potentially having to try to find adequate insurance coverage for

their borrower that may not exist or either accelerating payments under the terms

of the loan or calling-in the loan in its entirety. They may also be forced to cut down

on the amount of available credit as they build their reserves in the event of additional terrorist attacks. Finally, if businesses decide to self-insure the risk of future

terrorist attacks, they may find it difficult, if not impossible, to attract their own

reinsurance or even new capital.

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The principle upon which insurance rests is the ability to spread risk so that no

single person or entity is forced to bear the full impact of an economic loss. Without

this ability to spread risk, individual American businesses cannot afford to take on

the potentially unlimited exposure to loss arising from uninsured terrorist attacks.

Without some appropriate partnership between the insurance industry and the Federal Government, the looming constriction in the insurance and reinsurance markets threatens to inflict serious injury to the U.S. economy. This would potentially

result in American businesses and citizens incurring substantial losses even if we

do not suffer a future terrorist attack.

It is critical that the business community, the Administration, and Congress come

together before the end of this year’s Congressional session to develop and implement an appropriate Federal financial backstop for terrorism exposure. If such a

backstop is not created, our Nation’s economic recovery will be seriously jeopardized.

Whatever approach is developed, it should support ongoing efforts of the private insurance and reinsurance markets to return to their proper role of underwriting risks

while recognizing a Government backstop may be necessary for a period of time.

The Chamber recognizes that there are a number of ways in which this issue

could be addressed and we stand ready to work with all of the stakeholders to ensure that a workable mechanism is developed so that we can avoid a widespread

economic crisis and keep American businesses in business. I would be happy to answer any questions you may have. Thank you.

—————

PREPARED STATEMENT OF THOMAS J. O’BRIEN

SENIOR VICE PRESIDENT OF FINANCE AND CHIEF FINANCIAL OFFICER, LCOR, INC.

REPRESENTING

THE REAL ESTATE ROUNDTABLE

OCTOBER 25, 2001

My name is Thomas J. O’Brien, and I am the Senior Vice President of Finance

and Chief Financial Officer of LCOR. As a member of LCOR’s Management Committee, I am responsible for the company-wide oversight of LCOR’s finances, risk

management, and insurance activities—including those of the JFK International Air

Terminal LLC—a $1.2 billion air terminal redevelopment project and its related

operations.

LCOR is a national real estate development, asset management, investment, and

operations management company, specializes in structuring and implementing public/private developments. We have completed projects in 15 States and the District

of Columbia, including more than 1.6 million square feet of commercial space and

18,000 residential units. The company has $4.4 billion in developments completed

or under construction, and over $1.6 billion in predevelopment. As the leader in public/private development, LCOR is, or has been, involved in some of the Nation’s largest, most complex, and creative developments. LCOR’s operating offices are in New

York City, Washington, DC, New Jersey, Dallas, Denver, and Berwyn, Pennsylvania, where the company also has its corporate office.

I am here today as a long-standing member of The Real Estate Roundtable and

on behalf of a number of real estate organizations and trade groups that are separately submitting written testimony.

The tragic events of September 11 have triggered a withdrawal of virtually all

commercial property and casualty insurance coverage for terrorist damage. While

this will become readily apparent throughout the economy on January 1, when approximately 70 percent of the policies on commercial properties are scheduled for

renewal, it is already a problem in our market.

As the CFO of a commercial property owner, I know that it is not possible to buy,

sell, or finance a commercial building unless it is covered by adequate insurance.

A significant percentage of owners of commercial properties open to the public, including shopping centers, offices, and hotels renew their insurance coverage on January 1 each year. Many of these owners have been advised that their policies may

not be renewed or that their new policies will exclude terror/war risks.

Without adequate insurance, it will be difficult, if not impossible, to operate or

acquire properties, refinance loans, and to sell commercial-backed securities. Disappearance of coverage for terrorist acts for real estate and other businesses could

severely disrupt the economy. I am very concerned about the short-term future of

the real estate industry unless the Federal Government creates some type of mechanism that would provide this coverage.

