Federal Role in Terrorism Insurance
Transitional Federal Assistance for Commercial Property and Casualty Coverage Needed to Promote Economic Growth 1
This report examines the circumstances contributing to the current crisis in commercial property and casualty insurance and the responses emerging at the state and federal levels. The report concludes that congressional action is needed for losses due to terrorism to restore stability to the commercial property and casualty marketplace and identifies the principles that should govern such a plan. Specifically, the report endorses a general transitional plan developed in the United States Senate as most closely adhering to the principles espoused herein.
Side-by-side comparisons are provided concerning the leading congressional proposals for a federal role in coverage from losses arising from terrorism (including the endorsed Senate plan) as well as more detailed analysis of the proposals’ strengths and weaknesses.
One of the more serious economic problems caused by the September 11 terrorist attacks against the United States is the sharply reduced availability of commercial property and casualty insurance for losses arising out of acts of terrorism. In addition to the unfathomable tragic loss of life and numbers of persons injured in these attacks, we also experienced unprecedented losses to property and business activities that were covered by insurance. Confronted with a perpetual threat of additional attacks and the potential for crippling financial hardship or insolvency resulting from further acts, insurers and reinsurers have been compelled to diminish their exposure to terrorist-related losses. As a result, insurers are forgoing coverage altogether, excluding coverage for acts of terrorism where permissible, or charging substantially more for coverage.
These exclusions and increased costs are felt throughout our entire economy, from a small businessman on a rural community street corner to a major urban real estate developer. For many, the non-availability of insurance will mean greater uncertainty in protecting business investments from external and often uncontrollable threats. Some businesses are simply forgoing such investments. For others, it may mean their banks are unwilling to lend to endeavors that lack insurance coverage to protect collateral. 2 For many, increased premium costs or security measures could be the difference between a business succeeding or closing its doors. For all of us, it means a national economy that is less vigorous and prosperous than it could be. This point was underscored in three recent reports issued in Congress. The first report was conducted by the General Accounting Office and presented as testimony before the House Financial Service Committee.3 The report noted the growing difficulties in the availability of terrorism coverage and stated that this could create an economic drag slowing economic recovery and growth. Two additional reports issued by the Joint Economic Committee echoed these concerns and stated that a temporary federal program to pay for insurance losses related to terrorism was appropriate.4
It is entirely feasible, perhaps likely, that over time, the commercial insurance marketplace will make the necessary adjustments to the new reality of terrorist threats within our borders and produce abundant product offerings at prices lower than today. Indeed, the “hardening” of the insurance marketplace has attracted billions in new capital. Nevertheless, this infusion of new capital is just a small percentage of potential exposures to losses arising from acts of terrorism and long-term adjustments remain several months if not years away
Consequently, government intervention at the national level appears to be the only short-term mechanism available that would have an effective impact in mitigating the extreme shocks experienced in insurance markets as a result of September 11th, and promoting a more stable economic environment that is favorable to investment and growth. The need for federal intervention is so compelling that Federal Reserve Chairman Alan Greenspan and the Wall Street Journal have endorsed the concept.
The Committee on Insurance Law of the Association of the Bar of the City of New York also endorses the need for federal intervention based on the following principles:
To date, the legislation coming closest to meeting those objectives was drafted in the U.S. Senate, but never introduced (see discussion on “Senate Compromise” below). Although this legislation contains many technical flaws and could be improved, it should serve as the cornerstone for any additional congressional action.
Prior to September 11th, despite experience with terrorist attacks overseas, the anti-government bombing of a federal office building in Oklahoma City, and an earlier attack on the World Trade Center, the threat of terrorism in the United States continued to be perceived as a remote threat. There was little urgency concerning such risks. From a macroeconomic perspective, there was reasonable justification for this position since the resulting costs to the insurance industry from these previous events were relatively small. As a result, acts of terrorism were largely ignored in domestic commercial property and casualty insurance policies. Losses from terrorist acts were treated no differently from losses from fire or a truck going through a storefront window. Similarly, reinsurance for most domestic property and casualty policies did not account for potential losses arising from acts of terrorism.
