Terrorism Insurance: Effects of the Terrorism Risk Insurance Act of 2002
Published: 2004-05-18T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: After the terrorist attacks of September 11, 2001, insurance coverage for terrorism largely disappeared. Congress passed the Terrorism Risk Insurance Act (TRIA) in 2002 to help commercial property-casualty policyholders obtain terrorism insurance and give the insurance industry time to develop mechanisms to provide such insurance after the act expires on December 31, 2005. Under TRIA, the Department of Treasury (Treasury) caps insurer liability and would process claims and reimburse insurers for a large share of losses from terrorist acts that Treasury certified as meeting certain criteria. As Treasury and industry participants have operated under TRIA for more than a year, GAO was asked to assess Treasury's progress in implementing TRIA and describe how TRIA affected the terrorism insurance market.
section_title: What GAO Found
paragraphs: Treasury and industry participants have made significant progress in implementing TRIA to date, although Treasury has important actions to complete in order to comply with its responsibilities under TRIA. Treasury has issued regulations on TRIA, created and staffed the Terrorism Risk Insurance Program office, and begun mandated studies and data collection efforts. However, Treasury has not yet made a decision on whether to extend the mandate that insurers "make available" terrorism coverage, using terms not differing materially from other coverage, for policies issued or renewed in 2005. Treasury's ongoing studies and data collection efforts will provide further insight into TRIA's effectiveness. TRIA has enhanced the availability of terrorism insurance for commercial policyholders, largely fulfilling a principal objective of the legislation. In particular, TRIA has benefited commercial policyholders in major metropolitan areas perceived to be at greater risk for a terrorist attack, largely because of the requirement in TRIA that insurers offer coverage for terrorism. Prior to TRIA, GAO reported concern that some development projects had already been delayed or cancelled because of the unavailability of insurance and continued fears that other projects also would be adversely impacted. GAO also conveyed the widespread concern that general economic growth and development could be slowed by a lack of available terrorism insurance. Largely because of TRIA, these problems no longer appear to be major concerns. Despite increased availability of coverage, limited industry data suggest that most commercial policyholders are not buying terrorism insurance, perhaps because they perceive their risk of losses from a terrorist act as being relatively low. The potential negative effects of low purchase rates, in combination with the probability that those most likely to be the targets of terrorist attacks may also be the ones most likely to have purchased coverage, would become evident only in the aftermath of a terrorist attack. Such negative effects could include more difficult economic recovery for businesses without terrorism coverage or potentially significant financial problems for insurers. Moreover, those that have purchased terrorism insurance may still be exposed to significant risks that have been excluded by insurance companies, such as nuclear, biological, or chemical events. Finally, although insurers and some reinsurers have cautiously reentered the terrorism risk market to cover insurers' remaining exposures, industry sources indicated no progress to date toward finding a reliable method for pricing terrorism insurance and little movement toward any mechanism that would enable insurers to provide terrorism insurance to businesses without government involvement.

section_title: Letter
paragraphs: I am pleased to be here today to discuss our report on the implementation  of the Terrorism Risk Insurance Act of 2002 (TRIA) and the act’s impact  on the terrorism insurance market and, more generally, the economy. The  terrorist attacks of September 11, 2001, drastically changed the way  insurers viewed the risk of terrorism. An industry that had considered the  risk of terrorism so low that it did not identify or price terrorism risk  separate from property and casualty coverage will ultimately pay  approximately $40 billion for losses arising from September 11, according  to industry experts. Responding to terrorism risk after September 11,  reinsurers began excluding terrorism from coverage as contracts between  reinsurers and insurers came up for renewal. Without reinsurance,  insurers retained greater levels of risks than they could responsibly carry,  and their reaction was to exclude these risks from commercial policies as  they were renewed. In short, believing that neither the frequency nor  magnitude of terrorism losses could be estimated, insurance companies  withdrew from the market.
In the aftermath of September 11, we reported that terrorism insurance  was disappearing in the marketplace, particularly for large businesses and  those perceived to be at some risk. We also reported significant concern  that some development projects had already been delayed or cancelled  because of the unavailability of insurance and fears that others would  follow. Furthermore, there was widespread concern that general  economic growth and development would be slowed by a lack of  insurance availability and uncertainty in the marketplace. Because of  concerns about the lack of available and affordable terrorism insurance,  Congress passed TRIA, which took effect on November 26, 2002. TRIA is  currently scheduled to expire at the end of 2005.