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The scale of the real estate industry is immense—with income-producing real estate representing an estimated $4.6 trillion—with $2.05 trillion in institutionalgrade real estate. In the institutional real estate market—which includes office,

retail, hospitality, multifamily, and industrial—there is total equity of $372.7 billion—largely supplied by REIT’s (39.3 percent) and pension fund investors (38.6 percent)—and total debt of $1.67 billion—with 42 percent held by commercial banks,

14.8 percent held by CMBS investors, and life insurance companies holding 13 percent. This does not include approximately $6.7 trillion in owned homes (single family, condominiums, and co-ops).

As these policies expire, there is tremendous uncertainty about the status of debt

to the sector, with some $700 billion in commercial bank debt, $350 billion of loans

in CMBS, $220 billion of loans held by life insurance companies that ran the risk

of being in nonmonetary default without the availability of terrorist coverage. This

lack of coverage raises profound liquidity concerns not only on existing loans and

the institutions that hold them but on the ability of borrowers to secure financing

going forward.

Before September 11, property and general liability policies covered losses stemming from terrorist acts. But as confirmed by insurance industry CEOs’ testimony

before the House Financial Services Committee on September 26, future policies will

exclude coverage for both terrorist acts and acts of war. Additionally, they stated

that reinsurance for terrorism is currently unavailable in the marketplace, Without

reinsurance, there will likely be no primary insurance covering terrorist damage. As

a result, the real estate and construction industries, which account for over a quarter of the Nation’s gross domestic product, could face severe economic dislocation in

the coming months if the Federal Government does not immediately address insurance-related issues tied to terrorism.

The Federal Government should play a role to ensure that commercial property

owners and other businesses can obtain insurance coverage for damage from acts

of terrorism. It is important to act before these policies terminate on January 1 to

ensure that insurance coverage for terrorist acts is available in the future. Necessary characteristics of a workable plan include the following:

Duration: Because real property is a long-lived fixed asset, it is generally financed over a long term—typically 10–30 year term. Thus, if the program created is of insufficient length, it may not provide sufficient stability in the short

term. Any program created must be of sufficient duration to provide financial

certainty for these long-term lenders.

Definition: The line between ‘‘terrorism’’ and ‘‘acts of war’’ has been blurred significantly since the September 11 attacks on the World Trade Center and the

Pentagon. President Bush and news media have been focused on our current

‘‘war against terrorism.’’ The real estate industry is concerned that the next

incident in this ongoing conflict may be considered an ‘‘act of war’’ by the insurance industry and therefore be excluded from coverage. Accordingly, any program created must cover an expansive notion of terrorism so that future events

along the lines of September 11 are covered—and are not excluded from coverage in the future as an act of war.

Deductible: The real estate industry is concerned that a dramatic and

unsupportable increase in deductibles to property owners could be tantamount

to no insurance coverage at all. For example, if a real estate owner plans to acquire a $10 million property with $3 million of equity and $7 million of debt,

an insurance policy with a deductible of $3 million or more, effectively would

wipe out the real estate owner’s equity and would militate against investment

in the property. Accordingly, any program created must carefully consider apportionment of loss exposure among property owner, lender, insurer and the

Federal Government.

Disclosure: With property and casualty insurance rates already skyrocketing

prior to the attack on America, insurers should be required to separately disclose the cost of terrorist coverage to avoid any misunderstanding as to the program’s impact on overall insurance rates. Otherwise, it would not be possible

to discern the actual increase in the policy as a result of the difficulty in writing

terrorism and act of war coverage and the result of other issues.

The Congress must not fail to act. Our industry welcomes the opportunity to work

with the Administration and Congress to achieve a workable solution to this immediate problem this year.

Thank you for the opportunity to be here today.

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PREPARED STATEMENT OF WALTER K. KNORR

CHIEF FINANCIAL OFFICER, CITY OF CHICAGO, ILLINOIS

OCTOBER 25, 2001

Thank you, Mr. Chairman for inviting me to testify today. My name is Walter

Knorr and I am the Chief Financial Officer of the City of Chicago. I appreciate the

opportunity to present to the Committee a matter of great concern to the City of

Chicago and, I am sure, to other cities throughout America.

