Terrorism Insurance: Status of Coverage Availability for Attacks Involving Nuclear, Biological, Chemical, or Radiological Weapons
Released: 2008-12-12T00:00:00

Letter

Background

Congress enacted and the President signed TRIA in 2002 to help restore confidence and stability in commercial property insurance markets after private insurers withdrew terrorism coverage in the wake of the September 11 attacks. TRIA requires that commercial property/casualty insurers, including (among others) workers’ compensation insurers, “make available” coverage for certified terrorist events under the same terms and conditions as other, nonterrorism coverage. Following a terrorist attack, the federal government would reimburse insurers for 85 percent of their losses after insurers pay a deductible of 20 percent of the value of each company’s prior year’s direct earned premiums. Federal reimbursement is activated when aggregated industry losses exceed $100 million and is capped at an annual amount of $100 billion. TRIA also would cover losses caused by NBCR terrorist attacks if the insurer had included this coverage in the insurance policy.

Originally enacted as a 3-year program, TRIA was reauthorized in 2005; in 2007, Congress extended the program until 2014. In the deliberations over the 2005 and 2007 Reauthorization Acts, Congress considered mandating that commercial property/casualty insurers offer coverage for NBCR risks, with significantly lower deductibles and copayments. Congress also considered adding group life insurance to the TRIA program, so that group life insurers could receive reimbursements for the majority of their claims from terrorist events, including NBCR attacks. Members of Congress supporting this provision argued that group life insurers were vulnerable to the same extraordinary losses from a terrorist attack as other insurance lines and could become insolvent after a catastrophic event. However, Treasury testified that the Administration did not want to expand TRIA to cover group life insurers, citing some reports that the group life insurance market has remained competitive after September 11. The NBCR requirement and the group life provisions were not included in the final TRIA reauthorizing legislation.

Variation in Potential Weapons Involving NBCR Materials and Examples of Prior Attacks

Government and other experts have stated that terrorist attacks involving NBCR weapons could affect people and property in a variety of ways, depending on the weapon used as well as the location of the attack. Table 1 provides examples of attacks using NBCR weapons as well as some of their potential effects.

Previous attacks involving NBCR materials in United States and Japan also illustrate a range of consequences. In September and October 2001, contaminated letters laced with anthrax were sent through the mail to two U.S. senators and members of the media. As a result, 22 individuals contracted anthrax disease, and 5 of these individuals died. In 1984, the Rajneeshee religious cult in Oregon contaminated salad bars in local restaurants with salmonella bacteria to prevent people from voting in a local election. Although no one died, 751 people were diagnosed with the food-borne illness. In 1995, 12 people were killed and many more were injured after Aum Shinrikyo, a State Department-designated terrorist organization, released the chemical nerve agent Sarin in the Tokyo subway.

Overview of State Regulation of Insurance and Workers’ Compensation Insurance Providers

States have the primary responsibility for regulating the insurance industry in the United States, and the degree of oversight varies by insurance line and state. In some lines of insurance, state regulators guide the extent of coverage by approving the wording of policies, including the explicit exclusion of some perils. Regulators coordinate their activities, in part, through NAIC. According to an NAIC representative, while practices vary by state, state regulators generally review prices for personal lines of insurance and workers’ compensation policies but not for commercial property/casualty policies. In most cases, state insurance regulators perform neither rate nor form review for large commercial property/casualty insurance contracts because it is presumed that businesses have a better understanding of insurance contracts and pricing than the average personal-lines consumer. Reinsurers generally are not required to obtain state regulatory approval for the terms of coverage or the prices they charge.

Because state laws generally require employers to carry workers’ compensation insurance, which covers employees for death or injuries as a result of a workplace incident, employers generally obtain coverage either from a private insurance company or from a fund established by the state. Twenty-six states have established separate funds, either run by the state or as a separate company, according to the American Association of State Compensation Insurance Funds (AASCIF), and most of these states provide workers’ compensation coverage for all employers seeking it. An NAIC official told us that when state governments began requiring employers to purchase workers’ compensation coverage, many states established separate funds to provide a mechanism to ensure coverage for those employers that could not obtain it in the private market. The majority of state funds are competitive, meaning that the state fund competes for business with other private insurers. However, in four states, the state fund is the sole insurer for workers’ compensation, unless an employer is permitted to self-insure. The National Academy of Social Insurance reported that in 2006, just over half of workers’ compensation benefits (50.38 percent) were paid by private insurers, with just under half coming from state funds (19.66 percent), federal programs (5.98 percent), and self-insured employers (23.98 percent).

Most Commercial Property/Casualty Insurers and Reinsurers We Contacted Exclude or Limit Coverage for NBCR Risks, While Workers’ Compensation, Life, and Health Insurers Generally Are Required to Offer Such Coverage

Commercial property/casualty insurers and reinsurers generally seek to exclude coverage for NBCR risks or place significant restrictions on such coverage. According to industry participants, insurers interpret the language of longstanding exclusions developed for nuclear and pollution risks as excluding terrorist attacks involving NBCR weapons, but the use of such exclusions may be challenged in court. Representatives from policyholders from a variety of industries, including real estate, financial services, and hospitality, also told us that they do not have NBCR coverage either because a very limited amount of NBCR insurance is available or they do not view the rates for available coverage as reasonable. A few policyholders also reported self-insuring these risks through captive insurers. Representatives from workers’ compensation, life, and health insurers we contacted generally reported that they cover losses from terrorist attacks, including those involving NBCR materials, because they said state regulators generally do not allow these insurers to exclude such risks.

