Backstopping Terrorism Coverage

For property/casualty insurers and reinsurers, the terrorist attacks of September 11, 2001, remain one of the largest losses in global insurance history—producing insured payouts of about $32.5 billion, or $40 billion in 2010 dollars. Losses were paid out across many different lines of insurance, including property, business interruption, aviation, workers' compensation, life and liability.

Before 9/11, terrorism exclusions were virtually nonexistent in commercial insurance contracts sold in the United States. Soon after 9/11, however, insurers moved to exclude terrorism coverage from their commercial U.S. policies. Only when Congress enacted the Terrorism Risk Insurance Act (TRIA) in November 2002 did coverage resume on a consistent basis for terrorist attacks against commercial properties, utilities, and transportation networks.

TRIA established a public/private risk-sharing partnership that allows the federal government and the insurance industry to share losses in the event of a major terrorist attack. TRIA was modified and extended in recent years, with the current law, known as the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), due to expire on Dec. 31, 2014. However, the portion of the loss insurers would pay in the event of a terrorist attack has increased significantly over the years.

Insurers are solely responsible for terrorism losses that impact non-TRIA lines, such as private passenger auto and homeowners insurance and group life. Less than half of property/casualty insurance premiums are written in lines of insurance backstopped by TRIPRA, and the program provides no coverage for personal lines insurers, reinsurers or group life insurance losses.

Only commercial insurers and causes of loss specified in the underlying policies are covered under the program, and they are required to make coverage available to clients. Residual market insurers—such as workers' compensation pools, captive insurers and risk retention groups—are also covered. Some specialty coverages, such as medical malpractice and crop insurance, were excluded from the backstop under the original legislation. Under the 2005 extension, certain additional lines are now excluded: commercial auto; burglary and theft; surety; professional liability, except for D&O; and farm owner multi-peril insurance.

The standard fire policy (SFP) does not exclude fire following terrorism, and prior to 2003, the SFP did not permit this exclusion; therefore, a policyholder who had rejected terrorism coverage under TRIA would still have coverage for a blaze resulting from an act of terrorism. However, since 2003, some states have revised their SFP statutes to permit exclusions of the coverage under certain circumstances. Insurers have sought to limit fire coverage resulting from a terrorist attack because commercial policyholders that choose to reject TRIPRA or other terrorism coverage are effectively paying no premium for the protection offered by fire-following coverage. Thus, for a policyholder who has rejected terrorism coverage, in those states that allow exclusions there might be no coverage (or only limited coverage) for fire resulting from an act of terrorism. Many states do not have a standard fire policy statute, or they have SFPs that unconditionally exclude fire following terrorism. In these states, there is no stipulated coverage for fire following terrorism.

The threshold to trigger federal backstop coverage rose from $5 million under the original act to $50 million after March 2006. In 2007, the triggering event threshold rose to $100 million and remained there under TRIPRA. Federal funds will be paid out only in the event of a terrorist act that produces total insurance industry losses above this threshold.

The program is capped at $100 billion per year for insured losses (federal and insurer combined). A provision in the law requires the U.S. Department of the Treasury to establish a process for the allocation of pro-rata payments in the event that terrorism-related insured losses exceed the federal government's annual $100 billion cap.

The amount of terrorism losses that an individual insurer must pay before federal assistance becomes available rose to 20% of an insurer's direct earned premiums for commercial property/casualty insurance in 2007, and that is where it currently stands (up from 17.5% in 2006 and 15% in 2005). The share of losses that insurers pay above their individual retentions rose to 15% in 2007, where it remains today, up from 10% in 2006.

TRIA and its extension legislation contain no provision for handling liability claims in the future. As a result, the impact of tort claims following another major terrorist attack on U.S. soil has the potential to be enormous.

Budget pressures will probably make reauthorization contentious. Even before the debt brouhaha, the Obama administration's 2011 budget plan included a proposal to scale back federal support for the program. A 2009 report by insurance broker Aon estimated that some 70% to 80% of the commercial property insurance market would revert to absolute exclusions for terrorism if TRIA were changed.

Some up-and-coming risks are not covered by the federal backstop. A major terrorism attack is increasingly possible, but losses from such an event are largely uninsured under many scenarios and, therefore, would not be included in federal reinsurance. Secretary of Defense Leon Panetta describes the threat of cyber terrorism as "the battleground for the future." At a congressional hearing before the House Permanent Select Committee on Intelligence on February 10, 2011, then-CIA Director Panetta said, "When it comes to national security, I think this represents the battleground for the future. I think the potential for the next Pearl Harbor could very well be a cyber attack." Moreover, not every cyber attack is terrorism, but how will they be defined and by whom?