The cost of war-and-terrorism liability insurance as a result of the tragic acts of

September 11 has escalated to incredible levels. The insurance industry is uncertain

about the risk of terrorism, and therefore unable to assess and price that risk.

In Chicago, our insurance carrier recently canceled our war-and-terrorism liability

insurance coverage for Chicago O’Hare International Airport and Chicago Midway

Airport. Prior to September 11, we paid an annual premium of $125,000 for $750

million of war-and-terrorism liability coverage. If we want to renew our insurance,

it will cost us $6.95 million for $150 million of war-and-terrorism liability coverage.

I will repeat those figures for you. Our premium has risen from $125,000 to

$6,950,000. Our coverage has dropped by $600 million. That is a premium increase

of over 5,000 percent for substantially less coverage. Expressed another way, the

cost of $1,000 of coverage has risen from 16 cents to $46.33—an increase of 28,956

percent. This extraordinary cost increase would be passed along primarily to our

tenants at O’Hare and Midway, namely the airlines operating out of those two airports. The financial problems of most airlines have been well publicized. A cost increase of this magnitude would negate the city’s efforts to cut the costs of airport

operations to benefit the airlines and keep them viable. It also would undo the efforts of this Congress to assist the airlines financially during these uncertain times.

Chicago is not alone in this. We are aware of a number of other major airports

across the country that have received equally exorbitant quotes for war-and-terrorism liability coverage. In addition, the Chicago airports have been warned that

their premiums for property and liability insurance may double, triple, or even

quadruple—and deductibles will increase significantly.

The problem extends beyond airports. The City of Chicago insures a toll bridge

that connects Interstate 94 to the Indiana Tollway. Our most recent annual premium was $406,000 for $386 million of coverage. In mid-September the city received

a nonrenewal notice for this bridge, with the ominous indication that the insurance

carrier could not quote a new rate, but that the rate will increase by more than 30

percent and potentially much higher. One would expect insurance costs associated

with terrorism to increase substantially for many other public and private structures: existing buildings, buildings under construction, public meeting areas like

sports stadiums and convention centers, and other prominent infrastructure. The increased insurance costs would undoubtedly be passed along to the tenants and users

of the these assets. If those costs were significant—and I think they could be—they

could have an extremely negative economic impact. Tenants would have to decide

whether to pay those higher costs or leave the city and take jobs with them.

The insurance crisis hits major cities the hardest because cities would appear to

be the most likely targets for terrorist attacks. While terrorists may pick out individual targets, the attacks are directed at the Nation as a whole and the risk should

be spread to the Nation as a whole. In these uncertain times, the Federal Government should act as an insurer for future terrorist attacks and catastrophic losses.

There are two proposals before this Committee, and the City of Chicago is not taking a position on the two proposals. The city does believe it is imperative that the

Federal Government act on the insurance problem to provide certainty of insurance

at reasonable rates, and hopefully mitigate the cost to Government and business.

Thank you again for this opportunity. I will be available for any questions you

might have.

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STATEMENT OF STEVE LEHMANN, FCAS, MAAA

VICE PRESIDENT FOR PROPERTY/CASUALTY

AMERICAN ACADEMY OF ACTUARIES

OCTOBER 25, 2001

Introduction

The American Academy of Actuaries appreciates the opportunity to provide comments on issues related to insurance and the threat of future terrorist acts. The

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Academy hopes that these comments will be helpful as the Committee considers related proposals.

The Academy is the nonpartisan public policy organization for the actuarial profession and assists policymakers through presentation of clear actuarial analysis.

For more than 30 years, membership in the Academy has been a hallmark of professional quality for U.S. actuaries. Academy members are bound by rigorous professional standards for conduct, practice and qualification, and discipline.

The actuarial profession is uniquely qualified to examine issues relating to insurance and reinsurance of catastrophes. Academy members who practice in the insurance field typically have a broad understanding of insurance risk and company

financial management, and they are well equipped to evaluate reinsurance arrangements. Many Academy members also have extensive practical experience in evaluating the financial risk associated with natural disasters and other catastrophic

events and in pricing related coverages for the private marketplace.