NBCR Coverage Generally Is Unavailable in Commercial Property/Casualty Insurance and Reinsurance Policies, but the Exclusions Used to Limit Coverage Could Be Challenged in Court

While few market surveys that we identified specifically have addressed the availability of property/casualty insurance for terrorist attacks involving NBCR materials, our interviews with a range of industry participants suggests that such coverage continues to be limited. Representatives from the majority of the insurers and reinsurers we interviewed said that their companies generally do not offer NBCR coverage or offer a limited amount of such coverage. Representatives of large insurance and reinsurance trade associations, as well as national insurance brokers, also reported a general lack of coverage for NBCR risks. According to a representative from a large national insurance broker, he was not aware of any primary insurers that offered NBCR coverage as part of their standard property/casualty policies. The representative said that some insurers that offer “stand-alone” terrorism insurance policies offer NBCR coverage, but demand for this product is minimal due to its relatively high price and restrictions. Although representatives of several reinsurers based in Bermuda told us that their companies offer some NBCR coverage, the reported restrictions on these policies help illustrate some of the limitations of the available coverage. For example, the policy language of one reinsurance contract we reviewed limited NBCR coverage only to losses resulting from the initial “force or violence” of the NBCR terrorist attack and did not cover long-term effects, such as resulting illnesses or business interruption.

Insurance companies seek to limit their coverage for NBCR risks by relying on long-standing exclusions for nuclear and pollution risks, which already have been approved by state regulators. As we stated in our September 2006 report, insurers have written exclusions related to nuclear hazard risks into their standard policies for decades, generally to protect themselves from losses related to nuclear power accidents. Furthermore, representatives from the Insurance Services Office (ISO), a national organization for the property/casualty insurance industry that develops standardized policy language designed to comply with regulatory requirements, said that insurers also typically exclude coverage for losses caused by pollution and contamination. ISO representatives told us that the pollution exclusion was developed to exclude coverage for the release of many different substances—such as asbestos or pesticides—that could cause harm to people and the environment. Some insurance representatives said that the pollution exclusion could be applied to biological and chemical agents released in a terrorist attack.

Because these exclusions were developed for other purposes, some regulators and insurance industry participants said that their use by insurers in the event of an attack involving NBCR materials could be challenged. Representatives from one large insurer told us that language in the nuclear hazard exclusion may not be clear enough to apply to a nuclear terrorist attack. Similarly, representatives from a large insurance company said the pollution exclusion would not apply unless the terrorist attack itself was deemed to be a polluting event. An official from the New York Insurance Department also said that the Department did not interpret the definition of “pollutants” in the standard pollution exclusion forms to apply to biological and chemical terrorist attacks. Courts determine whether a particular substance is or is not a pollutant based upon, among other things, the language in the policy, the facts and circumstances of the case, and the law of jurisdiction. As we stated in our September 2006 report, given the potential for litigation and court interpretation, insurers and other industry experts have raised some concerns as to how effectively the pollution exclusion would protect insurers against losses resulting from an NBCR terrorist attack.

Property/casualty insurers also may face potential exposure to losses from NBCR attacks as the result of state requirements, but it is difficult to assess the extent of this exposure. According to industry officials, 16 states—including California, Illinois, and New York—require property/casualty insurers to cover losses from fire following an event, regardless of the cause of fire. As we reported in 2006, in the case of a nuclear bomb detonation, once the property was destroyed, insurers could dispute the extent to which fire (covered in “fire following” states) or the blast (excluded by the nuclear exclusion) caused the damage. However, given the potential devastation resulting from a nuclear terrorist attack— including potentially widespread destruction and protracted evacuations—it may be difficult for insurers, policyholders, regulators, and courts to resolve any issues related to the cause of loss.

Property/Casualty Policyholders Report That NBCR Coverage Generally Is Unavailable or Available at Prices They View as Unaffordable

Information we obtained from commercial policyholders in a range of industries across the country also indicate that property/casualty coverage for NBCR risks is very limited. For example, we interviewed representatives from real estate companies that own large, high-value commercial properties (such as office buildings or hotels) in cities— including Chicago, New York, and San Francisco—that generally are viewed as being at high risk of terrorist attack. While representatives from these companies said that they generally were able to obtain coverage for terrorist attacks that involve conventional weapons, such as truck bombs, they generally did not have NBCR coverage. In addition, results from a recent survey of risk managers conducted by the Risk and Insurance Management Society, Inc. (RIMS), show that commercial policyholders generally have not been offered NBCR coverage in their insurance policies. Although the RIMS survey has several limitations, it found that less than 15 percent of the respondents had coverage for NBCR attacks. Furthermore, representatives we contacted from industries such as transportation, hospitality, entertainment and utilities also reported that they did not have NBCR coverage, or had limited coverage, such as for only chemical risks.

Policyholders we contacted said that they generally lacked NBCR coverage because (1) their insurers did not offer it; (2) the prices quoted on the coverage that was available were viewed as too expensive to purchase; or (3) they did not seek coverage. For example, a representative of a shopping center development company with retail locations in various cities throughout the United States said that the company is concerned about the risks of NBCR attack and has sought insurance coverage. However, the representative said that the company has not been able to identify any insurers that would offer the company NBCR coverage or provide pricing information. In addition, representatives of a commercial real estate developer in Washington, D.C., said that quoted insurance premiums for NBCR coverage were five times higher than their total property insurance costs. Insurance brokers we contacted told us that although some of their commercial policyholder clients have inquired about NBCR coverage, the demand for such coverage is less than that for conventional terrorism coverage. As we stated in 2006, demand for conventional terrorism coverage is high in the commercial real estate sector because mortgage lenders generally require companies to purchase coverage. However, according to brokers and a lender that we interviewed, lenders do not require companies to secure coverage for NBCR terrorist attacks because such coverage is largely unavailable.

Due to concerns about the potential for NBCR attacks and the general lack of coverage offered by insurers, some policyholders said that they had established captive insurers to self-insure the risk and obtain federal reinsurance under TRIA. Captive insurers are generally established by major corporations, such as large real estate companies, to self-insure a variety of risks. Corporations may create captives for several reasons, including to obtain coverage for certain risks that may no longer be provided by the private market (such as medical malpractice insurance), access additional coverage directly from a reinsurer, or reduce tax payments. According to a representative from an insurance broker that helps companies in establishing and managing captives, companies either may add NBCR coverage to an existing captive insurer or may create one to cover NBCR risks. For example, a representative from a national real estate company told us that he had difficulty finding terrorism insurance at prices viewed as reasonable and without restrictions, so the company established a captive that covered NBCR risks. Although captives may help some companies limit their potential exposure from NBCR attacks, available information suggests that captives are not widely used for this purpose, perhaps because companies may lack the financial resources necessary to do so. To illustrate, representatives from 18 percent of the 39 policyholders we contacted and 6 percent of the 377 respondents to the RIMS survey that we have previously discussed reported using captives to insure NBCR risks.

