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76–182 PS 2001

PROTECTING POLICYHOLDERS FROM TERRORISM:

PRIVATE SECTOR SOLUTIONS

HEARING

BEFORE THE

SUBCOMMITTEE ON

CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON

FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

OCTOBER 24, 2001

Printed for the use of the Committee on Financial Services

Serial No. 107–48

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

BARNEY FRANK, Massachusetts

PAUL E. KANJORSKI, Pennsylvania

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

NYDIA M. VELA ́ ZQUEZ, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missiouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director

(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

ROBERT W. NEY, Ohio, Vice Chairman

CHRISTOPHER SHAYS, Connecticut

CHRISTOPHER COX, California

PAUL E. GILLMOR, Ohio

RON PAUL, Texas

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

BOB BARR, Georgia

WALTER B. JONES, North Carolina

STEVEN C. LATOURETTE, Ohio

JOHN B. SHADEGG, Arizona

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

VITO FOSSELLA, New York

JUDY BIGGERT, Illinois

GARY G. MILLER, California

DOUG OSE, California

PATRICK J. TOOMEY, Pennsylvania

MIKE FERGUSON, New Jersey

MELISSA A. HART, Pennsylvania

MIKE ROGERS, Michigan

PAUL E. KANJORSKI, Pennsylvania

GARY L. ACKERMAN, New York

NYDIA M. VELA ́ ZQUEZ, New York

KEN BENTSEN, Texas

MAX SANDLIN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

FRANK MASCARA, Pennsylvania

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

BRAD SHERMAN, California

GREGORY W. MEEKS, New York

JAY INSLEE, Washington

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

STEVE ISRAEL, New York

MIKE ROSS, Arizona

(V)

C O N T E N T S

Page

Hearing held on:

October 24, 2001 ............................................................................................... 1

Appendix:

October 24, 2001 ............................................................................................... 70

WITNESSES

WEDNESDAY, OCTOBER 24, 2001

Cummins, J. David, Harry J. Loman Professor of Insurance and Risk

Management, The Wharton School, University of Pennsylvania ..................... 48

Harrington, Scott E., Professor of Insurance and Finance, Moore School of

Business, University of South Carolina ............................................................. 46

Hillman, Richard J., Director, Financial Markets and Community Investment,

U.S. General Accounting Office .......................................................................... 58

Hubbard, R. Glenn, Chairman, Council of Economic Advisers ............................ 25

Iordanou, Constantinos, Senior Executive Vice President of Group Operations

and Business Development, Zurich Financial Services Group ......................... 44

Keating, David L., Senior Counselor, National Taxpayers Union ....................... 49

Mathis, David B., Chairman and CEO, Kemper Insurance Companies ............. 42

Nordlinger, Marjorie S., Senior Attorney, Office of the General Counsel, U.S.

Nuclear Regulatory Commission ......................................................................... 56

O’Neill, Hon. Paul H., Secretary, U.S. Department of the Treasury, accompanied by Sheila Bair, Assistant Secretary for Financial Institutions ............ 5

Sinnott, John T., Chairman and CEO, Marsh, Incorporated ............................... 52

Williams, Roy A., Director of Aviation, Louis Armstrong New Orleans

International Airport ........................................................................................... 54

APPENDIX

Prepared statements:

Kanjorski, Hon. Paul E. ................................................................................... 71

Cummins, J. David ........................................................................................... 107

Harrington, Scott E. ......................................................................................... 102

Hillman, Richard J. .......................................................................................... 137

Hubbard, R. Glenn ........................................................................................... 80

Iordanou, Constantinos .................................................................................... 95

Keating, David L. ............................................................................................. 113

Mathis, David B. ............................................................................................... 87

Nordlinger, Marjorie S. .................................................................................... 130

O’Neill, Hon. Paul H. ....................................................................................... 73

Sinnott, John T. ................................................................................................ 123

Williams, Roy A. ............................................................................................... 126

(VI)

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Page

Harrington, Scott E.:

Written response to a request from Hon. Richard Baker ............................. 106

American Academy of Actuaries, prepared statement ......................................... 179

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, joint

prepared statement .............................................................................................. 170

American Council of Life Insurers, prepared statement ...................................... 159

Independent Insurance Agents of America, prepared statement ........................ 167

(1)

PROTECTING POLICYHOLDERS FROM

TERRORISM: PRIVATE SECTOR SOLUTIONS

WEDNESDAY, OCTOBER 24, 2001,

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE

AND GOVERNMENT SPONSORED ENTERPRISES, COMMITTEE ON FINANCIAL SERVICES, Washington, DC.

The subcommittee met, pursuant to call, at 1:35 p.m., in room

HC-8, The Capitol, Hon. Richard H. Baker, [chairman of the

subcommittee], presiding.

Present: Chairman Baker; Representatives Ney, Shays, Cox,

Bachus, Royce, Lucas of Oklahoma, Shadegg, Weldon, Fossella,

Biggert, Miller, Ose, Toomey, Hart, Rogers, Kanjorski, Bentsen, J.

Maloney of Connecticut, Hooley, S. Jones of Ohio, Capuano, Sherman, Inslee, Crowley, Israel, and Ross.

Also Present: Representatives Oxley, Roukema, LaFalce, and C.

Maloney of New York.

Chairman BAKER. I offer a small apology for the environment in

which we find ourselves holding this hearing on this most important matter. We, of course, appreciate all of the courtesies extended

by all of those interested in the matter, and we certainly will try

to facilitate providing information from the hearing to all of the

parties, for those who can’t simply get in the room. Ranking Member Kanjorski and I have adopted a no-jacket requirement for the

proceedings. Feel free to comply at your leisure. I suspect as the

day wears on, that will become a better and better idea.

Of course the hearing today is an extraordinarily important one,

and I am very anxious that we as a subcommittee come to some

recommendation for resolution of a problem of potentially significant systemic events to our economy. There is no doubt that we

must act, and we must act in a timely way. But we should also act

as best we can in the most professional and responsible manner

time will permit. It may be very difficult to reach a long-term permanent solution if the remaining tenure of this session is indeed

a matter of days. If, however, we have the luxury of time, then I

am confident working together with regulators, the industry, stakeholders, consumers and members, we can reach an accord which

will make economic sense and sense to the American taxpayer.

To that end, I merely want to point out one historic event that

I think is constructive in these times. Going back to the days of the

Reconstruction Finance Corporation under the Roosevelt presidency pursuant to the Great Depression in which in the course of

the activities of that organization some $50 billion worth of finanVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
2

cial resources were made available to a plethora of business organizations. What I found interesting about it is the manner in which

the Texas businessman administered that program at the direction

of the President. Fifty billion dollars in the 1930s is an extraordinary program, and at the end of the day, Jessie Jones, the administrator of the program, recouped every cent of taxpayer dollars.

Now, I know that the discussion of repayment of credit extensions is a very contentious matter, but as I said to some insurance

company executives, they have their shareholders, and we have

ours. They simply want our shareholders to give up our resources

with no expectation at the moment of having their shareholders

repay this courtesy.

I for one feel that is a very appropriate thing for us to explore

and to discuss and not simply because of the urgency of this matter

take action that leaves taxpayers with unlimited, incalculable liabilities. However, there is no doubt that the events of this year

are extraordinary. Very difficult to reconcile, and we hope never to

occur again, but we simply cannot rely on those events not reoccurring, perhaps unfortunately even in the near term. So the subcommittee must act.

I would refer Members to the Jessie Jones story of the 1930s

with the recognition that the elements of that resolution were the

basis for the Lockheed assistance in 1971 and the Chrysler Corporation workout in 1979, both of which resulted in taxpayers’ resources being repaid and in one case the Government actually taking an equity position in one of the deals and showing a small profit. I think those are very helpful for the subcommittee to consider

in the course of this difficult matter.

With that, I would like to call on the Ranking Member Kanjorski

for an opening statement.

Mr. KANJORSKI. Thank you, Mr. Chairman. Mr. Chairman, I

have prepared a full statement, but not to bore everybody in the

room, I am going to try and truncate.

I just want to state my position, and it is very simply this. As

a result of the occurrence of September 11th, I believe we must

temporarily reinsure the marketplace to safeguard against the cascading financial crisis. In recent weeks, several alternatives to

solve the problems were merged from one plan to establish a Government backstop for reinsurance designed to spread the risk

across the industry. Another approach using quotas would distribute reinsurance costs for between industry and Government,

and other solutions include allowing companies to build taxpayers

reserves, limiting liabilities from damages as we presently do for

accidents to nuclear reactors and facilitating the issuance of catastrophic bonds.

From my perspective, any legislation to assist the insurance industry and our economy in the short term should adhere to four

principles. First, to the extent possible, the primary insurers must

continue to bear the tangible share of the risk for future attacks

through the use of deductibles, premiums or assessments. Equity

owners must also carry some share of the risk in order to encourage them to implement appropriate safeguards.

3

Second, we must sunset the program. The reinsurance industry

is dynamic, and we should not disrupt the development of new

products.

Third, in order to protect taxpayers, we should consider placing

caps on the Government’s liability and implementing adequate

oversight.

And fourth, everyone from the real estate mogul to the average

homeowner should participate in the program.

As I have said in our last hearing, we must move cautiously and

methodically in addressing this problem in order to prevent unintended consequences. Given our forthcoming adjournment, however, we must also move swiftly. Instead of convening additional

hearings on this problem, we should quickly assemble a bipartisan,

bicameral group to negotiate the solution with experts and industry

leaders. Time is of the essence, and I stand ready to work with you,

Mr. Chairman, and all other interested parties on these matters in

the upcoming days.

[The prepared statement of Hon. Paul Kanjorski can be found on

page 71 in the appendix.]

Chairman BAKER. Thank you, Mr. Kanjorski.

Chairman Oxley.

Mr. OXLEY. Thank you, Mr. Chairman, and I will make the full

statement part of the record. Without objection.

Chairman BAKER. Absolutely.

Mr. OXLEY. Welcome, Mr. Secretary. This is, as you can tell from

the other opening statements, a very serious issue we are all aware

of. We need to address this. This will be, along with our money

laundering bill we passed last night in the House, probably the

most important issue we are going to have to face and we need to

do it in a timely manner, and I salute the Chairman of the subcommittee and the Ranking Member for their leadership on this

issue. We all have to pull in the same direction.

I think we will find some differences of opinion on the proposal

that you will be outlining, along with the industry people, but the

purpose of this hearing, as I discussed with Chairman Baker, is to

get all of our cards on the table, all of the ideas on the table and

then start to whittle away until we create something that we can

all live with and that will work.

Clearly this is not just an insurance issue. This is an issue that

will affect our entire economy. A concern all of us have, I think,

is that we will get a domino effect on the inability of companies to

get insurance, the inability of lenders to lend to those companies,

and it would have enormous negative consequences, and I notice

you commented on that in your statement. So we are all in this together, and we will work with you and all your folks on this issue,

and I yield back.

Chairman BAKER. Thank you.

Ranking Member LaFalce.

Mr. LAFALCE. Thank you very much, Mr. Chairman. I ask too,

unanimous consent to put my full statement in the record.

Chairman BAKER. Without objection.

Mr. LAFALCE. Let me give you a couple of thoughts. First of all,

I have been through so many situations over the years where we

have been cutoff the credit or at least the credit crunch due to seVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
4

vere problems, lenders liability under CERCLA, for example, the

banks wouldn’t lend to the business if there was the remotest possibility of environmental difficulty for which they could, because of

a $5,000 loan be liable for a $5 million cleanup, and I am most

fearful of the economic impact to the United States, the damages

to the economy, if we have the cessation of terrorism insurance.

Do I think the problem is real? Unfortunately, I do. I do think

it is real, and therefore I think we have to do something.

Now, what do we do? I wish we had the luxury of careful deliberation. We don’t. If we had the luxury of careful deliberation, I

think we should come up with some scheme. It might be something

similar to the scheme that England has, with a Federal charter

and a Federal regulatory supervisory role commensurate with the

Federal risk. I think that is going to be difficult to implement. We

don’t have that much expertise within the Federal Government

right now to implement that immediately, and that is one of the

reasons I think that representatives from the insurance industry

have come up with a single State charter, but the State charter

could be with an administerial role for the State, but still, because

of the Federal assumption of risk a strong Federal regulatory supervisory role. I think that is a possibility. It is not my preference,

but it is something. But even then, I don’t know if we have the

time to do it or the present expertise in the Federal Government

to do it.

The third alternative is some stopgap, and I think that is where

the Administration is, based upon my conversations with both

Sheila and Peter Fisher. That is not my preferred option, but it

may be the only viable option now. If that is true, it is either easier

to coalesce around one Administration approach than it is one approach after 535 individuals have come to consensus, so I am willing to do it. But not willy nilly either. You know, there has got to

be some principles that we follow, and at least we have to make

sure that we are going to provide insurance for all Americans and

businesses who need it, including a full range of property and casualty coverage. For me—and I don’t know if the Administration is

there yet—I think that means business interruption insurance, too.

I want you to address the issue, because I don’t think we are

adequately covered if we don’t have that.

Second, if the Federal Government is going to put its toe into the

water, we have got to make sure we have got all the desirable regulatory safeguards to protect the American taxpayer. We can’t, you

know, put a toe in without being protected. OK?

We have to require the industry to share the burden of any system that is ultimately adopted, and I think perhaps requiring even

more of a first dollar contribution than presently contemplated by

the Administration, that is negotiable, and have the price structure

that provides compensation to the Federal Government while offering affordable prices to the ultimate consumer and facilitate the return of the private reinsurance market as soon as is possible if it

is ever going to be possible. I look forward to working with you and

Sheila.

Chairman BAKER. Thank you, Mr. LaFalce.

5

I would ask if possible for all of the Members’ statements be

made a part of the record so we could hear from our first witness.

Without objection, so ordered.

It is a pleasure to welcome you here, Mr. Secretary. Chairman

Oxley wanted me to make it very clear, he is not responsible for

the meeting arrangements. He would have treated you with greater

deference, I am sure, had we the luxury of time.

Mr. OXLEY. Mr. Ney.

Mr. NEY. Hey, this is the way our country was formed. Get with

it.

Chairman BAKER. I hope we are as successful. With no further

delay, Mr. Secretary, we are honored to have you here today on

this most important matter. Thank you, sir.

STATEMENT OF HON. PAUL H. O’NEILL, SECRETARY, U.S. DEPARTMENT OF THE TREASURY; ACCOMPANIED BY SHEILA

BAIR, ASSISTANT SECRETARY FOR FINANCIAL INSTITUTIONS

Secretary O’NEILL. It is a pleasure to be with you and all the

subcommittee Members. And Chairman Oxley, if I may pick up on

a point you made——

Unidentified SPEAKER. Can you speak up a little bit for those of

us that are sitting on the end here? Thank you.

Secretary O’NEILL. Let me say again, thank you very much for

the speedy and I think very valuable action on money laundering.

We are determined to do what the President said and wage a successful war on terrorist finance, and money laundering is a part of

that issue and drug running and all the other things that we have

talked about for a long time. With the added authority you have

given and with the President’s Executive Order, we are going to

make this happen. We are going to shake down these people and

their finances and do everything we can to take them out of business and we have had great cooperation around the world, and

thank you all for that.

Now, to the issue of today, I don’t know—did all of you—whether

you had a chance to look at the prepared statement or not? And

Chairman, how would you like for me to proceed? I have a short

oral—actually, it is about 10 or 12 minutes—oral statement. If you

would like me to begin with that, or I can simply put it in the

record and go to questions, whichever you would like.

Chairman BAKER. Proceed as you wish. Maybe outline the highlights of the plan, and I think this opportunity for Members to engage with you would be terrific.

Secretary O’NEILL. Great. As I said, I appreciate the opportunity

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

a real and present 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 the 11th. Such coverage is

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

6

As a result, after January 1st 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 much higher cost. This would have widespread effect to

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

Our view is the problem is that insurance companies do not take

a risk, and it is a misunderstanding of the insurance process to believe that insurance companies take risk. What they do do is knowingly accept and mutualize risk, which is another way of saying

they do analysis of the possibility and probability of an undesirable

event happening and then they assemble all the people in the society that they can who have the same kind of risk and charge

enough premium so that in the event there is an occurrence of an

adverse risk, they have the wherewithal to pay off the cost that

they have contracted to pay, and at the end of the day what insurance companies do is that mutualizing of risk function, and in

order to stay in business they must always have enough combination of premium income and earnings from the premiums that they

collect in order to discharge all their obligations and make a market rate of return on the capital that they have employed.

So I want to say as affirmatively as I can that the Administration is not for ‘‘bailing out’’ the insurance industry. What we have

proposed is not bail out anybody; it would instead provide for an

ongoing mechanism to insure and to provide for the mutualization

of risk.

Because insurance companies do not know 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 the consumers in the form of higher product prices, transportation costs, energy costs and reduced

production. Put another way, any of these choices have the potential to cause severe economic dislocations in the near term, either

through higher insurance costs or higher financing costs.

Since September the 11th, the uncertainty surrounding terrorism

risk has disrupted the ability of insurance companies to estimate

price and insure risk. Now, as we worked on this subject, we said

our objectives are, first, in grappling with this problem, 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 possible.

After reviewing an array of options—and I truly believe we have

looked at the limits of the options that are available—we developed

an approach that we believe best accomplishes these objectives.

This approach reflects the current evolution of our thinking on this

issue, and let me say as clearly as I can, we want to work with you

7

to achieve the best possible solution. When terrorists target symbols of our Nation’s political and military power, they are attacking

the Nation as a whole. 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 have 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 the

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

and would be the same as that for other risk.

Any loss claims resulting from a future terrorist act would be

submitted by the policyholders 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 also play an important role in monitoring the claims process and ensuring the overall integrity of the

insurance system. Through the end of next year, 2002, the Government would absorb 80 percent of the first $20 billion of insured

losses resulting from terrorism and 90 percent of insured losses,

about $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.

Under this approach, the Federal Government is about absorbing

a portion, but only a portion of the first dollar losses, which we believe is important to do in the first year of the program. The key

problems faced by insurance companies right now is pricing for 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 are prepared and happy to work with you to shape

an acceptable outcome.

The role of the Federal Government would recede over time, with

the expectation that the private sector would further develop its capacity each year. 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 insured losses between $20 and $40 billion, and 10 percent of insured losses above $40 billion, and 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

8

at $100 billion. It would be left for the Congress to determine payments above $100 billion.

The Federal Government’s involvement under our recommendation 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 ensure that the 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 behavior rather than overzealous litigation. These procedures are important in mitigating losses arising from future terrorist attacks on

our Nation and are an absolutely essential component of the program that we have put together.

Now, 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.

We have limits for Government’s direct involvement in all those

elements of our private insurance system that continue to operate

well, and we provide the transition period to allow the private sector to establish market mechanisms to deal with the risk that confronts our Nation.

In conclusion, I would say one more thing that I suggested this

morning to the Senate committee. I honestly don’t think we are

going to know whether what we fashion together will work, in fact,

until it is tested in the market. As well meaning as we may be and

as brilliant as we may be, only the market will tell us whether we

fashioned a solution that works. And so I suggested this morning

to the Senate committee that you all may want to consider giving

the Executive Branch some power to adjust the terms of trade in

the frame of reference, because the policies that are at risk now are

going to get canceled if we don’t act at the end of December, and

usually policy renewal takes place 45 days before the end of the

contract period. So we don’t have an awful lot of time to go through

an endless process that works itself into next year, and so I think

this is a time to think about some extraordinary ways we can make

sure that what we do will work in fact, because we can’t afford not

to have a workable solution that takes care of this problem for the

near term.

Mr. Chairman, I am happy to answer any questions.

[The prepared statement of Hon. Paul H. O’Neill can be found on

page 73 in the appendix.]

Chairman BAKER. Thank you, Mr. Secretary.

Does somebody have a clock so we can keep our 5-minute rule

here? OK. Give me a 30-second, you know, hand signal. And as

best we can, you will advise me whatever the order for recognition

is.

With that, Mr. Secretary, let me say I very much appreciate the

description of the plan as outlined. Certainly I think in prior meetings with the Treasury officials that I have some concerns about

elements of the plan, but I want to start with where we agree. I

do believe we have to act. I do believe that if we cannot expect the

occurrence of anything similar not to bring about significant ecoVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
9

nomic consequences. And if we do not have an event and we approach January 1 and coverage is not made available, construction—the economy just stops. So we want to act very timely. To

that end, I also agree we can’t know how the market will react to

whatever mechanism we do expect, and that for consideration only,

perhaps the advisability of a short-term emergency response is to

get us through the early months of the year, and I understand the

industry reluctance to that. They can’t price on something that is

not real. But I would just observe that there is very little likelihood

that this Congress will reconvene next year and will take this matter up as the highest priority and attempt to act in a very thorough

and responsible manner, that even if that is not achievable, then

I very much like the idea of discretionary authority and responsibility being given to the Administration to manage this event.

So if we don’t get it right, there is the ability to act without the

necessity of Congressional intervention to protect our economic viability. At the same time, one of the principal things I think that—

as you would surmise from my opening statement, is some capacity

at the appropriate window for expected repayment. If we go

through the scenario of a $100 billion event, given the constraints

of the programs now written, the United States taxpayer would ultimately pay for more than two-thirds of the claims paid. I hate to

use this, because I overuse this so much, and Mr. Kanjorski doesn’t

like me using it so much either, but I will do it anyway. It is almost like a GSE chart. If you make money you get to keep it. There

needs to be some balancing of equities in this, and with all due respect to the proposal, my initial first reaction to it is it certainly

is better than the industry proposal we saw, because we do have

some participation by the industry.