Our report on the implementation of TRIA has two objectives. First, we  describe the progress made by the Department of the Treasury (Treasury)  and insurance industry participants in implementing TRIA.  Second, we  discuss the changes in the market for terrorism insurance coverage under  TRIA. As requested, my statement today discusses both of these  objectives.  Additionally, I have included an appendix to this statement  that provides background information on TRIA.
In summary, Treasury and industry participants have made significant  progress in implementing TRIA to date, although Treasury has important  actions to complete in order to fully comply with its responsibilities under  TRIA.  Treasury’s progress includes issuing regulations on TRIA, staffing  the Terrorism Risk Insurance Program (TRIP) office, and beginning  mandated studies and data collection efforts. For example, in compliance  with one such study, Treasury decided not to extend TRIA to group life  based on its determination that insurers had continued to provide group  life coverage, although the availability of reinsurance was reduced.   Treasury also issued proposed rules defining a framework for the claims  process and litigation management under TRIA.  Additionally, Treasury  recently hired a contractor to provide claims payment services, according  to a Treasury official.  However, insurers have expressed reservations  about Treasury’s implementation of TRIA.  Specifically, insurers are   concerned about the potential length of time it may take for the Secretary  of the Treasury to certify a terrorist event, potential inefficiencies and time  lags in processing and paying claims once an event is certified, and TRIA’s  impending expiration at the end of 2005.  The industry has also expressed  concern about the timing of Treasury’s pending decision to extend the  “make available” requirement to policies issued or renewed in 2005.
TRIA has largely achieved Congress’s first goal—to ensure that business  activity did not suffer materially from a lack of available terrorism  insurance.  Since TRIA was enacted in November 2002, terrorism  insurance generally has been available to businesses; however, most  commercial policyholders are not buying terrorism coverage. According to  insurance industry experts, purchase rates have been higher in areas  considered to be at high risk of another terrorist attack. Many  policyholders with businesses or properties not located in perceived high– risk locations may not be buying coverage because they view any price for  terrorism insurance as high relative to their perceived risk exposure.  Industry experts view overall low purchase rates in combination with a  high concentration of purchases in areas thought to be most at risk as  increasing the potential for negative effects should a terrorist event  occur—either making economic recovery more difficult for those not  insured or causing financial problems for insurers with many policies in  the affected area. Further, those that have bought terrorism insurance  remain exposed to significant perils because insurers have broadened  longstanding policy exclusions for nuclear, biological, and chemical (NBC)  events. Finally, Congress’ second key goal in establishing TRIA—to give  private industry a transitional period during which it could begin pricing  terrorism insurance and develop ways to cover losses after TRIA expires— has not yet been achieved. Industry sources indicated that under TRIA,  insurance market participants have made no progress to date toward the  development of reliable methods for pricing terrorism risks and little  movement toward any mechanism that would enable insurers to provide  terrorism insurance to businesses without government involvement.
In conducting our work, we reviewed and analyzed relevant information  concerning state legislation and publicly available and proprietary industry  data and studies on the terrorism insurance market. We interviewed  officials at Treasury, the National Association of Insurance Commissioners  (NAIC), and state insurance regulators from six states with high insurance  sales volumes. We also interviewed representatives of insurance  companies, reinsurance companies, brokers for insurance and reinsurance  companies, industry associations, property owners and developers, and  insurance filing services and credit rating agencies. In our discussions  with these organizations, we endeavored to gain an understanding of their  experience in implementing TRIA requirements, obtain their views on the  effects of TRIA on the terrorism insurance market, and identify  developments within the industry to address terrorism risks after TRIA  expires. We conducted this work in Chicago, New York City, and  Washington, D.C., from January 2003 through April 2004 in accordance  with generally accepted government auditing standards.
subsections: section_title: Treasury and Insurers Have Made Progress in Implementing TRIA, although Important Work Remains
paragraphs: More than a year after TRIA’s enactment, Treasury and insurance industry  participants have made progress in implementing and complying with its  provisions, although Treasury has yet to fully implement the 3-year  program.  Treasury has issued regulations (final rules) to guide insurance  market participants, fully staffed the TRIP office, and begun collecting  data and performing studies mandated by TRIA.  For example, Treasury  complied with a mandate to collect and assess data on the availability of  group life insurance and reinsurance; based on that data, Treasury  determined that group life would not be covered by TRIA. However,  Treasury has yet to make the claims payment function fully operational,  although it has recently hired contractors to perform claims payment  functions.  Moreover, even though the act does not require Treasury to  make a decision about whether to extend the “make available”  requirement through 2005 until September of this year, some insurers  expressed concerns about whether such a late decision would allow them  sufficient time to make and implement changes to policy rates and terms.   Additionally, insurers have voiced concerns about the time Treasury might  take to certify an act of terrorism as eligible for reimbursement under  TRIA and pay claims after an act was certified.   Finally, as TRIA’s  midpoint nears, many insurers and other market participants are  concerned whether TRIA will be extended or not and the timing of such a  decision.