Workers’ Compensation, Life, and Health Insurers Generally Cover NBCR Risks Due to State Requirements

Unlike property/casualty insurers, workers’ compensation insurers we contacted said that they offer NBCR coverage because they generally are not permitted to exclude it under state laws and regulations. As we found in 2006, applicable state laws generally require workers’ compensation insurers to cover all perils, including those from NBCR risks. Under state workers’ compensation laws, employers are responsible for covering unlimited medical costs and a portion of lost earnings for injuries or illnesses that occur during the course of employment, regardless of the cause, according to NAIC.

Similarly, we were told that group life insurers generally do not exclude NBCR coverage from their policies, according to regulators and industry participants. Officials from five of the six state insurance regulators that we interviewed reported that they do not allow terrorism or NBCR attacks to be excluded from life insurance policies. However, officials from these regulatory agencies also said that their states had not enacted laws that explicitly require insurers to offer such coverage. Given the lack of statutory requirements, officials from Washington, D.C., told us that group life insurers in the District could exclude NBCR risks from their coverage. However, representatives from the American Council of Life Insurers, a national trade association for life insurers, reported that they were not aware of the use of NBCR exclusions and believed that group life insurers generally cover NBCR risks; officials from several large life insurance companies confirmed that they provided coverage.

Finally, health insurers also generally cover NBCR risks, according to state regulators, representatives from America’s Health Insurance Plans, and health insurers we contacted. According to industry participants, health insurers generally are required to pay claims, regardless of the cause that led to the claim. Insurance regulatory officials from several states with locations viewed as high risk—California, Georgia, Illinois, Massachusetts, and New York—told us that they do not permit health insurers to exclude NBCR coverage from their policies. However, regulatory officials in Washington, D.C., said that health insurers were not mandated to cover NBCR risks in the District and insurers had filed policies with NBCR exclusions. In addition, a representative from one large health insurer said that the insurer would invoke the force majeure clause—a general contract provision used to relieve parties from their responsibilities due to circumstances beyond their control, such as acts of God—to exclude NBCR risks. However, representatives from two state regulators we interviewed told us they were not familiar with the force majeure clause, and an official from the Georgia Department of Insurance told us he did not think the clause would apply to terrorist acts involving NBCR materials.

Potential Financial Consequences of NBCR Attacks Limit Property/Casualty Insurers’ Willingness to Offer Coverage; Insurers for Other Lines of Insurance Report Limited Capacity to Manage Associated Risks

Commercial property/casualty insurers and reinsurers generally are not willing to provide coverage for NBCR attacks or place significant restrictions on the coverage they offer because of the uncertainties surrounding such attacks and their potential for generating catastrophic losses. Although private workers’ compensation insurers generally have greater flexibility than state funds to limit their exposure to losses from NBCR attacks by not offering coverage to certain employers, both private insurers and state funds may face other challenges in managing the risks associated with terrorist attacks involving NBCR weapons, such as limits on their ability to price such risks and obtain private reinsurance. Life and health insurers may also face challenges in managing NBCR risks, such as competitive market pressures and challenges in establishing appropriate premiums for their potential exposures.

Commercial Property/Casualty Insurers and Reinsurers Are Concerned about the Uncertainty and Potential Enormity of Losses from NBCR Attacks

As we stated in our September 2006 report, many insurers view terrorist attacks, particularly attacks involving NBCR materials, as an uninsurable risk because of uncertainties about the severity and frequency of such attacks. Insurance companies typically manage and assess risk on the basis of their expected losses, using historical information about the range of damages (severity) and the number of incidents in a given period of time (frequency). For some risks, such as those related to driving automobiles, insurers have access to a substantial amount of statistical and historical data on accidents, from which they can predict expected losses and then calculate premiums that are adequate to cover these losses. Large claims from automobile accidents also generally do not occur to a large number of policyholders at the same time, which serves to limit insurers’ exposures. In contrast, catastrophes, including natural disasters such as hurricanes as well as terrorist attacks, present unique challenges to insurers because they may result in substantial losses and are relatively infrequent. To address these challenges, insurers may use computer models developed internally and by outside firms to help estimate the financial consequences of various disaster scenarios, and in some cases, to develop appropriate premiums. However, as we have previously noted, due to data limitations, estimating the potential consequences of terrorist attacks is fundamentally different and substantially more difficult than forecasting natural catastrophes. For example, substantial data are available on the frequency and severity of hurricanes, but the United States has experienced relatively few terrorist attacks, particularly those involving NBCR materials.

Estimates of the potential severity of attacks involving NBCR materials may be particularly difficult to produce for several reasons, according to insurance industry participants and representatives from firms that have developed computer models for catastrophe risks. For example, as we previously have discussed, a wide range of potential weapons are associated with NBCR attacks, which could result in varying amounts of property damage as well as injuries and deaths (see fig. 1). While estimates for the damage resulting from nuclear blast in an urban area exceed the loss estimates for a chemical attack on a single building or facility, loss estimates also may vary for different types of attacks using the same agent. For example, one modeling firm has produced a scenario in which a moving truck releases anthrax in a highly populated urban area creating total insured losses of $144 million, 20 times higher than if the anthrax were released through a sprayer inside the ground floor of a large building. Representatives of insurers and reinsurers we interviewed expressed concerns about models’ ability to account for all of the potential losses associated with an NBCR attack, such as business interruption and litigation costs, which may be difficult to quantify. In addition, a recent report by one modeling firm stated that decisions about the extent of cleanup required for nuclear and radiological contamination likely will be made after the attack, creating further uncertainties about the cost of rebuilding or remediation.

