Terrorism Insurance: Rising Uninsured Exposure to Attacks Heightens Potential Economic Vulnerabilities
Published: 2002-02-27T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: In the closing months of last year, insurers claimed that they could not afford to continue providing coverage for potential terrorism losses. Considerable debate has taken place on what the federal government can do to keep commercial insurance companies involved in providing terrorism insurance, even without the protection that they normally receive from reinsurance. Insurance companies are withdrawing from the market because they believe that neither the frequency nor the magnitude of future terrorist losses can be estimated. Insurance coverage for terroris is disappearing, particularly for large businesses and those perceived to be at some risk. This withdrawal is happening fastest among reinsurers. Because the insurers' withdrawal has been gradual, the extent of the potential economic consequences is still unclear. What is clear is that without terrorism insurance, terrorist attacks would dramatically increase direct losses to businesses, employees, and lenders. Furthermore, the government's ability to intervene after a future terrorist attack may be hampered by its lack of claims-processing and payments systems. Even without actual terrorist attacks, some properties and businesses have been unable to find terrorism coverage at any price. These problems are likely to increase as more insurance contracts come up for renewal during the coming year. The resulting economic drag could slow economic recovery and growth.

section_title: Letter
paragraphs: The tragic events of September 11, 2001 brought to light the huge potential  exposures insurance companies could face in the event of another  terrorist attack. Faced with continued uncertainties about the frequency  and magnitude of future attacks, at the same time government and military  leaders are warning of new attacks to come, both insurers and reinsurers  have determined that terrorism is not an insurable risk at this time. As a  result, in the closing months of last year insurers began announcing that  they could not afford to continue providing coverage for potential  terrorism losses. The effects of this trend have yet to be fully realized, but  there is some indication that it has begun to cause difficulties for some  firms in certain economic sectors.
Considerable debate has taken place on what the federal government can  do to keep commercial insurance companies involved in providing  terrorism insurance, even without the protection that they normally  receive from reinsurance. While this Committee and the House of  Representatives did pass H.R. 3210, the Congress as a whole did not adopt  legislation.
Today, two months into a new year, uncertainty and concerns continue,  both in the insurance industry and the economy, over the issue of  terrorism insurance. As you requested, my testimony today will describe  how, in the absence of federal action, insurance companies and the  marketplace have reacted to the events of September 11th. I will also  present GAO’s initial observations on the potential consequences these  market changes may have, both in the event of another terrorist attack  and, as we all hope, in the absence of one. Finally, I have included a  discussion of the language developed by the Insurance Services Office  (ISO) and adopted by most states to exclude terrorism from commercial  property and casualty (P/C) coverage (appendix 1).
My statement today is based on discussions with a variety of insurance  industry participants, regulators, policyholders, and other affected parties.  Because many companies were deeply concerned about the possibility  that their difficulties in getting terrorism coverage might become general  knowledge, they spoke to us only on condition of anonymity. Finally, my  statement primarily addresses the availability of terrorism insurance  coverage. Despite rising prices in the remainder of the commercial P/C  market, insurance coverage is still available, though at prices above those  in effect prior to September 11, 2001.
In summary, because insurance companies believe that neither the  frequency nor the magnitude of future terrorist losses can be estimated,  they are withdrawing themselves from the market. Insurance for losses  from terrorism is disappearing, particularly for large businesses and those  perceived to be at some risk. This withdrawal is happening fastest among  reinsurers. Direct commercial P/C insurers’ withdrawal has been slower  and less complete because of regulatory constraints and legal  requirements in some states that preclude insurers from excluding  terrorism from coverage for workers’ compensation and for fire  (irrespective of its cause).
Because the insurers’ withdrawal has been gradual, the extent of the  potential economic consequences is still unclear. What is clear is that in  the absence of terrorism insurance, another terrorist attack would  dramatically increase direct losses to businesses, employees, lenders, and  other noninsurance entities beyond those resulting from September 11th.  Furthermore, should the government decide to intervene after a future  attack, it would do so without readily available claims-processing and  payment mechanisms that exist in the insurance industry.