subsections: section_title: Treasury Has Issued Regulations, Staffed the TRIP Office, and Begun Studies and Data Collection Efforts
paragraphs: To implement TRIA and make TRIP functional, Treasury has taken  numerous regulatory and administrative actions that include rulemaking,  staffing a program office, and collecting and analyzing data.  To date,  Treasury has issued several final and proposed rules to implement TRIA;  these rules were preceded by four sets of interim guidance issued between  December 2002 and March 2003 to address time-sensitive requirements.     As of March 1, 2004, Treasury had issued three final rules that provided  uniform definitions of TRIA terms, explained disclosure (that is,  notification to policyholder) requirements, and determined which insurers  were subject to TRIA. Currently, Treasury is soliciting public comments on  additional proposed rules addressing claims processes and litigation  management issues.  Also, as of September 2003 Treasury had fully staffed  the TRIP office.  The office develops and oversees the operational aspects  of TRIA, which encompass claims management—processing, review, and  payment—and auditing functions.  Staff will also oversee operations  performed by the contractors that actually pay claims and audit insurers  that have filed claims.  Additionally, TRIP staff perform ongoing work such  as issuing interpretive letters in response to questions submitted by the  public and educating regulators, industry participants and the public about  TRIA provisions.
Treasury completed a TRIA-mandated study on group life insurance and  has begun other mandated studies and data collection efforts.   Specifically, TRIA mandated that Treasury provide information to  Congress in four areas: (1) the effects of terrorism on the availability of  group life insurance, (2) the effects of terrorism on the availability of life  and other lines of insurance, (3) annual data on premium rates, and (4) the  effectiveness of TRIA.  After Treasury completed an assessment of the  availability of group life insurance and reinsurance, it decided not to make  group life insurance subject to TRIA because it found that insurers had  continued to provide group life coverage, although the availability of  reinsurance was reduced.  Treasury has not yet reported to Congress the  results of a mandated study concerning the effects of terrorism on the  availability of life and other lines of insurance.  The study was to have  been completed by August 2003, but as of March 2004 the report had not  been issued.  Also, in November 2003 and January 2004, Treasury began  sending surveys to buyers and sellers, respectively, of insurance to collect  data on annual premium rates as well as other information for the study  that will assess the effectiveness of TRIA.
section_title: Treasury Has Tasks to Complete before TRIA Can Be Fully Implemented
paragraphs: Before TRIA will be fully implemented, Treasury has to make certain  decisions and make additional TRIP functions operational.  As of April  2004, Treasury had not yet decided whether to extend the “make available”  requirement to policies issued or renewed in 2005. TRIA gave Treasury  until September 1, 2004, to decide if the “make available” requirement  should be extended for policies issued or renewed in 2005, the third and  final year of the act.  Treasury did clarify in a press release that the “make  available” requirement for annual policies issued or renewed in 2004  extends until the policy expiration date, even though the coverage period  extends into 2005.
In addition, Treasury has not fully established a claims processing and  payment structure.  Treasury has issued a proposed rule that would  establish an initial framework for the claims process, which includes  procedural and recordkeeping requirements for insurers.  However, the  actual claims processing and payment function is not fully operational.  A  Treasury official said it has recently hired a contractor that would perform    payment functions in the aftermath of a terrorist attack, but has not yet  written regulations to cover the latter stages of the claims process such as  adjusting over- and underpayments or hired a separate contractor to  review claims and audit insurers after an event to ensure that underlying  documents adequately support the claims paid by Treasury.  Treasury  officials anticipate awarding this audit and review contract in the fourth  quarter of fiscal year 2004.
section_title: Insurers Have Expressed Some Concerns Related to TRIA’s Implementation
paragraphs: Insurers have expressed some concerns about Treasury’s implementation  of TRIA.  Insurers are concerned that Treasury has not already made a  decision about extending the “make available” requirement through 2005.  They are also concerned about the potential length of time it may take for  the Secretary of the Treasury to certify a terrorist event, potential  inefficiencies and time lags in processing and paying claims once an event  is certified, and the issue of TRIA expiration.  As discussed already, TRIA  gives Treasury until September 2004 to make a decision about the “make  available” requirement for policies issued or renewed in 2005.  Insurers  have stated that this deadline does not give them enough time to make  underwriting decisions and evaluate and possibly revise prices and terms,  actions they normally would want to undertake in mid-2004.   Moreover, in  most states insurers will have to obtain regulatory approval for such  changes because TRIA’s preemption of the states’ authority to approve  insurance policy rates and conditions expired on December 31, 2003.   Thus, insurers are concerned that delay of Treasury’s announcement on  the “make available” extension until the legal deadline may cost both  companies and policyholders money because policy changes will not be  implemented in time to issue or renew policies.