But I want to take you up on the statements that you repeatedly

made that we want to work through this, and a mechanism whereby we can visit again, maybe not this week, certainly early next,

and go through the essential elements that I think ought to be in

any proposal. Administrative concerns, again side-stepping the policy for a moment, if we are going to have to direct providers of insurance laying claim to the United States Treasury for reimbursement of monies paid out as a result of an act of terrorism, the administrative process to do that with 2300 insurance companies

each paying multiple claims, unfortunately for those concerned

about bureaucracy, you have got to have some questions about how

that is going to work. Then we are going to audit and make sure

where the money went. I have suggested that our interface with

the industry might be at a slightly different level. Wave fast and

hard, so I can see. If we engage at the commercial reinsurance

level, and it also speaks not only to minimizing the numbers of people with whom you would have to engage, but they are the folks

really backstopping in the private market the risk of the direct provider. They also are the ones who set the underwriting stuff. So if

you need that extra security, if you need an extra person at the

door, if there is some other extraordinary circumstance which is

identified in the market as being necessary, let the market dictate

those requirements. I would be concerned that the more we become

responsible, the more the pressure would be on the Congress to creVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
10

ate more regulatory constraints and to begin to set those standards

of what is acceptable conduct.

And then lastly, by leveling at the commercial reinsurance window, we narrow the scope of review of the eligible participants who

have access to the funds. I don’t want to have happen with the insurance industry what I would be so bold to say I think may have

happened with the airline industry, where there were losses going

into the September window that were rolled into the claims paid

pursuant to the September event. We need to know who is getting

in, that they are solvent, they have the capacity to meet the responsibilities as best any reasonable person could dictate, and if we

do that only with the commercial reinsurers, we again are looking

at corporations, generally international in scope, generally well

priced by the market, and we have a clear view of what their operational condition might be, to limit again the Federal role and bureaucratic responsibility in what will be a very difficult time.

I can only imagine the explanation by the agent on the street to

a claimant about why they hadn’t gotten the payment, because the

Federal Government hadn’t acted in a timely manner.

Am I out? I am out. I am not even 30 seconds. I am out. But let

me just leave it at this. I appreciate your willingness to come here

today for this purpose. I appreciate the tone and comments that

you have made, and I just as an individual in the room—and I am

sure others will speak for themselves—really do want to engage the

office to try to come with some resolution.

Thank you very much.

Mr. Kanjorski.

Mr. KANJORSKI. Mr. Chairman, thank you very much. I have a

few questions. Of course, I could name certain principles I would

like to go through in terms of when we put this policy together, but

first and foremost, on the Administration’s proposals, I don’t see an

incentive for the insurance industry to want to resolve the issue

until the absolute down day of 2004. I think if the Government gets

involved, and I think we should get involved, there has to be an

incentive, either premiums collected or a penalty derived by the

Government to encourage the private sector to take up the reinsurance issue. If not, it would seem to me all companies would stand

to the bitter end, and I think one of the examples we have always

had in flood insurance is there was never an incentive to get out

and privatize it. It is going to stay with the Government as long

as I guess the leaves turn to brown.

There is a couple of questions I have. One, I think we should insure actual loss, but not necessarily economic gain loss. You know,

we have gone through a tremendous appreciation of assets over the

last 7 or 8 years, and I think it would be foolhardy for the taxpayers to bail out investors 100 percent, or a mortgage holder 100

percent if there is reactivation going on in the system to take advantage of moving up the value of the asset to the highest degree

or even above 100 percent. We have got to have some stopgap in

there to protect it.

Second, I would like to ask you what portion of this business are

we providing the Federal insurance for that is international? How

many foreign companies?

Secretary O’NEILL. None.

11

Mr. KANJORSKI. We would not cover any foreign?

Secretary O’NEILL. Well, if they were a resident of the U.S., I

think they would have all the right that any one of standing has

in the U.S., but this is territorial. This is the U.S. .

Mr. KANJORSKI. Well, U.S. limited policy, but the—— Mr. KANJORSKI. Right, but we still have primary insurance for

foreign companies, and this would apply to all companies across

the board. Is that correct? Is there any way we can give a preference to the American insurers?

Secretary O’NEILL. I don’t think you want to distinguish between

sources of the capital where somebody’s money is better than somebody else’s.

Mr. KANJORSKI. So the RAC national insurance—— Secretary O’NEILL. There are people we don’t let into the country

for very good reasons.

Mr. KANJORSKI. I am just being facetious.

Mr. LAFALCE. If they are insurers, they have to be licensed

in——

Secretary O’NEILL. Yes.

Mr. KANJORSKI. I would rather look at a portion, some graduation of liability. I like the fact that the first dollar the primary insurer has to stand some risk, but I think there should be maybe

reverse graduation involved to where we get involved and then, finally, probably some sharing of the premiums. There has got to be

something to the taxpayer that takes the risk, simply because I am

trying to distinguish in my own mind—and I am not sure that I

can anymore—of the occurrence of September 11th, whether that

is a terrorist attack or an act of war. Clearly insurers and banks

and other investors take the risk of actual war. They are not covered for that. So we could pretty close—I mean, using the President’s word, we could make a very strong argument that we are in

an undeclared war, and, therefore, we are picking up the next liability for the taxpayer.

I am willing to do that because I see the economic component,

but I think that is justified. But I would just like to see that incentive for the private sector to get involved as early as possible. Some

share—maybe the premium should be higher than the private sector so that the private reinsurance industry will see an opportunity

to rush in and provide that insurance as soon as possible as opposed to delaying it. We may be interrupting the development of

that market by being too generous, and thirdly, real losses as opposed to book losses, I think that is essential.

Secretary O’NEILL. May I comment?

Chairman BAKER. Please proceed.

Secretary O’NEILL. I think from some of the things I have read

in the newspapers and some of the comments made, it may be useful to talk a little bit about the concept of insurance. I have tried

to do that a little bit in my paper, but I think maybe it is worth

emphasizing some points so that we are on the same ground together, and if—you know, simply because of the comments an insurer makes about repayment. Under our scheme, we are not giving—we, the people of the United States, are not giving the insurance companies anything. We are not giving them anything. Now,

when you say repayment——

12

Mr. KANJORSKI. We are giving them coverage support.

Secretary O’NEILL. No, we are not at all. What we are doing is

we are saying to the insurance companies that if you go out and

write terrorism insurance, that after you reach a level of 20 percent

of the $20 billion in the first year, that you don’t have any remaining liabilities. Now, you know, maybe what we haven’t made clear

enough, and I guess we presume is clear, but it is obvious it is not,

is that they are not going to write insurance for more than the size

of their liability and the size of the premiums that they aggregate

together. So they are not going to write us up for $100 billion. We

are simply saying we would like for the private sector to play a

role, and you are not going to do—we think they won’t do it if they

have unlimited liability and no reinsurance pool, that there is not

going to be any insurance available.

OK. But if you understand how insurance companies work, what

they do is they go out and find people with similar kinds of risk,

and they do an assessment of what is the possibility of an untoward event, and then they collect enough premiums and invest the

money so that they make income from the invested money, and

when there is an untoward event, they pay off. OK? And this would

work exactly the same way, but the liability, that is limited, and

the reason we started with a fairly low number is because if you

think about this now from the point of view of an individual insurance company and, you know, let’s take the World Trade Center

now and you be the proprietor of an individual insurance company.

You would not today go in there and take a risk of having to pay

off a $3.2 billion claim unless you are going to get paid something

like $3.2 billion, because if it happens, it is a 100 percent event.

OK?

Chairman BAKER. If I can, the gentleman’s time has long since

expired, and the Chairman is next. Chairman Oxley.

Mr. OXLEY. Mr. Secretary, let me take you through some of the

criticisms of your proposal. The first one is that this is an obvious

industry bailout. You have addressed that to some extent, but indeed we are asking insurers to collect 100 percent of the premiums

and then the taxpayers in the first year at least would pick up the

bulk of that cost at 80 percent.

Secretary O’NEILL. That is not really right. You know, it comes

across as that portrayal, and I realize now we were not clear

enough. The insurance company is not going to write $100 billion

worth of face value coverage for $4 billion worth of premiums.

What this basically says is we are creating a way for the insurance

industry to create a pool that provides a first layer of

mutualization of risk with an upper limit of $4 billion in the first

year, and the taxpayers are going to, in effect, self-insure the rest.

They are not getting paid premiums for $100 billion. They are

going to get paid premiums because of the way the process works

that gives them enough money to pay off the probable cost of insuring risk. And that is all they are going to get. They are not going

to get any gifts, because as competition works, the interaction between the consumers, like where I was before, the head of a company, the interaction between companies, they are saying I want

the lowest possible price, and the insurance company, you are saying I want to write the business. It is going to bring this price

13

down to a level that provides at the end a $4 billion pool to pay

off the probability of an untoward event, wiping out all of the

agreed contractual coverage for the insurance companies. It doesn’t

do more than that.

Mr. OXLEY. And in your proposal it is a 3-year package, basically?

Secretary O’NEILL. Well, we have said we think as we go along

that the insurance industry and the reinsurance industry will likely figure out how to deal with this issue as they were to deal with

Hurricane Andrew kinds of issues. They never have before. And so

we are saying let us look at a 3-year program with these kinds of

characteristics.

But again I want to say to you what I said before, until we put

this in the marketplace we are not going to know whether it really

works, and that is why we need to be fast on our feet, because if

this doesn’t work, we need to figure out a scheme that will actually

get the job done by the first of January.

Mr. OXLEY. Traditionally insurance has been based on obviously

risk assessment. Is it fair, for example, let us say that the target

is the Empire State Building, or obviously the World Trade Center

for a terrorist attack presents a lot more attractive target, if you

will, than, say, the Marathon Oil Building in Ohio. And indeed,

currently the insurance rates are, for a lot of reasons, different in

different parts of the country. Under your provision, and the way

you explained it, would the market ultimately then seek that?

Secretary O’NEILL. Absolutely. If you think about—and I don’t

want to be quoted as ‘‘O’Neill identified,’’ but you all think of places

that you know about that are obvious symbolic targets in the

United States. They are going to end up in what I would characterize as an assigned risk pool. You all know from your automobile

insurance, you know, if you are over 25 and have three children

and don’t drink and smoke, then you get a preferred rate than if

you are 15 years old and you wreck three cars and you get put in

an assigned pool. We are going to see the insurance industry go

through this probabilistic analysis and the premiums for high value

symbolic targets are going to be a lot higher than they are for a

suburban home in Maryland. The industry will work out what the

appropriate premiums are and again they will do it in a competitive framework of, you know, State Farm says I will cover your

house for this, and Hartford says I will give you a little bit less and

throw in a blender, and that is how this process is going to work.

Because of the scale of what we are facing and the short amount

of time that we have to deal with this, I think this is the only reason why we ought to be at the table, because it is right in front

of us. There is a high degree of uncertainty, and we need to make

sure that we don’t go over the cliff January 1st and there is no insurance protection, because the thing that drives us, if you are borrowing money—or even if you are getting money from equity supporters and you don’t have insurance to cover casualty loss to your

property, you are not going to be able to get intelligent investors

to give you money.

Right? Think about it as an individual investor. Would you give

your money to someone who had the risk of losing 100 percent of

14

all of their assets, including all of yours and no insurance coverage?

You wouldn’t do it.

Mr. KANJORSKI. Well, they do it all the time in war.

Secretary O’NEILL. Well, you know, I think you made an excellent point. If you go back and look at what we have done where

we have declared wars, basically the American people have been

the guarantor of casualty—of war-related events, and if we had a

declared war, I think you could make an argument that we ought

to move to that position. And I said earlier, one of the things that

we did in working this subject, because, you know, for me—and I

think for most of you—this is not an issue that lends itself in any

way to partisanship. This is how we get it right, and so we looked

at the question of maybe the American people should simply say

define terrorism and determination of a terrorist act, we are going

to use our system of collecting revenues and distributing benefits

to people; that is to say, the general fiscal policy of the United

States, to pay for acts, for the cost of acts that are determined to

be terrorist acts and we will just take the insurance industry out

of it.

Now, as I have said here, we didn’t get there because we think

the infrastructure of the insurance industry can bring real value to

dealing with the possible future terrorist events that otherwise one

would have to consider creating in the Federal Government. That

we think would be a disaster, to create a new Federal freestanding

agency that is in the insurance business with policy writers and

claims adjusters and all the rest of that stuff.

Chairman BAKER. Now you are scaring me.

Secretary O’NEILL. We don’t want to do that. And so we built in

this idea that by creating in effect the controlled and limited risk

and then ratcheting it up over time, that we can have the best of

all possible worlds and learn as we go along. None of us have been

here before.

Chairman BAKER. If I can, Mr. LaFalce.

Mr. LAFALCE. Yeah. Thanks very much. I will go quickly. We are

ready to let you take the lead. When will you get us the legislative

language by? I think there is a disposition to adjourn Congress by

Thanksgiving, maybe by Veterans’ Day. Some people will say Halloween.

Ms. BAIR. There is no Administration bill.

Mr. LAFALCE. Are you preparing it?

Ms. BAIR. We are prepared to work with the staff.

Mr. LAFALCE. Well, if you want to take the lead, you have to

take the lead. That means you have to come up with the language

quickly.

Second, what is the necessary effective date? It is one thing to

pass it in November, but when must it be effective by?

Secretary O’NEILL. The sooner the better. As I said to you, most

of the notices for renewal come out on the 15th of November, policies that expire on the 31st. So, you know, we need it quick.

Mr. LAFALCE. OK. Next, if you were to insure, Mr. Secretary,

would you advise them to give business interruption insurance or

not? I think the answer is yes, you would.

Secretary O’NEILL. The reason I am hesitating, I used to run a

$30 billion company. I did make a decision in some cases to provide

15

business interruption insurance, but out of my 26 businesses, I

made different judgments about different parts of my business, depending what the customer relationships were and contractual relationships.

Mr. LAFALCE. My point is for an awful lot of businesses it is not

their physical infrastructure. It is their business itself that is damaged. You know, they have no revenues coming in. They can’t pay

their bank back. They are going to go belly up with bankruptcy,

and they need insurance against that.

Secretary O’NEILL. We have not included it. It is a debatable

issue, and we ought to talk.

Mr. LAFALCE. You are not advancing it, but right now you are

not saying you are opposed to it?

Secretary O’NEILL. No.

Mr. LAFALCE. All right. I think we have to act on it quickly. I

am a little afraid that the insurance industry might be taking advantage of us, other people taking advantage of us. You have to be

wary of that, too, the same way this economic stimulus bill, think

the people are taking advantage of us. I think you would agree

with me.

Secretary O’NEILL. On the latter I agree with you; on the former

I don’t.

Mr. LAFALCE. Well, good. In other words, you agree with me on

the economic stimulus. It is an open question on insurance, or you

don’t. Fine.

Secretary O’NEILL. I think as long as we have competition.

Mr. LAFALCE. Then I understand you correctly, you agree with

me on the economic stimulus bill that we are being taken advantage of.

Mr. KANJORSKI. You are going to be quoted on the floor.

Secretary O’NEILL. I don’t want to get in trouble.

Mr. LAFALCE. You did say we were being taken advantage of.

Secretary O’NEILL. I didn’t say by who.

Mr. LAFALCE. This money——

Chairman BAKER. Is the gentleman out of time?

Mr. LAFALCE. I have been interrupted. I want my time. We

passed the money laundering bill today in the House. OK, fine. It

is up to you to implement it strongly, aggressively. It is a great

law. It can be meaningless unless you implement it strongly.

Secretary O’NEILL. Not to worry.

Mr. LAFALCE. OK, good. Now, I am a little concerned about your

theological opposition to the concept of a Federal charter. You

know, my God, we talk about the global economy and the need for

harmonization of our banking laws, our bankruptcy laws, our

money laundering laws, and so forth. But with respect to the insurance industry, which was one of the largest industries in the world,

my God, we can’t have the United States have a law on that. We

have got to defer it to the States. This is the 21st century, Mr. Secretary, and let us not be afraid to step our toe into the 21st century

with respect to insurance laws. Now, I am not saying we ought to

do it with respect to terrorism insurance, because we only have a

few weeks, and I don’t know that we could get there, but don’t be

afraid to put your toe in. It is necessary.

16

Chairman BAKER. Thank you, Mr. LaFalce. By my list, I have

Mr. Royce next. Is he here, Mr. Royce?

Mr. Bachus.

Mr. BACHUS. Thank you. Secretary O’Neill, I commend you for

coming forward. I am as serious as you about what you are proposing. The first is that to me this is not a backstop. We have got

the most recent proposal. Why is there not a layer of industry exposure any time there is a claim?

UNIDENTIFIED SPEAKER. Could you both speak a little louder,

please?

Secretary O’NEILL. The reserves that are currently held by insurance companies are held because it is their best assessment,

backed up by the securities laws about how much money they need

to put away in order to be worthy, creditworthy by the judgment

of the State insurance commissioner, that when they have events

they can pay off their customers. And so the reserves—— Mr. BACHUS. Adequate reserves.

Secretary O’NEILL. I am saying they don’t have extra reserves.

They have reserves to take care of the business they have already

written.

Mr. BACHUS. You are saying they don’t have adequate reserves?

Secretary O’NEILL. No.

Mr. BACHUS. So, that is why you came—no. I am just—that is

why——

Secretary O’NEILL. Well, you know, it begins with a very basic

understanding of how business works.

Mr. BACHUS. Yeah. I know how insurance works.

Secretary O’NEILL. And how insurance companies work. They go

out and they sell policies—. Mr. BACHUS. Now, you are lecturing us about—— Secretary O’NEILL. I don’t mean to be lecturing.

Mr. BACHUS. You have looked at a backstop proposal and you

have rejected that. You think first dollar coverage is necessary,

right?

Secretary O’NEILL. I think if we said to the insurance companies,

for example, right now that we want you to write terrorist risk insurance and you all are responsible for the first $50 billion.

Mr. BACHUS. The second question is this, there is no catastrophic loss of over $100 million, which is what I think is the worst-case

scenario, which I would think that you would address that. I think

that is what the reinsurance people are concerned most about.

There is absolutely nothing above $100 billion. Did you all consider

that?

Secretary O’NEILL. Well, what we basically said is when you get

to $100 billion, we the people of the United States will own it all.

Mr. BACHUS. You think so?

Secretary O’NEILL. Absolutely. Who else is going to put up the

money? I don’t know. There is no other mechanism in the world except the good faith and credit of the people of the United States

that is going to be good for anything over $100 billion.

Mr. BACHUS. All right, let me think. Third, I don’t think the insurance companies can prepare for phase-out of the Treasury program, because there is no tax incentive. There is no reserves

against terrorist risk or other means. Why don’t we start planning

17

for the future? This 3-year plan basically acts as if the world is

going to last another 3 years. What we ought to be doing is planning for the future and addressing this problem long term.

Secretary O’NEILL. A couple of points. I don’t think we know

enough to craft a plan that anybody can say this is the right thing

and this is what we ought to do. You know, I haven’t found anybody anywhere who thinks they completely understand how we can

fashion a perfect solution to this problem and work.

Mr. BACHUS. Let me ask you this. As I see it, it fails to spread

the risk of terrorist loss throughout the commercial insurance industries, does not provide the market stability necessary to encourage companies to cover terrorist risk. There is no requirement that

they cover risk to participate. They could cherry pick. How do you

respond?

Secretary O’NEILL. You know, let me revert to being a businessman. If I were where I was a year ago and I were faced with this

situation—and fortunately I was with a company that was so

good—but for most businesses they have got to pay a lot of attention to their bankers and to their equity holders and what their equity holders and bank holders will say to them—if there isn’t something done like this by January 1st, we are taking our money away

from you. And so what is going to happen is businesses are going

to be driven to the insurance company to get terrorism coverage,

and the price that is going to be charged is going to be related to

the risk that an insurance company sees——

Mr. BACHUS. I understand all that. You know, the final thing,

and let me just make this comment. You are not covering life insurance or health insurance?

Secretary O’NEILL. No.

Mr. BACHUS. This is basically commercial policyholders.

Secretary O’NEILL. Yes.

Mr. BACHUS. So when you say that you are underwriting the taxpayers, in effect you don’t really mean the taxpayers; you mean

those that are commercial?

Secretary O’NEILL. We are not underwriting them at all. They

are going to be out there——

Mr. BACHUS. You said we were——

Secretary O’NEILL. They are either going to have to self-insure,

be forced into the hands of the insurance companies who will write

the risk insurance.

Mr. BACHUS. But, if those people were backing up, not exactly

the taxpayers, but the policyholders as opposed to taxpayers——

Secretary O’NEILL. We are working a way to try to reduce the

economic shock that is related to either no coverage or very, very

high premiums as many companies wouldn’t be able to afford, and

some would therefore not have access to financial markets because

nobody would give them any money.

Chairman BAKER. The gentleman’s time has expired.

Mr. BACHUS. I am just concerned about people’s life insurance

policies.

Chairman BAKER. Mr. Inslee, are you here?

Mr. INSLEE. Thank you, Mr. Secretary, for coming. I am going to

take issue with what I think I heard you say, that this is not a

18

benefit to the industry as a whole. I think I heard you say that or

something to that effect.

Secretary O’NEILL. That is exactly right.

Mr. INSLEE. And I have got to take issue with that, because it

seems to me that if we do this, we are telling the industry that you

can go out to prospective customers and tell them that if you buy

my policy, you will also have in effect access to, you know, $90 billion plus of Federal money if things go south, and vis-a-vis other

uses of that customer’s money to protect themselves against risk,

either by risk reduction work or other investments or the like.