Insurers also face challenges with developing frequency estimates for NBCR attack scenarios. Representatives of risk modeling firms told us they use worldwide incidents of NBCR attacks and researchers’ opinions on terrorists’ capabilities and potential targets to develop estimates for NBCR event frequency. However, some insurance industry participants described frequency estimates of NBCR attacks as too subjective to be used as a basis for pricing coverage, because views on the frequency of attacks vary. For example, while one modeling firm stated in a recent report that its estimates for the frequency of terrorist attacks are 0.6 events per year, or 2.0 events every 3 years, the representative of a large commercial property/casualty insurer said that his firm viewed the risk as occurring once every 8 years. Furthermore, insurance experts said that terrorists continue to adjust their strategies, thereby making past attacks a poor predictor of future events.

Because insurers and reinsurers face challenges in reliably estimating the severity and frequency of terrorist attacks involving NBCR materials and setting appropriate premiums, industry representatives reported that their companies focus on the most catastrophic attacks under scenarios with widespread financial losses. For example, some representatives of property/casualty insurers told us that the scale of a nuclear blast could have a devastating impact on an insurer that chose to offer NBCR coverage, because such an attack could destroy or render uninhabitable many or all buildings within a large metropolitan area. In contrast, we have previously reported that since TRIA was enacted, insurers have some ability to limit their potential losses from terrorist attacks involving conventional weapons such as truck bombs, because the damage resulting from such attacks might be confined to a smaller geographic area, such as a radius of several blocks from the attack. Representatives of insurers we contacted told us their companies may limit their property/casualty coverage in locations viewed as at high risk for a terrorist attack, such as New York City; however, they reported that the potential losses from an NBCR attack could far exceed what their company would be able to cover. As we reported in 2006, academic experts and industry participants have pointed out that insurers have little incentive to insure catastrophic events that might jeopardize their financial soundness and solvency, so insurers remain unwilling to offer coverage for NBCR attacks.

Private Workers’ Compensation Insurers Have Somewhat Greater Flexibility to Manage NBCR Risks by Choosing Which Employers to Offer Coverage, but Private Insurers and State Funds Face Other Risk Management Challenges

Although private and state workers’ compensation insurers generally must cover losses resulting from NBCR attacks, private companies generally have greater flexibility in managing their exposures to losses from NBCR attacks under the TRIA program. Specifically, private insurers may choose to which employers they will offer coverage. Accordingly, representatives of private insurers reported that their companies have monitored or limited coverage offerings to employers with employees concentrated in locations considered to be at higher risk for an NBCR attack. For example, representatives of smaller, more regionally based insurers said their companies decided not to offer coverage for certain employers that have employees concentrated in densely populated locations, or limited their overall coverage offerings for workers’ compensation in urban areas.

In contrast to private insurers, state workers’ compensation funds generally are unable to limit their NBCR risks on the basis of employers’ perceived risk levels. State laws and regulations generally require state funds to provide coverage to all employers—regardless of their location or risk level—and serve either as the state’s sole insurer or as the insurer of last resort. While officials from some state funds we contacted said that they were concerned about exposure to losses from an NBCR attack, they also said the nature of their funds’ operations might limit that exposure to some degree. For example, representatives from some funds said that because they offered coverage to a significantly large group of employers of varying sizes across the state, their exposure to losses from NBCR attacks was somewhat diversified.

Finally, representatives of private workers’ compensation insurers and state funds told us that they faced some challenges in managing NBCR exposures, such as pricing the risk and obtaining adequate amounts of private reinsurance. Recognizing workers’ compensation insurers’ exposure to terrorism risks, state regulators in at least 37 states, including the District of Columbia, have permitted insurers to apply a statewide surcharge, or additional premium, (which is on average about 1 cent per $100 payroll) to cover the potential losses from terrorist attacks, including those involving NBCR materials. The National Council on Compensation Insurance, Inc. (NCCI), developed statewide surcharges based on the results of a model, as a way for insurers that underwrite in states that belong to NCCI to cover potential losses from terrorism, including those using NBCR materials. NCCI officials told us that their surcharges generally are uniform across a state and insurers using this surcharge generally cannot levy higher surcharges for employers they perceive to be at higher risk of terrorist attack. Furthermore, NCCI’s surcharges were developed to cover potential losses from terrorist attacks involving conventional as well as NBCR weapons. Officials from the New York Compensation Rating Board, which develops workers’ compensation rate proposals for the state of New York (which does not belong to NCCI), also told us the state’s surcharges were developed to cover potential losses from both conventional and NBCR terrorist attacks. However, as we stated in our 2006 report, state regulators and insurance representatives advised us that any surcharges that insurers may be permitted to charge for NBCR exposure likely would not cover potential losses. Similarly, representatives of private workers’ compensation insurers we contacted for this report that underwrite coverage in locations considered at high risk for terrorist attacks said that their surcharges for terrorism may not cover all of their potential exposure. In addition, representatives of many of the private insurers and some of the state funds we interviewed said that they had little to no private reinsurance for NBCR risks, and that they would rely on TRIA in the event of a catastrophic NBCR attack.

Group Life and Health Insurers May Face Challenges in Managing NBCR Risks

In contrast to workers’ compensation insurers, life and health insurers may have somewhat more flexibility to manage the risks associated with terrorist attacks involving NBCR materials. For example, unlike workers’ compensation insurers, the prices charged by group life insurers generally are not subject to state regulatory approval. Group health insurers generally are able to negotiate the terms of health care coverage with employers and employees, unlike workers’ compensation benefits that are state-mandated.