Given this expertise, the actuarial perspective is valuable in examining the fundamental aspects of insurance and in describing policy considerations associated with

proposals to address the impact of terrorism on the insurance industry.

Defining the Problem

In the aftermath of September 11, insurers and insureds face a significant problem with respect to future coverage of terrorism risk, due to both the nature of insurance and the nature of the threat involved.

Insurance is at the foundation of a free market system, because it gives entrepreneurs and businesses the freedom to focus their resources on the conduct of their

business without concern over the magnitude and volatility of potential fortuitous

losses. Insurers accept that risk as long as it is quantifiable and appropriately

priced. Where that is not possible, insurers become reluctant to accept the risk.

A dramatic change occurred on September 11, when a new risk of terrorism

emerged from an event that had never even been imagined by insurers or insureds.

The risk of terrorism involves prospective losses of unknown but potentially very

high severity and unknown frequency. This makes risk quantification very difficult.

Furthermore, it reaches beyond first-party property coverage to involve other coverages (such as workers’ compensation, liability, and business interruption) that are

also difficult to quantify. Even building a new risk model to define the scope of

potential losses from acts of terrorism will be extremely difficult. This difficulty is

aggravated by the inapplicability of existing models and the total absence of any

historical data.

As a result of the September 11 events, there is enormous strain on the entire

insurance system. Insurance mechanisms have to bear previously existing risks as

well as the unknown and unpriced risk associated with terrorism. Additionally,

though the industry may have retained significant surplus following the September

11 attacks, such surplus is needed to support all of the risk assumed by insurers

for all of the lines of business they have written. Given these difficulties, in the

short term at least, insurers are being driven to avoid losses that could occur from

acts of terrorism in order to preserve their own financial security. From a public

policy perspective, lack of coverage for such losses is not an acceptable outcome.

Private-Sector Solutions

Because insurance coverage plays such a vital role in our economic system, various proposals have emerged to provide some limitation on the aggregate risk from

terrorism to be borne by the private sector. The immediate actuarial problem of

pricing this new risk can be diminished by limiting the losses that would have to

be paid by the private insurance market. In considering solutions to the problem,

considerable discussion has focused on the concept of a terrorism reinsurance mechanism, that in turn raises a number of important concerns. For example:

• How would such a mechanism be funded? Would it be funded prospectively by

premiums charged to the participant insurers, retrospectively by assessments to

the participant insurers, or through some combination of these approaches?

• How would liquidity be assured so that funds would be immediately available to

pay claims when they occur?

• How would the terrorism trigger be defined so as to preclude coverage disputes

between participating insurers?

• Would this mechanism be voluntary or mandatory? Would it be available to noninsurer, risk-assuming entities such as self-insured municipality pools?

• Will Governmental protection be available as a backstop above a finite limit of

loss?

Answers to each of these questions and perhaps others will be necessary before

a pricing model can be developed. Broad-based participation by insurers is critical

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to spreading terrorism risk if a private-sector mechanism is adopted. If the mechanism is voluntary, there must be adequate incentives to entice insurers to participate. Voluntary participation in any mechanism also brings up issues of potential

adverse selection (that is, only high-risk insurers and businesses participate).

It has been suggested that it would be appropriate for Government to provide coverage for terrorism losses above a certain limit. In view of the magnitude of potential losses, it is difficult to conceive of any effective mechanism that would not have

to involve the Federal Government, at least in the short term. However, any shortterm solution will undoubtedly require future modification to reflect an increased

understanding of the risk involved as well as subsequent experience gained in addressing it. All of the proposals currently being considered sunset in less than 10

years. A sunset period is necessary to provide time for the insurance industry to

develop adequate risk assessment techniques while providing protection for insurers

and insureds in the interim. A new mechanism may also be needed to address terrorism risk over the long term.

Conclusion

Some mechanism is needed now to ensure stability of insurance coverage. Some

level of Government intervention appears to be necessary and appropriate in the

short term. Over time, the insurance industry should be able to develop tools and

techniques to help quantify and assess the risk of terrorist attacks more effectively.