This, quote, distorts the market by helping the insurance industry

vis-a-vis other expenditures that that investor could make.

Now, tell me where I am missing something in that analysis.

This does benefit the city, because it makes their product more attractive vis-a-vis, say, risk loss investments.

Secretary O’NEILL. Well, think about the problem as a

disaggregated problem. We here in Washington tend to talk about

the insurance industry like it is one big monolithic thing. This is

all going to be done one transaction at a time. So if you have a corner grocery store, you know, you are not thinking about, oh, the

Government is going to provide $16 billion worth of additional coverage. Your issue with your insurance agent is how much the premium is to insure you against complete catastrophic loss in a terrorist incident. And when he tells you that the premium is more

than the value of your business, you are going to say, I am going

to get on the phone and start calling through the insurance list in

the yellow pages and you are going to get people in there swarming

around, nickling, diming, trying to figure out how they can reduce

your premium so they can write your business. That is the way

competition works. That is the way insurance works, and so, you

know, all this lofty stuff about $20 billion and $80 billion, it is just

an aggregation of millions of individual transactions.

So, you know, nobody is going to get done a favor here. Competition, given some time, is going to grind these rates down to an assessment of the probabilistic cost of a terrorist event.

Mr. INSLEE. Yeah, I agree with you as this is not going to benefit

one insurance carrier vis-a-vis another insurance carrier. I accept

your point in this regard, but it does benefit the whole industry,

vis-a-vis other investment or other expenses by the insured. For instance, if I got a thousand dollars, whether I buy a bomb screening

detection device to keep bombs out of my business or whether I put

it in insurance premium, this lowers the price of the premium visa-vis that other investment.

Secretary O’NEILL. But the insurance company will help you

make that decision.

Mr. INSLEE. I understand, but the investor, the customer makes

that decision, and this is a clear benefit to the industry, because

it makes their investment more valuable in relationship.

Secretary O’NEILL. No. If there is a thousand dollar value associated with a detection device, the insurance company will either

charge you the thousand dollars you didn’t invest or you will put

the money into the detection device.

Mr. INSLEE. Well, I see we are at loggerheads on that issue. Let

me try another one.

19

If you did accept the proposition, if you did, that this was of some

benefit to the insurance industry and that the taxpayer ought to

have some upside potential in this investment, how would you

structure it? If you did want to do something like that, to, in effect,

whether it is an equity or it is some benefit to the general fund,

how would you structure the other experiences?

Secretary O’NEILL. Well, I know this is very difficult and I don’t

mean to sound like lecturing, but let me tell you with 25 years

worth of experience running big companies and knowing a lot

about this stuff, the way competition works, you know, you can find

aberrations, but the insurance industry over time has to earn the

cost of capital, and the competition is tough enough that it is very

difficult to earn the cost of capital. There are a lot of companies out

there, including in the insurance industry, are not even close to

earning the cost of capital. So if you want the general taxpayer to

get something out of what you think is a benefit, then you are

going to have to give the insurance industry enough room so that

they can make additional net profit so they can pay you—you, the

Congress—something, because competition is going to grind them

down to the necessary rate of return on the capital that they employ. They are not going to make economic rent out of this proposal. Competition doesn’t create economic rent.

Mr. INSLEE. My time has expired. I remain unconvinced, but I

appreciate the brilliance.

Chairman BAKER. Mrs. Biggert.

Mrs. BIGGERT. Mr. Secretary, as the market is sorting itself out,

there are certain areas that are thought of as high risk. One of

those would be, let us say, public schools or maybe municipalities

or amusement parks. Does your proposal cover those?

Secretary O’NEILL. We are assuming as to the current practice,

it would continue. The Federal Government, basically we are a selfinsurer. We do not insure anything. We by habit, if not by explicit

decision, have decided to use the future cash flow from our taxes

to pay for these kind of events.

Local government has made different kinds of decisions. Some of

them buy insurance. Some of them actually budget for a rainy day

fund. We just basically assume that public bodies will continue to

do whatever they are doing. We have not made a special provision

or assumption about a change in policy direction.

Mrs. BIGGERT. I think a lot of those local governments are selfinsured now. Whether they can afford that risk, if you take those

high risks out of those, will we still have problems?

Secretary O’NEILL. I think so. I think we can find lots of examples like the World Trade Towers where catastrophic loss would be

multi-billion dollars. Again, I don’t want to tell you any names, but

I see the threat list every day. A lot of those places are on the

threat list.

Mrs. BIGGERT. If they are not self-insured, we are right back

where we started.

Secretary O’NEILL. I am not talking about public, I am talking

about private buildings like the World Trade Towers. There are a

substantial number of places in this country that have multi-billion

dollar replacement costs. I think Mr. Kanjorski made the point

about historical value. We should have no conversations like that,

20

because the difference between historical and replacement value in

some places is significant, and I don’t think you would like to be

stuck with just the historical value protection.

Mrs. BIGGERT. So, if there is high risk and no coverage, is there

a provision to require it, or is it just commercial insurance?

Secretary O’NEILL. We are working on the private sector side. I

had a role in Pittsburgh in Allegheny County when I was there,

and given what has happened, I probably would be advising the

mayor that we have to take a look at whether we can buy some

terrorism coverage for bridges.

Mrs. BIGGERT. Utilities?

Secretary O’NEILL. Public property. People must be rethinking

those things on the State and local level, but we have not designed

a new kind of Federal intervention or coverage.

Mrs. BIGGERT. Do you think that would be a possibility?

Secretary O’NEILL. I am not sure that we need to do that. I think

the market will sort those pieces out without our intervention.

Mrs. BIGGERT. Thank you.

Chairman BAKER. Mr. Capuano.

Mr. CAPUANO. Mr. Chairman, thank you.

Mr. Secretary, this is a thoughtful approach toward a difficult

issue. I love the fact that you said no one really knows how to deal

with this. I appreciate that.

For the record, I would also like to get your answer relative to

if this does not work, I assume you would have no objection to revisiting this next year or 2 or 3 years from now?

Secretary O’NEILL. As I said earlier, you all may want to consider writing a very unusual provision in whatever you may do,

and give the Executive Branch the ability to modify terms and conditions on a very short turnaround basis, because if what you all

write gets done, it will be the 10th or 15th of November. If it does

not work, we need to make the changes right away.

Mr. CAPUANO. I am glad to hear that. One of my concerns is as

you submit this, and I know it would be very difficult, but I would

like to see some pricing estimates. The reason I ask this is because

my concern is that terrorism is clearly a societal problem. Insurance is, in theory, in the greatest philosophical theory, all of us

chipping in a few dollars so that nobody in particular takes a hit.

In the private market system, that gets a little muddled. That is

fine.

In this particular case when the Government gets out entirely in

a couple of years, and let us assume that we do not change it between now and then, my concern is if there is a market impact of

the cost of that insurance, that market impact will negatively impact downtown areas in general. That is a general statement.

The reason I say that is because, let us be serious, the best terrorist targets are downtown. In Boston, it would be the Hancock

Tower, the Prudential Tower. That is not a secret. We all know

that. It is unlikely that terrorists are going to target a one-story

office complex along Route 128 in Massachusetts.

What kind of impact on the market of leasing, because most of

our buildings in Boston are owned by real estate investment

trusts? They are not owned by the Alcoas of the world. They are

owned by real estate investment trusts that own the buildings.

21

They are the ones that have to buy the insurance, not the companies in the building. The companies in the building will be paying

it through lease agreements. You pay a premium for being downtown, and you make a decision, and so forth, and so forth, how

much more of an impact is that going to have.

That is very important, because it doubles the cost of downtown

space. You are clearly having an impact on a different market that

is unintentional. Again, I don’t know enough about pricing insurance to know whether or not this is real or not, but I would like

to see something on it.

Secretary O’NEILL. I think your question is an excellent one. It

is useful to return to the principles of insurance. Over time the way

premiums are determined is on the basis of experience. If you are

an insurance company and you are covering 10 million automobiles

and they have crashes at a certain rate, that determines what the

premiums are in order to stay afloat and pay the claims and earn

your cost of capital.

What we all ought to pray for is we never have another experience, and that means there will be no economic cost. There will be

premiums for awhile, but the longer we can go without another experience, the lower the premiums can be because there is no cost.

God forbid we have experience so we can begin to create premiums

on the basis of terrible events happening on a regular basis.

So I think again, we do not know. There are so many things associated with these events that are just new thoughts that we

never had to think about before. This is a broader question even

than the question of insurance. If we are going to have to continue

to, for example, have a separate facility to open mail because of the

anthrax scare, it creates all cost and no value to our society.

Those kind of deadweights on our society are like the deadweight

of having to have insurance coverage that hopefully we never really

need to use. We do not know the answer to your question.

Mr. CAPUANO. I respect that. I think it needs to be thought

about, not the least of which are the indirect items such as downtown parking facilities.

We just had a thousand pounds of fertilizer stolen in Massachusetts. We do not know what is going to happen to it, if it is going

to be used by somebody that wants to do something horrendous,

they are going to go to a downtown parking structure under a

building. That means all the parking structures are gone, and that

increases rents.

I am a little concerned about the free market having a completely terrible negative impact on the cost of rental property, particularly in downtown markets where people can least afford to

have people move out of.

Chairman BAKER. The gentleman’s time has expired.

Mr. Shays.

Mr. SHAYS. Mr. Secretary, I would have thought, unless I am not

reading your proposal right, that you would want premiums to go

up so you start to build a reserve, and that cost could be passed

on, but you want a reasonable increase, something that is not outrageous. I was thinking that the cost of premiums would go up,

and you would buildup a special reserve, and that over time this

reserve would become so large that the liability disappears; that is,

22

if there are no further terrorist activities. My reading is that you

really do not buildup long-term reserves.

Secretary O’NEILL. I don’t believe it is desirable for the Federal

Government to create an insurance system. I think we have a way

in our country of spreading the cost of things that impact society,

and it is through a combination of our tax system and our spending

system, and it ends up with a distribution effect on the general

population.

I think for the part of the terrorism cost that we are going to accept, unless somebody has a better idea, the interaction of all those

things that we do is perfectly fine with me, and we have a basis

for spreading the cost for that part that we are going to put on the

American people, for the insurance companies. What they will do,

they will set premiums that they believe will give them the wherewithal to service terrorist events and earn a 12 or 15 percent return on their capital.

Mr. SHAYS. Are you saying they will build the reserve?

Secretary O’NEILL. They have reserves now against business that

they have already written. If they add new business, they will add

new reserves. Their premiums will include enough earnings to

building up a reserve so if an untoward event happens, they have

the money to pay it off.

Mr. SHAYS. My understanding is that you do the back end and

not the front end. The Government says catastrophic, you are the

first payer. Yet you are not doing it that way.

Secretary O’NEILL. I tell you why. It is a very important question

of how much the traffic can bear under uncertain conditions and

a lack of experience.

Think about this as an individual business person. You can afford to pay a certain level of insurance costs. Let us say you have

been paying a certain level of insurance cost, and now this event

comes along and your insurance company says in order to give you

terrorist coverage which you need in order to get financing from

your bank, I am going to raise your premiums on $1 million a year

to $10 million a year. As a business person, if you are go to stay

in business, you do not have a whole lot of choice.

The way we have crafted our proposal is in a way that we think

will permit the premiums to be written on each of those business

people and not put them out of business.

Mr. SHAYS. Do you believe premiums are going to go up significantly?

Secretary O’NEILL. Premiums will go up.

Mr. SHAYS. Even if we back them? Significantly?

Secretary O’NEILL. Yes. Premiums are going to go up, although

it depends what you mean by ‘‘significant.’’ if you want to make the

insurance company just paper processors and guarantee them a 25

or 30 percent rate of return on their capital, they would be happy

to take that.

This is an attempt to get the administrative structure and the

value part of the insurance in front of us before the loss.

Mr. SHAYS. Thank you.

Chairman BAKER. Mr. Crowley.

Mr. Bentsen.

Mr. BENTSEN. Thank you, Mr. Chairman.

23

Mr. Secretary, first of all, I concur with the Chairman. I think

we would be better off, and I appreciate what you have done and

what you have looked at. I don’t completely agree with your proposal. None of us know what the perfect proposal is. I think we

would be better off having a little shorter sunset, and I would also

be a little reticent of extending too much flexibility to the Executive

Branch, with all due respect, because at the end of the day, whether our name is on the bond or not, the Congress underwrites, if not

fiduciary responsibility, the political responsibility for the taxpayer’s liability.

I hope you all would take that into consideration, whether we try

and do something that just gets us over the hump, and I realize

that Congress is not always good about meeting its own deadlines,

but we are going to have to focus on this.

Second of all, I am curious of how you determine your shared

loss schedule? How did you decide the ratios that you set in 2002,

2003, and 2004?

Third, I am not convinced that you have made the case that from

a cost-benefit standpoint to the taxpayers, that having a shared

loss program with the first dollar coverage on the part of the taxpayers is all that much better on a dollar-per-dollar basis, or even

on a market basis quite frankly, than a pooled model similar to deposit insurance.

I am curious whether or not the fear there, and it is not necessarily a cost-benefit analysis issue, it is a concern of the creation

of another bureaucracy, and I am not sure that we can look at the

deposit insurance and say that is such a bad system.

Finally, I would think the way your proposal is structured, and

it might be true with pooled structure, is how we score it for budget

purposes. I would think that under your proposal we might have

to score it dollar for dollar and at some point we are going to have

to keep an accounting of the money spent and back into what our

long-term solution is.

Secretary O’NEILL. The last issue is that it would be scored like

the money that is now spent for disaster assistance.

The pooling idea has some complications in terms of, if you are

going to have a pool, yes, it suggests you are going to write policies.

If you are going to write policies, somebody in the Federal Government is going to decide what the premium schedule is. And then

we are going to charge premiums to people and money will come

in, and what will we do with it. If we do with it what we do with

almost all of the other money, we invest it in Government bonds

where we do not really do anything. We have this paper game.

Mr. BENTSEN. And I grant you that, in your testimony you bring

that up. But even in the shared loss, we are going to have to go

through some underwriting analysis.

Secretary O’NEILL. We are going to write checks.

Mr. BENTSEN. My question, Mr. Secretary, from the taxpayers’

standpoint, have you all determined where the taxpayer is really

better off?

Secretary O’NEILL. I think the taxpayer is better off not having

the fiction of a pool and all of the appearance of being in the insurance business when we really do not want to be in the insurance

business.

24

If you think about setting up a pool, the implication of that is

basically that we are going to withdraw capital from society on no

particular basis and we are going to hold it aside. That is an added

cost to society, that we take capital and in effect neutralize it.

Mr. BENTSEN. In fairness, Mr. Secretary, if we incur a liability,

we are taking capital from society.

Secretary O’NEILL. But we take it when we need it and not in

anticipation.

Mr. BENTSEN. If your staff can look at those issues. I agree that

we could not do a pooled issue right away. I don’t know that we

can do any of this right away other than get us over the December

hump. If you can get back to me on the question of how you determine your shared loss schedule, what the analysis was, I would appreciate that.

Chairman BAKER. Thank you, Mr. Bentsen.

Mr. Ney.

Mr. NEY. Mr. Chairman, I want to focus on the issue on a broader, generic basis concerning McCarren-Ferguson and our current

system and how we regulate insurance. Do you have any idea how

the proposal would affect how we regulate insurance with respect

to McCarren-Ferguson.

Secretary O’NEILL. Perhaps Ms. Bair could address that.

Ms. BAIR. We would want to rely on the current regulatory structure. I think there are a couple of scenarios and issues.

Mr. NEY. My second question, the plan hopefully addresses the

underlying problem of the pricing and various taxes. In other

words, if we had an attack 6 years from now, would we be right

back to where we started? Is there any consideration about what

the tax incentive side of this does for businesses?

Secretary O’NEILL. Is your question how you would entertain the

needs of tax incentives, and who would they go to?

Mr. NEY. Without changing our tax laws on the insurance side

reserves for terrorism, has that been discussed?

Secretary O’NEILL. Yes, we have discussed it. It has a certain

amount of appeal, because it sounds like we are inducing insurance

companies to do the right thing. We are lowering the cost of capital

for insurance companies. I don’t know why we would want to do

that.

Mr. NEY. Assuming we want to phaseout the Government backstop, if that is an issue?

Secretary O’NEILL. We are assuming as there is more experience,

the insurance companies will figure out a way to neutralize the

risk of terrorist attacks in the way that they have done for hurricanes and tornadoes. There have been accusations that there is

somehow an interest in bailing out the insurance companies or

helping the insurance companies. A tax incentive would lower the

cost of capital for insurance companies, which would be a prima

facia case for a bailout for the insurance industry.

Mr. NEY. I just wondered when we talk about incentives, to eventually phaseout the Government’s portion.

Secretary O’NEILL. We are saying that we will back out, and the

industry will fill the hole.

Mr. NEY. I just wonder in 6 years, where are we at? I am not

saying that I would have an idea to have a proposal that tax incenVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
25

tives are the way to go, I am just saying that the Government is

going to be removing the backstop. Are there other incentives?

Secretary O’NEILL. I don’t believe so.

Mr. NEY. Thank you.

Chairman BAKER. I am advised that the Secretary has a need to

depart. If I could make this request of Ms. Bair in your absence

to continue. We are most appreciative of your generous time. We

do thank you, Mr. Secretary.

If I might suggest to the Members, we appreciate Ms. Bair’s willingness to stay. We would ask that Mr. Hubbard come forward.

STATEMENT OF R. GLENN HUBBARD, CHAIRMAN, COUNCIL OF

ECONOMIC ADVISORS

Mr. HUBBARD. Thank you, Mr. Chairman.

I know that Secretary O’Neill has said a lot about the proposal,

so I do not want to go into a great detail, but I want to spend a

few minutes with your permission, Mr. Chairman, to talk a little

bit about the economic rationale and why we proposed what we

did, because I picked up a little of that in the discussion, the questions that you were asking the Secretary.

As an economist, the way that I think about the pure economic

events of September 11, in addition to the terrible human tragedy,

is that in one shot it gave a very powerful supply shock to the economy and a demand shock.

The supply shock is that it raised the cost of almost everything

that we do. The first thing that we looked at with the Congress is

commercial aviation. We are talking about insurance costs today,

but the transacting cost of doing business went up a lot. That ultimately is going to show up in lower output and all the bad things

we are worried about.

The second issue that does not concern us today is what is the

effect on household and business confidence. I think it is important

at the outset to reiterate something that Paul said, this is not

about the insurance industry.

The purpose of your holding these hearings, which I think is very

helpful, is to think about the property and casualty insurance market and the cost of insurance. There is no reason to suspect that

this industry is not competitive, so that the issue here is about

costs of insurance and not about the industry.

One way of thinking about the consequences of not acting or not

acting in a timely way is to ask what we might lose. We have already been through the aviation issues and insurance. Here the

problem is much more widespread. There are at least three ways

of thinking about this. One, think about the new projects. I am trying to build a new skyscraper or general commercial real estate

property. My ability to do that depends on the availability of insurance and its cost. Second, and more important, is existing assets.

My ability to sell a building I own, a power plant, any facility, depends on the availability and cost of insurance. Those costs are

capitalized into the value of that asset.

If one thinks about the size of potential costs here, the P&C

premia are about 3 percent of domestic income, about $155 billion

a year.

26

The Administration was concerned about some principles, and I

want to go over those. I picked up the flavor of some of the questions to the Secretary.

In my own ordering, since I was not here for his remarks, I don’t

know if it is his ordering. One is intervention should encourage, not

discourage, the private industry’s ability to expand capacity. That

is what this is all about. That is principle number one.

The second principle is that any intervention should be explicitly

temporary. We are in the view in the Administration, and I gather

many of you are from the questions that I heard, that the industry

is capable of stepping up to the plate for a very large share of this

and is capable of learning how to price. We have seen this in other

areas. We will come back to that. We need to make sure that we

have a receding Government intervention.

Third, we need to give the private sector incentives to limit

losses should terrorist events occur, which means less than full cost

takeover by the Federal Government.

A fourth that I will come to at the end is that we need to reduce

one source of uncertainty that we really can deal with, which is uncertainty about liabilities that arise from litigation surrounding

terrorist events.

Again, I would underscore that none of these principles has anything to do with a bailout of the insurance industry. In today’s Wall

Street Journal on the editorial page, an editorial that I otherwise

liked, I did not like the beginning because there was an indication

of ‘‘eating cabbage.’’ There was an indication, coming to the table

like we are today, that was ‘‘eating cabbage’’ in the editor of the

Wall Street Journal’s judgment. They talked again about bailing

out the insurance industry, and that is not what we are talking

about.

We want to work with you on the specifics. This is an outline of

our ideas. We think that our approach is consistent with the principles from the economics of the problem.

First, we think that it encourages private sector capacity building and respects the industry’s ability to price, market and service

products. I am quite suspicious of alternatives that involve direct

Government setting of premiums. I don’t think that is something

that Government officials, with all due respect to my Treasury colleagues, want to be doing.

Also in that respect I think there are plenty of people who say

that the insurance industry cannot learn to do this. As somebody

who in my academic life has worked in insurance a long time, I can

remember 10 or 15 years ago naysayers saying we will never figure

out how to really do disaster insurance. We will never figure out

how to get beyond basic insurance and reinsurance, and experience

has proven that wrong. I realize that this is a different set of risks,

but I have every faith in the industry as being better able to figure

out the way to go.