Insurers are also concerned that delays in the payment of claims by  Treasury, whether because of the length of time taken to certify that an act  of terrorism met the requirements for federal reimbursement or to process  and pay claims, might seriously impact insurer cash flows or, in certain  circumstances, solvency.  While TRIA does not specify the length of time  available for determining whether an event meets the criteria for  certification, an NAIC official told us that insurers are bound by law and  regulations in most states to pay claims in a timely manner.  As a result, an  insurer may have to pay policyholder claims in full while still awaiting a  certification decision, which could create a cash flow problem for  insurers.  Insurers identified the anthrax letter incidents as an example  where law enforcement officials still have not identified the source,  whether foreign or domestic, more than 2 years after the incidents.   Moreover, if Treasury decided not to certify an event after insurers had  already paid policyholder claims, some insurers could become insolvent.   Unless the policyholder had paid for coverage of all terrorist events— including those caused by domestic terrorists, which would be excluded  from reimbursement under TRIA—insurers would have paid for losses for  which they had collected no premium.  An NAIC official explained that  insurers would have no way to recover payments already made to  policyholders for losses associated with the event other than to seek  remedies through the courts.  Treasury officials have said that they  understand the difficulties facing insurers but cannot impose a time frame  on the certification process because it could involve complex fact-finding  processes.  To facilitate the certification process, Treasury has met with  relevant individuals within the Department of Justice and the Department  of State to discuss their roles in the certification process.  Insurers are  similarly concerned that the length of time Treasury may take to process  and pay claims could impact insurers’ cash flow.  In response to this  concern, Treasury has decided to use electronic fund transfers to insurer’s  accounts to speed reimbursement to insurers with approved claims.   Treasury expects this method could speed payment of claims and reduce  potential cash flow problems for insurers.
Finally, insurance industry officials are worried that uncertainty about the  extension of TRIA past its stated expiration date of December 2005 would  impede their business and planning processes.  Although TRIA does not  contain any specific extension provisions, industry participants are  concerned that a late decision on whether or not to extend TRIA would  deny them the time needed to tailor business operations and plans to an  insurance environment that either would or would not contain TRIA.
section_title: Although Available, Few Are Buying Terrorism Insurance and the Industry Has Made Little Progress Toward Post-TRIA Coverage
paragraphs: While TRIA has improved the availability of terrorism insurance,  particularly for high-risk properties in major metropolitan areas, most  commercial policyholders are not buying the coverage. Limited industry  data suggest that 10–30 percent of commercial policyholders are  purchasing terrorism insurance, perhaps because most policyholders  perceive themselves at relatively low risk for a terrorist event. Some  industry experts are concerned that those most at risk from terrorism are  generally the ones buying terrorism insurance. In combination with low  purchase rates, these conditions could result in uninsured losses for those  businesses without terrorism coverage or cause financial problems for  insurers, should a terrorist event occur. Moreover, even policyholders who  have purchased terrorism insurance may remain uninsured for significant  risks arising from certified terrorist events—that is, those meeting  statutory criteria for reimbursement under TRIA—such as those involving  NBC agents or radioactive contamination. Finally, although insurers and  some reinsurers have cautiously reentered the terrorism risk market,  insurance industry participants have made little progress toward  developing a mechanism that could permit the commercial insurance  market to resume providing terrorism coverage without a government  backstop.
subsections: section_title: TRIA Has Improved the Availability of Terrorism Insurance, Particularly for Some High-Risk Policyholders
paragraphs: TRIA has improved the availability of terrorism insurance, especially for  some high-risk policyholders. According to insurance and risk  management experts, these were the policyholders who had difficulty  finding coverage before TRIA. TRIA requires that insurers “make  available” coverage for terrorism on terms not differing materially from  other coverage. Largely because of this requirement, terrorism insurance  has been widely available, even for development projects in high-risk areas  of the country. Although industry data on policyholder characteristics are  limited and cannot be generalized to all policyholders in the United States,  risk management and real estate representatives generally agree that after  TRIA was passed, policyholders—including borrowers obtaining  mortgages for “trophy” properties, owners and developers of high-risk  properties in major city centers, and those in or near “trophy” properties— were able to purchase terrorism insurance.