Even in the absence of an actual terrorist event, however, there are  growing indications that some sectors of the economy—notably real estate  and commercial lending—are beginning to experience difficulties because  some properties and businesses are unable to find sufficient terrorism  coverage, at any price. If allowed to go unchecked, these difficulties are  likely to increase as more insurance contracts come up for renewal over  the next year. The resulting economic drag could slow economic recovery  and growth.
subsections: section_title: Insurers Are Shifting Terrorism Risk to Property Owners and Businesses
paragraphs: Since the September 11th attacks, the key dynamic taking place in the  insurance industry has been a shifting of the risk for terrorism-related  losses from reinsurers to primary insurers and then to the insured.  Reinsurers and insurers have begun shedding their exposure to terrorism  risk as insurance contracts come up for renewal, leaving policyholders  increasingly exposed to losses from a terrorist attack. Prior to September  11, 2001, insured losses resulting from terrorism in this country were  extremely infrequent. Insurance companies considered the risk so low that  they did not identify or price potential losses from terrorist activity  separately from the general property and liability coverage provided to  businesses. But after the September 11th attacks, insurance companies  recognized that their risk exposure was both real and potentially  enormous. As a result, they began to express concern about continuing to  include terrorism coverage as an unpriced component of commercial P/C  insurance contracts. Insurers pointed out that experience with major  terrorist events has been so limited, and the potential losses so large, that  setting an actuarially sound price for such coverage is virtually impossible.  Many insurers now consider terrorism an uninsurable risk, at least for the  moment. Their response to any risk they consider uninsurable, as many  Californians living on fault lines have found, is not to offer insurance. This  trend has become evident in the case of terrorism insurance.
subsections: section_title: Reinsurers Are Withdrawing from the Market for Terrorism Insurance
paragraphs: Reinsurers—companies that routinely take on some of the risk that direct  primary insurers face in return for a share of the premiums—are now  unwilling to participate in terrorism coverage because of the enormous  losses they suffered after September 11th and the newly recognized  difficulties of pricing terrorism insurance. Reinsurance is a vitally  important element of the insurance industry’s capacity to provide  coverage to policyholders. As a mechanism for spreading the risks taken  by insurance companies, reinsurance allows primary insurers to accept  large risks and, by reinsuring a portion of those risks, to protect  themselves from a potentially catastrophic loss. Like syndications of large  loans by groups of lenders, reinsurance provides a way to insure large  risks without exposing a single insurer to the possibility that its entire  capital base would be wiped out because of a single event. Reinsurance  companies also provide a channel through which investors can introduce  capital to insurance markets without having to develop the extensive  distribution channels required by direct primary insurers.
However, because reinsurance markets are global in scope and because  reinsurance transactions are considered to be contracts between  sophisticated parties, neither the prices nor the conditions of such  coverage are subject to direct regulation. As a result, after September 11th,  reinsurers had little difficulty excluding terrorism from coverage.  Generally, these exclusions become effective on the policy renewal date.  As stated by witnesses before this Subcommittee in October, a large share  of those contracts expired at the beginning of January. Industry sources  confirm that little reinsurance is being written today that includes  coverage for terrorism. There are exceptions. Low and medium risks,  particularly in industries or geographic locations where there is little  perceived exposure to a terrorist event, are the least affected. However,  large companies, businesses of any size perceived to be in or near a target  location, or those with some concentration of personnel or facilities are  unlikely to be able to obtain a meaningful level of terrorism coverage at an  economically viable price. Where coverage is available, it tends to have  high deductibles and tight limits on the level of coverage. In general,  reinsurers are being very selective on the exposures they will accept, if  any. The higher the risk, the less likely it is that reinsurance coverage will  be available. And even in those limited cases in which some reinsurance  coverage for terrorism is still available, the prices are very high.
section_title: As Primary Insurers’ Exposure Increases, They Also Are Excluding Terrorism Coverage
paragraphs: As reinsurers walk away from terrorism insurance, primary insurers’  exposure increases, at least in the short run. However, while reinsurance  contract renewals tend to be concentrated at the beginning of January and  July, primary insurance contracts tend to renew at a relatively even rate  over the year. As a result, industry observers and participants have told us  that primary insurers’ exposures have increased dramatically and will not  fall unless and until they can, in turn, exclude terrorism from their  coverage.