The second piece of what the Administration wants to do that I

think is important is addressing the issue of capacity. I know that

came up in some of the questions that the Secretary got. The big

issue here is back end capacity. Several Members asked that question. I want to come back to that. That is the key insurance question that the Government ought to be at the table for.

27

The third is the fact that the industry is sharing in losses, and

indeed in our proposal sharing a greater burden over time up to

a cap, and provides, frankly speaking, a profit motive to learn the

price. Somebody asked why we had this particular model, I believe

it was Mr. Bentsen. The exact numbers one can quibble with. The

idea was to give slivers of risk that the private sector would have

an incentive to go out and learn. If we take 100 percent of that for

some short period of time, we do not give that incentive. That was

our economic rationale for doing that.

A final point I would make with regard to these principles is that

the potential losses that we are looking at in this event, hopefully

not in any future events, certainly in this event, depend not only

on the security environment, which is something that we are coming to grips with and has a lot of uncertainty, but also in the legal

setting.

The physical costs of Hurricane Andrew at the beginning of 1992 were pegged at $6 billion. They grew over time to more than $20

billion, not because the physical damage was any bigger that it was

in 1992, but because of the cost in litigation.

In order for the private market to do what we want it to do,

which is to take over the lion’s share of this, we believe and put

in the approach that I believe the Secretary outlined for you, a set

of legal procedure issues that we felt would facilitate greater private market participation. Those were consolidating claims in a

single Federal jurisdiction. That is the sign to promote consistency

and avoid redundancy, limit some punitive damages other than obviously for actual perpetrators and abettors, and proportional liability for noneconomic harms.

This is not an attempt to marry tort reform agendas with insurance agendas. We want the private market to come in and work

here. In addition to the uncertainty we are facing about terrorism

itself, we have to be able to address uncertainty issues in the litigation area.

Let me say a little bit about roads not taken. Why not the monopoly pool? There I think a couple of reasons. One, we were very

worried about monopoly power. To be frank, that just means higher

premiums for businesses and ultimately consumers. We did not

think that was wise. It also had the flavor of a very long-term Government presence, which is not something we wanted to suggest to

you.

Somebody asked about charging premiums, why are we not

charging premiums for taxpayers being on the hook. We decided on

this sliding scale sharing mechanism as an alternative, because we

did not want the Government in the business of setting arbitrary

premiums. We will learn more about pricing only as the private

sector figures this out, not us in Government.

Questions came up about health, life and business interruption.

Let me take those up. The health issues are issues that should be

discussed, but not in our view in the context of the P&C legislation.

Likewise on life.

Business interruption is, just to be really frank with you as to

why we did not put this in, is subject to very, in econspeak, moral

hazard problems. For small businesses, the FEMA and the SBA

emergency disaster programs do provide some stepping in on busiVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
28

ness insurance. We, of course, obviously are willing to work with

you on what is in and out. In terms of exposure for the taxpayer,

as an economist I would offer you advice: You do not want to put

health, life and business interruptions in.

The other road not taken was full Government socialization.

There again we felt the industry would not have any incentive to

learn how to price, and the exit from that we viewed at least as

being pretty dicey. That is a quick tour. I am sure that the Secretary told you all about our wonderful proposal.

[The prepared statement of R. Glenn Hubbard can be found on

page 80 in the appendix.]

Chairman BAKER. Thank you.

We are going to pick up in the line of questioning from the Members who indicated an interest in asking questions of the Secretary.

Next is Mrs. Hooley.

Mr. Israel.

Mr. Ross.

Mr. Maloney of Connecticut.

Mr. MALONEY. I have a couple of questions. The first one goes

to the issue of experience and the idea that companies are going

to learn how to price this risk. It strikes me that 3 years is a very

short time to anticipate that to happen. I think it is a short time

from a couple of different perspectives. The good news is what the

Secretary was alluding to, perhaps there will not be another event;

and if there is not, there is no experience from which to price.

Second, it is a very short timeframe from the perspective of the

world we live in. I think it is clear from what I understand of the

origins of these attacks, these are the results of historical processes

which have been at work for 20-50 years. Bin Laden says 80. My

first question is why 3 years? Isn’t that far too short, even accepting the model, you say the road taken, even accepting the model

for what you advocate, isn’t 3 years much, much too short?

Mr. HUBBARD. This is a double-edged sword. What we wanted

was a quickly receding Government presence. So we compromised

with the 3-year number. We felt there was enough time for the industry to begin getting experience on pricing. Part of that would

come from—since the industry is shouldering slivers of risk, they

will try to lay off that risk on the capital markets, and modeling

efforts will be used to fill in price, and the natural disaster area

will come to bear as well.

So is 3 years a magic number? No. But that was our thinking.

We wanted something longer than a very short run, but not so long

as to intimate a long-term Government presence.

Mr. MALONEY. So there is no economic analysis behind the 3

years? It is a judgment call? It is sort of a best guess, is what we

are being told?

Mr. HUBBARD. I can give you a fancy answer or a plain answer.

The plain answer is this is new terrain. What we can learn by indirect example from the natural disaster area is relatively rapid

learning, modeling capabilities to set up a securitization. We are in

new terrain. I cannot tell you that period is exact here, but we

were comfortable enough after talking with people in the industry

and people expert in the disaster area that was a reasonable place

to start. If you said 4 years, we would not scream.

29

Mr. MALONEY. Let me ask a similar question in regard to the

cutoff point of the $100 billion. First of all, if I understand the proposal correctly, at the $100 billion there is no mechanism for payment, there is simply at that point the Treasury will sort of seek

the advice of the Congress, and maybe the Congress will do something and maybe it will not. Maybe it will invest in some public improvements or maybe it will not. In terms of the market and the

ability of the market to look at it, the $100 billion is the end of the

line of any kind of insurance that can be then priced?

Mr. HUBBARD. I don’t think so. I think on the back end, $100 billion was just a sign that we need to go back to the Congress. The

obvious political answer is for a disaster that large, we probably

are looking at Federal Government intervention. One model we

might consider is a Price-Anderson type model.

Our view was $100 billion is a sufficiently big event.

Mr. MALONEY. The follow-on discussion is that that is what the

insurance industry is concerned about? At some level the insurance

industry, as I understand it, is not as concerned about a $5 billion

event or a $10 billion event? There is a sense if that were the level

of events, if that were the size and scope of the events, there might

not be a need for any bill at all, and that their real concern is when

you begin to get to the upper end? That is where the real concern

is? The point is if you are asking the market to price something,

you have built a cliff, and I am a lawyer and not an economist, but

you have built a cliff in this bill that you have some coverage up

to $100 billion, and then there is nothing?

Mr. HUBBARD. No, not that it is nothing.

Mr. MALONEY. What is it? As I read the bill, it basically says at

$100 billion, go talk to the Congress?

Mr. HUBBARD. Our intent was to try to come up with alternative

solutions. As you folks and the Treasury folks work on this, you

may specify what that is. I think that from an economic perspective, you want the industry bearing some role, even if it is tiny.

Our intent was not to walk away, you are exactly right.

Chairman BAKER. Mr. Weldon.

Dr. WELDON. I understand your criticisms of creating a pool

which would put the Government in the business of pricing. It

would take a lot of capital and just kind of lock it up. I am not sure

that is the exact way to describe it, but the way you have laid this

proposal out, at the end of 1 year, and the Secretary just testified

if there is any first dollar exposure the insurance companies are

not going to write it, but if you asked for first dollar exposure in

the second year, do you really think in 1 year the insurance companies, and unless we have more experience, how are they going to

be able to write premiums to effectively value that level of exposure

in just 12 months?

Mr. HUBBARD. I don’t know what the Secretary said, I was not

here. But if you look at year 1 and year 2 in the proposal, our

thinking was not just that insurance companies could not do anything in year 1. They can. It is a question of cost.

For example, if we did nothing, we do not believe that every

project in America would go negative. I don’t think that will happen at all. Part of our concern was trying to stabilize that supply

30

shock so that there is a small cost to the business sector in the first

year. Then the deductible starts in the second year.

If you decided to have a deductible in year 1, it does not mean

that none of this works. It simply means a higher cost and makes

it harder for us.

Dr. WELDON. I want to follow up on something that Mr. Ney

asked about in trying to address this through the Tax Code.

One of the ways I think we can possibly do that if you had an

officially declared disaster, the way that the insurance companies

pay the tax system and collect on the premiums, they settle on the

claims and what is left is taxed. If you had a provision in the law

that allowed for, once a terrorist act was declared, that the costs

of those claims would then be taken off the corporate tax responsibility, would that not be an easier way to encourage the industry

to step up to the plate and start pricing?

Mr. HUBBARD. I don’t think so. I agree with the Secretary’s remarks that you do not want to start complicating the Tax Code. If

there is a desire to revisit the taxation of insurance, that should

be a general question that gets taken up by Congress. We felt that

it was more transparent to do it the way we did. We think that the

incentive for the industry to go out and build capacity is because

of the risk that it is now having to bear.

Chairman BAKER. Mrs. Maloney.

Mrs. MALONEY. I want to thank as a New Yorker the Administration working swiftly on this.

Given your statement that we are in new terrain and the comments of many of my colleagues, why not a shorter period? Why

not say for a year or just getting over the November crisis and then

coming back and studying it more. Many of my colleagues are saying that we acted too swiftly on the airline proposals, that we

should have thought it through a little better. Why not a shorter

frame like a year or even shorter, just getting through November

and giving us more time to look at it?

Second, the bill appears to be written in a way that would give

a big incentive to interpret occurrences as terrorist occurences. Politics is everywhere. Earlier the Secretary was saying the Administration should have more leeway. There would be tremendous pressure if there is a crisis in one State to declare something a terrorist

act because it would reflect a great deal of money. So how are we

going to define it in a way that it does not become something that

can be so flexible and that really has more taxpayer exposure?

Third, why 80 percent of the first $20 billion? Why not 50 percent? 50 percent for the taxpayers and 50 percent for the private

industry? How did we get to the 80 percent?

Lastly, could you share with us some of your thoughts on what

happened in England? Apparently they have had this pool insurance policy. Has it been a big liability on taxpayers? Has it

worked? What has the experience in Britain been on insuring for

terrorism?

Mr. HUBBARD. First, I am a fellow New Yorker.

Mrs. MALONEY. Great. So you are feeling our pain.

Mr. HUBBARD. I am feeling your pain.

First, on the question of why not just a year, I think our feeling

was in order to give some certainty to the process in commercial

31

lending and the construction of new projects, particularly of concern in Manhattan, that we believe some period longer than a year

was necessary. We suggested three. This is not a religious position

that it be three, but I think our position was that it be longer than

a year.

On your issue of interpretation of occurrences of terrorism, it is

important to have a rigorous definition of a terrorist act.

Second, a cabinet board or Presidentially directed board, probably consisting of the Attorney General, the Treasury Secretary,

perhaps some others at the President’s discretion, to make

these—— Mrs. MALONEY. As a Member of the legislative body that has to

produce the money, that would put us in a very difficult position,

because the President can be put under political pressure to determine that this is a terrorist activity, and then we have to raise

taxes to pay for it.

Mr. HUBBARD. That is why you want a tight definition of a terrorist act.

Mrs. MALONEY. I would want to have it shared with the legislative, not just be an Executive Branch decision.

Mr. HUBBARD. That is something to be worked out in the process.

It is not obvious that the same political economy problem does not

arise in Congress.

The third question was the 80/20 versus 50/50. This is not about

industry, it is about cost. We picked a position which would have

cushioned the cost for business insurance purchases in year 1. You

could certainly do it 50/50. That would be a smaller cushion. That

is why we made the decision.

The U.K. pool Re model is a different policy choice. It was a decision actually to have the Government more involved on a long-term

basis.

Mrs. MALONEY. But has it worked? What has been the experience? Has it cost more for consumers? Has it been a successful experience?

Mr. HUBBARD. The British made a conscious decision to be long

term.

Ms. BAIR. The capitalization at the end of 2000 was 1.3 billion

pounds. It was set up to deal with car bombs. We are envisioning

significantly greater events.

They do financial insolvency regulation. They have a monopoly

pricing structure, so they have to have financial integrity regulation. It is quite an apparatus.

Chairman BAKER. I am sorry, Sheila Bair was never properly introduced. Sheila Bair is the Assistant Secretary for Financial Institutions.

Mr. Rogers.

Mr. Miller.

Mr. Lucas.

Mr. Toomey.

Ms. Hart.

Ms. HART. I just have a couple of questions. Is there anything

that you see in here that would encourage private insurers to get

back into the market, and I am not saying skyscrapers, say nuclear

power plants?

32

Mr. HUBBARD. This proposal is related only for terrorism risk insurance, unless you wanted to rethink generally. The simple answer is nuclear power plants are covered under a separate provision of Government intervention.

The insurance companies see now an opportunity to deal with

business, and the fact that the Government is on the back end of

it, the hope is that they will.

Ms. HART. I didn’t get a clear enough answer to Mrs. Maloney’s

question about the 80/20.

Mr. HUBBARD. The issue is what is the cost that is going to be

borne in premiums. Our judgment is in the short run we wanted

to err on the side of being cautious about premium increases for

business. That is the 80/20. You could well decide to do 50/50 and

stick within the same model. Indeed, you move toward that in later

years in our proposal. If you do that, it would be higher cost increases in the short run. That is the tradeoff.

Ms. HART. Is it based on input from the industry?

Mr. HUBBARD. We talked with industry and mainly with commercial real estate holders and with large companies about the

share of insurance premia in income. You could do 50/50. It would

be a larger cost increase.

Ms. HART. My question is when you made the determination how

much the Government would cover, was it based largely on what

would make it affordable to the consumer as well as obviously what

private insurers would cover?

Mr. HUBBARD. There were two parts. One, if you think about the

outyears, the back end was primarily to focus on catastrophic

issues; and in the short run, we deliberately erred on cost increases. That was our first and foremost issue.

Chairman BAKER. Mrs. Jones.

Mrs. JONES OF OHIO. Thank you, Mr. Chairman.

Mr. Hubbard, you keep saying it is not about the industry, it is

about what?

Mr. HUBBARD. It is about people who buy insurance.

Mrs. JONES. But people who buy insurance create the industry?

Mr. HUBBARD. What I mean about it not being about the industry, there is a use, even in the Wall Street Journal editorial pages,

which normally I praise, of saying this is a bailout of the industry.

That is simply not true. This is a competitive marketplace. What

you decide to do is being reflected in premiums that policyholders

pay.

Mrs. JONES. But the basis of us doing this is saying that the people who use the industry will not be able to afford the industry.

Mr. HUBBARD. It is about the customers of this industry. Insurance companies are just a pass through, as the Secretary explained. They are just a financial intermediary. This is about risk

sharing in the economy and the cost of that risk sharing.

Mrs. JONES. But there is some benefit of being a part of the industry and having an insurance company? That is why people invest in insurance companies because they are a good benefit?

Mr. HUBBARD. Absolutely.

Mrs. JONES. I am trying to make the point that it is about the

industry, otherwise we would not be sitting at the table having this

discussion about insurance.

33

My next question goes to you are saying this intervention should

encourage private industry to increase capacity. Elaborate on that

for me.

Mr. HUBBARD. In other words, by creating an incentive to price

this; and after all the insurance companies are bearing part of this

risk and you have to figure out how to price it, they will have to

add capacity for those new lines of business. And they should, prudent business practice, try to lay off some of that risk, both through

reinsurance and later to securitize it.

Mrs. JONES. How do we ensure that the buyers of this insurance,

that they will not be priced out of the market when their dollars

are undergirding this industry by doing what we do?

Mr. HUBBARD. Competition. If the taxpayers are on the hook for

a fraction of this, that should float through to premiums. If Sheila’s

insurance company tries to charge too much, I will come in and undercut her. That process keeps insurance prices down.

Mr. KANJORSKI. If the gentlewoman would yield.

Mrs. JONES. Go ahead.

Mr. KANJORSKI. That all depends on the size of the policy. For

a homeowner, there is not going to be competition. If Mrs. Jones’ insurance company triples her insurance policy, All-State is not

going to try to take that policy. That only happens in large industry?

Mr. HUBBARD. The process of competition works in mysterious

ways, and if you think about something known as long distance

telecommunications and aggressive competition on almost a customer-by-customer basis, where there are profit opportunities, people will come.

Mrs. JONES. I have got two more questions, so I am going to ask

you to keep your answers short for me. Compare what you are talking about right now with floodplain insurance. Remember when we

couldn’t cover—people weren’t covered for floods and we began to

talk about a 100-year flood, and so forth, and so forth, and so forth,

tell me—compare that, if you could.

Mr. HUBBARD. Well, the disaster insurance doesn’t have the

same kind of sharing mechanism that we are talking about. It is

a subject for another day, would actually be the reform of natural

disaster insurance generally.

Mrs. JONES. Well, forget that question. Tell me—compare what

you are talking about—apply the concept you are talking about to

what we did for the airline industry and no caps on victims, on the

victims of September 11th.

Mr. HUBBARD. You mean the whole airline package?

Mrs. JONES. Yes.

Mr. HUBBARD. Basically I think what we are doing for aviation—

and I say aviation, not airline industry, for the same reason I did

before—was you were trying to——

Mrs. JONES. A semantical. Right?

Mr. HUBBARD. Not under competition, it is about customers and

travelers. The reason for a Government intervention in aviation,

we can always argue about the—— Mrs. JONES. Short.

Mr. HUBBARD. ——Is to help travelers, and today we think about

another industry where business costs are very, very high. Well,

34

part of your response earlier was something about private market

participation and putting caps on people’s ability to collect claims

and so forth and so on. What are you factoring in for the people,

the victims in this instance, if you are putting caps on their claims

in the insurance industry? And I may not be able to get an answer.

Maybe you can give me an answer later on. Am I out of time, or

can I get the answer to my question?

Chairman BAKER. The time has expired, but if the gentleman

wants to respond.

Mr. HUBBARD. This proposal, or this hopefully soon-to-be proposal, doesn’t envision separate victims’ funds. That is a separate

thing. Is your question about the litigation involving victims or——

Mrs. JONES. No. In one of your answers, you said the reason we

created this proposal was we took into consideration private market participation. We put in caps on people’s abilities to make—and

you listed six or seven other things that I wasn’t——

Mr. HUBBARD. Yes. Punitive damages was important. To avoid

certain litigation costs, you would want to cap non-economic damages and punitive damages.

Mrs. JONES. But we didn’t do that in the airline industry.

Ms. BAIR. You eliminated——

Mrs. JONES. But there were no caps.

Ms. BAIR. We are talking about a $100 billion aggregate cap on

payments that the Treasury Department and industry combined

would make before we would have—there is the moral obligation,

but before we would have to go to Congress. This is an aggregate

cap on liability under this program. It is not a cap on tort liability.

We believe to manage the litigation process in the event of a major

event, there need to be some reforms along the lines of what was

in the airline bill, which mainly were claims consolidation and

elimination of punitive damages. So, two separate issues. And we

were talking about aggregate capping on this.

Mrs. JONES. I didn’t understand that to be what you were saying.

Mr. HUBBARD. Yes. The $100 billion is an aggregate cap.

Mrs. JONES. Thank you, Mr. Chairman.

Chairman BAKER. Mr. Ose.

Mr. OSE. Ms. Bair, my question comes to you. I served for a number of years in Florida. The large property casualty issues—also

borrow money to build things, and I understand the dilemma we

are in. The thing we all struggled with before was providing certainty for the actuarial models. Does Treasury have a definition of

a terrorist act that you would suggest we consider?

Ms. BAIR. We have been giving it a lot of thought and, yes, we

are ready to sit down as soon as you would like and share our

thoughts on that.

Mr. OSE. I think that would be very helpful to us. The other

question I have is whether the proposal that we have talked about

today, is this the President’s proposal or is this the Treasury Department’s proposal? Is this just an option to consider? What is it

we are looking at here?

Mr. HUBBARD. This is from the President. This is not something

the Treasury—that is why we are—this is a White House-adopted,

signed off on—this is the Administration’s approach.

35

Mr. OSE. I do want to compliment you. The biggest problem we

always had was, first, the certainty; then the pricing; and then the

processing of claims. And to the extent that this proposal would insulate the Federal Government from getting involved in the processing of claims, a remarkable step for clarity and for the purpose

to bring something to the conclusion that goes beyond the understanding of people in this room.

I do want to encourage you to get us a definition of what the Terrorist Act is. That is the starting point, it would seem to me. What

is the Terrorist Act?

Thank you, Mr. Chairman.

Chairman BAKER. Thank you, Mr. Ose. I have no further Democrat Members, I think, to be recognized. I would continue on our

side. Mr. Fossella? Mr. Shays?

I just want to conclude by saying how much I appreciate your

willingness to participate today.

Mr. BACHUS. We are going to continue to call him for questioning, yes?

Chairman BAKER. Well, we have another panel.

Mr. BACHUS. I haven’t had an opportunity to question him.

Chairman BAKER. Oh, OK. Well, I went down the list and I

didn’t let the senior Members ask questions of this panel. One of

the concerns that I had in reading an earlier version—and I don’t

know where the definition is now, not having read it of late. With

regard to Mr. Ose’s concerns and the definitive circumstance under

which an act of terrorism would occur and then looking at the definition, the reading of it at the time was that it was very broad, and

I hate the word ‘‘nebulous,’’ but it wasn’t necessarily very specific;

and you could do careful reading of the provision, and I can see

where there would be the question of $40, $50, $60 billion at stake,

where there might be some legal perspective that would want to

take that matter to court for some final determination. I rather

suggested that since the nature of these events are extraordinary

and unique and unfortunately will remain, I think, in that category

no matter what our preparations; that the elements of each event

are so unique that that should be a determination by somebody,

not a statutory definition, for the principal reason of minimizing

the potential for litigation.

