After property/casualty insurance industry representatives presented testimony before the House Committee on Financial Services on the future of the federal terror backstop, a research firm predicted that the Terrorism Risk Insurance Act (TRIA) will be extended but with structural changes.

Not basing the prediction on the weight of the testimony on Thursday but on counts of Republicans and Democrats on the committee and in the House of Representatives overall, William Wilt and Alan Zimmermann of Assured Research also looked back at the party split on the last reauthorization to make their forecast.

“In short, we believe it will be difficult for the industry to retain the current structure given that there is now a Republican-controlled House of Representatives with a conservative fiscal bent. It seems most likely that some type of compromise will have to be worked out,” the insurance analysts wrote in a research note.

In Thursday’s Assured Research commentary, the analysts said possible changes to scale back the federal government’s role could include:

• Lowering the $100 billion policy limit and making insurers responsible for losses above that amount.
• Raising the $100 million loss attachment trigger.
• Raising the 15 percent co-insurance level.
• Raising the 20 percent deductible.
• Charging the industry a premium.

The analysts note that when TRIA was renewed as the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) in 2007, by a 312-100 vote, the House was controlled by Democrats, and the vote by party was 224-2 for Democrats and 88-108 for Republicans.

Currently, the House makeup is 234 Republicans and 201 Democrats, and the Financial Services Committee is 31-28 Republican. Fourteen of the 31 committee Republicans voted on the 2007 bill, with 11 of those 14 voting not to extend the act. Still, six New York representatives on the committee—four Democrats and two Republicans—will all support reauthorization, the researchers suggest.

Brokers Testify

Meanwhile, at Thursday’s committee hearing, insurance broker Marsh told lawmakers that TRIA is a “model” for public-private cooperation and should be renewed.

Peter J. Beshar, executive vice president and general counsel of Marsh & McLennan Cos., said his firm strongly supports reauthorization and modernization of the law. “We consider TRIA to be a model public-private partnership. TRIA restored insurance capacity at a critical time after 9/11 and continues to be the backbone of a healthy terrorism insurance market,” said Beshar.

He said that an April report by Marsh (2013 Terrorism Risk Insurance Report) that surveyed more than 2,500 Marsh clients showed that demand for terrorism risk insurance remains strong and that the TRIA program plays a major part in the availability and affordability of coverage.

According to the report, 62 percent of Marsh’s clients purchased property terrorism coverage backed by TRIA in 2012.

“Our clients across the United States—including real estate developers, media companies, health care organizations and educational institutions—need and want terrorism coverage and would be less likely to get it without TRIA,” he said.

“In our judgment, the existence of a private terrorism insurance market, backstopped by TRIA, actually serves to protect the government and taxpayers from absorbing virtually all of the financial loss in the event of a terrorist attack.”

One of Marsh’s competitors, Aon, said its research shows that more than 85 percent of insurers will no longer insure terror risk if the federal backstop goes away. In a written comment to the U.S. Treasury Department, Aon advised that renewal of TRIA will ensure the continuation of a functional market for commercial property/casualty terrorism coverage and that the program’s imminent expiration at the end of 2014 “has already generated dislocation” in the commercial property/casualty insurance and reinsurance marketplace.

“If the mandatory offer of coverage disappears with TRIPRA 2007 expiring without replacement, then the market will contract. This is not supposition—it has been backed up by carrier behavior with prior TRIA expirations, with nearly 85 percent of property insurance carriers looking to exclude terrorism in the absence of TRIA,” Aon said in its letter.

Marsh’s Beshar offered three recommendations for refinement of the program, including:

• Specific clarification that coverage is provided by TRIA for all forms of terrorism—including nuclear, biological, chemical and radiological events—if coverage is afforded on the primary policy.
• Modernization of TRIA to reflect new terrorist threats that have emerged—in particular, the risk of cyber terrorism.
• Establishment of a 90-day time period for determining whether or not an act of terrorism is covered by TRIA.

Marsh representatives also shared their views on TRIA with Michael McRaith, director of the Federal Insurance Office (FIO), at Wednesday’s meeting of the Federal Advisory Committee on Insurance (FACI).