Faced with this kind of exposure and a risk they do not believe can be  priced, industry observers and participates mentioned that primary  insurers will need to emulate their reinsurance counterparts and exclude  terrorism coverage from some commercial insurance policies. However, a  number of factors are affecting both the speed and the extent to which  primary insurers can insulate themselves from terrorism. First, in contrast  to reinsurance, changes to the coverage provided by direct insurers  require regulatory approval in most states, at least for low- and medium- risk companies. This regulatory hurdle caused ISO, acting on behalf of  P/C insurers, to file a request in every state for permission to exclude  terrorism from all commercial insurance coverage. As of February 22,  2002, 45 states and the District of Columbia and Puerto Rico had approved  the ISO exclusion, according to information received by ISO and the  National Association of Insurance Commissioners (NAIC). The other five  states either denied the suggested language from ISO or are still  considering the language for approval or disapproval. States that have not  approved the ISO exclusion expressed concerns about various issues.  Among them are the low thresholds for exclusion ($25 million or 50  serious casualties); the all-or-nothing nature of the threshold (insurers pay  nothing if either threshold is reached); the aggregation of all losses from  multiple incidents within a 72-hour period and across most of North  America into one event if they “appear to be carried out in concert or to  have a related purpose or common leadership”; fear that the exclusion  would leave some small and medium-sized businesses that could least  afford the losses from a terrorist attack totally unprotected; and worry that  the included definition of terrorism is overly broad. Nevertheless, because  of regulatory concerns about the solvency of primary insurers who cannot  get reinsurance, ISO’s exclusion language has been approved in 45 states  and the District of Columbia and Puerto Rico. Primary insurers in those  states can now exclude terrorism from coverage on various lines of  commercial policies. While only five states have not (yet) accepted the ISO  exclusion language, those five states account for more than 35 percent of  the total U.S. commercial insurance market.
Second, even though direct insurers now have regulatory approval to  exclude terrorism from commercial P/C insurance contracts in most  states, such a change in coverage generally would have to wait until the  renewal date. According to some insurance regulators with whom we  spoke, losing reinsurance would not generally be a sufficient reason for  canceling or changing coverage for policyholders during the policy period.  Moreover, even when an insurance policy terminates, insurers generally  have to give 30 to 60 days advance notice to policyholders before non- renewing a policy or making a significant change in coverage. As a result,  it could be as much as a year after a direct insurer loses reinsurance  coverage for terrorism before a similar exclusion could be passed on to all  its policyholders.
Finally, even at renewal, laws existing in some or most states will affect  the extent to which insurers can completely end their exposure to losses  resulting from terrorist events. For example, laws in nearly all states  preclude a workers’ compensation insurer from excluding coverage for a  particular type of event. Workers’ compensation must cover all the risks to  which an employee is exposed while at work, irrespective of the cause.  Industry sources estimate that approximately 10 percent of the losses  resulting from the World Trade Center attack will be due to payments for  workers’ compensation claims.
Similarly, insurance laws in approximately 30 states include what is called  “standard fire policy” language, according to ISO officials. In that  language, insurers are required to pay losses resulting from fire,  irrespective of the cause. Thus, in an explosion like the World Trade  Center attack, a terrorism exclusion would protect insurers from liability  for losses resulting from the direct effects of the explosion, but not for the  losses caused by the resulting fire. Estimates suggest that the fire, rather  than the explosion itself, caused a substantial portion of the losses in the  World Trade Center attacks. Industry sources have said that they expect  an effort to change this requirement. In all of the states where the standard  is written into state statutes, an act of the state legislature would be  required to modify it.
Thus, even though many reinsurers can and have moved quickly to  exclude terrorism from reinsurance coverage, primary insurers’ ability to  exclude terrorism is more limited, at least in the short run. However, the  rapid submission of the ISO exclusion language to state insurance  regulators, and their generally rapid and positive response, clearly indicate  the urgency of primary insurers’ desire to be able to exclude terrorism  from commercial P/C insurance coverage. Early indications suggest that  many businesses, particularly those in large metropolitan areas, are  already beginning to experience difficulty obtaining terrorism coverage as  their insurance policies come to renewal. In our discussions with  insurance industry participants, observers, and policyholders, we found  that large commercial enterprises were among the first to feel the impact  of terrorism exclusions. Some large property owners or developers  reported that they are having to underinsure or “go bare” by self-insuring  for terrorist risks because of the lack of available coverage or very limited  coverage for the quoted prices.
section_title: As Business Exposure to Uninsured Risks Rises, so Do the Potential Economic Consequences
paragraphs: While the extent of the negative economic impacts of a lack of terrorism  coverage is not yet clear, the potential for more severe economic impacts  is increasing as the level of uninsured risk climbs. Over the next year, the  level of uninsured risk for terrorism-related incidents is expected to  continue to rise as commercial policies renew between primary insurers  and policyholders and insurers seek to exclude terrorism-related coverage  from policies they cannot reinsure. Therefore, the economic burden of  another terrorist attack would fall increasingly on policyholders as the  insurance industry sheds or limits its risks to such exposures, raising the  potential for more devastating economic consequences should such an  event occur. Additionally, as insurers exit the market for terrorism-related  coverage, so too does their claims-processing capacity for administering  recovery assistance to victims of a terrorist event.