Where we delegate—and the concern I think I heard expressed

earlier today, if it were not the President, if it were a board, or we

find some team on which this terrible decision would have to be

placed. As opposed to a statutory definition, because I have not yet

seen—and there may be an artful crafting yet to be done that

would eliminate all probabilities—but my observation is that these

events are each unique in themselves, and you are not ever going

to have a definition of what has already occurred that would make

absolute clarity possible.

Mr. HUBBARD. That is an excellent point. In the whole process

of trying to write out a definition, multiple sets of bracketed language, we are struggling with it ourselves. I think the idea of the

board is a good one and one that we are pursuing. I think we do

want to have some designated board that would make this decision.

How much guidance you give that board through the definitions is

something that would be worked out.

36

Chairman BAKER. Certainly. Well, if the President or a President’s representatives are required to make a declaration of the

natural disaster for purposes of FEMA relief, it certainly seems

like it should be appropriate in this regard.

Second, with regard to minimizing the bureaucracies, if the proposal still stands where the 2,300 insurance principles will make

the claims for reinsurance reimbursement from the Federal Government—and the Secretary’s characterization is we just write

checks—even if that were the case, to process several thousand

claims with 2,300 providers, merely looking at the forms is going

to require I think an ample number of people that we don’t now

employ to do that work.

Second, to then audit, as he expressed, the efficacy of the claim

and the fact that the person receiving it sustained the damages for

which the claim was made is an enormous task. I can well imagine

the Federal bureaucracy required to establish that role. Hence, my

suggestion that the interface might more appropriately be the commercial reinsurance industry as opposed to the Federal Government’s relationship directly to the insurance private delivery system; because the reinsurance market is where the underwriting criteria are established, where the security guards could be required,

the doors be replaced, whatever it is that the markets determine

are the most advisable to deter additional acts of terrorism, let the

market work, and in that event we are not paying money out until

after an actual claim has been paid.

We could then address some of the Members’ concerns who have

spoken earlier about first dollar coverage or haircuts on both end

of the pipe, early and late, and at that juncture then consider the

repayment process. And at the end of the day, under the current

proposal, the Administration will share in the cost of those events,

and we are going to do that by using taxpayer dollars.

Now, whether that is a subsidy or a bailout, that is not appropriate. What I am hoping is that we can come to an understanding

we are using taxpayer money for a public purpose, but that the

taxpayer should not bear the brunt of this for this reason: If we do

the liquidity in the market so the economy remains stable and we

do it for the economic system, but when they return to profitable

and economic conditions are stable, I would hate to think there

would be a year in which we would write a check for several million dollars for an industry that at year end reports several million

dollars profit. We would not be looked on as very capable stewards

of the taxpayers’ resources, for this is to facilitate our economic system, not to enable the system to gain the books and make a profit.

And I have great concerns about that, the way the structure of the

current proposal is put together.

Mr. HUBBARD. Well, because the proposal is so short term, the

Federal Government receives, and then if it has a presence at all,

if the Congress wishes, it would be on the back end. And so I don’t

think you would be in that position. The question you raise would

be more for the very short term.

Chairman BAKER. Well, I would never suggest this, but if I were

in the insurance industry and had great PR people, then I would

begin today after the passage of the act, begin building a public necessity for permit—engage in a rather significant communications

37

program to say that unless the Congress continues this at even better levels, you are not going to get your coverage. We are going to

have to face that one day or another, and I would rather not put

into place a system which I think creates unlimited liability without an ability to recoup, in some manner or mechanism, even to the

extent of just giving it to the Secretary of the Treasury and say

when you think it is right, go get a check. And if it is not right

and if it will cause economic turmoil, don’t do it. But not give authority to write checks rather without limit, not fully understanding who the check is going to. And look at the interface with

commercial reinsurers to minimize that bureaucratic structure.

Now I am out of time.

Mr. KANJORSKI. They talked about the need for a fair impartial

equity board, and by definition, that would rule out the Supreme

Court.

Mr. HUBBARD. No comment.

Mr. KANJORSKI. No. I am a little bit disturbed in terms of—we

seem to be talking about the events of September 11th in New

York, and not talking about the recent anthrax problem. And if you

look at it, I know I have one constituent in my district who runs

a huge mail order house. They officially are out of business as a

result of the threat through the mail and the potential closing

down of the post office. And if that were to happen, we would have

to make sure that we are not insuring all businesses across the

country because they can’t get their transactions. So we have to be

fairly restrictive as to how we write this policy.

I know my friend from New York, Mr. LaFalce, mentioned business cessation, but there is no way that we could recover that kind

of losses. A catastrophic event, even of a minimal nature, would

rule that out.

I am disturbed that we are not thinking about other type events.

This is not just something that is going to be concentrated in one

area, but very easily could end up being a nuclear stockpile, a

waste facility that probably in one event out of 104 nuclear plants,

are likely to cause hundreds of billions of dollars of damage. I think

that should be included, because, you know, we can’t go to the limitations of policies on nuclear plants—I think is $7 billion—and

then we have 102* an $300 billion dollars and a million people

killed or radiated and we have no coverage.

But one of the things that really disturbed me about our failure

to think this through to a large extent—and I don’t want to push

on you and then the Administration—is that the airline bill, the

compensation act I think is atrocious. It is indefensible, because it

wasn’t thought out, it wasn’t properly presented. We had 15 minutes, I believe, to read the bill beforehand. I almost had a heart

attack as a former tort lawyer as to the potential liability. As I told

Sheila, someday in the not too distant future, the Treasury is going

to be writing out $1- and $2- and $3-billion checks to single estates

in the United States Treasury. I don’t think that was ever the intent of Congress, and yet the Administration hasn’t come forward

with a terrorist victims’ compensation act. We have already had

four or five deaths, and these people were in the service of this

Government. They were the direct result of terrorist activity, and

because they don’t have contingent liability to have to go to banks,

38

they are not going to get airline protection unless we do something

about it.

And we have got a great time to do it right now. With this bill— I agree we are not bailing out the insurance company, but we sure

as hell are encouraging business and providing a reduced cost of

business. If we are going to do that, we ought to make sure that

we compensate some of these people that are directly or indirectly

affected in their life and person from the tragedies that are occurring and will occur in the future. I think it is absolutely incumbent

upon the Administration to face that.

I also encourage the Administration to revisit the compensation

act. I just believe we have to have limitations on this thing. To pay

a bond trader that died in that building $3 billion when we are not

compensating the people that died in Oklahoma City as a result of

the terrorist act, that we won’t be compensating these postal people

that are dying all over the country, that is ludicrous and unacceptable, and we have to get out of a mind-set of just thinking about

money for bricks and mortar. There are more people that could be

hurt, and will be hurt, in terrorist activities in this country that

deserve the total feeling of the taxpayers in the entire country to

provide some compensation, not to make them wealthy, but to

make them as near whole so that they can exist with their loss as

possible. So I think we really have to study that. And in reality,

we will be saving the taxpayers money when we do go back and

find out how we can put a cap on this exposure.

Mr. OSE. Will the gentleman yield?

Mr. KANJORSKI. Yes.

Mr. OSE. When Paul talks about this, one of the questions that

comes to my mind is with what happened on September 11th, one,

two, or three terrorist acts, and I think that is right in the middle

of your questioning, and we don’t know what the answer to that

is, and if it is 1, you know, the limitations on the policy are X; but

if it is 2, it is twice a big as pi; or if it is 3, it is 3 times as big.

Chairman BAKER. 3.6 at risk if it is one event. 7.2 if it is two

events.

Mr. KANJORSKI. Right now we are really trying to insure bricks

and mortar and not people. After all, if the General Motors plant

gets wiped out, it may be a $10-, $20-billion disaster. I would hate

like hell to see a check for $20 billion going to General Motors

when there are 2,000 families that lost their breath—and if we can

send people in harm’s way over to Afghanistan and only have a li- ability of $250,000 with them, we have to provide the soldiers on

the homefront with some liability. And we shouldn’t have unlimited

liability or compensation for people that have to die in New York.

And I feel very sorry for them, but we are not to make them totally whole. That was never the intention, should never be the intention of the United States Government, because it is just incredibly—that liability, $30 to $70 billion, that is an awful lot of money.

It should be used in other anticipatory events. And I guess with

that I will——

Chairman BAKER. Your time has expired.

We are going to have to step out for a vote on the floor. I believe

Mr. Bachus indicated to ask his question. On the conclusions of Mr.

Bachus’ questions, he will have to come up to the floor for the next

39

vote. The bad news is for the next panel, I am told, that the votes

that are now pending will keep us 20 minutes. And then we will

reconvene for our final group. It has been suggested that we just

delay the third panel and conclude that tomorrow, but I haven’t

had a chance to talk to Mr. Kanjorski about it. If you are here, I

suspect many of you would like to go ahead. With that, I recognize

Mr. Bachus in the chair, and we will return in a moment.

Mr. BACHUS. [Presiding.] Mr. Hubbard—and I think some of

these questions have just been asked—there has been a significant

blurring of the line between acts of terrorism and—between acts of

terrorism and acts of war, and I don’t know that anything in this

will clear it up. Will a future attack by Usama bin Laden’s network

be covered by the Administration’s proposal?

Mr. HUBBARD. Well, formally what we have been looking at is

the war being mutually declared, more a formal declaration of war

as opposed to a terrorist act. I agree with you, including the President’s own rhetoric, maybe the impression of a blurred line between war and terrorism is certainly an open question.

Mr. BACHUS. Another attack by this network or another terrorist

network. And if we don’t clarify what this Government—I mean, if

it doesn’t cover acts of war, then—— Mr. HUBBARD. At least under the current definitions, another bin

Laden attack and the present lack of a declared war would qualify

as a terrorist act.

Mr. BACHUS. How about by the Taliban?

Ms. BAIR. No, we have decided that our current thinking is to

have a bright line with a U.S.-declared war and—— Mr. BACHUS. The other thing, and I am not sure I disagree, but

public policy questions have got to be what this Congress is going

to do about health and life insurance coverage. If it is written to

exclude terrorist acts, it is going to affect an awful lot of people,

particularly when we are stepping in and procuring commercial

law, not health law.

Mr. HUBBARD. We felt that at the moment, we wanted to focus

narrowly on P&C laws, one of which is workmans’ compensation,

so there is some health related. What isn’t is other health insurance. My impression of the HIA folks is that at least at the moment, to not exercise—they are——

Mr. BACHUS. That is something that we probably ought to at

some point take up.

Ms. BAIR. There doesn’t appear to be an obstruction of the market for life and health right now.

Mr. BACHUS. You are talking about the short term, and you want

to get into the short term and do something, and the long term

that the market ought to take care of. Let us assume that—should

there be tax incentives for the private sector to build reserves

against terrorist groups? That is not in here.

Mr. HUBBARD. No. That’s right. We felt that we should just go

more directly with the sharing scheme in the short run. I don’t

think it is a wise idea to distort the Tax Code. I think we can more

explicitly——

Mr. BACHUS. Well, you know, what you do is a 3-year deal, but

at the same time, when people finance property, they finance 10

years, 20 years, and 30 years.

40

Mr. HUBBARD. That is true, but nobody guarantees you insurance

over 10, 20 or 30—all insurance has features or rate change features. I think the idea was to give the industry time.

Mr. BACHUS. If they are going to finance property and—will a 3-

year plan actually cause them to bill that—to finance that property, when, you know, they are going to be financing it over 10

years or 15 years or 20 years? And what I am thinking, you know,

have a 1-year plan, but come with some Government backstop is

a better proposal than what you have here, and then you are not

getting the Government as involved in the second and third—creating some backstop.

Mr. HUBBARD. Well, our hope is that 3 years would be enough

time that the industry would have developed better pricing methodologies going forward. If you do just the year, our concern was

that you are having an almost freezing in place for a year while

people wonder what the Congress will do.

Mr. BACHUS. Another terrorist attack, another terrorist attack,

this 3 years is going to turn into 6 years and it is going to continue

to be pushed back. I am just saying that—backstop as part of a

long-term solution.

Mr. HUBBARD. You should defensively do a backstop for a longterm solution. The question is the short term.

Mr. BACHUS. Should an insurance company’s eligibility for the

program be conditioned on providing terrorist risk insurance in all

its P&C policies? You are not doing that in here.

Mr. HUBBARD. Well, it is an open question, actually, whether this

is mandatory or not.

Mr. BACHUS. You mean legislation? We are not sure about looking at the legislation?

Mr. HUBBARD. No. I think it is an open question in this process

whether you want to make it mandatory or not. One school of

thought would be that——

Mr. BACHUS. Require P&C insurance to provide——

Mr. HUBBARD. Well, that would be a step that you could take.

Mr. BACHUS. Is the Administration open to that?

Mr. HUBBARD. We are looking at all these options.

Mr. BACHUS. You haven’t rejected that option.

Mr. HUBBARD. No.

Mr. BACHUS. Particularly if the Government is going to be involved in a matter of public policy, if we are going to get involved

in it, we want to make insurance affordable and available. And if

we don’t, and if we allow P&C companies to only select certain risk

and—more high risk—to me it doesn’t get—utilities, things of that

nature.

Mr. HUBBARD. I agree. The tension was the Federal versus State

aspects of the insurance industry in the U.S., but I agree with you

in principle that that is a concern.

Mr. BACHUS. And I am just saying if the Government is going to

get involved, the Government ought to say, you know, you offer it

and you make it available.

Ms. BAIR. I would just say I think we thoroughly discussed that,

and you might want to pose that question to them. I think there

are a couple of questions. One is do you want to require that all

41

P&C insurers provide the coverage, or do you just want to say it

has to be a standard part of the P&C policy?

Mr. BACHUS. Well, you could. So your eligibility to participate in

this program—— Ms. BAIR. Well, you still have an adverse—— Mr. BACHUS. You don’t have to provide that coverage, but if you

don’t provide that coverage, you don’t participate in this program,

because the program’s design is to make that coverage available.

And why allow someone who has no intention of providing that coverage to participate in the program; or has existing coverage, perhaps for the next year that is already written, but, you know, they

have no intention of rewriting it?

Ms. BAIR. I think the 20/80 approach in the first year reduces the

incentive for insurers to cherry-pick.

Mr. BACHUS. Well, a better incentive would be just a requirement

that they participate in the program. And I would rather do that

than constitutionally tell them they have to provide it. I think if

they participate in the program, they have to.

Ms. BAIR. Yes.

Mr. BACHUS. You know, the British plan, their contribution— well, let me just say this. What about an ex-post subsidy? You

know, for our cause, would you consider that?

Mr. HUBBARD. Priced how?

Mr. BACHUS. I don’t know. Just give maybe the Secretary some

discretionary authority to charge assessments based on some of

the—to recoup any losses associated with administering the program.

Mr. HUBBARD. But then you are not encouraging the private industries’ ability to price. I think our—— Mr. BACHUS. No, I agree.

Mr. HUBBARD. Our prejudice is the private industry could—— Mr. BACHUS. Yes. Thank you both for your testimony. I would

now like to bring our third panel up.

We have a distinguished panel, and I always feel sorry for the

third panel of any day, but particularly today, I know some of you

came from out of town, in these wonderful quarters we are having

for this hearing. But all that aside, we truly appreciate your being

here, and I am subbing for Chairman Baker until he returns. But

we wanted to give you folks an opportunity to testify and for the

panel to ask questions.

Let me begin just to introduce the panel: Mr. David Mathis,

Chairman and CEO of the Kemper Insurance Companies; Mr.

Constantinos Iordanou—I always mess up this—Iordanou, Senior

Executive Vice President of Group Operations and Business Development for the Zurich Financial Services Group; Scott Harrington,

Professor of Insurance and Finance, Moore School of Business, University of South Carolina; Mr. J. David Cummins, Harry J. Loman

Professor of Insurance and Risk Management at the Wharton

School at the University of Pennsylvania; Mr. David Keating of the

National Taxpayers Union; Mr. John T. Sinnott, Chairman and

CEO of Marsh, Inc; Mr. Roy A. Williams, Director of Aviation from

the Lewis Armstrong New Orleans International Airport; Mr. Richard J. Hillman, the Director of Financial Markets and Community

Investment, U.S. General Accounting Office; and Ms. Marjorie S.

42

Nordlinger, Senior Attorney, Office of the General Counsel, Nuclear

Regulatory Commission.

Thank you all for your patience under these very difficult circumstances.

We will begin with the gentleman from Chicago, Mr. Mathis.

STATEMENT OF DAVID B. MATHIS, CHAIRMAN AND CEO,

KEMPER INSURANCE COMPANIES

Mr. MATHIS. Thank you. Thank you all for allowing us to attend.

Having listened to some of the presentations today and having seen

some of the other presentations earlier, I am going to cut short

some of the comments that I would make in order to allow more

time for questions and answers at the end. I do want to point out

that Kemper is a large property and casualty insurance company,

based in Chicago, with offices throughout the United States and in

many foreign countries. Our largest line of business is workers’ compensation coverage, but we also are a prominent writer of commercial coverages for a variety of businesses, from Main Street operations to mid-sized firms and to Fortune 500 companies.

I would point out also that as a structure, we are a mutual insurance company owned by our policyholders as opposed to being

owned by the stockholders.

Skipping forward, I would mention that Kemper, like other property and casualty insurers, has been steadfastly committed to

meeting our promises to policyholders as a result of the September

11 event. Our pretax losses are estimated at $360 million gross and

$60 to $80 million net of reinsurance. I mentioned the two figures,

because as we go forward I think it is interesting to keep in mind

that absent reinsurance in this type of event, we would be looking

at a $440 million loss as opposed to an $80 million loss. So the

function of reinsurance has been important and continues to be important for the industry. While that is a significant sum, we will

continue to meet our obligations to policyholders with no difficulties, and that includes the payment from our reinsurers as we go

forward. For the industry as a whole, we are looking at losses from

$30- to $60-billion, although the final number will not be known for

some time.

Although no natural disaster or, for that matter, man-made catastrophe even comes close, for the sake of reference, I would note

that Hurricane Andrew, which devastated south Florida, caused

approximately $19 billion in insured losses, perhaps half compared

to the September 11th losses. Put another way, the September 11

losses will exceed the entire property and casualty insurance net

income for the past 3 years, 1999, 2000 and 2001. In just one day,

industry profits for 3 years were wiped out, depleting investment

income.

Recognizing that the American people and our economy will recover and move onward, we also are looking ahead. And although

the property and casualty insurance industry can deal with the incredible loss of September 11th, we are very concerned about what

will happen if additional large-scale terrorist acts in the future

occur. It is critical that you as public policymakers share our recognition that terrorism currently presents four challenges to the insurance marketplace which we cannot meet. It is crucial that evVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
43

eryone recognize that we are dealing with a peril that is at this

stage not quantifiable and therefore not insurable within the finite

resources of the insurance industry. Quite simply, the financial capacity of the industry is limited, and unfortunately, the potential

harm that terrorists may inflict is unpredictable in frequency and

unlimited in severity. Given this mismatch, insurers and reinsurers

cannot assess, measure or spread the risk of terrorism. As a result,

terrorism has become uninsurable in the private market. This insurance market crisis, and, by its extension, pending economic crisis is why we are all here today.

As you probably are aware, more than two-thirds of the annual

reinsurance agreements—and we have all talked about that—by

which primary insurance companies purchase their own insurance

to adequately spread risk are renewed as of January 1, and reinsurers have already notified primary carriers that the reinsurance

contracts coming up for renewal will provide no coverage for terrorism. And although the primary insurance sector in the industry

is adversely affected by such decisions, we recognize that this may

well be the reinsurers’ only way to protect against insolvency themselves.

Primary carriers, however, do not have the same flexibility as reinsurers with respect to their own products, because we are subject

to tighter regulatory oversight. Any terrorism exclusion we might

choose to introduce must be approved by individual State regulators. If approved, our customers could find them bearing 100 percent of the risk associated with terrorism, and certainly the repercussions of this are clear. However, if exclusions are not approved,

primary insurers would be left to shoulder 100 percent of future

terrorist losses, which we cannot do.

Allow me to give you an example of and to illustrate the higher

retention of risk imposed on the industry. One of the Members of

the subcommittee mentioned that we were not involved in dealing

with lives here. We specialize in workers’ compensation sector business, which significantly deals with lives. And let us say that an

insurer provides workers’ compensation coverage for a manufacturing facility with 6,000 employees. The plant in my example

would not be located near an earthquake fault or any other place

where a natural disaster caused a workforce loss of life. If, God forbid, that plant would be targeted by an extreme terrorist act which

takes the lives of all the employees, the workers’ compensation

claim, depending on the State where the plant is located, could run

between $2.5 billion to $3 billion and could fall on that individual

insurer without reinsurance.

Chairman BAKER. I hate to interrupt you, but for the sake of the

proceeding, on the panel I would ask that everybody try to prepare

your remarks, revise them to, like, a 5-minute limit. We will incorporate the full statement into the record, and to give you a minute

to collect your thoughts, if you could begin to summarize for us, because we will have other Members coming back, and it is going to

be a lengthy evening for us if everybody wants to ask everybody

questions.

Mr. MATHIS. I will do it without notes. Let me just say that a

basic part of our discussion has been associated with trying to find

a means where the industry would spread risk and could get a

44

backup to replace the reinsurance mechanism. In our instance, I

think the major issue that should be kept in mind really relates to

four points. One is that the larger the amount of risk that the industry is forced to retain, without an adequate ability to spread

that risk, will create a dislocation by individual companies. And

that was the reason that the industry put forward a proposal to

spread the risk and provide a Federal Government backstop.