Christopher Flatt, leader of Marsh’s Workers Compensation Center of Excellence, and Aaron D. Bueler, managing director and leader of Guy Carpenter’s workers compensation practice and terrorism task force, told the federal regulators that continuation of TRIA is “essential.”

“Nonrenewal or a major change in the program will negatively affect the affordability and availability of commercial lines insurance vital to the economy,” Bueler said. “Since TRIA’s enactment in 2002, the terrorism reinsurance market has become a critical component of risk management strategy for many insurers. A dramatic change in the federal backstop could lead to a contraction in both the insurance and reinsurance marketplace.”

Flatt said TRIA affects the state-regulated workers compensation market, especially in the areas of pricing and capacity. “The uncertainty in the market is causing some carriers to reduce their available capacity and aggregate exposures in large cities, and workers compensation prices on these risks are certainly going up,” he told members of FACI.

Carriers, Reinsurers Echo the View

Insurance carriers submitted similar testimony in support of TRIA.

Like Marsh, the National Association of Mutual Insurance Companies (NAMIC) devoted part of its House committee testimony to workers comp, stressing the need for special attention to the line in the debate to extend the program, and noting that comp insurers are not allowed to exclude losses due to terrorism.

“The expiration of TRIA could result in disaster for workers compensation insurers, and the businesses they serve, should a catastrophic terrorist event occur,” NAMIC said, predicting that the initial impact to TRIA’s expiration would be the migration of business currently offered by private carriers to public state funds, residual markets and guaranty funds for large segments of metropolitan areas.

“These public options…are not designed to handle a catastrophic terrorist event. Injured workers and their families would face potential disruption in benefits. If the workers compensation system fails, taxpayers could still be responsible for compensating victims—the very scenario that some policymakers want to avoid by letting TRIA expire,” NAMIC said in its testimony.

“For over a decade, the risk-sharing mechanism created by TRIA has ensured our national and economic security at virtually no cost to the taxpayers,” said Jimi Grande, NAMIC’s senior vice president of federal and political affairs, in a statement announcing the testimony, referring not just to workers comp.

“The program has created space for a robust private market for terrorism insurance to form where it might not have otherwise. Allowing this program to expire or materially altering the trigger or deductibles would lead to higher costs for the insured and less coverage in the market, which increases the ultimate burden on taxpayers,” he said.

Grande said that failing to reauthorize the program would have “far-reaching effects, including making the American economy more vulnerable to terrorists.”

Predicting “significant consequences across the economy,” Grande said: “We saw after 9/11 what kind of damage to the economy is possible. Many lenders require terrorism coverage, and without TRIA that financing would dry up, causing development projects to grind to a halt and costing thousands of jobs.

“This happened in the immediate aftermath of 9/11 and was one of the main reasons TRIA was created in the first place.”

Separately, in a statement from the American Insurance Association, Leigh Ann Pusey, president and CEO, said that “rather than ‘crowding out’ private market capacity, TRIA’s public-private partnership, which requires insurers to offer terrorism coverage, has actually enabled commercial insurers to become more comfortable with individually managing terrorism exposures without compromising financial solvency.”

She also noted that unlike the situation that exists for natural catastrophes, “where the industry can leverage scientific information dating back hundreds of years, only the government has access to the critical information insurers would need to underwrite this unique risk.”

“There is simply no way for insurers to gauge the frequency, location and means used to carry out terrorist attacks, which are intentional events largely controlled by the terrorists themselves.” She added that “because terrorism is a dynamic and interdependent risk, the benefits of individual mitigation efforts are diminished.”

Understanding the Risks

Eric Smith, president and CEO of Swiss Re Americas, drove home the point in his testimony on Capitol Hill, according to a written version of his prepared remarks available on the committee website. “Swiss Re is celebrating its 150th anniversary this year. Terrorism has been around since our company began operations, as have natural catastrophes. Yet re/insurance for natural catastrophes is much more available and much more affordable than coverage for terrorism.”

Explaining why, he said: “Even with all our years of underwriting experience, we do not believe that we understand terrorism risk in the same way that we understand natural catastrophe risk.

“For the private insurance marketplace to function with respect to a risk, it must be measurable, have loss occurrences that are largely independent, have manageable average and maximum losses, and be mutually acceptable to both the insured and the insurer. Terrorism risk fails each of these conditions.

