Smaller insurers with less capital and more terrorism exposures could be subject to negative rating actions under a renewed but changed federal terrorism insurance program, rating agency Standard & Poor’s said in a report earlier this week.

Expressing cautious optimism that Congress will renew the Terrorism Risk Insurance Program Reauthorization Act of 2007 (TRIPRA) before it expires at year-end 2014, S&P analysts noted the likelihood of changes upon renewal, including:

• A higher industry event trigger (currently $100 million).
• Higher deductibles (now set at 20 percent of prior-year direct earned premiums).
• Greater coinsurance (now 15 percent for losses over the $27.5 billion aggregate industry retention).
• Lower total coverage limits (currently $100 billion).
• Greater recoupment. (As currently written, TRIPRA provides that if a terrorist event triggers government payout, then insurers must add a surcharge up to 3 percent of the previous year’s premium to all TRIPRA-related premiums going forward, until the government receives 133 percent of its payout.)
• More coverage exclusions.

Explaining that conventional terrorism might be one possible exclusion, leaving a backstop in place only for nuclear, biological, chemical and radiological risks, the S&P report notes that a renewed by changed version of TRIPRA could also mandate that insurers explicitly cover cyber terrorism.

“Taken together, potential changes would lead us to review several rating factors, including an

insurer’s capital and earnings, risk position, enterprise risk management (ERM), and insurance industry and country risk assessment (IICRA) score,” S&P said.

Expanding on the potential for TRIPRA changes to impact one of the factors, the “capital and earnings” factor, the report notes that S&P ‘s analysis of deterministic loss scenarios—a two-to-six-ton truck bomb with a 500 foot blast radius, for example—could prompt adjustments to prospective assessments of capital and earnings used for its ratings.

“Negative rating actions would be most likely where the [scenario] losses exceed a company’s net income for the year and erode a sizable portion of capital, sufficient to revise our forward-looking view of a company’s capital adequacy.”

“We could also make negative adjustments if it becomes evident that a particular insurer has outsized terrorism exposure relative to peers.”

Taking all the potential factor changes into consideration, the S&P report says, “we could take rating actions on commercial-lines insurers that we determine are less prepared and those with sizable concentrations in urban locations that we believe would be most vulnerable to potential terrorism events.”

“We also believe insurers with smaller capital bases could be hurt more than larger insurers if deductibles and the industry event trigger are raised,” the report adds.

Potential changes to TRIPRA “could wipe out the capital base[s] of smaller companies before terrorism relief from the federal program kicks in,” the S&P report says, noting, however, that the rating agency does not rate a significant proportion of smaller insurers in the U.S. P/C industry.

The S&P report includes a ranking of the top-10 direct writers with the highest terrorism exposure, listing AIG, Liberty and Travelers in the top-three spots. To compile the rankings, S&P considered insurers with heavy commercial property and workers compensation exposures in areas likely to be terror targets (New York, California and Washington, D.C.), using 2012 direct written premiums for the assessment.