Second, the industry needs to be in a position where it can pass

rate increases on, in terms of any kind of charges for whatever net

retention or, for that matter, whatever charge the Government may

impose for its backup in terms of reinsurance. So any Federal legislation should provide some State regulatory preemption to allow

that rate regulation to go through.

Third, the industry would need to be consistent in its wording for

terrorism, not only with the Federal Government, but also with

each insurance policy, and as a pass-through to the reinsurance industry as well. If you have a different definition of terrorism, which

is excluded in the reinsurance industry, the industry would have

no recourse but to underwrite against the biggest potential loss or

net losses to the company.

And finally, the industry would need to have some measure of

giving credit for any kind of reinsurance. So, bottom line, the industry needs to find a way to spread risk. We do not think that

all of the proposals that are presented allow us to do that.

[The prepared statement of David B. Mathis can be found on

page 87 in the appendix.]

Chairman BAKER. Thank you very much.

Please excuse me, is it Iordanou?

Mr. IORDANOU. Yes. It is a Greek name.

STATEMENT OF CONSTANTINOS IORDANOU, SENIOR EXECUTIVE VICE PRESIDENT, GROUP OPERATIONS AND BUSINESS

DEVELOPMENT, ZURICH FINANCIAL SERVICES GROUP

Mr. IORDANOU. Chairman Baker, Chairman Oxley, it is a pleasure to be here. Zurich is a multinational insurer of significant size.

We operate in 60 countries with $20 billion in equity capital. We

have significant operations in the U.S.

The event of September 11th will cost consumers anywhere between $700 and $900 million in losses. This is net of reinsurance.

If we would have counted our direct loss absent of any reinsurance

protection, that would have been significantly higher, probably approaching $2 billion. Clearly, these are substantial amounts, but,

however, Zurich in its strength with its global capital base can absorb these losses without any long-term financial implications for

us, assuming there is no subsequent event of a size and assuming

that we continue to have the ability to protect our balance sheet

reinsurance purchases.

I will tell you today that we have notifications from all of our reinsurers that as of January 1, coverage for terrorist acts will be excluded from our reinsurance. So what does that mean? Unfortunately, for us it means that at a time when our customers need

this coverage the most, not all the customers, but our largest and

our smaller customers are being told by us that they cannot renew

their insurance coverage absent some way of excluding terrorist

45

risk. The larger ones have been told so because they represent very

high-dollar risks to a single location and the smaller ones are being

told so because the potential of risk in a particular territory creates

the same issue.

This is a new economic reality, which is sad, but very real, and

we need to deal with it. We now have such drastic steps—— Chairman BAKER. We are sorry. We are just trying to figure out

strategy on the votes we have, just so we can dispel this. We are

going to wait and run up to the—so we will go 5 minutes.

Mr. IORDANOU. Without the drastic steps that Zurich is taking to

protect its balance sheet, but at the expense of our customers, we

can’t continue to assume these kinds of risks.

The private sector, in my view, is the way to respond to the situation and could potentially fill the void with some normal risk

management tools. However, the cost to the Zurich for such tools

will be prohibitive, and they will fail to provide sufficient capacity

to address the multiexposures that the U.S. economy faces today.

Any Government solution should measure and should focus on

bringing sufficient stability back to the insurance market so that

companies like Zurich will feel comfortable including coverage for

terrorist exposures to its risk portfolio.

I would remind the subcommittee that the essence of insurance

is to efficiently apply capital to risk, so the standard way in which

we determine whatever that goal has been met will be to whatever

the degree and concentration of capital exposed to future terrorist

acts is manageable. Too much exposure will force insurance to continue excluding terrorists from their coverages. However, we also

appreciate that too much taxpayer exposure results are unacceptable. The solution, in our view, will need to balance the market’s

need for maximum stability with the Government’s need for minimum exposure to these types of risk and involvement in the free

marketplace.

I, for one, am confident that such a balance exists and would

urge all participants to move this debate to focus on the common

themes embedded in the options offered to date instead of the

shared shortcomings we see in those options.

For example, the industry’s original proposal utilized a pooling

concept utilized a pooling structure, an approach that has longstanding use within the industry and has served other nations well

in their quest to address the economic realities of terrorist risks.

We understand while the concerns have been expressed, and that

the debate has moved beyond this proposal, but the underlying concept of facilitating the spreading of this new type of risk is an important one that should not be abandoned. Ultimately the success

or failure of this effort will be judged in the marketplace on a riskby-risk basis, not by some broad industry aggregate, so there might

be some component that serves as a proxy, even in the medium

term, to the traditional reinsurance mechanism.

The White House has quoted a different approach that utilizes

a pro rata risk sharing concept. It is a short-term stop-gap measure

that increases the private sector retention in the second or third

year, probably to the levels that are beyond the industry’s capability to handle. Plus, there are a number of operational questions

that would need to be answered before judging the effectiveness of

46

this approach. However, the proposal effectively spreads both the

risk and aggregate exposures that the industry is facing and signals a very important recognition on the part of the Administration

that the Government does have a role to play in managing what

are fundamentally political risks in our view.

Both proposals, then, reflect the underlying concept of shared

private and public sector responsibility, and with modifications— some major, some minor—could serve as the basis of a meaningful

resolution to this problem.

In closing, I would suggest that anyone who views a thorough

backstop as a bailout may be underestimating the discipline of the

private marketplace. The actions Zurich and other insurers have

taken to minimize their exposure to terrorism are firmly in line

with economic reality. Our capital is finite, but the risk is infinite.

Thus, if there is any ‘‘bailing’’ out occurring, it is the natural tendency and expected flight of capital away from terrorism risk. This

should not be surprising, since it is how markets operate in general, and it reflects an immediate manifestation of how the capital

markets are responding to the ‘‘new normalcy’’ of post-September

11th American life.

Thank you for allowing me the time to present to you Zurich’s

perspective, and I would be happy to answer questions.

[The prepared statement of Constantinos Iordanou can be found

on page 95 in the appendix.]

Chairman BAKER. Thank you very much.

What time do we have remaining? If we would, Mr. Harrington,

we will recognize you, Professor of Insurance and Finance, University of South Carolina. Welcome.

STATEMENT OF SCOTT E. HARRINGTON, PROFESSOR OF INSURANCE AND FINANCE, MOORE SCHOOL OF BUSINESS,

UNIVERSITY OF SOUTH CAROLINA

Mr. HARRINGTON. Chairman Baker, Mr. Oxley. I spent my career

studying insurance, and I really appreciate the opportunity to be

here to have this opportunity to testify.

We don’t know how bad things are going to get this winter when

these contracts are ultimately—we don’t just know yet. Some Federal intervention may be very desirable to prevent a potential crisis. But we need to consider very carefully—insurance involves the

fundamental tension between risk sharing and incentives—you

have heard a little bit about this today. We widely appreciate the

incentives of risk sharing. The moral hazard effects are likely less

appreciated. It tends to dull incentives to manage risk. At this

time, private markets do a tolerably good job of dealing with moral

hazard.

Government insurance programs or Government-backed insurance mechanisms—they are also not likely to provide good incentives for efficient claims management. They are not going to provide the right incentives for risk management in the private sector.

Subsidized Federal reinsurance or direct Federal reimbursement

of a large proportion of terrorist losses could make citizens more

vulnerable to harm. And, again, it could make citizens more vulnerable to harm. If insurance against terrorist acts is made available at heavily-subsidized rates, some—perhaps many—businesses

47

could take far fewer precautions to protect life and property. If you

help too much, there is a good chance that more property will be

destroyed and more people will, in fact, die.

The Administration’s proposal has some advantages. It might

keep the Federal Government out of pricing insurance; but then, it

might not, because if you start thinking about mandating the offer

of such coverage, I think you are going to pretty quickly have to

think about limiting price. It could be awkward.

I think the Administration’s proposal would provide some limited

subsidy to the insurance industry. It would provide some significant subsidies to large commercial property owners. I think the

major problem is the first dollar coverage at an 80 percent basis.

Professor Hubbard said that they wanted to err on the side of caution. They erred on the side of too much precautionary risk spreading. That proposal would seriously undermine the integrity of risk

assessment, claims adjustment, and management. And the proposal does relatively little to encourage capacity. In fact, I think it

does very little to encourage capacity.

I encourage you to consider two things. One is some form of tax

incentives for insurance companies to build the massive amounts

of capital it takes to write this stuff. We are not talking about distorting the Tax Code. The Tax Code distorts these markets immensely. It is a punitive tax on the private sector. If we are going

to try and help these markets accumulate capital, then we need to

remove some of that punitive taxation.

I think you could encourage supply substantially with some form

of temporary system of ex-post assessments. Let me just step

through that very quickly. You might have a system where, with

$5- or $10-billion in terrorist losses in a year, God forbid, that insurance companies, all property casualty insurance companies, will

be assessed to finance a material proportion of the losses above

that threshold. The insurance companies could limit their risk. We

could allow them to borrow from the Treasury if the assessments

in any given year exceeded some amount like 2 percent of the premiums. They could pay back the amount that they borrowed with

future assessments under that type of proposal, if necessary, at a

higher threshold. The Government could then become a direct sharer in the risk bearing.

In conclusion, I think the tax incentive approach and the possibility of ex-post assessment of the insurance industry would help

mitigate the threat of a crisis and mitigate these inherent problems

without substantial undermining of private sector risk assessment,

claims settlement, and risk management, and I really think that

the result could be less loss of property and less loss of life. Thank

you.

[The prepared statement of Scott Harrington can be found on

page 102 in the appendix.]

Chairman BAKER. Thank you very much.

I think we are going to call our next witness and proceed before

we depart for the vote. So Mr. David Cummins, Professor of Insurance and Risk Management at the Wharton School.

48

STATEMENT OF J. DAVID CUMMINS, HARRY J. LOMAN PROFESSOR OF INSURANCE AND RISK MANAGEMENT, THE

WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA

Mr. CUMMINS. I would like to thank the Chairman and subcommittee Members for allowing me to be here today. I have outlined some principles that I think any Federal program should satisfy, and to say at the outset that they are more consistent with

the Administration plan than they are with the private insurance

industry plan. I am basically very much opposed to the private industry plan. I think the Administration plan has a number of features to recommend it, but there are a number of features or problems that would have to be fixed before it would be enacted and

be really an effective program.

I think, first of all, the program should have the clearly stated

objectives of helping the policyholders, insurers, and the economy

to weather the current crisis by encouraging private insurers to return to the market as soon as possible.

Second, the Federal program should avoid the creation of any

new institutions or new bureaucracies, such as the homeland security insurance company proposed by the industry.

Third, the Federal contracts have to be sold at a positive price.

Providing free coverage would set off all the wrong incentives in

terms of claims settlement and charging premiums in the direct

market. So you have to come up with a price. I would recommend

hiring an actuarial firm to apply the principles of actuarial science

to come up with the best possible price under the uncertainties

that we know are present in the program.

Fourth—and this is a commendable part of the Administration’s

proposal—that any Federal coverage should have a cost sharing

provision, where the Government should never cover 100 percent of

any layers. So it should at least be 20 percent covered by the industry, or maybe even more than that, except possibly at the very

highest layers.

Fifth, Federal coverage should start after a reasonably large deductible. There should be no first dollar coverage, even during the

first year. The industry could easily bear $5- to $10-billion. That

is not the layer that they are really concerned about, and it sets

the wrong incentives to provide Federal first dollar coverage.

Sixth, the Federal obligation should be capped. There is no magic number, but $100 billion is probably reasonable; perhaps something somewhat less than that would also be a possibility. And this

basically gives the Congress the option to come back in at the $100

billion layer and either agree to continue or extend the program or

decide to do something else. You don’t want to put an unlimited

program in place.

Seven, the program should be limited to property coverage—— Chairman BAKER. Just stop for a moment. We will put Mr. Bachus in the chair. We will be right back.

Mr. CUMMINS. The coverage should be limited to property coverage and other coverage to terrorism where the loss amounts are

relatively easy to identify. For example, the program should not

provide coverage for difficult-to-verify claims such as business

interruption insurance. This is to prevent abuse of the Federal program and to provide incentives for policyholders to get back in

49

business as quickly as possible following a loss. There may be the

need for other policy remedies, especially for small businesses facing business interruption crises, but it shouldn’t be a part of the

insurance program.

Consideration should be given to incorporating ‘‘finite reinsurance’’ provisions in any Federal plan. Essentially finite reinsurance

transfers less risk to the reinsurer than traditional indemnity reinsurance that is basically intended to smooth out the insurers’ losses

over time. The reinsurer essentially advances money to the insurance company when losses are high, with the obligation of the insurer to repay most of the money when losses are relatively low.

This might be especially appropriate in a Federal plan at the lower

layers of coverage.

And then finally, the Government should explore ways in which

it could encourage the development of private markets for catastrophic risk without providing Federal backing, such as lowering

regulatory barriers to securitize the insurance risk, and perhaps

acting as a facilitator of securitization by providing data that could

be used by private firms in developing better loss indices to enable

the provision of securitized financial instruments which are much

more efficient than insurance in insuring this type of risk.

So I guess just a couple comments on the Administration proposal. Several things I see wrong with it. First is providing first

dollar coverage during the initial year is not a good idea. The industry should bear the first $10 billion of coverage.

Second, without going into each year and each layer, case by

case, the proposal is generally too generous, and it is split between

the Government share and the industry share.

Third, the finite reinsurance option should be seriously considered for lower layers of coverage, with the indemnity reinsurance

going to the higher layers.

And then, fourth, the program should exclude certain types of

difficult-to-verify claims, such as business interruption insurance.

And then also it is important to charge a premium for the coverage. Thank you.

[The prepared statement of J. David Cummins can be found on

page 107 in the appendix.]

Mr. BACHUS. [Presiding.] And their proposal does exclude businesses. Right?

Mr. CUMMINS. It excludes punitive damages.

Mr. BACHUS. My understanding is the last draft took out that.

Well, I think it is going to, if it hasn’t, as a result of the testimony

today.

Mr. Keating.

STATEMENT OF DAVID L. KEATING, SENIOR COUNSELOR,

NATIONAL TAXPAYERS UNION

Mr. KEATING. Mr. Chairman, thank you for the invitation to

speak before the subcommittee today. We represent 335,000 members, and we are strongly opposed to the insurance industry proposal and the Administration proposal, at least as it has been offered. I would like to associate our views with what I have heard

both from Professor Harrington and Professor Cummins. All of the

concerns that they have raised, all the points that they both made

50

I think were excellent, and the subcommittee should keep them

foremost in your mind as you go to draft any legislation.

We wholeheartedly agree that both these proposals stand the

risk not only pf putting taxpayers in danger of unnecessary losses

of human life and property, and I didn’t hear much—and much to

my disappointment—from the Treasury Secretary or Mr. Hubbard

about that, and I think that most people agree human life is the

key thing that we should be watching here. And we need to have

incentives for the people in the industry to watch their clients to

see that they are putting forth the proper security measures, escape mechanisms and such, and if we just give away Federal reinsurance, we are not going to see that kind of activity taking place

and clearly we need to have that kind of activity. People need to

reassess how they are running their businesses.

It is essential that we limit the Government’s total liabilities in

any action or legislation, that you make firm limits or policy, clearly define terrorism, and limit the Government’s exposure to certain

types of losses. We are very concerned about business interruption

coverage. Otherwise we could see the Government paying companies not to go back to work for years.

We see the same problems with unemployment insurance. I

mean, people don’t have the same incentive to go get a new job if

the Government is underwriting their business revenues even

though you are not in business. Things are very vague and can be

stretched out. We can’t go there.

We also have to make sure insurers pay enough of the claims out

of their own pocket. Otherwise they are going to make their longterm clients happy with Federal Government taxpayer dollars.

Easiest thing in the world to make someone happy with someone

else’s money.

Now, I also want to express my surprise and shock about the

Treasury Secretary, of all people, and the Chairman of the Council

of Economic Advisers, their understanding of tax laws regarding insurance. To me it is astonishing that they think that somehow allowing reserving on a tax-free basis for the expected losses from catastrophes is somehow a distortion of the tax laws. They have got

it exactly backward. The tax laws are what are distorting sound insurance principles here. If we knew with precision what the future

would bring, we could set aside the money now, the exact correct

amount, so that when the disaster happens, the money would be

there. If you guide it by years, you know it is the cost of doing business; yet the way the tax laws are written, that cost of doing business is counted as a profit and taxed. It is crazy.

So I think they have got it exactly backward, and Members that

had asked about that, perhaps you are using the wrong language.

Maybe they heard the question wrong. It is not so much we need

a tax incentive. Should we stop the tax penalty for sound reserving

catastrophes? That is the way I would ask the question and perhaps you would get a different answer next time.

Rather than discuss point by point what we have in front of us

from the industry to the station, I would like to outline some principles for legislation. One.

51

One is, I think this is obvious, any Federal capacity should offer

the maximum amount of economic benefit, not only to the Nation,

but injured parties, at the lowest cost to the taxpayers.

Two, legislation must not erode incentives for wise underwriting

and insurance company management of risk, proper security escape

contingency plans I spoke of earlier. We cannot have a blank Federal reinsurance check and reduce incentives for increased security.

Three, if Federal reinsurance capacity is offered, then there

should be payment for the use of capital and the assumption of

risk, for many of the reasons I spoke of earlier.

Four, Federal coverage should certainly not insure against all industry terrorism losses. Coverage in the first dollar of losses is unnecessary and unwise, because it would erode incentives and increase security.

Fifth, Federal insurance capacity should be temporary to maximize the use of market mechanism, first for reentry of prior reinsurance at higher levels at the earliest possible date.

Six, legislation must contain strong incentives to pay only valid

claims. We believe the Federal Government’s copayment claims

should never exceed 80 percent. As spoken of earlier, it is too easy

to make other people happy with someone else’s money, in this case

the Federal Government’s.

Seven, and this is a point I haven’t heard yet today, maybe it is

so obvious that no one has spoken of it, but I am not sure so I will

say it. The Federal Government’s exposure should be capped primarily to preserve America’s national security options. Let us face

it, we are in a war. We don’t want to have a Federal Government

entitlement program to underwrite every dollar of every damage

that might happen. We are not facing the bombing of London like

they did during World War II, but if something terrible should happen here, we can’t have a Federal entitlement program to cover

every dollar of loss for war or terrorist attacks.

So I am not even sure where the definition is, but the primary

purpose of the Government is to defend our Nation. So we cannot

have an unlimited liability, and that is one positive trait in this

Administration proposal. We will have to balance off what we can

do for our Nation’s people, their property losses, the lives that are

lost, but we also have to balance the key reason for Government,

to defend the country. So that is the real reason why it needs to

be capped.

Another principle that the Administration has talked about and

we agree with, we need some sort of panel to quickly pay and settle

claims to incur losses in a fair and inexpensive way. We don’t want

to spend taxpayer money paying the trial lawyer a lot of money,

stretching out litigation years and years. If the private markets

were to get back and cover this kind of loss, they need to know

what the loss is. We can’t stretch it out over the 5 or 10 years, figure out what the eventual losses are, and we don’t need to waste

money paying a lot of lawyers to do this.

So those I think are the key principles. I think by—listening to

those principles and applying them to the proposals before you I

think will help steer the subcommittee and the Congress in the

proper direction, and we are willing to work with you, Mr. ChairVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00057 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
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man, other people in the industry, other interested parties to help

work out a solution here. Thank you very much for the invitation.

[The prepared statement of David L. Keating can be found on

page 113 in the appendix.]

Chairman BAKER. Thank you.

Mr. John Sinnott. You are Chairman and CEO of Marsh, Incorporated.

STATEMENT OF JOHN T. SINNOTT, CHAIRMAN AND CEO,

MARSH, INC.

Mr. SINNOTT. Thank you, Mr. Chairman, for allowing me to be

here. I should probably explain what Marsh, Inc., is, because we

represent, perhaps a slightly different constituency than others. We

are the world’s largest risk adviser and insurance broker. We have

about 35,000 employees around the world, and we are located in

about a hundred countries. Our clients comprise all segments of

the commercial world. Private clients also. And we also act as advisors and reinsurance brokers to insurance companies. So I think

that we have a pretty good view of what is happening today in this

marketplace and what we expect will happen for our clients if

something doesn’t happen here very quickly.

I should also point out that I represent not just Marsh, Inc., but

I also represent the member firms of the Council of Insurance

Agents and Brokers which is the national trade association. So I

am speaking for both constituents. I will cut through some of the

comments that I had planned to make. There are two problems

here. One is the size of this event, which is more than twice the

size of the next largest catastrophic event. If you add the other five

largest events that took place in the last 10 years, you have only

about aggregated what the estimated loss coming out of this particular event is.

The second problem is the uncertainty of the current environment. That is what is different since September 11th and why we

are talking about this issue now. The nature of this risk has radically changed because of certainly a perception of what we have

heard from Washington which is the probability that there will be

another event. So trying to compare the way we approach this preSeptember 11th and today you will never come up with the right

answer.

What is the result of these two problems? Since September 11th,

we have undertaken many renewals on behalf of our clients, and

most reinsurance is still in place, although we are seeing terrorist

exclusions on the policies more so than not. And the other thing

that I can say, as we look forward to January 1st, our reinsurance

unit cannot identify a reinsurance company that is not going to exclude terrorism come January 1. So the issue of this is not an issue

of supporting the industry, but the fact that American business will

not have protection for a catastrophic potential loss come January

1st.