Nuclear, biological, chemical and radiological (NBCR) acts are not covered under a standard policy, nor are they backstopped by the federal government's program. The American Academy of Actuaries explored the insured losses that NBCR incidents might cause in four U.S. cities. It estimated that in New York a large NBCR event could cost as much as $778.1 billion, with insured losses for commercial property at $158.3 billion and for workers' compensation at $483.7 billion. A loss of this magnitude is more than three times the size of the commercial property/casualty insurance industry's claims-paying capacity.

However, a June 2010 report by Guy Carpenter noted that some two thirds of reinsurers surveyed are now offering coverage for NBCR events, reflecting a true evolution in underwriting appetite since 9/11. An increasing number of reinsurers have entered the market over the last few years and are offering new solutions for various large-scale risks such as airports, industrial plants, sports stadiums and shopping centers, Guy Carpenter said. It noted that costs of coverage vary depending on a number of factors, including geographical spread of risk, the location and type of exposure, proximity to other risks and the program's structure (e.g., limits and deductibles).

Standard homeowners insurance policies include coverage for damage to property and personal possessions resulting from acts of terrorism. Terrorism is not specifically referenced in homeowners policies. However, the policy does cover the homeowner for damage due to explosion, fire and smoke—the likely causes of damage in a terrorist attack.

Condominium or co-op owner policies also provide coverage for damage to personal possessions resulting from acts of terrorism. Damage to the common areas of a building like the roof, basement, elevator, boiler and walkways would be covered only if the condo/co-op board has purchased terrorism coverage. Standard renters policies include coverage for damage to personal possessions due to a terrorist attack. Coverage for the apartment complex itself must be purchased by the property owner or landlord.

Auto insurance policies will cover a vehicle that is damaged or destroyed in a terrorist attack only if the policyholder has purchased comprehensive coverage. Most people who lease or have loans on their vehicles are required by leasing companies and lenders to carry this optional form of coverage. People who buy only liability coverage are not covered in the event their vehicle is damaged or destroyed as the result of a terrorist attack.

Property damage to commercial buildings from a terrorist attack also could include claims for business interruption. Business interruption losses associated with acts of civil authority (e.g., closure of certain areas around the disaster) can be triggered only when there is physical loss or damage arising from a covered peril (e.g., explosion, fire, smoke, etc.) within the area affected by the declaration. The loss or damage need not occur to the insured premises specifically. Reductions in business income associated with fear of traveling to a location would not be covered by business interruption policies.

Workers' compensation—a compulsory line of insurance for all businesses—covers employees injured or killed on the job and, therefore, automatically includes coverage for acts of terrorism. Workers' compensation is also the only line of insurance that does not exclude coverage for acts of war. Coverage for terrorist acts cannot be excluded from workers' compensation policies in any state.

Given the federal government's essential role in providing a financial backstop for private-sector insurers that offer terrorism risk insurance, the U.S. Treasury Department has a lot to say about what constitutes a terrorist attack. State regulators may weigh in on disputes governing whether or not a specific policy covers a certain type of event; nonetheless, the federal government will have a major impact on the outcome of the claims process.

For terrorism coverage to be triggered under TRIPRA for commercial policies, the U.S. Treasury Secretary has to declare the attack a "certified act." No such declaration is needed to trigger coverage under home and auto policies because there are no exclusions for terrorism.

War-risk exclusions reflect the realization that damage from acts of war is fundamentally uninsurable. No formal declaration of war by Congress is required for the war risk exclusion to apply. Nuclear, biological, chemical and radiological attacks are a prime example of catastrophic events that are fundamentally uninsurable due to the nature of the risk. Under the terrorism risk insurance program, if some NBCR exclusions are permitted by a state, an insurer does not have to make available the excluded coverage.

Stay tuned for battles on funding. The argument that deficit reduction compels cuts in federal terrorism reinsurance is contested by proponents of the program who argue that expenditures occur only if an attack triggers the backstop and that cuts are not really savings unless such an attack happens.

Dr. Robert Hartwig is president of the Insurance Information Institute. For her contribution, the author would like to thank Claire Wilkinson, co-author of Terrorism Risk: A Reemergent Threat: Impacts for Property/Casualty Insurers.