Additionally, TRIA contributed to better credit ratings for some  commercial mortgage-backed securities. For example, prior to TRIA’s  passage, the credit ratings of certain mortgage-backed securities, in which  the underlying collateral consisted of a single high-risk commercial  property, were downgraded because the property lacked or had  inadequate terrorism insurance. The credit ratings for other types of  mortgage-backed securities, in which the underlying assets were pools of  many types of commercial properties, were also downgraded but not to  the same extent because the number and variety of properties in the pool  diversified their risk of terrorism. Because TRIA made terrorism insurance  available for the underlying assets, thus reducing the risk of losses from  terrorist events, it improved the overall credit ratings of mortgage-backed  securities, particularly single-asset mortgage-backed securities. Credit  ratings affect investment decisions that revolve around factors such as  interest rates because higher credit ratings result in lower costs of capital.  According to an industry expert, investors use credit ratings as guidance  when evaluating the risk of mortgage-backed securities for investment  purposes. Higher credit ratings reflect lower credit risks. The typical  investor response to lower credit risks is to accept lower returns, thereby  reducing the cost of capital, which translates into lower interest rates for  the borrower.
To the extent that the widespread availability of terrorism insurance is a  result of TRIA’s “make available” requirement, Treasury’s decision on  whether to extend the requirement to year three of the program is vitally  important. While TRIA has ensured the availability of terrorism insurance,  we have little quantitative information on the prices charged for this  insurance. Treasury is engaged in gathering data through surveys that  should provide useful information about terrorism insurance prices. TRIA  requires that they make the information available to Congress upon  request. In addition, TRIA also requires Treasury to assess the  effectiveness of the act and evaluate the capacity of the industry to offer  terrorism insurance after its expiration. This report is to be delivered to  Congress no later than June 30, 2005.
section_title: Most Policyholders Have Not Bought Terrorism Insurance
paragraphs: Although TRIA improved the availability of terrorism insurance, relatively  few policyholders have purchased terrorism coverage. We testified  previously that prior to September 11, 2001, policyholders enjoyed “free”  coverage for terrorism risks because insurers believed that this risk was so  low that they provided the coverage without additional premiums as part  of the policyholder’s general property insurance policy. After September  11, prices for coverage increased rapidly and, in some cases, insurance  became very difficult to find at any price. Although a purpose of TRIA is to  make terrorism insurance available and affordable, the act does not  specify a price structure.
However, experts in the insurance industry generally agree that after the  passage of TRIA, low-risk policyholders (for example, those not in major  urban centers) received relatively low-priced offers for terrorism  insurance compared to high-risk policyholders, and some policyholders  received terrorism coverage without additional premium charges. Yet  according to insurance experts, despite low premiums, many businesses  (especially those not in “target” localities or industries) did not buy  terrorism insurance. Some simply may not have perceived themselves at  risk from terrorist events and considered terrorism insurance, even at low  premiums (relative to high-risk areas), a bad investment. According to  insurance sources, other policyholders may have deferred their decision to  buy terrorism insurance until their policy renewal date.
Some industry experts have voiced concerns that low purchase rates may  indicate adverse selection—where those at the most risk from terrorism  are generally the only ones buying terrorism insurance. Although industry  surveys are limited in their scope and not appropriate for marketwide  projections, the surveys are consistent with each other in finding low  “take-up” rates, the percentage of policyholders buying terrorism  insurance, ranging from 10 to 30 percent. According to one industry  survey, the highest take-up rates have occurred in the Northeast, where  premiums were generally higher than the rest of the country.
The combination of low take-up rates and high concentration of purchases  in an area thought to be most at risk raises concerns that, depending on its  location, a terrorist event could have additional negative effects.
If a terrorist event took place in a location not thought to be a terrorist  “target,” where most businesses had chosen not to purchase terrorism  insurance, then businesses would receive little funding from insurance  claims for business recovery efforts, with consequent negative effects  on owners, employers, suppliers, and customers.