I would disagree with the comments about business interruption.

Business interruption is a normal sort of risk that business clients

transfer to others. It will comprise a significant part of the September 11th event. And why one would exclude, when the commercial market is going to be picking up and adjusting these claims,

53

and they have had to adjust these claims, if it is straight fire they

will have to adjust it, if it is a fire caused by terrorism, they would

have the same adjustment issue. The markets will not provide coverage for a terrorist event for business interruption if it is not covered for property damage in the first place. Markets almost never

cover business interruption in isolation to property damage.

So I was not aware that there was a disconnect here on business

interruption. But that just puts it back. There will be no coverage

for this come January 1 with businesses if that is the case. Seems

to me as far as the timing, it is fairly straightforward. If the current environment doesn’t change, this risk is going to be 100 percent uninsurable in the commercial market.

What the Government is trying to do obviously is change that environment and cure this problem so we get back to some normalcy

the way we were before September 11th. I am not saying it is going

to be exactly the same, but at some point that has got to be our

hope. I don’t know whether that is in 2 years, 3 years or 6 years.

I think it is something that one has to look at. And as soon as normalcy starts to come back, you will see the commercial market

come back to this arena. That is why the Administration’s plan

does allow for that. And I think that will happen as long as we find

some way to cure the environment.

I will just finish with one other comment. In 1993, we had the

first terrorist attack on the World Trade Center. We had offices in

that building at that time. Fortunately, we had no loss of life. That

is most important. Second, the amount of the insurance claim that

we had resulting from that loss was less than $5 million. So as a

result of that particular incident, you didn’t hear anything about

the commercial insurance market saying it needed help that you

are hearing now.

On September 11th, my firm lost almost 300 people in the World

Trade Center. Obviously, that is the biggest loss that we have ever

sustained. And it is something that my colleagues carry around in

the halls and will for a long time. But secondarily, we will also

have an insurance claim to present not of a few million, but in the

hundreds of millions of dollars. And we just have an office occupancy.

Mr. BACHUS. Hundreds of millions?

Mr. SINNOTT. Hundreds of millions of dollars. That is the difference. That is what has happened. I don’t see any way for us to

get terrorism coverage—and we are starting on our renewals right

now with our clients—if some mechanism isn’t coming up for sharing the risk, even on a temporary basis between the Government

and the private industry, we have got a train wreck coming January 1 in the property area.

Somebody mentioned the aspect of life insurance. I don’t believe

that withdrawal of coverage in the life insurance field is an issue,

although I would defer maybe to Constantinos and Dave who are

in that business.

[The prepared statement of John T. Sinnott can be found on page

123 in the appendix.]

Chairman BAKER. We are told it is not now. Or if you look at it

from that perspective, the life industry pays 5,000 claims a day. So

even this incident will not be significant for them. Because you

54

take the U.S. population, 275 million people, if you say the

average—— Mr. IORDANOU. 7,000. And most of them that have that understanding, so that industry covers it. It is not an unusual and extraordinary event for them. Yes, it is dramatic based on the way

it happened, but not a big event for the life insurance business.

Chairman BAKER. Thank you, sir.

Mr. BACHUS. Just to clarify, again, we don’t have the text of any

legislation. It is in appropriations.

Chairman BAKER. All we have is a recommendation.

Mr. BACHUS. The approach says that business interruption is not

a big deal.

Chairman BAKER. I would like to recognize Mr. Roy Williams, director of aviation, Louis Armstrong New Orleans International Airport, with which I am greatly familiar. Welcome.

STATEMENT OF ROY A. WILLIAMS, DIRECTOR OF AVIATION,

LEWIS ARMSTRONG NEW ORLEANS INTERNATIONAL AIRPORT

Mr. WILLIAMS. Thank you, Mr. Chairman. Mr. Bachus, Members

of the subcommittee. And I am sure you are only familiar with it

because you fly over it after you have left out of Baton Rouge Airport. But I am very happy to be here today, although I do feel I

am a bit like a fish out of water with this panel that you have assembled here with you. Perhaps the airport experience that we are

experiencing today gives some credence to the discussion of what

may happen to other industries in the coming months.

Let me begin with a little background. Armstrong International

has 16 passenger carriers and five air cargo carriers, and we just

celebrated serving more than 10 million passengers in one 12-

month period, an all-time record for the airport. That ranks us as

39th in the United States. There is nothing particularly unique in

the airport in terms of insurance risks. It doesn’t have any reservation centers, it is not a hub for a passenger cargo carrier. So I

think we are sort of a normal example of an airport.

Prior to the events of September 11th, airports usually had substantial levels of war and terrorism risk included as part of their

general airport liability coverage. In our case, $300 million and

sometimes up to $1 billion at large hub airports. To date, since

September 11th, only 2 insurers have come back into the market

with a product that is very expensive and has a very limited and

inadequate liability cap of $50 million. At least one of the available

policies contains massive exclusions such as not covering screening,

baggage and security functions. In addition, these policies include

a 7-day cancellation clause.

So turning specifically to Armstrong International, for the 12

months which ended September 30th, 2001, our policies covered essentially all risks, including war and terrorism, up to $300 million.

Our annual premium was $321,000.

We had already begun a search for a new policy before September 11th, and in fact, after September 20th we did have an

offer of a policy. But the new policy excluded war and terrorism

completely. It excluded certain officer and director coverage, and

was at a price of $520,000 per year for the same $300 million coverage.

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A short while later, we received an offer of $50 million in terrorism coverage for a $450,000 premium. Thankfully, we received

a second offer for the same level of coverage, $50 million for a premium of just over $300,000. And we have bound those coverages.

So right now we are now at about $900,000 in insurance costs for

much less coverage than we had before at $321,000.

Now, just this week, we received an additional option to consider,

and that is an offer of an additional $100 million in war and terrorism coverage which would increase our total protection to $150

million, half of what we had before. The premium on that additional coverage is $573,000 a year. So put simply, if we accept that

coverage, we would have half of our prior war and terrorism coverage, essentially all of our other coverage as we had before for a

total annual premium of nearly 5 times what the airport paid last

year. About $1.4 million versus $321,000.

And the important point in this is who pays for this? In terms

of our agreement with the airlines, we pass costs such as this directly to the air carriers in their rents and landing fees. That $1.1

million insurance premium increase that we are facing represents

a 3 percent increase in the total air carrier costs to operate at Armstrong. This would raise our landing fee by about 15 cents per

thousand pounds. Put another way, it is 22 cents per passenger.

Again, this is simply not the same coverage we had before.

We really don’t recommend that we sustain these risks of insuring ourselves against the risk of terrorism by simply assessing exorbitant costs. We instead recommend the subcommittee consider

solutions to spread these risks as broadly as possible, taking into

account the fact that the risks associated with an act of terrorism

far exceed the economic capacity of any individual airport to sustain or pay.

For example, one solution might be to extend the current Federal

War Risk Insurance Program exclusively to airports. The program

now does cover airlines and covers their vendors and agents.

Looking forward, New Orleans is doing well. We are down only

14 percent from our regular scheduled flights. We appear to be operating at close to 75 percent of our normal traffic. We think these

numbers will continue to improve. But we cannot fulfill our obligation to Louisiana unless national air volumes return to normal. We

believe that what will get those passengers flying again is to restore confidence in the security of our planes and our airports and

provide stability in the marketplace. The insecurity regarding the

availability of insurance and the calculation of risks associated

with actions of terror creates a background of instability, has

wreaked havoc with the traveling public and the insurance industry. Restoring the insurance at reasonable rates should underpin

any legislative effort to restore this confidence.

[The prepared statement of Roy A. Williams can be found on

page 126 in the appendix.]

Chairman BAKER. Thank you, Mr. Williams.

Next, Ms. Marjorie Nordlinger, Senior Attorney, Office of General

Counsel, Nuclear Regulatory Commission. Welcome.

56

STATEMENT OF MARJORIE S. NORDLINGER, SENIOR ATTORNEY, OFFICE OF THE GENERAL COUNSEL, U.S. NUCLEAR

REGULATORY COMMISSION

Ms. NORDLINGER. I am pleased to be here today to provide information about the unique nontraditional Price-Anderson system referred to so many times today. It has evolved from Congress’s initial 1957 enactment of the Price-Anderson Act. I will focus on the

development of the functions of the indemnification of public liability compensation. The testimony, of course, relates to the nuclear

power reactors regulated by the Nuclear Regulatory Commission. I

am not speaking on behalf of DOE’s parallel functions.

The Act addressed an unusual insurance situation which was

blocking Congress’s aim for the development of the peaceful uses

of atomic energy. That situation was one where it was impossible

to rule out the potential for an accident. There was little or no experience of the kind Secretary O’Neill described. And the possible

costs of damages were uncertain. And thus neither industry nor

private insurers could absorb the risk. Congress had two paramount goals in resolving this predicament. One was to make available adequate funds to satisfy public liability claims in a catastrophic nuclear accident, and the other was to permit private sector use of nuclear energy by removing the threat of potentially

enormous liability in the event of such an accident.

The solution combined indemnification with the limit on liability.

The solution applied to all reactors as a further condition of licensing. And the licensing process itself provided substantial assurance

that each reactor would be designed, built and operated to satisfy

high safety standards. Originally, Price-Anderson prescribed that

each power reactor licensee had to procure available financial protection, which as a practical matter, meant the purchase of $60

million of commercial insurance, the maximum then available. I

might add here that the commercial insurance was itself pooled

coverage and that was the only way they could get some companies

to stand behind the commitment for funding.

That first layer was then followed by indemnification by the

United States itself to cover up to $500 million in liability over the

amount covered by commercial insurance. And the United States

never, on the commercial side, exceeded a $500 million indemnification role.

Aggregate liability for any single accident is, by statute, limited

to the sum of the commercial insurance available and the Government indemnity. As you all perhaps know, the Government has

never had to pay any indemnity for a nuclear accident on the commercial side, nuclear power plan. The aggregate liability included

the liability of any one who was found liable for any reactor accident with the exception of an accident resulting from an act of war.

This broad coverage is known as omnibus coverage. The omnibus

nature of the coverage was designed to serve many purposes. It

was to ensure the availability of funds to compensate for personal

injury or damage to property of members of the public, no matter

who caused the accident. It was there to permit suppliers and professionals to participate in the industry without fear of liability far

out of proportion to any profit they might expect to gain, and it was

57

to make possible efficiencies in the process of presenting, settling

and satisfying claims.

Mechanisms to accomplish these goals were incorporated in insurance contracts and in required agreements of indemnification

between the licensee and the United States. The end result benefited the public by channeling all legal claims to the reactor licensee or operator.

While the Price-Anderson Act provided that liability was limited,

the reports of both Houses on passage noted that if actual damages

were to exceed the available funds in commercial insurance coverage and Government indemnity, ‘‘the way was left open for Federal contributions after further congressional consideration.’’ This

concept present at the outset was later expressly included in the

Price-Anderson Act amendment, and is often referred to as a ‘‘third

layer of protection.’’ Congress amends the Price-Anderson Act from time to time, always mindful of the delicate balance of obligations between operators at nuclear facilities and the United States Government as

indemnitor and as representative of the people.

The most significant amendments to date were those that effectively remove the United States from its obligation to indemnify

commercial power reactors and place the burden on the nuclear

power industry. This was accomplished without any substantial alteration of the other elements that characterized the Price-Anderson theme, most particularly, without affecting omnibus coverage

and liability limited to the availability of funding. And it was enacted with increased protection for the public.

The first step in this direction occurred in 1975 when Congress mandated that each commercial power reactor contribute $5 million to a retrospective payment premium pool. This retrospective

premium was due if, and only if, there were to be damages for a

nuclear accident that exceeded the maximum commercial insurance

available. The limit of liability was then $560 million. Government

indemnification was phased out in 1982 when the potential pool

and available insurance reached that sum.

In 1988, Congress increased the potential obligation of each and

every reactor in the event of a single accident at any reactor to $63

million. The liability insurance available to comprise the first layer

is now $200 million. When that insurance is exhausted, each U.S.

reactor licensee must pay into the pool up to $83.9 million as adjusted for inflation, if needed, to cover damages in excess of the

sum covered by the commercial insurance. The $83.9 million is payable in annual installments not to exceed $10 million.

Today, the first layer of commercial insurance and the second

layer from the reactor pool together would make available over $9

billion to cover any person or property harm to the public caused

by an accident. An early amendment expanded the waivers so that

in serious accidents, denominated extraordinary nuclear occurrences by the NRC, the defendants must also waive other defenses.

The waivers in sum provide a result in the nature of strict liability

where the harmed public need prove only that the accident caused

their injury, proof of fault is eliminated.

The statute excludes coverage of property damage at the reactor

site, and there are also provisions covering, among other things,

58

settlements, establishment of a single Federal forum, case management, distribution of funds, criteria for allowing legal costs, and the

preparation of reports to Congress in the event there is an expectation liabilities will exceed the available sums.

Thank you, Mr. Chairman. I welcome your comments and questions.

[The prepared statement of Marjorie S. Nordlinger can be found

on page 130 in the appendix.]

Chairman BAKER. Thank you.

Our final panelist this afternoon, Mr. Richard Hillman, Director

of Financial Markets and Community Investment with GAO. Welcome, sir.

STATEMENT OF RICHARD J. HILLMAN, DIRECTOR, FINANCIAL

MARKETS AND COMMUNITY INVESTMENT, U.S. GENERAL ACCOUNTING OFFICE

Mr. HILLMAN. In the interest of time, I will be very brief. At your

request, our testimony today outlined features of selected insurance

programs covering terrorists and other catastrophic events ranking

from programs completely controlled and managed by the Federal

Government or other governments to programs with little or no explicit Government involvement. Sandwiched in between was a wide

range of programs that the public and private sector shared risks

together and in varying and different ways.

The second point of my testimony provided information on alternative mechanisms for funding insureds also including both preand post-funding mechanisms and the use of industry pools to

share risk.

Finally, our last point provided some of our own thoughts about

how the Congress ought to be approaching next steps. Most importantly we are hopeful that what we are seeing before us is a temporary market failure. And in that vein, we are hopeful that the

program that would be designed would not displace the private

market. Rather, it should create an environment in which the private market can displace the Government program.

In summary, we have provided a great deal of information on

Federal and international programs to your staffs. And we stand

ready to provide any additional information on these programs

should you so desire.

[The prepared statement of Richard J. Hillman can be found on

page 137 in the appendix.]

Chairman BAKER. Thank you very much. We appreciate your attendance and your brevity.

Let me suggest, Mr. Chairman, that since it is just the three of

us and likely to be the only three of us that rather than just proceed with 5 minutes apiece, that we take advantage of a group discussion which would be a little more beneficial, I think and just

dispense with the normal 5-minute rule and just jump in when you

like.

We know that we have to do something. We are not sure what

that something is. But providing liquidity to the markets at some

point with some limit—because like the shareholders of insurance

companies who don’t and will not tolerate unlimited exposure, neither will our shareholders. So the meeting, I think, needs to be

59

around perhaps a two-step approach, something immediate and

short term that would buy us time to do the long-term resolution

that might be more appropriate. Is that something—just that protocol from an industry perspective, say we are going to do X and

then come back next spring and address the remaining issues, let’s

assume the short-term program is a 12- or 15-month short-term solution, is that enough comfort for the reinsurance markets to function, given that we are going to come back with a longer term resolution when we have the appropriate time to construct it? Is that

acceptable?

Mr. MATHIS. Can I take the first crack at that? I think that several issues are associated with that. One, the reinsurance market

isn’t going to function. It is my hope and belief that they may function if there is a viable limit out there in the market. But there

isn’t any associated with that.

Mr. OXLEY. That wouldn’t be right away.

Mr. MATHIS. No, it would be a matter of time associated with

that. Second, that was the reason why there was an industry mechanism associated with a pool to try to spread the risk in that area,

which could work in the retention area. The problem associated

with big net retentions against the industry, and I understand

that, in Government, is that it doesn’t deal with the individual risk

exposure. So therefore, individual companies still have to underwrite against the collective loss that they feel that they might have

on an individual risk exposure. And I would predict that, even

though a top level measurement on the top part of the Government

would certainly bring some measure of comfort and stability back

into the marketplace, it wouldn’t solve it all unless there was some

solution to that mechanism.

And third, if the Government comes up with something that is

associated with a short term timeframe stopgap that isn’t consistent over a period of time, you have to recognize that we write

policies that have a 1-year policy limit. So if you have that, you

have a net retention that is going to move next year to a much

higher number, then you have to write the business understanding

that that is what your net retention is.

Chairman BAKER. But that is a problem with even the 3-year

program. Because there are projects that are going to take longer.

Mr. MATHIS. The industry or the current Administration proposal

talks about a plan that is 80/20 to begin with and moves to 50/50

in the second year then to higher retention. I think that that is a

problem for the industry to not have something that is consistent

all the way across to look at and try to quantify and measure because, you know, one month after January 1st, you are writing into

the next year.

Mr. SINNOTT. I think if you did it on a risk attachment basis,

which is the normal way of doing things, since it will be the commercial insurance policy there that will adjust the claim, the Government will have to agree that the cause was terrorism, but if it

is on a risk-attaching basis, it is during that policy year, it follows

that policy. And if that acceptance happens to extend out over a period of years, it still goes back to that period. That is the way the

insurance mechanism works. As long as it follows that, I don’t see

a problem.

60

Mr. IORDANOU. If there was no sunset provision. But you are

postponing the issue, because at the end of the day you have to revisit it.

Chairman BAKER. We are understanding what we are doing is

not final. We need more time to examine, study and understand.

What I fear is we act precipitously in the next 3 weeks not fully

understanding what we are doing, and find out that we have represented to the industry a 3- or 4- or 5-year program that is fatally

flawed. That, to me, is a great disservice as opposed to a short

term, publicly acknowledged, this is to get us by January 1, guys,

and by March or April of next year, we will have an ample opportunity to thoroughly vet it. I wanted to know if there was a visceral

no to that. But it may be with certain conditions.

Mr. IORDANOU. Let me jump in on a couple of our issues.

Mr. OXLEY. Let me back up. What is the biggest down argument

against what Chairman Baker was talking about? What is the

worst-case scenario if we were to do that? Is it that there is no

longer the political will to fix the problem entirely?

Mr. SINNOTT. Really, the issue comes down to what is the sharing between the private industry and this mechanism. As long as

that is basically agreed.

Chairman BAKER. For purposes of discussion, let’s just take the

President’s first year of his plan and just say year one, here is the

deal.

Mr. SINNOTT. If the industry and the insurers can live with that,

and if the brokers and others, Dave, can go out now that it is only

a 20 percent issue rather than 100 percent withdrawal from the

market, I think there is an opportunity to start the market moving

along to maybe provide some protection for that 20 percent.

Mr. OXLEY. The subcommittee will have some evidence by then

as to what is happening in the marketplace?

Mr. SINNOTT. I think getting through January 1 is a big issue.

Mr. IORDANOU. You are talking——

Mr. OXLEY. The policy being renewed for another year?

Mr. SINNOTT. Yes.

Mr. IORDANOU. Or maybe more. On the risk attachment basis, if

any of you own a 3-year policy for a project a construction project,

that it will take 26 months or 27 months, if the risk attachment

is there, then the coverage will follow throughout that period.

Mr. SINNOTT. It is the only logical way to do it. The 20 percent

that the private industry has, that is the way the commercial market will look at the claim. It is on a risk attaching basis, even if

it is a construction project that runs out. There is nothing unique

about that. That is the way the mechanism works.

Mr. IORDANOU. There is another issue here that I think is grossly

misunderstood about how the mechanisms in the industry work.

Even I was surprised to hear the comments by my colleagues from

academia that were opposed to the first dollar sharing of risk. I

will agree that $5- or $10- or $15 billion in the aggregate is a size

of risk that the industry can handle collectively. But the way contracts are issued, unless you create within that mechanism an invented sharing, it is not going to work in the marketplace; because

at the end of the day, who does provide the insurance for the facVerDate 11-MAY-2000 11:10 Mar 27, 2002 Jkt 000000 PO 00000 Frm 00066 Fmt 6633 Sfmt 6633 76182.TXT HBANK1 PsN: HBANK1
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tory that has the 10,000 employees or assembly plant that might

be the next attack?

Now, even though the industry loss might be $5 billion, not significant, it is only covered by one insurer, and that insurer is out

of business. Because if it was Kemper or if it was Zurich in North

America, with $4 billion committed to North America, we would be

out of business. And that is the part that is being misunderstood

in the debate today. That we have not only an issue with aggregation of small risk, but we have an issue in the way the mechanism

works today in the private market by instructing the insurance

component that allows spreading of risk to operate efficiently.

And focusing on $5-, $10-, $15-billion in the aggregate, it is significant, but not catastrophic, but it could be catastrophic to a single insurer.

Chairman BAKER. What has bothered me in the interface between the Government and the industry in the proposal is the direct providers of the policy to the insured property as opposed to

the commercial reinsurance industry. Everybody that I have heard

express concern about exposure goes to dense projects where you

have high value, high numbers of people in small areas, not necessarily to cattle operations in Wyoming. And in order to not create

more of a hazard, we need for insureds to take appropriate self-protecting actions.

Since the commercial reinsurance guys set the underwriting

standards, doesn’t it make some business sense for us to enter into

our agreement for the backstop with the commercial reinsurers,

and then have them set the new security measures or standards

in a private market context, but ensure that they do provide coverage for terrorism?

Mr. BACHUS. I think actually what has been also discussed is the

State-chartered reinsurance. They would then—in turn the Government would come in and——

Mr. MATHIS. The pool.