Even in the absence of another terrorist event, adverse impacts due to the  lack of adequate terrorism coverage appear to be surfacing, although their  ultimate impact on the economy as a whole cannot yet be gauged.  Additional cases of adverse economic impacts to individual firms caused  by the absence or high price of coverage for terrorism-related events are  likely to become more evident as policies continue to be renewed over the  next year.
subsections: section_title: Another Terrorist Attack Could Have More Severe Economic Consequences
paragraphs: Many of the most severe potential negative consequences resulting from  the lack of terrorism insurance coverage will only become evident if  another terrorist attack occurs. The shifting of risk from reinsurers to  primary insurers to commercial policyholders and other affected parties  could place more risk and economic burden on businesses and the public  at large should another terrorist attack similar to September 11th occur. Consequently, a lack of such coverage in the event of another attack could  have much broader effects on the economy.
Recent estimates of the losses paid by insurers as a result of the attacks on  the World Trade Center are about $50 billion, of which reinsurers are  expected to ultimately pay about two-thirds. If another terrorist event of  similar magnitude were to take place, all those losses would still be  incurred. However, depending on the timing of the event, the effect would  be very different, because even today the reinsurers would be responsible  for a much smaller share of the losses. As the event moves farther into the  future and primary insurers successfully exclude terrorism from insurance  coverage, the losses will increasingly be left to the affected businesses and  their employees, lenders, suppliers, and customers. Because these entities  lack the ability to spread such risks among themselves the way insurers  do, another terrorist attack similar to that experienced on September 11th  could have significant economic effects on the marketplace and the public  at large. These effects could include bankruptcies, layoffs, and loan  defaults.
Another significant consequence of the insurers’ exiting the market for  terrorism coverage is the absence of a claims-processing mechanism that  can effectively and efficiently respond to victims of an attack. After  September 11th, insurance companies, working with public risk- management groups, are reported to have mobilized extensive resources  to pay many claims quickly. The administrator of the special government  program to compensate victims in the aftermath of the September 11th  attacks has noted the challenges of creating a mechanism for identifying  victims and properly disbursing aid, even several months after the attacks.  If, without insurers, the government should emerge as a principal source  of financial recovery after another attack, it would first have to create the  infrastructure to process claims and disburse financial assistance to  victims, duplicating the mechanism already in place in the insurance  industry. Therefore, the potential economic impacts of another incident on  the scale of a September 11th attack could become even more devastating  absent insurance mechanisms to quickly help businesses recover and  restore economic activity. The current movement by insurers to insulate  themselves from terrorism-related losses, however, means that their  involvement in the recovery process after another terrorist event would  also likely be substantially lessened.
section_title: Some Examples of Adverse Impacts Are Surfacing Due to the Lack of Adequate Terrorism Coverage
paragraphs: Even if no other terrorist attacks occur, some adverse conditions are  beginning to appear in the marketplace due to the lack of adequate  terrorism coverage, though the impacts on the economy as a whole are  still unclear. As noted earlier, commercial property owners and businesses  are now facing higher P/C rates coupled with substantially reduced  protection for terrorism-related risks as P/C policies renew over the  coming year. Insurance industry observers and policyholders report that  while limited coverage for terrorism-related losses is currently available at  very high rates, full coverage is often not available at any price, forcing  larger commercial policyholders to operate with little or no coverage for  such risks. Cases of adverse economic impacts to individual firms caused  by the absence or high price of coverage for terrorism-related events are  likely to become more evident as policies continue to be renewed over the  next year.
Some examples of large projects canceling or experiencing delays have  surfaced, with the lack of terrorism coverage being cited as a principal  contributing factor. Overall, it is still unclear to what extent financing  arrangements for existing or planned projects will be jeopardized as  lenders and investors are faced with the prospect of absorbing additional  terrorism-related risks that cannot be insured. These financing  arrangements encompass both development and resale markets, where  financing is contingent upon full insurance coverage for collateral assets  backing the loan or investment. Some industry observers believe private  markets will eventually develop and expand the capital available for  terrorism insurance coverage, but whether or how quickly an adequate  market can materialize is not yet evident.