Alternatively, if the terrorist event took place in a location deemed to  be a “target,” where most businesses had purchased terrorism  insurance, then adverse selection could result in significant financial  problems for insurers. A small customer base of geographically  concentrated, high-risk policyholders could leave insurers unable to  cover potential losses, facing possible insolvency. If, however, a higher  percentage of business owners had chosen to buy the coverage, the  increased number of policyholders would have reduced the chance that  losses in any one geographic location would create a significant  financial problem for an insurer.
section_title: Tighter Exclusions Leave Policyholders Exposed to Significant Perils
paragraphs: Since September 11, 2001, the insurance industry has moved to tighten  long-standing exclusions from coverage for losses resulting from NBC  attacks and radiation contamination. As a result of these exclusions and  the actions of a growing number of state legislatures to exclude losses  from fire following a terrorist attack, even those policyholders who choose  to buy terrorism insurance may be exposed to potentially significant  losses. Although NBC coverage was generally not available before  September 11, after that event insurers and reinsurers recognized the  enormity of potential losses from terrorist events and introduced new  practices and tightened policy language to further limit as much of their  loss exposures as possible. (We discuss some of these practices and  exclusions in more detail in the next section.) State regulators and  legislatures have approved these exclusions, allowing insurers to restrict  the terms and conditions of coverage for these perils. Moreover, because  TRIA’s “make available” requirements state that terms for terrorism  coverage be similar to those offered for other types of policies, insurers  may choose to exclude the perils from terrorism coverage just as they  have in other types of coverage. According to Treasury officials, TRIA  does not preclude Treasury from providing reimbursement for NBC  events, if insurers offered this coverage. However, policyholder losses  from perils excluded from coverage, such as NBCs, would not be “insured  losses” as defined by TRIA and would not be covered even in the event of  a certified terrorist attack.
In an increasing number of states, policyholders may not be able to  recover losses from fire following a terrorist event if the coverage in those  states is not purchased as part of the offered terrorism coverage. We have  previously reported that approximately 30 states had laws requiring  coverage for “fire-following” an event—known as the standard fire policy  (SFP)—irrespective of the fire’s cause. Therefore, in SFP states fire  following a terrorist event is covered whether there is insurance coverage  for terrorism or not. After September 11, some legislatures in SFP states  amended their laws to allow the exclusion of fire following a terrorist  event from coverage. As of March 1, 2004, 7 of the 30 SFP states had  amended their laws to allow for the exclusion of acts of terrorism from  statutory coverage requirements. However as discussed previously, the  “make available” provision requires coverage terms offered for terrorist  events to be similar to coverage for other events. Treasury officials  explained that in all non-SFP states, and the seven states with modified  SFPs, insurers must include in their offer of terrorism insurance coverage  for fire following a certified terrorist event because coverage for fire is  part of the property coverage for all other risks. Thus, policyholders who  have accepted the offer would be covered for fire following a terrorist  event, even though their state allows exclusion of the coverage. However,  policyholders who have rejected their offer of coverage for terrorism  insurance would not be covered for fire following a terrorist event.  According to insurance experts, losses from fire damage can be a  relatively large proportion of the total property loss. As a result, excluding  terrorist events from SFP requirements could result in potentially large  losses that cannot be recovered if the policyholder did not purchase  terrorism coverage. For example, following the 1994 Northridge  earthquake in California, total insured losses for the earthquake were $15  billion—$12.5 billion of which were for fire damage. According to an  insurance expert, policyholders were able to recover losses from fire  damage because California is an SFP state, even though most policies had  excluded coverage for earthquakes.
section_title: Reinsurers Have Cautiously Returned to the Market, but Many Insurers Have Not Bought Reinsurance
paragraphs: Under TRIA, reinsurers are offering a limited amount of coverage for  terrorist events for insurers’ remaining exposures, but insurers have not  been buying much of this reinsurance. According to insurance industry  sources, TRIA’s ceiling on potential losses has enabled reinsurers to return  cautiously to the market. That is, reinsurers generally are not offering  coverage for terrorism risk beyond the limits of the insurer deductibles  and the 10 percent share that insurers would pay under TRIA (see app. I).  In spite of reinsurers’ willingness to offer this coverage, company  representatives have said that many insurers have not purchased  reinsurance. Insurance experts suggested that the low demand for the  reinsurance might reflect, in part, commercial policyholders’ generally low  take-up rates for terrorism insurance. Moreover, insurance experts also  have suggested that insurers may believe that the price of reinsurance is  too high relative to the premiums they are earning from policyholders for  terrorism insurance.
The relatively high prices charged for the limited amounts of terrorism  reinsurance available are probably the result of interrelated factors. First,  even before September 11 both insurance and reinsurance markets were  beginning to harden; that is, prices were beginning to increase after  several years of lower prices. Reinsurance losses resulting from  September 11 also depressed reinsurance capacity and accelerated the rise  in prices. The resulting hard market for property-casualty insurance  affected the price of most lines of insurance and reinsurance. A notable  example has been the market for medical malpractice insurance. The  hard market is only now showing signs of coming to an end, with a  resulting stabilization of prices for most lines of insurance. In addition to  the effects of the hard market, reinsurer awareness of the adverse  selection that may be occurring in the commercial insurance market could  be another factor contributing to higher reinsurance prices. Adverse  selection usually represents a larger-than-expected exposure to loss.  Reinsurers are likely to react by increasing prices for the terrorism  coverage that they do sell.