However, based on the limited amount of work we conducted, we found that for terrorist attacks involving NBCR materials, group life and health insurers face the following risk-management challenges: Group life insurers may not actively seek to limit the amount of coverage that they offer in geographic markets perceived to be at high risk of attack, according to representatives from the American Council on Life Insurance (ACLI) and several large companies we contacted. According to these officials, the group life insurance market is highly competitive, with insurers competing to cover employers, even in densely populated urban areas at risk for terrorist attacks. Furthermore, life insurers’ use of models to manage the risks associated with providing coverage in densely populated areas may be limited. We spoke with representatives from two group life insurers that reported that while they have started to use models to review the impact of catastrophic scenarios, they lack specific data on the location of employees from some employers to monitor their concentration of insured individuals. An ACLI representative said that group life insurers with exposures across the country may be better able to manage risks from an NBCR attack than smaller, more regional insurers with portfolio concentrations near target locations.

We also previously reported on the difficulties group life insurers face in charging higher premium rates to employers perceived to be at higher risk of terrorist attacks, including attacks involving NBCR materials. Life insurers price their products on the basis of mortality tables derived from experience with prior insurance contracts and calibrated to the effects of individual characteristics, such as smoking, or group characteristics, such as occupation type. According to ACLI, group life insurance policies currently are not designed or priced to account for catastrophic financial losses and mass casualties from an unpredictable terrorist attack with an NBCR weapon.

Similarly, health insurers may face difficulties in setting premium rates to address the risks of terrorist attacks, including those involving NBCR materials. For example, health insurers said that they generally price coverage on the basis of previous experience with insured populations, and that without knowing the frequency and severity of NBCR risks, they could not develop actuarially sound prices for such a risk. Furthermore, because illnesses or symptoms of illnesses resulting from NBCR attacks could take years to develop, it might be very difficult for insurers to establish appropriate premiums for such long-term risks.

Proposals to Increase Coverage for NBCR Attacks in the Property/Casualty Market Have Advantages and Disadvantages

Because the current commercial property/casualty market generally lacks coverage for terrorist attacks involving NBCR materials, the two proposals we reviewed to increase the availability of such coverage focus on that market. The proposals involve the federal government assuming most or all of the associated financial liabilities of such attacks. For example, an early version of the bill to reauthorize TRIA in 2007 would have required insurers to make NBCR coverage available and would have lowered their exposure to potential losses. While such a proposal may increase the availability of NBCR insurance, some industry participants believe it would disrupt insurance markets. Alternatively, some industry participants have suggested that the federal government should fully insure losses from terrorist attacks involving NBCR materials, similar to other federal disaster insurance programs. This program could help ensure the availability of NBCR insurance, according to some industry participants, but others said the program could result in substantial losses to the federal government.

Proposal 1: Amend TRIA to Require Insurers to Make NBCR Coverage Available with the Federal Government Assuming Greater Financial Responsibility for Potential Losses

The House of Representatives initially passed an early version of the 2007 reauthorization of TRIA that would have amended the act to (1) require insurers to make NBCR coverage available to policyholders, and (2) require the federal government to assume a relatively high proportion of the associated financial risk. With certain exceptions, the proposal would have required insurers to offer coverage for NBCR attacks under terms, amounts, and other coverage limitations that did not differ materially from their coverage for other types of risks. The proposal would have allowed an insurer to exclude NBCR coverage altogether (except for workers’ compensation or other state coverage requirements) or offer a separate NBCR terrorism policy at different terms, amounts, and other coverage limitations than other types of coverage, if a policyholder rejected an insurer’s initial offer for coverage. To compensate insurers for the risks associated with providing NBCR coverage, the proposal initially would have set insurers’ TRIA deductibles for such attacks at 3.5 percent of direct earned premiums, substantially lower than the 20.0 percent deductible insurers would pay under the current program for terrorist attacks in general. In addition, under this proposal, insurers’ copayment, or additional share of losses, for an NBCR attack would have varied depending on the size of the losses associated with the attack. In the case of a smaller NBCR attack, an insurer would have paid 15 percent of its losses after paying its deductible, and for very large NBCR attacks, 5 percent. Additionally, the proposal would have permitted insurers to voluntarily reserve some of their conventional and NBCR terrorism premiums, tax-free, in a fund maintained by Treasury to cover the TRIA deductibles or copayments associated with losses from future terrorist attacks.

Given insurers’ general reluctance to provide NBCR coverage, some industry participants we contacted stated that this proposal was reasonable. For example, a representative from one insurer said that unless mandated to do so, insurers would not offer coverage for NBCR risks. Representatives from other insurers and industry participants, including regulators, told us that limiting insurer losses for NBCR events would help insurers better manage risks associated with NBCR attacks. With their financial exposures limited, insurers could more easily develop terms and conditions for NBCR coverage to policyholders and offer the coverage at lower rates. In addition, some industry participants said that the provision in the legislation allowing for separate pricing of NBCR coverage would (1) allow insurers to tailor insurance coverage and prices to the type of terrorist attack, and (2) provide policyholders with the choice of purchasing NBCR and conventional terrorism coverage together or separately.

A recent study by the RAND Corporation found that requiring insurers to offer NBCR coverage, with the federal government assuming significant financial liability for the associated losses from large attacks could be beneficial. For example, the RAND study stated that under such a program the number of policyholders purchasing coverage would increase substantially from current levels. Furthermore, the study concluded that the federal government’s expected outlays for compensation and assistance following attacks involving NBCR materials actually might decrease. Given that property/casualty coverage for NBCR attacks is largely unavailable, in the event of such an attack, the study noted that the federal government might decide to provide a large amount of disaster assistance or other compensation following an attack, as it has done for the victims of natural catastrophes and terrorist attacks. If insurers were required to provide some coverage for NBCR attacks, the study concluded that the federal government’s expected costs could be somewhat lower under certain conditions than otherwise would be the case.

Some industry participants also suggested that insurers could use different strategies in addition to TRIA to further manage the risks associated with providing NBCR coverage, as would be mandated under this proposal. In particular, some participants said they favored insurers forming risk pools or changing tax laws to permit insurers to set aside tax-deductible reserves to offset some of the losses associated with terrorist (including NBCR) attacks, similar to provisions in the legislative proposal. We have reported that establishing a group of insurance companies to pool their assets could allow insurers to provide a greater amount of coverage for the entire market than could be provided by each individual company. Furthermore, as we discussed in our prior reports, allowing either a pool or individual insurers to maintain tax-deductible reserves could provide the industry with incentives to expand capacity to cover catastrophic risks, such as attacks with NBCR materials. Table 2 provides information on existing or proposed pooling arrangements in the United Kingdom and the United States that are designed to help insurers manage the risks associated with terrorist attacks involving NBCR materials or accidents involving nuclear materials.

