CRITICAL ISSUE REPORT

THE TIP OF THE ICEBERG

Insurance industry continues to wrestle with terrorism concerns

By Phil Zinkewicz

"...The effects on the insurance market are ... slowly rising to the surface. We need to be prepared to respond to these challenges or they could swamp economic growth just when it is needed most."

--John J. Kollar, Chairperson, Extreme Events Committee of the American Academy of Actuaries

American businesses now fear that their staff and premises in the United States are at a greater risk of terrorist attack than those in regions like South America and the Middle East. A new survey conducted by none other than Lloyd's of London reveals that two out of three U.S. chief financial officers (CFOs) believe their company's domestic assets are more of a target than their assets overseas. Moreover, the survey found that the majority of CFOs have little or no confidence in the insurance industry's ability to provide a comprehensive package to protect against future terrorist attacks.

Underwriters at Lloyd's believe that the results of this survey highlight a fundamental shift in CFOs' perceptions of terrorist exposure with regard to U.S.-based staff, property and assets. Commenting on the survey, David James, terrorism underwriter for Ascot Underwriting at Lloyd's, said: "September 11 has led to a sea of change in attitudes towards the need for terrorism cover in the U.S. The attacks showed with chilling efficiency how terrorists can strike at the heart of U.S. business interests. As a result, insurance buyers have become more focused on the risks, not only in terms of protecting property, but in having access to funds to offset the business interruption concerns. Similarly, insurers and reinsurers have realized this is a separate risk that needs to be studied, rated and priced separately."

James said that, historically, terrorism coverage has been associated with countries characterized by political and civil instability, like South America and the Middle East. Prior to September 11, he said, the United States accounted for as little as 1% of the typical terrorism underwriter's book of business. But after September 11, the figure derived from North America for Ascot's terrorism business has grown to over 80%.

Business interruption also has moved up on the London underwriter's agenda, with the majority of respondents now more concerned about the cost of being temporarily out of business than about the physical damage to property, he said. Lloyd's has estimated that $10 billion--or roughly 25% of the overall World Trade Center loss--can be attributed to business interruption coverage.

Commenting on this, Lloyd's Director of Worldwide Markets, Julian James, said: "Once upon a time, when people thought of insuring against terrorism, they thought about property insurance. Now it's clear that business interruption has become just as important."

Regarding the results of the survey and CFOs' lack of confidence in the insurance industry, Lloyd's America President Wendy Blair, said: "In this new environment, the insurance industry is providing more tailored coverage that responds to specific exposures rather than global policies in which specific exposures are not appropriately recognized and priced. All of these policies such as terrorism, business interruption, and commercial property are still available, but they are not necessarily grouped together as part of a comprehensive policy."

The Lloyd's survey is clear regarding larger corporations that were queried. But what about Main Street operations, mom and pop stores? How are they affected economically by the threat of terrorism? After all, when the Twin Towers fell, small shops and restaurants in the surrounding areas were closed down for months. Some of them never re-opened. If the large corporations included in the Lloyd's survey fear for their financial stability because of insurers' loss of appetite in providing terrorism coverage, what about the little guys?

Another survey, conducted by the Extreme Events Committee of the American Academy of Actuaries, talks about terrorism's threat to the economy overall. The committee said there is mounting evidence of the effects of the September 11 terrorist attacks on the cost and availability of property and casualty insurance--not just terrorism insurance, but property and casualty insurance overall.

"The evidence is growing that insurance companies are significantly raising premiums, and eliminating or limiting terrorism coverage, because of the tremendous financial risks posed by the threat of terrorism," said John J. Kollar, the committee's chairperson. His report notes that a "tangible negative effect on the economy is emerging, particularly in the real estate and construction sectors. As insurers and reinsurers try to find ways to protect themselves from potential losses due to catastrophic terrorist events, the burden of risk will be shifted to the business community as an out-of-pocket expense. This will likely imperil new investment and place a greater drag on the economy," said Kollar.

The committee's report, "Terrorism Insurance Coverage in the Aftermath of September 11," is an analysis of the impact of the terrorist attacks on the property and casualty insurance industry's current surplus; and it discusses the legal, regulatory, financial and actuarial barriers to a non-governmental solution. While the report does not address specific bills under consideration in Congress, it cautions, "the stability of the market, at least in the short term, lies in the hands of the U.S. Congress."

Kollar said: "The committee agrees that the challenges faced by the U.S. private insurance industry are daunting, and we have only seen the tip of the iceberg of the impact of September 11. Many indications of the effects on the insurance market are submerged, but they are slowly rising to the surface. We need to be prepared to respond to these challenges or they could swamp economic growth just when it is needed most."

At press time, the U.S. Congress was considering federal legislation to provide a backup reinsurance mechanism for insurers in the event of a terrorist attack. The feeling is running strong among insurance industry interests, regulators and legislators that a backup mechanism is desperately needed. In April, Sen. Chris Dodd (D-Conn.), speaking before the Independent Insurance Agents and Brokers of America (IIABA) Annual National Legislative Conference in Washington, D.C., called upon Congress to pass a terrorism bill "immediately." Alluding to some consumer activists who oppose such a backup facility on the grounds that it would benefit the insurance industry and not the consumer, Dodd said: "This isn't about bailing anybody out. It's about doing what's smart and wise in the interest of our nation. This is about insurance consumers. The industry is not going to die. But it's the consumer who can end up really paying the price."

Also, in April, state governors from South Carolina, Nebraska, Kentucky, Montana, Alabama, Missouri, Virginia, Connecticut, Maine, Arkansas, Wyoming, Illinois, Colorado, Wisconsin, Florida and Indiana signed a letter addressed to Senate leaders urging them to pass a federal reinsurance backup program for terrorism "in order to restore stability to U.S. insurance markets."

President George W. Bush has come out in favor of such a program. Late last year the House of Representatives passed H.R. 3210, the Terrorism Risk Protection Act, but the Senate adjourned without taking action. Various insurance industry associations, including the IIABA, PIA National and the Council of Insurance Agents and Brokers have echoed the sentiments of President Bush, state governors and legislative leaders, saying that the need for a federal backup terrorism program is essential for the insurance industry in particular and for the economy overall.

At press time, the measure was stalled in the Senate because of a provision calling for tort reform, a provision that the plaintiff's bar would like to see removed. If the House and Senate do not come to an agreement, it will almost certainly cause insurance markets to dry up, not just for terrorist coverage but for other lines of insurance coverages as well.

However, even if the terrorism bill is passed, the problems in today's insurance markets will not end. First, it should be remembered that the federal measure calls for reinsurance backup, but only after insurers have sustained certain levels of losses from a terrorist attack. Coming in at the top levels in the event of another terrorist attack of the magnitude of September 11, the federal government might be able to keep some insurers from going under, but it would not diminish the large losses they might face at the lower levels. That would still mean higher premiums and restricted coverage for other lines of business as insurers seek to recoup some of their losses.

Second, it should also be remembered that the property/
casualty insurance marketplace began hardening before September 11, as the result of a prolonged soft market, which insurers could no longer tolerate. The terrorism situation only exacerbated that market hardening.

So, even with the possible passage of a federal reinsurance backup facility, insurance buyers--especially those in the commercial lines arena, from the smallest mom and pop store to the largest corporation--are very likely to see insurance rates soar and some coverages severely restricted.

A recent RIMS panel at that association's annual conference agreed that there is a 100% probability of another devastating terrorist attack in the near future. Even with federal backup, most of the costs of another possible attack will be paid for by the insurance industry and, ultimately, the business community. *