Our contacts with various industry and regulatory sources indicate that  some financial problems are surfacing due to the lack of terrorism  coverage, though it is still too early to gauge how widespread these  problems will become. Though we could not independently validate each  of the assertions provided, we found consistency among the sources in the  reasons contributing to delays or cancellation of projects. These reasons  can be attributed to uncertainty and an unwillingness among lenders and  investors to accept risks that cannot yet be reasonably estimated and that  insurance companies are unable to price.
subsections: section_title: Property Owners and Developers
paragraphs: Two of the most common adverse impacts being cited by commercial  sources, particularly owners and developers, are the conditions of having  to go bare or only partially insure assets against terrorism due to the  inability to obtain meaningful terrorism coverage. Even when limited  coverage is available, uncertainties about the frequency and cost of future  events cause insurers to set premiums very high. This condition appears to  be particularly acute for properties located in central business districts of  major metropolitan areas.
Specifically, several property owners that we spoke to with properties  across the United States reported not being able to purchase the amount  of terrorism coverage they need because the capacity they require is not  available in the current market. As a result, these owners are largely bare  for terrorism risks and liable for any uninsured damages that would result  from a terrorist attack on their properties.
For instance, a major North American commercial real estate firm that  owns trophy properties and office buildings in the central business  districts of several major U.S. cities reported that it cannot find enough  terrorism insurance to cover the value of its properties. This firm  previously had a blanket property insurance policy providing $1 billion of  total coverage—including terrorism—that expired in October of 2001.  Since that time, the firm has been able to find only one insurer who would  offer it a quote for stand-alone terrorism insurance for a maximum $25  million of coverage. The firm stated that minimal damage to its buildings  could surpass $25 million in claims and that this limit was inadequate.
In another example, a New York insurance brokerage firm reported that it  tried to obtain terrorism coverage for a client’s portfolio of non-trophy  office buildings in New York City. The incumbent insurer agreed to  provide $100 million of insurance coverage on the portfolio that included  terrorism, at double the cost of the previous year’s $500 million policy. The  broker could not find more terrorism coverage for these properties.  Industry consultants also reported that their clients were experiencing  difficulty finding sufficient liability insurance for terrorism risk.
An owner and operator of a midwestern city’s principal airport and several  smaller area airports reportedly experienced a 280 percent increase in its  aviation liability premium for 2002. The new policy does not include war  risk. The insurer offered $50 million in war risk and terrorism coverage  back to the airport owner in a stand-alone policy for a premium of $1  million. The owner needs $500 million in coverage to satisfy its obligation  to customers.
section_title: Lenders and Borrowers
paragraphs: Property owners’ search for terrorism coverage has been driven not only  by the fear of personal liability for terrorist attacks to their properties, but  also by the fact that lenders are requiring this coverage on the collateral  backing existing mortgage loans. Therefore, the shifting of risk back to the  policyholders is also creating adverse business conditions for lenders and  investors. Lenders typically require borrowers to carry all-risk insurance  coverage to protect the value of loan collateral.
Lenders and investors are now voicing their concern over their increasing  exposure to terrorism-related risks as collateral assets on mortgages  become uninsured for such risks. Post-September 11th, many lenders  began notifying borrowers with properties considered at risk for terrorism  of the requirement to carry insurance for the risk of terrorism. If  borrowers cannot obtain the requisite terrorism coverage, lenders may  find them in violation of their loan covenants. Lenders and investors are  now being faced with the dilemma of either allowing their risk exposure to  increase or acting to terminate existing loan agreements because terrorism  coverage is not available to satisfy insurance requirements on the  agreement. Overall, it is not yet clear how financial institutions will react  to borrowers that cannot satisfy insurance requirements on existing loans.