In spite of the reentry of reinsurers into the terrorism market, insurance  experts said that without TRIA caps on potential losses, both insurers and  reinsurers likely still would be unwilling to sell terrorism coverage  because they have not found a reliable way to price their exposure to  terrorist losses. According to industry representatives, neither insurers nor  reinsurers can estimate potential losses from terrorism or determine  prices for terrorism insurance without a pricing model that can estimate  both the frequency and the severity of terrorist events. Reinsurance  experts said that current models of risks for terrorist events do not have  enough historical data to dependably estimate the frequency or severity of  terrorist events, and therefore cannot be relied upon for pricing terrorism  insurance. According to the experts, the models can predict a likely range  of insured losses resulting from the damage if specific event parameters  such as type and size of weapon and location are specified. However, the  models are unable to predict the probability of such an attack.
Even as they are charging high prices, reinsurers are covering less. In  response to the losses of September 11, industry sources have said that  reinsurers have changed some practices to limit their exposures to acts of  terrorism. For example, reinsurers have begun monitoring their exposures  by geographic area, requiring more detailed information from insurers,  introducing annual aggregate and event limits, excluding large insurable  values, and requiring stricter measures to safeguard assets and lives where  risks are high. And as discussed previously, almost immediately after  September 11 reinsurers began broadening NBC exclusions beyond  scenarios involving industrial accidents, to include events such as nuclear  plant accidents and chemical spills and encompass intentional destruction  from terrorists. For example, post-September 11 exclusions for nuclear  risks include losses from radioactive contamination to property and  radiation sickness from dirty bombs.
As of March 1, 2004, industry sources indicated that there has been little  development or movement among insurers or reinsurers toward  developing a private-sector mechanism that could provide capacity,  without government involvement, to absorb losses from terrorist events.  Industry officials have said that their level of willingness to participate  more fully in the terrorism insurance market in the future will be  determined, in part, by whether any more events occur. Industry sources  could not predict if reinsurers would return to the terrorism insurance  market after TRIA expires, even after several years and in the absence of  further major terrorist attacks in the United States. They explained that  reinsurers are still recovering from the enormous losses of September 11  and still cannot price terrorism coverage. In the long term and without  another major terrorist attack, insurance and reinsurance companies  might eventually return. However, should another major terrorist attack  take place, reinsurers told us that they would not return to this market— with or without TRIA.
section_title: Conclusions
paragraphs: Congress had two major objectives in establishing TRIA. The first was to  ensure that business activity did not suffer from the lack of insurance by  requiring insurers to continue to provide protection from the financial  consequences of another terrorist attack. Since TRIA was enacted in  November 2002, terrorism insurance generally has been widely available  even for development projects in high-risk areas of the country, in large  part because of TRIA’s “make available” requirement. Although most  businesses are not buying coverage, there is little evidence that  commercial development has suffered to a great extent—even in lower- risk areas of the county, where purchases of coverage may be lowest.  Further, although quantifiable evidence is lacking on whether the  availability of terrorism coverage under TRIA has contributed to the  economy, the current revival of economic activity suggests that the  decision of most commercial policyholders to decline terrorism coverage  has not resulted in widespread, negative economic effects. As a result, the  first objective of TRIA appears largely to have been achieved.
Congress’s second objective was to give the insurance industry a  transitional period during which it could begin pricing terrorism risks and  developing ways to provide such insurance after TRIA expires. The  insurance industry has not yet achieved this goal. We observed after  September 11 the crucial importance of reinsurers for the survival of the  terrorism insurance market and reported that reinsurers’ inability to price  terrorism risks was a major factor in their departure from the market.  Additionally, most industry experts are tentative about predictions of the  level of reinsurer and insurer participation in the terrorism insurance  market after TRIA expires. Unfortunately, insurers and reinsurers still  have not found a reliable method for pricing terrorism insurance, and  although TRIA has provided reinsurers the opportunity to reenter the  market to a limited extent, industry participants have not developed a  mechanism to replace TRIA. As a result, reinsurer and consequently,  insurer, participation in the terrorism insurance market likely will decline  significantly after TRIA expires.