However, other industry participants cautioned that requiring insurers to provide NBCR coverage, even with the federal government assuming a relatively high percentage of the associated financial exposure, could have adverse consequences for insurance markets. For example, a variety of industry participants said that under such a mandate, insurers may be less willing to offer property/casualty coverage and may withdraw from the market or not offer coverage in areas viewed as at high risk of attack. Some industry participants expressed particular concern about the impact that such a proposal would have on smaller insurers. While this proposal substantially would have lowered the deductible for attacks involving NBCR materials, a few industry participants said that the proposed copayments for such attacks still could be substantial for smaller insurers. The officials said that smaller insurers may lack the financial capacity to cover such potential costs.

In addition, some industry participants and policyholders said that this proposal could be prohibitively costly to policyholders and taxpayers. As we have previously discussed, industry participants said that estimates of the severity and frequency of terrorist attacks involve many uncertainties, making pricing difficult. Consequently, some industry participants said that insurers, faced with a mandate of providing NBCR coverage, might set premiums at rates they consider necessary to compensate for the risks of a catastrophic attack, which could deter many commercial entities from purchasing such coverage. For example, two researchers we contacted said that when Pool Re expanded its coverage to include NBCR risks after the September 11 attacks, prices for terrorism coverage doubled. In addition, some industry participants said that if the federal government were liable for a greater portion of insured losses resulting from an NBCR attack, then the overall costs to the taxpayer from that attack could be significant. Furthermore, although the RAND study concluded that costs to the federal government could be reduced by requiring insurers to offer NBCR coverage, the study noted that in the case of extremely large NBCR attacks, the federal government’s financial liability could be larger than if it did not participate in the market for terrorism insurance and require insurers to offer NBCR coverage. We also note that the federal government’s total costs could be higher under this option than the current situation where NBCR coverage is generally unavailable, and Congress later decided to provide additional funding to pay for uninsured losses from such an attack.

Finally, information from our previous work, as well as interviews with some industry participants, raises questions about whether establishing pools or permitting insurers to maintain tax-deductible reserves materially would enhance available coverage for terrorist attacks, including those involving NBCR materials. According to industry participants and a study by a global consulting firm on a proposed pool for workers’ compensation coverage for terrorism risk, a reinsurance pool might not create new industry capacity or bring in additional capital to support writing more business. The study noted that if the overall industry does not have enough capital to manage the risk of an NBCR attack, then neither would an industry pool that simply combines existing industry capital in a new structure. Furthermore, we have reported that overall insurance capacity might not increase if a pool or individual insurers were allowed to establish tax-deductible reserves. Because reinsurance premiums already are tax-deductible, insurers would receive similar tax benefits from traditional reinsurance, pool reinsurance, or individual reserves.

Therefore, insurers might substitute the pool reinsurance or individual reserves for their current reinsurance program, if that program includes coverage for NBCR attacks.

Proposal 2: Federal Government Completely Insures Losses for Terrorist Attacks Involving NBCR Materials, with Insurers Administering the Program

Given concerns about the potential financial and other consequences of requiring insurers to provide NBCR coverage, some industry participants we contacted suggested that the federal government should develop a separate program to insure against such attacks. Under this proposal, the federal government would serve as insurer, covering all losses for NBCR attacks and charging premiums for providing these services. The insurance industry’s role largely would be administrative, as some industry representatives reported that the industry would have the staff, processes, and experience in place to manage such tasks. For example, insurance companies could be responsible for collecting premiums, adjusting claims, and disbursing claims payments from the government to policyholders. This proposal could be similar to other federal insurance programs shown in table 3, where the government assumes most, if not all, of the risk. These other programs generally were created because of gaps in coverage in the private market or the perception that the risks were uninsurable.

While some industry analysts said that this proposal was the only way to ensure that NBCR coverage would be widely available, others expressed concerns about the potential costs of such a program to the federal government and its effects on the private market. With the government responsible for most, if not all, of the losses in the event of a terrorist attack involving NBCR materials, several industry participants expressed concerns about the potentially large post-disaster costs for the federal government and, ultimately, taxpayers. We note that other government disaster insurance programs have proven to be costly and have administrative challenges. For example, we have reported that while NFIP and the Federal Crop Insurance Program were created to provide affordable insurance coverage, they do not collect enough in premiums to fund potential losses from catastrophic disasters. Therefore, Congress has had to appropriate funds after disasters, such as floods, to pay catastrophic claims. Given the difficulties associated with reliably estimating the potential severity and frequency of terrorist attacks involving NBCR materials as discussed in this report, the federal government may face substantial challenges in establishing premiums sufficient to offset the risks involved in providing insurance coverage for such attacks.

In addition to the large potential costs to taxpayers, industry participants expressed other concerns about the federal government assuming complete financial responsibility for potential NBCR property/casualty losses. For example, some industry participants, including regulators, did not think that the government should be responsible for all of the potential losses from an NBCR attack and that insurers could assume some of the risk. Furthermore, we have previously reported that some industry participants believe that too much federal government involvement in disaster relief crowds out private insurance and reduces the private market’s ability and willingness to provide insurance-based solutions to covering catastrophe risk. Finally, while insurers would play a largely administrative role under this proposal, some insurers expressed reservations about this potential responsibility because they have no experience training, equipping, and sending claims adjusters and other personnel into areas where NBCR materials have been released.

Agency Comments and Our Evaluation

We provided a draft of this report to the Department of the Treasury and NAIC for their review and comment. In their oral comments, Treasury officials said that they found the report informative and useful. They also provided technical comments that were incorporated where appropriate.

