Terrorism can be a difficult concept to define, but irregular warfare and covert attacks against civilians targets are not new hazards. There were thousands of significant terrorist attacks worldwide in the 1970’s, 1980’s and 1990’s. The U.S. had suffered attacks from both foreign and domestic terrorists, including separatists, anarchists, environmentalists and many others before September 11, 2001. While insurance and reinsurance contracts in the U.S. already defined and excluded war, they were silent about terrorism. The market adjusted quickly and by January 1, 2002 most reinsurance contracts explicitly handled terrorism risk with an exclusion, sublimit or separate coverage, and many insurance policies did as well.

Today, terrorism exposure from personal lines policies is generally covered by reinsurance contracts except for nuclear and similar attacks, while coverage for commercial lines policies is either limited or excluded. There are a variety of approaches and contract clauses used in the market today. Different insurers’ treaty coverages have individually negotiated terms, conditions and costs.

Late in 2002, the Federal Government enacted the Terrorism Risk Insurance Act, or TRIA, which requires insurers to offer coverage for foreign-led attacks and provides a financial backstop for the insurance industry, with government funding. TRIA’s current term expires at this year end. The form of the next extension, if any, is not yet clear, with sharp differences between the White House and Congress. On September 19, the House of Representatives passed an extension bill. This week, the Senate Financial Services Committee passed a bill with terms closer to the President’s position than the House bill. This makes an extension this year more likely.

Holborn estimates that another terror attack in a concentrated city could cost the U.S. property and casualty insurance industry tens of billions of dollars. An attack that used nuclear or biological weapons could cause hundreds of billions in damage and injuries.

This edition of Holborn Perspectives reviews the exposures, coverage issues and market options for reinsuring U.S. insurers’ terrorism exposures in 2008.

B. TRIA Coverage in 2007

TRIA was enacted on November 26, 2002 as a limited, temporary backstop for the U.S. commercial lines insurance industry’s exposure to loss from foreign terrorism. It established a definition of Certified Events for significant (over $100Mn in P&C industry loss), foreign-led attacks. Insurers must offer coverage for certified terrorism losses on the same basis as they cover other losses. While TRIA is in effect, certified losses are shared between individual insurers, the industry, the government, and businesses in four layers:

1. Each insurer retains an aggregate amount of loss per year, based on a percentage (currently 20%) of direct written premiums for covered lines in the previous calendar year. (Retentions are calculated on a group basis.)



2. Losses in excess of each individual insurer’s retention, up to an aggregate limit for the industry, are “shared” among all insurers, including those who had no loss. Under current Treasury regulations, this loss sharing is recouped from policyholders in the future.



3. Losses in excess of the industry aggregate retention (currently $27.5Bn) are ceded to the Treasury, up to a cap of $100Bn in aggregate losses (from the ground, including insurer participations).



4. Any losses in excess of $100Bn per year are retained by the original policyholders. If that cap is exceeded, TRIA is unclear about which policyholders will be asked to retain how much loss. Will the difference be allocated pro rata by amount? Last to pay, etc.? A review of congressional committee reports suggests that Congress would revisit this issue after a loss, and might expand the government relief to broaden recovery by policyholders, and to minimize disputes.

2007 TRIA Protection

Insurers’ recoveries under the second and third layers are subject to a 15% co-participation. TRIA currently covers commercial property and casualty lines except: auto, farmowners, surety, medical malpractice and D&O. A&H is excluded for both property and casualty and life companies. Loss adjustment expenses are not covered.

Terrorism insurance coverage has a separate premium, and insureds are free to accept or decline coverage. Many insureds do decline property coverage, especially in concentrated and other high hazard territories, where the price for coverage can be relatively high. Coverage for the largest or most exposed risks are often agreed on a surplus lines (non-admitted) basis with customized exclusions. In lower hazard territories, take-up rates can be well over 90% and coverage is usually sold on an admitted basis. All workers compensation policies are admitted and provide full terrorism coverage.

Prior to the adoption of TRIA, and again if it should expire, insurers were free under Federal law to exclude terrorism coverage. In late 2001, ISO filed terrorism exclusions and received approvals in most, states. Notably, both New York and California rejected the exclusions. Also, standard fire policies in many states may not have any exclusions endorsed.

TRIA was first enacted for a term that expired on December 31, 2005. It was extended, with adjustments, for a new term that expires this year end. Since most policies bound in 2007 will remain in force after the current expiration of TRIA, insurers often use a contingent exclusion that will apply if TRIA expires. This contingent exclusion is only used in states where the ISO exclusions were approved.

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