Mr. IORDANOU. Independent of how you do it, Chairman Baker,

there is no opposition if it is insurance or reinsurance. The principle is the ability to share risk. But that is how you allow the free

mechanism, you know, the freedom to go out and write these very

large limit policies for the airport or for the water supply company

or for the train station or for the stadium. Because at the end of

the day, they know that if an event happens, you know that risk

will be spread.

Chairman BAKER. The insurance company has to lay it off to the

reinsurer. The reinsurer is going to lay it off to the Federal Government. All I am saying is from an operations standpoint, when your

customer makes the claim and you have to fill out the form the

Federal Government prescribes and send it to the Secretary of the

Treasury for him to issue a check, I suspect for 2,300 companies

and thousands of claims, you are going to have a long wait.

I would rather, as much as it is practicable, have you engage,

turn it around as a business matter and ask a reinsurance company for their appropriate contribution and have the reinsurers

dealing with the Department of the Treasury. It seems to me to be

a more efficient mechanism.

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Mr. SINNOTT. I hope no one is envisioning that we had a frequency problem. It is a severity issue. If you had a frequency problem, you are 100 percent right. But we are talking severity, which

means very few; hopefully no events, but at the worst severity of

events. They will be severe in nature. And that can be managed

this way. That is the other reason why we advise our clients to

take deductibles. Don’t do first dollar. But in this case, with the

few events—or hopefully none—but the few events that could

occur, it is not really first dollar. The industry is going to be in

there, because if you get an event, it is likely to be a major event.

So the whole idea of first dollar doesn’t ring with me on this. I

don’t view this as really first dollar, because we are talking catastrophic risk.

Mr. BACHUS. What about a special State-chartered reinsurance

company?

Mr. CUMMINGS. I am really against setting up that. I think the

market works more efficiently in terms of reinsurance contracts. I

think that’s what we see in commercial markets. It is fairly like financial.

Mr. BACHUS. You wouldn’t have to. They could see—— Mr. MATHIS. The industry proposal. Not that it could pick and

choose individual risk.

Mr. BACHUS. It is an option you can cede risk to. The reinsurance

company, the Government would then participate.

Mr. HARRINGTON. Then you have the Government in pricing. You

should avoid the Government in pricing. If you go down that

route—— Mr. BACHUS. Don’t you do that on other—— Mr. MATHIS. Supporting a funding of the first $10 billion of

losses that has built up over a period of time.

Mr. BACHUS. You actually said that you thought there ought to

be a first dollar.

Mr. IORDANOU. You oppose that.

Mr. HARRINGTON. I have assumed that given what I know about

the sophistication of reinsurers, if there was a $5- or $10-billion attachment point, there are a lot of smart people in this business

that would start thinking about how they could design property

treaties so they could price it in recognition that there was a relatively low probability that there will be an amount greater than

that amount. Maybe I have grossly overestimated sophistication in

the reinsurance markets. But the latest contracts are set up, it has

got to attach an 80/20 basis in the first dollar.

Mr. IORDANOU. There is no way to spread the risk on a catastrophic event. The concept of an industry aggregate of $5 or $10

billion and then something that attaches on the next system, it creates an environment that singular insurers will be exposing up to

100 percent of their capital to an acceptable risk. For that reason,

you are defeating the purpose of trying to create liquidity.

Mr. HARRINGTON. I thought you could deal—you and your reinsurance friends could get together and negotiate this.

Mr. IORDANOU. It needs to be part of this proposal. If that happens and there is some encouragement either with tax, which I

think is a great idea, the reason we are exploring more coverage

to foreign markets today in the United States is because we have

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a bias against the mechanism of setting the reserves for events

that we know that will happen once every 10 years, once every 25

years, once every 50 years. Today it is tax efficient for me as a

buyer to send my dollars for reinsurance to Bermuda and get a deduction as a business expense, it is a cost of doing business, versus

putting it in a tax-free pool.

Chairman BAKER. Let’s go right to that point. We had the discussion earlier. If you were to create a tax-free pool for terrorism reserves only—and that is a reserve which does not exist—therefore

I would argue has no budget implications, but that is a thin argument, what would that do for you in your perspective in enabling

you to insure against terrorist risk?

Mr. IORDANOU. Over time—not immediately, over time as that

builds up, it will create more and more capacity in an ability for

companies——

Chairman BAKER. Are you talking 2 or 3 years?

Mr. IORDANOU. It depends on the size of how much would allow

it to—because you got to have some—there is not going to be an

open-ended ability to set terrorist reserves, you know, for risk.

There has got to be some parameters; otherwise you will eliminate

paying any taxes, continue putting up reserves and earmarking

them.

Chairman BAKER. But from an industry perspective, that is a

major element in the long-term private market resolution of this

problem.

Mr. IORDANOU. I agree.

Chairman BAKER. Doesn’t help us January 1.

Mr. KEATING. If we don’t think about the long term, we are not

going to get there. We will wind up having more of this.

Mr. SINNOTT. I think that is right. As I say, we do not have much

time to figure out what we are going to do for January 1.

Chairman BAKER. Let’s jump on that, if I may. If we take the

President’s first year proposal, what additions or modifications

would this group suggest to make it a workable plan for, say, 15

months?

Mr. KEATING. Could I say something? I really don’t think it

makes sense that the Treasury do first dollar, because the assumption here is that anything that happens is going to be a catastrophic event. Just because they were so clever the first time

around doesn’t mean every event is going to be a huge event. I

don’t see the need for the Treasury to step in on everything that

might be considered a terrorist act. So first dollar coverage to me

makes absolutely no sense.

Mr. OXLEY. There ought to be a deductible.

Mr. SINNOTT. You are complicating it, because now you are trying to aggregate the industry together. You are getting into a very

complex mechanism. If you keep it simple, it is a co-insurance, policy by policy by policy. Now, that is, you could view that as interim.

But otherwise, you figure out an event occurs and you have many

insurance companies; how do you allocate it? Who gets the benefit?

It becomes more complicated.

Mr. IORDANOU. Worse than that, you get two insurance companies, both of them out of business.

64

Mr. SINNOTT. So you have to keep it simple starting out, although these points, looking at taxes, are clearly good; you know,

the near-term/long-term things that can be done. The other thing

that as I said before, I mean I don’t know why the mechanism

would not include business interruption. It will create another disconnect between the 0 percent that the commercial market is offering and the 80 percent, if that is the number that the Federal program provides. Because these are programs that are together. Most

businesses buy property damage and business interruption.

Mr. IORDANOU. Let me give you the statistics. The business interruption component of loss arising out of covered perils is 50 percent

of the loss. So for every dollar of indemnity we give to a customer,

50 cents goes to rebuild the factory and 50 cents goes to reimburse

them for business interruption.

Mr. KEATING. But not everybody buys business interruption.

Mr. IORDANOU. There is no commercial enterprise that I know

that has no business interruption coverage.

Mr. SINNOTT. Wait a second. Let me tell you. We have experience

on this. We do the Fortune 500. I can tell you that there is only

a handful, relatively speaking, of the very largest companies that

don’t buy business interruption. . You are talking about Fortune

500.

Mr. HARRINGTON. There are lots of things that are on business

interruption.

Mr. IORDANOU. The business interruption provided by the insurance industry is business interruption arising out of covered perils,

so you have to have an incident.

Mr. SINNOTT. Of your actual lost loss.

Mr. OXLEY. Mr. Hillman has been studying this at GAO. What

is your cut on these different proposals?

Mr. HILLMAN. I find some of the remarks that these gentlemen

are making to be very useful. One of the points that I think may

be worth considering is rather than coming up with a $5 billion,

a $10 billion, a $15 billion retention for the industry as a whole,

because that provides a lot of complicating factors, one thing you

may wish to consider is establishing a per-claim limit. And perhaps

I will have Mr. Cluff provide that.

Mr. CLUFF. Either per claim or per insurer.

Chairman BAKER. For the record, give your name.

Mr. CLUFF. Lawrence Cluff with the U.S. General Accounting Office. But either way, you avoid the problem of trying to aggregate

to some $5 billion, $10 billion, you avoid the pricing problem, and

you also avoid the Treasury having to write a check for every little

thing that happens. If you have a retention on a per-claim or a perinsurer basis, that solves a lot of those problems.

Chairman BAKER. Any reaction?

Mr. MATHIS. Well the 80/20 is a retention per claim.

Mr. SINNOTT. That does eliminate the problem that I was saying.

It is specific.

Mr. KEATING. That is fine with me; but going on each claim, each

first dollar doesn’t make any sense.

Mr. CLUFF. I concur.

Mr. IORDANOU. There is no first dollar coverage to begin with in

the business. First dollar coverage is for your homeowners. When

65

you get into the commercial business, a lot of our clients will retain

maybe $100,000, $500,000, $1 million, some of them $5 to $10 million over the first dollar coverage. They buy beyond that. So in

those parameters, I think everything is workable. I don’t think it

is a bad idea. I think it needs to be on the table. As a company

we will not be opposed to it.

Mr. SINNOTT. It just gets back to what the retention tolerance is

of the industry. Fine. They take the first X amount, then they

know that they are also going to have 80 percent. It is a matter

of figuring out what the retention tolerance of the private industry

is, and the willingness of the Government; and hopefully those two

things on a temporary basis will match, so that we get beyond this

particular real problem that we have and have more time.

And the brokers can help in this. There are already small bits

of capacity that are being developed. The problem is it is just too

big a gap that we are looking at, and we are looking at 100 percent

withdrawal. If this was just 10 percent, it would be different, like

when some markets decided to get out of the business when we

went through this 16 years ago. We were able to deal with it without asking the Government to step in, and we were able to get policyholder investment, and we got it done, and the market returned

to normal.

I think the same thing can happen here, though there is one difference. We didn’t have an environmental issue 15 years ago that

had to be changed, that we had to find a solution for. In our case,

I can tell you that our midtown office, which is where our headquarters is, security is on the top of our list of priorities. I think

the comments about this being a free ride for businesses is

innacurate.

Mr. BACHUS. What about the comment, I thought you said, that

would increase the risk when the Government steps in?

Mr. IORDANOU. We totally disagree.

Mr. SINNOTT. The insurance was there before. We are talking

about the withdrawal of insurance. Let’s continue to provide insurance which is a social instrument, continuing to provide it on a

temporary basis, get the Government in there, get it out as quickly

as possible and do it on a basis that allows competition, the particular competition that we like to see on behalf of our clients,

which is each of the markets doing its own thing.

Chairman BAKER. Let me jump in.

Mr. HARRINGTON. Temporary, that is fine. But over the long

term, it will be a good idea to have some relocation of certain businesses, to spread the risk out to reduce the risk of a big event in

a particular place. In the long term, if we intervene we are going

to discourage those type of responses.

Mr. SINNOTT. We are looking at it ourselves because we have

5,500 people in New York City in one big building. I mean, forget

about whether or not we have insurance. We are looking at lives

here, whether or not there is business disruption. Regardless of the

insurance response, we had business disruption. If we have our

risks better spread, we will have less business disruption and we

lessen the risk to our colleagues. So all of those things are ongoing

right now.

Chairman BAKER. Our position is not to——

66

Mr. BACHUS. Can we get into some of the finer points?

Chairman BAKER. Let me jump one more thing before you do

that. As to the element of why there is the pushback on the structure either to the industry or the Administration proposal from

some unidentified Members of Congress, you are going through this

self-assessment of how do we protect our people, how do we ensure

our business exists? But the resolution of that is to ask people with

the checkbook or the money, without the people who are going to

write that check knowing anything, with the industry, the solvency

of the companies to whom we are extending the credit, the limit

of our exposure if, God forbid, this thing does turn out to be frequent and large. What we are tying to say, we understand the importance of acting timely and responsibly, but we have to take risk

aversion steps ourselves.

So that is what we are looking for here. If we can do that with

something temporary and come back and not have industry claiming that Congress has not met its obligations because it has not

met final resolution, and do that next year, we can have more of

these and really get down to the fine points that Mr. Bachus and

others would choose to pursue.

Only to that end in looking at the Administration proposal, pro

and con, all the ideas possible are about how we tweak the firstyear methodology to potentially be a short-term remedy to give us

the long-term critical analysis. None of you gentlemen would invest

large sums of money without relying on a great deal of examination

by the best staff you could find to give you all the pros and cons.

That is where at least I am speaking for myself. I don’t feel I am

competent to make this decision this afternoon. I may not be competent to make it next year, according to some people. But I think

I want to give myself the best shot. So that is where I am.

Mr. BACHUS. Adverse risk selection. I ask this question: Should

an insurance company eligibility for the program be conditioned on

providing terrorist risk insurance in all its P and C policies?

Mr. MATHIS. To a large degree, it already is.

Mr. SINNOTT. The large commercial markets file and use, where

you don’t have to get State agreement.

Mr. BACHUS. But what I am saying, again, should one of the policies of this Congress be that we would require them to offer it?

Mr. MATHIS. Well, I have two questions which are associated

with that. Are you going to agree that there is a rate preemption

and that people can charge whatever rates they choose in the marketplace? The other is that you clearly wouldn’t expect that every

company would want to underwrite every risk.

Mr. IORDANOU. In order to eliminate the moral hazard, it has to

put the pressure on the management of that company to deal with

the kind of risk that would be criticized today in this area that

maybe the industry is not paying much attention to.

And the second point is that, in our view, risk management for

terrorism risk, the only authority who can do the best risk management is the U.S. military and the CIA and the FBI and the Federal

Government. At the end of the day—that is why we have this event

today. In 1993, in 1993 we knew we had a terrorist attack. In 1993

we knew it was the same set of buildings. In 1998 the industry suffered about a little over $1 billion in claims. And we were down in

67

Washington looking, because actual mechanisms of the industry

dealt with it.

Today, just for the record on the perspective that we are talking about, the property casualty business has a revenue of $155 billion.

When you look at the equity capital of the industry supporting the

$155 billion, it is anywhere from $80 to $100 billion. In one event,

almost 50 percent of that capital has appeared. So now you face executives that say they are providing that liquidity in the marketplace. They say if they have two such events in the next year, you

will have no property casualty business. The entire business will

vanish.

Chairman BAKER. That is only the case if we have a significant

untoward event in the near term. If we are able to get a few years’ grace, the industry can survive. And perhaps with tax incentives

for reserves, whatever the necessary steps, we can get there. The

short-term question is—I think the principal question we have got

to resolve today, in the next few days, what do we do about January 1? What does it look like and what are the elements for the

taxpayer to make marketplace sense?

Mr. BACHUS. Let me ask another. Should the Secretary be given

discretion to preempt State regulation?

Mr. MATHIS. In certain areas. Not total.

Mr. BACHUS. It will have to happen.

Mr. SINNOTT. As he says, it will happen in certain cases once you

get beyond a certain point where rates are not tariffed. You know,

rates are freely negotiated, policy conditions are negotiated. There

is not much issue there as far as scope of coverage.

Mr. MATHIS. Let us take workers’ compensation.

Mr. SINNOTT. Well, that is statutory.

Mr. MATHIS. And it is State regulated in every State, and there

is no ability to deal with—— Mr. SINNOTT. I was thinking workers’ comp. Or what is a terrorist about? If we go to 50 States, we will be in litigation for the

next 50 years.

Chairman BAKER. Some of the things I have read, we are going

to be in litigation for the next 50 years.

Mr. BACHUS. That is something to give thought to.

Mr. MATHIS. I want to talk totally about a large—we write a lot

of middle-America business. That is in urban areas.

Mr. BACHUS. OK. Now, this thing includes private passenger

automobile coverage. We are talking about 7,000 people die every

day. We insure every automobile every day. Should the Government program insure private passenger—isn’t there going to be a

lot of claims?

Mr. IORDANOU. Let me give you a scenario and you draw your

own conclusion. Most personalized carriers write personal automobile and also write homeowners policies.

Mr. BACHUS. Homeowners?

Mr. IORDANOU. Well, if I am in your home and I drink contaminated water, I can have a claim against you, in essence, against

your homeowner’s, and I can paint a scenario that maybe a water

company, their wells get contaminated, and now you have a significant number of homes that have contaminated water through an

agent. And we have significant number of——

68

Mr. BACHUS. I am just concerned about the volume. If we cover

private passenger automobile coverage, the Government proposed

it, that is a big volume of claims.

Mr. IORDANOU. I can envision private passenger automobile to

have a large number of claims.

Mr. BACHUS. It is in here. Right? What you don’t want, you don’t

want a process in the automobile claim where there is some——

Mr. SINNOTT. Right.

Mr. MATHIS. I would say to you, we are in the commercial line.

But I don’t want to speak for——

Mr. BACHUS. It is in here right now.

Chairman BAKER. And I thought we had generally agreement

that—because my comments earlier, I was reflecting on commercial

reinsurance principally as an interface and commercial lines only

being subject to——

Mr. BACHUS. Well, right now it is commercial property and commercial liability and commercial automobile, workers’ compensation, private passenger automobile, homeowners. It does include

business interruption, and that is my next question. You know, you

are saying that that is——

Mr. SINNOTT. Sure it is.

Mr. BACHUS. It is possible to design a two-tier—what I did here

is it is more subjective in figuring out——

Mr. SINNOTT. Yeah. It is a difficult business interruption adjustment.

Mr. BACHUS. We just have a different—you know, where we insure 90 percent, you know, and——

Mr. SINNOTT. We could, but——

Mr. BACHUS. Could we do 80, 75 percent——

Mr. SINNOTT. But the adjustment issue is not as straightforward,

I grant you, but the World Trade Center claims are going to be adjusted eventually. There are going to be some disputes as respects

property damage and also business interruption. There will be a

sum total. So the fact that it is more difficult to adjust.

Mr. BACHUS. You mean to compute what the loss——

Mr. SINNOTT. Yeah. To calculate what the loss is. I don’t see why

that would make different treatment from the sharing.

Mr. BACHUS. It is——

Mr. IORDANOU. No. It is——

Mr. BACHUS. Certainly you are talking about a proposal by the

Administration to take care of 50 percent of the profit.

Mr. SINNOTT. I wasn’t aware of that. Was that a recent takeout?

Chairman BAKER. There are several memoranda characterizing

the Administration’s proposal. So we don’t really have a——

Mr. SINNOTT. I heard the Secretary, and that was the first I had

heard about it.

Mr. BACHUS. It is in here right now, and what I am saying, it

certainly won’t take care of the problems of increased premiums,

which I agree is not an insurance problem. It is an economic problem. If we are going to have a recovery——

Mr. IORDANOU. You——

Mr. BACHUS. We are already in a recessionary situation.

69

Mr. SINNOTT. I can almost guarantee that the primary insurance

carriers will not cover terrorism on their own for business interruption.

Mr. BACHUS. It may be what is done, is that it is an 80/20. Either way.

Mr. IORDANOU. So there have got to be those mechanisms. But

I can tell you the liquidity of the market, working capital and capital for fixed assets will disappear. Why will a bank lend to a restaurant owner if he can’t pay the mortgage back because of a business interruption versus a fire?

Chairman BAKER. Sure.

Mr. BACHUS. These are little things. You know, you get a package and—— Mr. KEATING. We have got to be very careful to have the things

to protect—— Chairman BAKER. Well, let me suggest this as a starting point

for us, because we have got to do something pretty quickly. Among

the respective interests represented here, send us a couple pages

apiece on the essential elements you think make short-term sense.

Let us not try to fix the world long term. Let us try and get us past

January 1, with the understanding that if we can reach an agreement, it would be our obligation to come back to stakeholders next

year and do it the right way, but if you really—in my casual observation, where our potential risk is, there aren’t many remaining

elements that offer all the downside that occurred September 11th,

and the likelihood of something of that magnitude occurring in the

near term, no one knows.

But it would be very difficult, I think, given all the extraordinary

measures that have been engaged in, and we certainly can expect,

I think, more events, but, you know, hopefully no loss of lives and

very little dollar. If we have that luxury and we can do this in a

less difficult environment. February, March, I think we can craft

a package, hearing everyone’s perspective that makes some longterm economic sense, without only debating unnecessarily tax dollars beyond foreseeable vision. And to that end, unless you have

got something further, Spencer, I just——

Mr. BACHUS. Well, we have had mail interruptions here. Does

that—if you had a company that had mail interruptions because of

an anthrax scare at a local post office, can they make a claim

under business—— Mr. SINNOTT. There has got to be——

Mr. BACHUS. Or the business has to be shut?

Mr. SINNOTT. It has got to be damaged from a peril.

Mr. BACHUS. Mail interruption does——

Mr. SINNOTT. Sure.

Mr. IORDANOU. It was the same issue with the Y2K, that there

was no business interruption, you know, and there was mitigation

around that.

Mr. SINNOTT. Remember that we will have, I mentioned, our insured losses. We will have uninsured losses that will be very significant. So insurance—— Mr. IORDANOU. Professionals that you have—— Mr. SINNOTT. Insurance only covers generally a relatively small

part of what the total loss is.

70

Mr. BACHUS. And Mr. Williams, there has been a proposal from

this airline security to the airports, and you all write some of that.

Be aware that in that bill, the proposal, the standby coverage,

extended—— Mr. WILLIAMS. Yes.

Mr. BACHUS. We don’t know. I am just telling you. They can

start fighting and you can start fighting about that.

Chairman BAKER. Let me express my appreciation to all of you

for your long-standing tolerance today. It was a difficult day and

we made it and it was helpful to us in getting a better understanding. Thank you very much.

[Whereupon, at 5:55 p.m., the hearing was adjourned.]

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A P P E N D I X

October 24, 2001

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