Public policymakers evaluating any proposal designed to assist insurers in achieving that objective and to protect insureds from the threat of terrorism should carefully weigh the following considerations:

• Incentives for participation in voluntary mechanisms;

• Potential for adverse selection;

• Funding source and liquidity of mechanism; and

• Level of government involvement in the short term and long term.

The American Academy of Actuaries is available as a resource to the Committee

as it seeks to address this important concern.

—————

STATEMENT OF THE AMERICAN COUNCIL OF LIFE INSURERS

OCTOBER 25, 2001

The ACLI is the principal trade association for the life insurance industry, representing 426 companies, which account for 80 percent of the life insurance premiums and 81 percent of annuity considerations in the United States among legal

reserve life insurance companies. ACLI member company assets account for 80 percent the total assets of legal reserve life insurance companies. We appreciate the

opportunity to present this statement to the Committee on Banking, Housing, and

Urban Affairs on the topic of insurance coverage for terrorist acts.

As the collateral effects of the attacks of September 11 continue to unfold, much

attention has been focused on the financial condition of the insurance industry. In

this regard, the property/casualty insurance business will ultimately incur losses estimated at between $30 to 50 billion, while the life insurance industry losses will

be in the $4 to 6 billion range.

Both segments of the insurance industry have repeatedly sought to assure the

public and Members of Congress that they have adequate resources to cover these

losses. However, the threat of additional and perhaps more widespread terrorist attacks, with even more devastating losses, dictate that Congress examine the capacity of the insurance system to respond to such previously unthinkable scenarios. We

commend the Committee for its timely examination of this critical issue.

Thus far, the property/casualty industry has been the focus of efforts to develop

a private sector/Government partnership to underwrite the risks associated with expanded terrorist losses. This is appropriate as the property/casualty industry has obviously had to absorb a much greater impact on its available capital reserves as well

as a more immediate response from its reinsurers that terrorist coverage would be

severely limited or unavailable in the future.

Because the life insurance industry has more than $3.2 trillion in assets and processes, on the average, about 10,000 death claims each day, the losses of life resulting from the September 11 attacks, while tragic, do not pose a threat to the solvency

of the life insurance industry. However, the potential for continued acts of terrorism

to result in substantially more significant adverse effects on mortality, and by that

we mean the potential for mass death and disability on a much larger scale than

we have previously experienced or imagined, gives rise to questions that we believe

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must be considered by Congress as well as the life insurance business. Will there

continue to be a viable private sector market for life insurance products that cover

risks of terrorism? Put differently, will life reinsurers continue to enter into reinsurance treaties covering catastrophic risks that include acts of terrorism? Additionally,

if there are realistic prospects of an act of terrorism of sufficient magnitude to adversely affect the overall solvency of the life insurance business, is there a justifiable

need for some mechanism to address that situation, and, if so, what form might

such a mechanism take? The uncertainty surrounding these questions suggests a

need for the Committee to evaluate the potential needs of the life insurance industry, including its customers, as part of its current inquiry.

At this time, we are not seeking the establishment of a mechanism similar to

those under consideration for property/casualty insurers. Indeed, it is not clear at

this point that such a mechanism would be necessary or useful for life insurers. Nor

is there any agreement within our industry as to what such a mechanism should

look like were it deemed to be necessary. We think it is prudent, however, to start

the process of asking ‘‘what if?’’ and to begin doing it now, before events necessitate

a last-minute, crisis-driven reaction that might not be entirely in the best interests

of the life insurance industry or its customers.

In that regard, the ACLI has developed a proposal to create a study commission

comprised of Government and private sector representatives to assess the potential

effects on the life insurance industry of further terrorist activities. The proposal is

designed to be included in whatever legislation the Congress develops to address

property/casualty insurance issues. This is not a request for Government assistance.

It is instead our industry laying down a marker to reflect the need to examine this

issue thoughtfully, hopefully without the risk of being overtaken by events.

Briefly, the proposal would work as follows. A nine member study commission

would be appointed to assess: (1) possible steps that could be taken to encourage

and sustain the private market for life insurance products covering death or disability resulting from acts of terrorism and the threat of such acts; and (2) possible

steps or mechanisms to sustain or supplement the ability of life insurers to cover

losses due to death or disability resulting from acts of terrorism that significantly

affect mortality experience or jeopardize the solvency of the industry as a whole.