NAIC provided written comments on a draft of this report, which have been reprinted in appendix II. In their comments, NAIC stated that the report was materially accurate and they agreed with our discussion on proposed policy proposals for expanding NBCR coverage in the commercial property/casualty market. However, NAIC reported a philosophical difference of opinion with comments in the draft report about the ability of workers’ compensation insurers to charge risk-based premiums for attacks involving NBCR weapons. NAIC stated that our draft report contained references that implied that state insurance regulators, due to voter and legislative pressure, keep premium rates artificially low for workers’ compensation insurers rather than relying on actuarial science. NAIC disputed what it characterized as our implied contention and suggested that the recent profitability of the insurance industry indicates that premiums have not been suppressed by regulatory actions.

We made clarifications in the draft to address certain NAIC comments, such as more fully describing the surcharges that workers’ compensation insurers may levy for covering losses from terrorist attacks, including those involving NBCR weapons. However, the draft report in no way meant to imply that state insurance regulators succumb to voter and legislative pressures in approving rates, and simply reported that workers’ compensation insurers and some regulators we contacted for both our September 2006 report and this report said that they did not believe the permissible surcharges would be sufficient to cover the potential losses associated with an NBCR attack. Given that NBCR risks may not fully satisfy the principles of insurability, as we said in our September 2006 report, statements by representatives of workers’ compensation insurers that question whether the permitted surcharges are sufficient to cover potential losses do not appear inherently unreasonable. As discussed in the final report, the permitted surcharge in many states is the same for conventional terrorist attacks and for those involving NBCR weapons and insurers generally are not permitted to levy higher surcharges for employers they perceive to be at higher risk of attack. Furthermore, we note that while NAIC reports that workers’ compensation insurers have been profitable over the past several years, this does not mean that any premiums collected from this surcharge would be sufficient to cover the losses associated with a future NBCR attack.

NAIC also commented on statements in the draft report regarding the ability of group life insurers to manage exposures to NBCR risks. Specifically, NAIC said that the competitive nature of group life insurance markets has more of an impact on group life insurers’ decisions to provide NBCR coverage in their policies than any regulatory constraints. NAIC stated that if one group life insurer were to exclude coverage for NBCR risks, and other group life insurers did not exclude such coverage, the insurer excluding NBCR risks would be at a competitive disadvantage. NAIC concluded that employers may choose not to purchase coverage from the group life insurer that excluded NBCR risks, unless the price difference was substantial. We generally agree with NAIC that competitive market pressures may affect group life insurers’ willingness to limit NBCR coverage, and note that the argument was included in the draft provided to NAIC for its review and comment. Nevertheless, we made some adjustments to the text to ensure that this analysis was better communicated throughout the final report. NAIC also provided additional technical comments and observations that were incorporated as appropriate.

We also sent excerpts of our draft report to the six state regulators discussed in this report (California, Georgia, Illinois, Massachusetts, New York, and Washington, D.C.) for their review. Three state regulators responded that they did not have any changes to our characterization of NBCR requirements in their states, and one regulator provided a technical comment that we made. We also provided excerpts of the draft report to five other organizations referenced in this report, and all five responded, some with technical comments that were incorporated where appropriate.

We are sending copies of this report to the appropriate congressional committees, the Department of the Treasury, NAIC, and other interested parties. The report is also available at no charge on our Web site at http://www.gao.gov.

If you or your staffs have any questions about this report, please contact me at (202) 512-8678 or williamso@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III.

Appendix I: Objectives, Scope, and Methodology

Our objectives were to review (1) the extent to which insurers and reinsurers offer coverage for nuclear, biological, chemical, and radiological (NBCR) attacks; (2) the factors that contribute to the willingness of insurers and reinsurers to provide coverage for NBCR attacks and their ability to manage these risks; and (3) any public policy options for expanding coverage for these risks, given current insurance market conditions.

To address the first objective, we reviewed relevant studies and interviewed representatives of more then 100 organizations, including insurer and policyholder trade associations; individual policyholders; national insurance and reinsurance brokers; and insurance and reinsurance companies with knowledge of the commercial property/casualty, workers’ compensation, group life, and health insurance markets nationwide and with expertise in specific geographic markets. We also interviewed local brokers, insurance companies, and local property owners in cities and regions with locations considered to be at high, moderate, and low risk of exposure to terrorist attacks. These locations included Atlanta; Boston; Chicago; New York; San Francisco; and Washington, D.C. We selected these markets on the basis of rankings of locations by risk of terrorism exposure from the Insurance Services Office (ISO), an insurance industry analytics firm. Insurers may use these rankings, which account for cities’ risk of terrorist attacks and the potential for associated losses, as a basis for charging additional premiums for terrorism exposure, according to ISO and several regulators we contacted. We interviewed some participants in specialized insurance markets, including a nuclear pool, Bermuda reinsurers, and a national broker with expertise in environmental insurance. We spoke with representatives of policyholders that own hundreds of properties and other entities nationwide. These entities included large office towers in major U.S. cities, properties in proximity to high-profile federal buildings, hotels, industrial buildings, hospitals, sports stadiums, a chemical company, a railroad company, and residential properties in locations throughout the United States. In addition to one-on-one interviews, we also conducted group discussions with representatives of 14 policyholders at the annual Risk and Insurance Management Society, Inc. (RIMS), conference in San Diego, California, in April 2008. Although we selected industry participants to provide broad representation of market conditions geographically and by industry, their responses may not be representative of the universe of insurers, insurance brokers, policyholders, and regulators. As a result, we could not generalize the results of our analysis to the entire national market for commercial property/casualty, workers’ compensation, group life, and health insurance. We determined that the selection of these sites and participants was appropriate for our objectives, and that this selection would allow coverage of locations considered to be at high, moderate, and low risk of exposure to terrorist attacks, and would obtain information related to NBCR coverage for major insurers, policyholders, and other organizations to generate valid and reliable evidence to support our work.