In one case, a firm that develops large-scale buildings and that owns over a  hundred non-trophy office and residential buildings both in the suburbs  and central business districts of cities in several East Coast states reported  that it cannot find enough terrorism coverage to cover the replacement  value of its holdings and satisfy the lenders’ insurance requirements. The  firm currently has mortgage loans on each of its properties with over 30  different lenders ranging from local savings banks to investment banks,  pension funds, and the securities market. All of the firms’ lenders notified  the firm that insurance policies on the properties must include the risk of  terrorism. As the firm’s current umbrella policy expires in March 2002, the  firm began looking for the requisite insurance coverage to maintain  compliance with the lenders’ terms. For fiscal year 2001–2002, the firm had  purchased a blanket property insurance policy covering $300 million per  property per occurrence for a premium of $1 million. The firm reported  that the same amount of coverage was available for 2002–2003 for $5  million, but it excluded terrorism. The firm found only one insurer who  would offer a quote for a stand-alone terrorism insurance policy. This  quote specified a maximum coverage of $75 million for a premium of 1.5  percent, or $1,125,000. As $75 million is not enough to cover the  replacement value of any of the buildings it owns, the firm stated that it  would be in technical default of its loan covenants when its current  insurance policy expired.
In another case, the owners of a major midwestern mall reported that  when their all-risk insurance policy on the property expired at the end of  2001, they purchased a terrorism-excluded insurance policy because they  could not find one that would cover the risk of terrorism. The mall’s  mortgage lender objected to the policy’s terrorism exclusion and argued  that it violated the “all-risk” insurance requirement stipulated in the loan  documents. Consequently, the lender notified the owners that it had  purchased a stand–alone $100 million terrorism insurance policy to  protect the mall from this risk. Furthermore, the lender demanded  repayment by the mall of the $750,000 premium. The mall owners  protested the lender’s action, arguing that they could not be required to  purchase insurance that was not available to them or other owners of  similar properties. The owners successfully sought a temporary restraining  order from the courts to prevent the lender from forcing repayment of the  insurance premium.
Similarly, another lender described the adverse business relationships  created as the bank responded to the technical default of mortgages when  full terrorism insurance was not in force. From the bank’s perspective, it is  being asked to absorb risk that it had not previously priced into the  mortgages and is therefore putting pressure on its mortgage holders to  obtain terrorism coverage. At the same time, the bank recognizes that the  unavailability or increased cost of terrorism coverage will also negatively  impact the mortgage holder’s ability to service the loans. Consequently,  the bank’s likely course of action will be to review each loan on a case-by- case basis.
section_title: New Lending and Investment Activities
paragraphs: While owners with existing mortgages are not sure what actions lenders  will take if sufficient terrorism coverage is not available, firms interested  in buying and selling properties reported that the lack of adequate  terrorism coverage has delayed or prevented certain projects. Several  developers, financiers, and insurance industry observers noted a number  of examples where lenders or investors were reluctant to commit  resources to projects that could not be insured against terrorist acts. A  common financing requirement places the responsibility on borrowers to  fully insure the assets used as collateral in lending arrangements. In these  instances, lenders and investors were unwilling to supply financing  because the buyer or seller could not obtain adequate terrorism coverage  on the property.
For instance, a general contracting firm in New York City reported that its  bank will not provide financing for a proposed construction project unless  it obtains all-risk insurance that includes terrorism coverage. The planned  project is a 30-story apartment building in a high-risk area in New York  City. The firm reported it has not been able to find an insurer that will sell  it terrorism coverage at any price. Without this coverage, the firm cannot  obtain the financing needed to hire construction workers and begin  construction. The firm stated it typically hires 500 construction workers  for projects such as this one.
Similarly, a firm stated that it could not obtain mortgage financing on an  office building it owns on the East Coast because the firm could not  purchase enough terrorism insurance to cover the replacement value of  the property. Only one insurer offered a quote—for a premium of $800,000,  at a level far below what the lender is requiring. Before September 11th,  the insurance for this building, including terrorism coverage, was $60,000  for $80 million of coverage. The firm stated the mortgage lender refused to  lend the money, despite the fact that the building had a guaranteed  multimillion-dollar cash flow for the next 20 years. Without this loan and  others like it, the firm’s future growth potential is severely limited.
In another case, an insurance broker stated that a client who was  interested in purchasing a major property found terrorism coverage  available in the needed amount to satisfy the lender, but the coverage was  too expensive to make the deal economically viable. This buyer needed  $300 million in terrorism insurance to cover the replacement value of the  asset and satisfy the lender’ s insurance requirements. According to the  broker, the buyer received a quote of $6 million for a $300 million stand- alone terrorism insurance policy. Although the buyer was able to find  coverage, he was unable to purchase it, as the building in question  generates only $75 million annually in rent. The buyer had budgeted  $750,000 for all of the building’s insurance needs. Given all the other  expenses associated with the building’s operation, maintenance, and loan  service, the buyer believed that he could not afford terrorism insurance at  that price. However, without that insurance, the buyer could not obtain  financing for the deal and it was not completed.