This study commission would be comprised of five representatives from Government (two from Treasury, one from Commerce, one from the Office of Homeland Security, and one from the ranks of State insurance regulators) and four from the private sector (two representing life insurers, and two representing life reinsurers).

Any affirmative recommendations by the study commission would have to have the

concurrence of at least two-thirds of the commission members to assure that such

recommendations have at least some support from the life insurance business.

The study commission would have 30 days to organize itself and another 90 days

to complete its work. The report of the commission would be submitted to the President pro tempore of the Senate and the Speaker of the House, with a copy to the

White House. The legislation would direct Congress to give ‘‘prompt and deliberate

consideration’’ to any recommendations for Federal legislative action contained in

the report. The study commission would be disbanded within 60 days after submission of the report.

To reiterate, by advancing this study commission, the ACLI is simply suggesting

that the question of how acts of terrorism, or even the threat of such acts, will affect

the life insurance business is a critical matter warranting prompt and thoughtful

consideration by both the private sector and Government. The events of September

11 have unquestionably introduced great uncertainty into the life insurance business. This uncertainty involves concerns over the way in which the risk of terrorism

will be covered in insurance policies, how that risk will be quantified, how attendant

pricing decisions will be made, and whether future events that even a few months

ago were unimaginable carry with them the potential to overwhelm the solvency of

our business. Given this uncertainty and the gravity of the issues at stake, we believe a study as outlined in the attached draft language is an appropriate response

at this juncture.

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STATEMENT OF THE INDEPENDENT INSURANCE AGENTS OF AMERICA

OCTOBER 25, 2001

This testimony is submitted on behalf of the Independent Insurance Agents of

America (IIAA). IIAA is a nonprofit trade association that represents over 300,000

independent insurance agents and brokers and their employees nationwide. IIAA’s membership is composed of large and small businesses that offer consumers a wide

array of products in every State, city, and town in the country. The independent insurance agent and broker industry sells 75 percent of all commercial lines policies

in the country. In essence, independent agents and brokers write coverage for America’s businesses, and through this unique prism of expertise and for the reasons outlined below, we strongly urge the passage of legislation to ensure the availability

and affordability of essential business insurance products in the aftermath of the

horrific acts of September 11.

The terrorist acts of September 11 have had a profound impact upon all of us,

with the insurance industry being hit particularly hard, both physically and financially. IIAA has over 20 agency members in Lower Manhattan, including one that

was previously located in the South Tower of the World Trade Center, and many

more had valued customers who were located in the complex. In the days and weeks

that have followed the attacks, countless victims and survivors have begun putting

their lives back in order, and the insurance industry has played a pivotal role in

this recovery-and-rebuilding process. We are proud and pleased by the manner in

which our industry responded to the events of September 11, and the best news was

that things worked as they were intended. The insurance industry has honored its

commitment to thousands of Americans in their greatest time of need—and the industry is proving that it has the resources needed to quickly and fully pay claims.

Although the insurance industry has responded efficiently and effectively to these

attacks, we must now work to ensure that the industry is in a position to respond

in similar ways to future terrorist attacks. In order to address these new challenges,

we will need the leadership and assistance of the U.S. Congress and the Bush Administration to ensure that appropriate insurance coverage remains available. The

issue of terrorism reinsurance is so vital to the future of American businesses— large and small alike—and to the health of the Nation’s economy that it needs

Washington’s immediate attention. The time for action is now. Congress and the

Administration need to address this important national policy issue as soon as

possible.

The possibility of further terrorist attacks elucidates the need for mechanisms to

assure the continuing availability of coverage for these risks. Although the insurance industry is prudently managed and well capitalized, it cannot and should not

be expected to provide coverage for an uncertain number of attacks in the future

(that cannot be scientifically modeled) without the establishment of a Government

mechanism that can provide a backstop for losses caused by terrorism. While most

insurance policies today exclude damage from war, they typically do not include terrorism exclusions.