Not only has no private-sector mechanism emerged for supplying  terrorism insurance after TRIA expires, but to date there also has been  little discussion of possible alternatives for ensuring the availability and  affordability of terrorism coverage after TRIA expires. Congress may  benefit from an informed assessment of possible alternatives—including  both wholly private alternatives and alternatives that could involve some  government participation or action. Such an assessment could be a part of  Treasury’s TRIA-mandated study to “assess…the likely capacity of the  property and casualty insurance industry to offer insurance for terrorism  risk after termination of the Program.”
section_title: Recommendation for Executive Action
paragraphs: As part of the response to the TRIA-mandated study that requires Treasury  to assess the effectiveness of TRIA and evaluate the capacity of the  industry to offer terrorism insurance after TRIA expires, we recommend  that the Secretary of the Treasury, after consulting with the insurance  industry and other interested parties, identify for Congress an array of  alternatives that may exist for expanding the availability and affordability  of terrorism insurance after TRIA expires. These alternatives could assist  Congress during its deliberations on how best to ensure the availability  and affordability of terrorism insurance after December 2005.
Mr. Chairman, this concludes my prepared statement, and I would be  pleased to respond to any questions that you or other members of the  Committee 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, (202) 512-8678. Individuals making  key contributions to this testimony include Rachel DeMarcus, Barry Kirby,  Tarek Mahmassani, Angela Pun, and Barbara Roesmann.
section_title: Appendix I: TRIA Background
paragraphs: Under TRIA, Treasury is responsible for reimbursing insurers for a portion  of terrorism losses under certain conditions. Payments are triggered when  (1) the Secretary of the Treasury certifies that terrorists acting on behalf of  foreign interests have carried out an act of terrorism and (2) aggregate  insured losses for commercial property and casualty damages exceed  $5,000,000 for a single event. TRIA specifies that an insurer is responsible  (that is, will not be reimbursed) for the first dollars of its insured losses— its deductible amount. TRIA sets the deductible amount for each insurer  equal to a percentage of its direct earned premiums for the previous year.  Beyond the deductible, insurers also are responsible for paying a  percentage of insured losses. Specifically, TRIA structures pay-out  provisions so that the federal government shares the payment of insured  losses with insurers at a 9:1 ratio—the federal government pays 90 percent  of insured losses and insurers pay 10 percent—until aggregate insured  losses from all insurers reach $100 billion in a calendar year (see fig. 1).  Thus, under TRIA’s formula for sharing losses, insurers are reimbursed for  portions of the claims they have paid to policyholders. Furthermore, TRIA  then releases insurers who have paid their deductibles from any further  liability for losses that exceed aggregate insured losses of $100 billion in  any one year. Congress is charged with determining how losses in excess  of $100 billion will be paid.
TRIA also contains provisions and a formula requiring Treasury to recoup  part of the federal share if the aggregate sum of all insurers’ deductibles  and 10 percent share is less than the amount prescribed in the act—the  “insurance marketplace aggregate retention amount.” TRIA also gives the  Secretary of the Treasury discretion to recoup more of the federal  payment if deemed appropriate. Commercial property-casualty  policyholders would pay for the recoupment through a surcharge on   premiums for all the property-casualty policies in force after Treasury  established the surcharge amount; the insurers would collect the  surcharge. TRIA limits the surcharge to a maximum of 3 percent of annual  premiums, to be assessed for as many years as necessary to recoup the  mandatory amount. TRIA also gives the Secretary of the Treasury  discretion to reduce the annual surcharge in consideration of various  factors such as the economic impact on urban centers. However, if  Treasury makes such adjustments, it has to extend the surcharges for  additional years to collect the remainder of the recoupment.
Treasury is funding the Terrorism Risk Insurance Program (TRIP) office  —through which it administers TRIA provisions and would pay claims— with “no-year money” under a TRIA provision that gives Treasury  authority to utilize funds necessary to set up and run the program. The  TRIP office had a budget of $8.97 million for fiscal year 2003 (of which  TRIP spent $4 million), $9 million for fiscal year 2004, and a projected  budget of $10.56 million for fiscal year 2005—a total of $28.53 million over  3 years. The funding levels incorporate the estimated costs of running a  claims-processing operation in the aftermath of a terrorist event: $5  million in fiscal years 2003 and 2004 and $6.5 million in fiscal year 2005,  representing about 55–60 percent of the budget for each fiscal year. If no  certified terrorist event occurrs, the claims-processing function would be  maintained at a standby level, reducing the projected costs to $1.2 million  annually, or about 23 percent of the office’s budget in each fiscal year. Any  funds ultimately used to pay the federal share after a certified terrorist  event would be in addition to these budgeted amounts.
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