Again, a mortgage broker reported that a client interested in the purchase  of a trophy property in New York City could not obtain the $200 million  necessary to finance its purchase. The broker stated that arrangements for  financing with one lender were almost complete before the events of  September 11th. After the terrorist attacks, the lender’s credit committee  reportedly decided it would not approve the loan unless the client could  get enough terrorism coverage to cover the replacement value of the  property. The prospective buyer could not find coverage or another bank  that would lend the money without it.
In some cases investors have been unwilling to buy securities when the  availability of terrorism coverage on assets backing the securities is  uncertain. One example included a large insurance company with a loan of  approximately $250 million on an office building in New York. An  investment firm reported that this loan was scheduled for securitization as  a way for the company to reduce exposure. Potential investors in the loan  reportedly said they would not buy shares of the loan without terrorism  coverage. The investment firm stated that since the insurance company  cannot reduce its exposure in this type of loan, it is unlikely to provide  capital for similar projects in the future unless terrorism coverage  becomes available. In a second example, a capital management firm stated  that it led the marketing effort for a domestic commercial mortgage- backed securities deal in the United States at the end of 2001. Investment  firms in the United States and Europe chose not to purchase these  securities primarily out of concern that terrorism insurance would not be  available in the future.
The examples cited above do not allow definitive conclusions about the  ultimate economic effects of the ongoing risk shift from reinsurers to  insurers and on to property owners and businesses. However, they do  indicate greater uncertainty, which may affect both financial decisions and  real economic activity.
section_title: The Potential Negative Consequences of Not Having Terrorism Insurance Are Cause for Concern
paragraphs: Our government leaders continue to warn of imminent and credible  terrorist threats. Should one of these threats become a reality in a world  where insurers are no longer the first line of protection for businesses, the  economic consequences could be very different from those following  September 11th. As businesses both large and small are faced with  uninsured losses that threaten their ability to survive, Congress could be  faced with a time-critical decision to intervene or not. A decision not to act  could have debilitating financial consequences for businesses, together  with their employees, lenders, suppliers, and customers. At the same time,  a decision by Congress to act could be difficult to implement quickly—and  extremely expensive.
Even if, as we all fervently hope, another terrorist attack does not occur,  there are indications that the lack of adequate terrorism insurance is  beginning to affect firms in some sectors of the national economy. The  ultimate scope of these effects is uncertain at this time, but they could  become potentially significant in an economy recovering from a recession.  Deciding whether Congress should act to help businesses obtain insurance  against losses caused by terrorism is properly a matter of public policy.  The consequences of continued inaction, however, may be real and are  potentially large.
Madam Chairman, this concludes my statement. I would be happy to  respond to any questions that you or other members of the Subcommittee  may have.
section_title: Contacts and Acknowledgments
paragraphs: For further information regarding this testimony, please contact Richard J.  Hillman, Director, or Lawrence D. Cluff, Assistant Director, Financial  Markets and Community Investment Issues, (202) 512-8678. Individuals  making key contributions to this testimony include James Black, Rachael  DeMarcus, Thomas Givens III, Ronald Ito, Stefanie Jonkman, Monty  Kincaid, Barry Kirby, and Angela Pun.
section_title: Appendix I: Information on the Insurance Services Office (ISO) Exclusions for Terrorism and War Risk
paragraphs: The Insurance Services Office (ISO) develops standardized policy contract  language - forms and endorsements - for use by property-casualty (P/C)  insurers.  Last October, ISO developed terrorism exclusion language and  filed the language with each state’s insurance department for use by its  insurer-customers.  ISO also offered the use of these endorsements for  free to insurers that were not its clients.  Insurers operating in states that  have approved ISO’s endorsements can choose to incorporate them into  their insurance policies; insurers operating in states that have rejected or  have not yet approved ISO’s endorsements typically cannot.
Generally, ISO’s endorsements describe, among other things, events that  are considered “terrorism” and “war,” define various thresholds that  trigger the exclusion of insurance coverage, and describe events that  would trigger the exclusion of all insurance coverage.  For terrorism  events, ISO wrote endorsements that could be used for different lines of  insurance to explain when claims are not covered by an insurance policy.  These endorsements contain essentially the same language.  Concerning  commercial property insurance lines, two endorsements were written –  one for states that have statutory requirements for fire coverage and one  for states without such a requirement.  Another endorsement was written  for commercial general liability policies.