The problem now is that many understandably skittish domestic and foreign reinsurers stated that they would not cover terrorist acts when contracts come up for

renewal on January 1. Primary insurers warn they cannot support repeated terror

claims, especially if reinsurers exclude such losses from coverage. Without reinsurance, insurers will leave markets, exclude terrorism coverage or charge premiums

that, in essence, will make insurance coverage unaffordable and largely unavailable.

The specter of any of these options has dire ramifications for commercial consumers

of insurance products that need the financial protection offered by insurance to stay

in business and on commercial life insurers, agents, and brokers that serve them.

Failure to address this potential coverage gap will thus not be felt only within the

insurance industry but on the national economy as a whole.

Development of a terrorism reinsurance pool to cover commercial policies is critically important not just to insurance companies, agents and brokers, but also to the

future viability of literally hundreds of thousands of small and large U.S. businesses. Without some kind of mechanism to cover terrorism losses, insurance protection would be difficult—if not impossible—to find, financiers would be reluctant to

lend, and businesses would be hesitant to invest. The end result is an economic

shockwave to the U.S. economy. No one wants to return to an insurance market like

the mid-to-late 1980’s when the lack of available or affordable insurance altered the

business and personal activities of Americans. Therefore, the issue of terrorism reinsurance is critical.

For this reason, IIAA supports the creation of a Federal backstop to ensure that

the industry will be able to continue offering coverage for damages caused by terrorism. In establishing such a backstop, we will be able to restore coverage for the

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millions of businesses that will otherwise be unable to renew their current insurance policies and we will be able to restore the confidence customers rely upon in

securing their needs through all insurance policies.

When insurance industry representatives testified before the U.S. House of Representatives Financial Services Committee on September 26, the panelists’ concerns focused more on the future than the present, and all seemed to agree that the U.S.

Government must play a role in addressing the need for terrorism reinsurance. IIAA

believes that Congressional action is necessary, and we believe the creation of a

Federal backstop is a necessary element of any proposal that attempts to address

these issues. The establishment of a Federal backstop would help ensure the continued solvency of the insurance industry, stabilize premiums, allow reinsurance companies to have renewed confidence to underwrite primary insurers, and make terrorism coverage available to the buyers who urgently need it. Regardless of whether

it is the stability expected from the proposed establishment of a U.S. Treasury Federal backstop that the insurance industry agrees upon, a division of future terrorist

claims between the insurance industry and the Federal Government suggested by

the Administration, or a hybrid proposal, the core objective must be to insure that

mechanism are instituted to enable small and large businesses to purchase insurance policies that might otherwise be unavailable or unaffordable in the wake of the

September 11 attacks. IIAA pledges to continue working with the Administration,

Members of this Committee, consumers, our industry colleagues, and any others to

ensure that an appropriate solution is attained. The issue of terrorism reinsurance

is so vital to the future of American businesses and to the health of the Nation’s

economy that it needs the immediate attention of Congress. Without a backstop for

acts of terrorism, most insurance companies have two options stop writing many

types of commercial insurance or charge significantly higher premiums. The specter

of either option has dire ramifications for many business owners and agents and

brokers. The impact on independent agents and brokers and their business clients

is such a major concern that IIAA believes prompt Congressional action is absolutely necessary. We are very pragmatic when it comes to drafting and moving legislation to address this national issue. While interested parties may have differing

opinions on how such a mechanism should work, we believe it is far more important

to expeditiously work through differences to achieve the timely enactment of a proposal that can meet the immediate and long-term needs of the customers of independent agents and brokers, We stand ready to work with you on this important

national issue.

—————

STATEMENT OF MARC H. MORIAL

MAYOR OF NEW ORLEANS, LOUISIANA AND

PRESIDENT, U.S. CONFERENCE OF MAYORS

My name is Marc H. Morial, and I serve as the Mayor of New Orleans, as well

as the President of the U.S. Conference of Mayors. I appreciate the opportunity to

submit this statement in support of Federal legislation to create a reinsurance

mechanism to help manage future terrorism risk.

The U.S. Conference of Mayors has been in Washington this week meeting with

Governor Ridge regarding the efforts of the Office of Homeland Security to protect

our Nation from heinous terrorist acts such as the World Trade Center and Pentagon attacks of September 11, and the more recent distribution of anthrax through

the U.S. mails.