“Despite the best efforts of modelers, terrorism risk remains unmeasurable today, largely because of the intentional nature of a terrorist attack,” he said, contrasting natural catastrophes, which are “random with uncorrelated outcomes [of] underlying physical processes or phenomena” for which a steadily growing body of data exists for model development.

“The terrorist actually tries to confound those who study them—effectively invalidating any sample used to estimate their behavior. As such, even the most skilled practitioners are far from an informed consensus regarding how to accurately model terrorism risk.

“The models that do exist have not been tested, so we don’t have the same level of confidence in terrorism models that we would have in models for other types of perils,” he said.

“There simply is no effective basis for assessing the likelihood, location or type of a terrorist attack,” he said.

Counterterrorism

Presenting a somewhat different view of the state of terror modeling, Dr. Gordon Woo of catastrophe modeler Risk Management Solutions said that “terrorism insurance risk modeling has attained a level of capability, validation and maturity to make a more notable contribution to the discussion over the future of TRIA.”

Woo also suggested that insurability is a ZIP code specific problem, with insurance capacity challenges around major cities, according to prepared remarks published on the committee website.

“What has become clearer since 2007 is that terrorism risk is as much about counterterrorism action as about terrorists themselves. U.S. terrorism insurance is essentially insurance against the failure of counterterrorism,” Woo said.

The vast majority of terror plots are foiled through the diligence of Western intelligence and law enforcement agencies, he asserted, adding that “mass surveillance of communication links, and the intrusion of intelligence moles, elevate the likelihood of plot interdiction with plot size.”

“The ambitious plots that might have the potential to cause massive insurance loss would tend to involve a significant number of operatives, and thus be very prone to interdiction,” he said, explaining that “too many terrorists spoil the plot.” He added that horrific lone-wolf acts of murder and destruction are unlikely to cause large catastrophe insurance payouts.

Accumulating evidence of counterterrorism control of loss volatility, combined with low terrorism insurance losses, “should encourage cautious expansion of the U.S. terrorism insurance market,” he said, noting, however, that terrorism risk is not geographically diversifiable.

“Terrorists predominantly choose iconic targets with name recognition in populous urban centers,” he said, contrasting hurricanes, which can land in suburban and rural areas as well as the crowded centers of large cities. “The lack of geographical diversification inherently limits the insurance market capacity for covering terrorism risk in the central business districts of Manhattan and other main metropolitan areas.

“A key ongoing challenge for future terrorism insurance market development is the lack of capacity in some prominent ZIP codes,” Woo said.

Counterargument

Also on Capitol Hill, Steve Ellis, vice president of Taxpayers for Common Sense, which describes itself as a national nonpartisan budget watchdog, offered opposing views and proposed changes more drastic than Assured Research envisioned if TRIA is extended.

He also noted that while terrorism models didn’t exist before 9/11, companies modeling terrorism have been refining and updating their models each year since 2002. “While this discipline isn’t as developed as natural catastrophe modeling, it has clearly grown significantly over the last decade,” he said.

Should Congress decide to continue TRIA in some form, Ellis said that only a short-term extension of two or three years should be considered and that insurers should have “skin in the game.”

“Any new extension should increase the trigger for federal involvement dramatically—gradually increasing to as much as $50 billion,” he said, also recommending deductible increases and premium payments to be made by insurers to the federal government for reinsurance coverage.

“Congress enacted TRIA to ‘establish a temporary federal program’ that would ‘allow for a transitional period for the private market to stabilize, resume pricing of such insurance and build capacity to absorb any future losses,'” he said.

“With the riot insurance program being the possible exception, President Reagan once observed that federal programs and agencies are ‘the nearest thing to eternal life we’ll ever see on this earth,'” Ellis continued.

TRIA has been extended twice since originally being enacted in November 2002 as a response to the attacks of Sept. 11, 2001—a fact that didn’t escape Ellis’ attention. He said that extending TRIA another five or 10 years—after the three-year program was initially extended for two years, and then extended again for another seven—”would result in a ‘temporary’ program that’s old enough to vote or get a drink.”

The Senate Banking Committee plans to hold a hearing on TRIA on Sept. 25.