As of February 22, 2002, forty-five states, the District of Columbia and  Puerto Rico have adopted ISO’s terrorism exclusions, while five states  have either rejected the exclusions or are still evaluating them, according  to NAIC officials.  To gain further insight at the state regulatory level, GAO  interviewed NAIC and several state regulators.
According to NAIC officials, ISO initially developed very broad  exclusionary language and filed it with insurance regulators across the  country.  State insurance regulators raised concerns about the overly  broad exclusionary language and recommended that ISO develop more  consumer-friendly language that did not endanger insurer solvency.  Late  last year, when NAIC assessed that Congress would not be passing a  federal solution, NAIC facilitated communications between ISO and state  insurance regulators to narrow the impact of the exclusionary language.  ISO has amended that language.
NAIC and many state regulators that GAO interviewed said that their  primary motive for adopting the ISO endorsements was to protect insurer  solvency.  NAIC officials also told GAO that they have worked with ISO in  developing a level of coverage that individual insurers could bear.  NAIC  agreed with insurers that without reinsurance, insurers’ solvency could be  at risk if they were required to provide insurance for terrorism.  However,  regulators told us that they were uncomfortable with ISO’s original  proposal to exclude all terrorism, from the first dollar of losses, because of  the potential to exclude acts that may not be the result of terrorism.  NAIC  officials stated that the $25 million threshold was acceptable because it  reflected the maximum losses that a single company could absorb.  They  told GAO that losses of $25 million born by a single insurer would threaten  the solvency of 886 insurers representing approximately 44% of the P/C  insurance companies writing commercial lines of insurance in the United  States.
Some state regulators have not yet adopted ISO’s terrorism exclusion  endorsements for various reasons. These states include California, Florida,  Georgia, New York and Texas.  GAO interviewed these state regulators to  obtain their views and concerns.  In general, their concerns were related  to the definition of terrorism, the loss thresholds for which coverage  would apply, and the impact that such exclusions would have on small  businesses in their states.
One state regulator maintained that ISO’s definition of terrorism is overly  broad, and could exclude insurance coverage of relatively minor incidents  such as vandalism.  ISO officials told us that the $25 million threshold, in  effect, addresses lower levels of events that may come from domestic  terrorism or vandalism.  Another state regulator said the $25 million  threshold is too low and that a minor incident in a central business district  would trigger the total loss of coverage.  One regulator found the  exclusion language reasonable, but was concerned about the exposure  small businesses would bear because they are least able to afford  terrorism insurance.
ISO endorsements contain several key elements. One key aspect of the  endorsements is its definition of terrorism. ISO’s definition of a terrorist  act provides that:  Terrorism means activities against persons, organizations or property of  any nature:  1.  That involve the following or preparation for the following:
Use or threat of force or violence; or
Commission or threat of a dangerous act; or
Commission or threat of an act that interferes with or disrupts an  electronic, communication, information, or mechanical system; and  2.  When one or both of the following applies:
The effect is to intimidate or coerce a government or the civilian  population or any segment thereof, or to disrupt any segment of the  economy; or  It appears that the intent is to intimidate or coerce a government, or to  further political, ideological, religious, social or economic objectives or to  express (or express opposition to) a philosophy or ideology.
Although ISO’s endorsements are commonly referred to as terrorism  exclusions, they also contain language to define acts of war and to exclude  war from coverage. While the endorsements’ definition and application of  the war exclusion did not change the war risk exclusion already used for  commercial property lines, its application of the war exclusion was greatly  extended for commercial general liability lines. ISO officials explained that  historically, the war exclusion was limited to contractual liability in  commercial general liability insurance lines, but now it will be applied  much more broadly, similar to its application in commercial property  lines.
A second key element of the ISO terrorism exclusion endorsements relates  to the thresholds at which losses are excluded from coverage.  The  endorsements for both the commercial property and commercial general  liability lines contain a $25 million loss threshold. Along with this  threshold, the terrorism exclusion threshold for commercial general  liability lines will also be met if an event causes death or serious injury to  fifty or more people.  Specifically, if a terrorism event causes aggregate  damages of $25 million or less, insurance will cover insured property  losses to policyholders. However, if aggregate damages exceed $25  million, insurers will not be liable for any resulting losses, not even the  first $25 million.  In some urban centers the value of many individual  buildings, even those not considered to be trophy properties, exceed $25  million.