We also reviewed the Department of the Treasury’s 2005 Report to Congress, Assessment: The Terrorism Risk Insurance Act of 2002 and its results from a survey of commercial property/casualty insurers on the coverage they offered for NBCR risks. We were limited in our ability to use this information because it was unclear from the survey question whether an insurer offered NBCR coverage in one commercial property/casualty policy or in all policies. We also reviewed results from a survey of risk managers conducted by RIMS of their membership. However, we also were limited in our ability to use results from this survey on purchase rates of NBCR insurance as a signal for approximating overall demand because of the low response rate (approximately 10 percent) to the survey.

To address the second objective, we selected large, national insurance companies to interview on the basis of their market share in the states we studied—California, Georgia, Illinois, Massachusetts, and New York as well as Washington, D.C. In the commercial property/casualty and workers’ compensation market, these national insurance companies held from 37 to 52 percent of the market share in the states we studied, according to information provided by the Insurance Information Institute. In addition, we interviewed representatives of regional insurance companies in our selected markets. We also spoke with representatives of seven reinsurance companies, including two of the largest worldwide reinsurance companies as well as risk modeling firms, state regulators, and two credit rating agencies.

To select state workers’ compensation funds, we compiled and analyzed available data on workers’ compensation state funds based on information from the American Association of State Compensation Insurance Funds and the National Council on Compensation Insurance, Inc. We selected nine workers’ compensation state funds on the basis of the presence of a metropolitan city in the state; presence of cities considered at risk for terrorist attacks, developed using estimates from ISO; and type of state fund—either monopolistic (fund is the sole insurer in the state) or competitive (fund competes with private insurers to offer workers’ compensation coverage)—and its size.

To learn more about the coverage in the group life and health insurance markets and factors affecting that coverage, we interviewed state regulators in California; Georgia; Illinois; Massachusetts; New York; and Washington, D.C., as well as officials from the American Council of Life Insurers and America’s Health Insurance Plans—two large national trade associations. We also interviewed several group life and health insurers with large shares of the market both nationally and in the selected states, as well as one large group life reinsurance company and a representative from a national brokerage firm with expertise in the reinsurance market for group life carriers. Although we selected insurers from each of the lines we studied to provide a broad representation of size and geographic scope, we could not generalize the results of our analysis to the entire population of private insurers or workers’ compensation state funds.

To address the third objective, we reviewed options proposed in legislation, discussed in our prior reports or in other reports, or suggested by industry participants. We also interviewed academics, representatives from research organizations, and consumer interest groups. Although these discussions did not produce a consensus about what measures would increase the availability of NBCR coverage, for this report we focused on two proposals deemed viable by a variety of industry participants. We selected the proposal to amend Terrorism Risk Insurance Act to require insurers to make NBCR coverage available and lower insurers’ deductibles and co-payments from a recent legislative proposal. We selected the option for the federal government to insure losses for terrorist attacks involving NBCR materials from interviews conducted with industry participants. We compiled and analyzed the views of the industry participants listed above on these two proposals and reviewed our prior reports to obtain information about other federal insurance programs. We did not attempt to evaluate the prospective impact of these proposals and, therefore, did not come to any conclusions about the advisability of implementing them.

We conducted this audit in Atlanta; Boston; Chicago; New York; San Diego; San Francisco; and Washington, D.C., from January 2008 to December 2008, in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides basis for our findings and conclusions based on our audit objectives.

Appendix II: Comments from the National Association of Insurance Commissioners

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, Wesley M. Phillips, Assistant Director; Rudy Chatlos; Andrea Clark; Katherine Bittinger Eikel; Marc Molino; Jill M. Naamane; Linda Rego; Barbara Roesmann; Kathryn Supinski; and Shamiah Woods made key contributions to this report.

Related GAO Products

Terrorism Insurance: Status of Efforts by Policyholders to Obtain Coverage. GAO-08-1057. Washington, D.C.: September 15, 2008.

Terrorism Insurance Availability: Initial Results on Availability of Terrorism Insurance in Specific Geographic Markets. GAO-08-919R. Washington, D.C.: July 11, 2008.

Homeland Security: First Responders’ Ability to Detect and Model Hazardous Releases in Urban Areas Is Significantly Limited, GAO-08-180. Washington, D.C.: June 27, 2008.

Natural Disasters: Public Policy Options for Changing the Federal Role in Natural Catastrophe Insurance. GAO-08-7. Washington, D.C.: November 26, 2007.

Terrorism Insurance: Measuring and Predicting Losses from Unconventional Weapons is Difficult, But Some Industry Exposure Exists. GAO-06-1081. Washington, D.C.: September 25, 2006.

Catastrophe Risk: U.S. and European Approaches to Insure Natural Catastrophe and Terrorism Risks. GAO-05-199. Washington, D.C.: February 28, 2005.

Terrorism Insurance: Effects of the Terrorism Risk Insurance Act of 2002. GAO-04-806T. Washington, D.C.: May 18, 2004.

Terrorism Insurance: Effects of the Terrorism Risk Insurance Act of 2002. GAO-04-720T. Washington, D.C.: April 28, 2004.

Terrorism Insurance: Implementation of the Terrorism Risk Insurance Act of 2002. GAO-04-307. Washington, D.C.: April 23, 2004.

Catastrophe Insurance Risks: Status of Efforts to Securitize Natural Catastrophe and Terrorism Risk. GAO-03-1033. Washington, D.C.: September 24, 2003.

Catastrophe Insurance Risks: The Role of Risk-Linked Securities and Factors Affecting Their Use. GAO-02-941. Washington, D.C.: September 24, 2002.

Terrorism Insurance: Rising Uninsured Exposure to Attacks Heightens Potential Economic Vulnerabilities. GAO-02-472T. Washington, D.C.: February 27, 2002.

Terrorism Insurance: Alternative Programs for Protecting Insurance Consumers. GAO-02-199T. Washington, D.C.: October 24, 2001.

Terrorism Insurance: Alternative Programs for Protecting Insurance Consumers. GAO-02-175T. Washington, D.C.: October 24, 2001.