We are hopeful that the Office of Homeland Security, as well as the other fine

efforts of Congress and the Administration, will prevent future terrorist attacks on

U.S. soil. However, in the event that such attacks may occur, insurance is critical

to the ability of cities like New Orleans to protect themselves, their residents, and

the businesses located within them from ruinous financial harm.

Unfortunately, the possibility of further terrorist attacks has made property/casualty insurance against the terrorism risk virtually unobtainable. This market crisis

will be greatly exacerbated very soon, since many reinsurance and commercial

insurance contracts come up for renewal each January 1. Reinsurers already are

saying they will exclude ‘‘acts of terrorism’’ from coverage on a going-forward basis.

Primary insurers may soon seek to follow suit. Such exclusions would leave municipalities and airports, as well as their residents and business citizens, greatly exposed to future losses. The immediate enactment of Federal terrorism reinsurance

legislation is needed to avert this market crisis. Cities like New Orleans need to

focus their efforts on preventing future terrorist attacks, not on struggling to find

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insurance in a market that does not have the financial capacity to address our

needs.

The need for a Federal terrorism reinsurance program affects us at several levels.

First, our Nation’s economy is in turmoil and was in trouble before the September

11 tragedy. Now in the aftermath, we recognize that certain economic sectors are

further imperiled. It is important for Congress to enact an economic stimulus program. America needs to create new jobs for its workers and help keep the people

who have jobs employed. But this effort may be all for naught if there is no insurance. Insurance is a critical element supporting our Nation’s economic infrastructure. We can talk stimulus all we want but without insurance no one is going to

build new buildings, no one is going to invest capital in new ventures, no one is

going to employ the people who live in our cities and towns. Our economic well

being is dependent on the availability of insurance.

Second, many cities carry private sector insurance for our municipal properties,

municipal workforce, and liability exposures. In the absence of insurance, we simply

do not have programs in place to manage terrorism risk. Moreover, even assuming

we can obtain coverage, if the price of insurance skyrockets because insurers have

no way to even begin to quantify this exposure, these cost increases must be passed

through to our taxpayers, at a time when many of them have seen their income drop

as a result of the indirect effects of the September 11 tragedy. While we recognize

that Federal legislation is not going to remove this risk entirely from our portfolio,

a Federal backstop to private insurance will help us to better manage this risk.

Third, our residents and corporate citizens need to obtain their own insurance

coverage. While this need exists nationwide, based on the attack on the World Trade

Center some people perceive that the cities in our Nation have a greater terrorist

threat. If businesses which choose to locate in urban areas cannot obtain insurance,

they may relocate to suburban or rural areas, robbing us of critical economic development and the resulting tax base. For cities like New Orleans that rely heavily

on tourism, it is also critical that hotels and other tourist destinations in urban

areas can get insurance, or they may be forced to shut their doors, robbing us of

the revenue that tourists bring to establishments throughout our city.

Fourth, cities throughout the United States rely on insurers to invest in municipal

bonds. In 2000, the par value of municipal bonds held by the insurance industry

in the United States totaled $212,443,600,509 (102,368 issues), and for the State of

Louisiana, $2,590,746,580 (1,835 issues). Moreover, nearly two-thirds of the property/casualty insurance industry’s assets, or over $500 billion, are invested in governmental bonds, with the vast majority of these at the municipal level. These

bonds are essential in allowing State and local governments to finance everything

from schools, parks, highways, sewer, and water facilities to airports and senior citizen housing. If another major terrorist attack occurs, and insurers do not have adequate capacity, insurers would be faced with selling billions in bonds. This, in turn,

could depress the value of bonds as huge volumes are liquidated, particularly in an

economic downturn environment, making it more difficult for State and local governments to finance new projects or to rebuild.

For cities like New Orleans, the consequences of the impending terrorism insurance market failure are real and serious, from the perspective of our own risk management programs, the preservation of our tax base, and the viability of our municipal bond offerings. I urge Congress to take immediate legislative action to address

this issue as part of our Nation’s efforts to enhance homeland security.