With hindsight, it’s easy to argue that this was a mistake. Perhaps acts of terrorism should have been treated just like acts of war and excluded from coverage. Perhaps a separate premium should have been charged for terrorism coverage. Some insurers believed that an act of terrorism was an act of war, and fell outside coverage under war exclusions.
While economists, historians, regulators, and other public officials can debate in perpetuity the wisdom of the approach taken through September 10th, no one can argue that our understanding of the world changed on September 11th. Not only did the attacks vividly demonstrate the vulnerability of domestic targets to terrorism, they also illustrated the tremendous extent of damage that could be caused through terrorist aggression. Thousands of workers were killed or injured. Others may have been exposed to harmful substances. Numerous properties and businesses were destroyed or impaired. Downtown Manhattan was immobilized for an extended period of time. Insurance claims resulting from these losses are now estimated to range from $30 billion to $50 billion-by far, the largest insurance loss in history! 5 These striking facts could no longer be ignored-and they were not.
Almost immediately following September 11th, major reinsurers announced their intention to discontinue coverage for terrorist-related losses upon their next treaty-renewal dates (January 1, 2002 in many cases). Reinsurers simply did not have the capacity to pay for another terrorist attack. In turn, without a mechanism to spread the costs of insuring the risks of terrorism, direct insurers announced their intention to similarly exclude coverage for losses resulting from acts of terrorism. Moreover, where terrorism coverage continued to be available, the new realities of the insurance marketplace dictated higher premiums for insurance consumers.
Many direct insurers, however, faced a problem not experienced by their reinsurers: state regulation of rate and forms. Reinsurance is a mechanism utilized by direct insurers to spread their own risk, and as a general matter, the States do not regulate reinsurance itself. Thus, while reinsurers were free to exclude coverage from terrorism at the earliest dates permitted under their treaties with direct insurers, direct insurers faced the requirement of obtaining state-by-state approval of exclusions and rate increases.
State insurance regulators, acting primarily through the National Association of Insurance Commissioners (NAIC), immediately recognized these emerging problems. While concerned about limiting the availability of insurance coverage for acts of terrorism, regulators also clearly understood that additional terrorist attacks would threaten the solvency of numerous insurance companies.
While remaining hopeful that a federal response could be developed, the NAIC approved an interim solution, comprising a limited exclusion for terrorism related losses under commercial policies. In general, the NAIC recommended that terrorism exclusions should apply if aggregate losses resulting from an act of terrorism exceeded $25 million for interrelated events in a 72-hour period. In the event the federal government did enact an adequate solution, the exclusions would expire within 15 days of enactment.
Language developed by Insurance Services Office, Inc. (ISO), which provides statistical, actuarial, and underwriting information to the property and casualty industry, served as the foundation for this NAIC decision. As of May 10, 2002, final ISO language was approved in 45 states for general liability, commercial property, business owners, farm, crime, commercial inland marine, boiler and machinery, and commercial umbrella policies. This language defines term “terrorism” with sufficient scope to cover most terrorist acts irrespective of source. In addition, it allows more permissive exclusions for certain types of terrorist acts and consequences. Other states have approved additional ISO language covering commercial auto policies and some states have even addressed personal lines, although the NAIC saw no need to adopt exclusions for personal insurance products.6 However, states encompassing a large portion of the national insurance market have not acted. 7
New York State:
The New York State Insurance Department and its Superintendent, Gregory V. Serio, have done a remarkable job in dealing with the numerous matters arising just blocks away from their main office. Nowhere was the impact of September 11th felt more directly than in New York City and the Department has managed the aftermath, including assisting victims and their families with utmost diligence and professionalism.
Going forward, a blue ribbon commission is planned to analyze and assess the impact of September 11th on the New York insurance market and determine the legislative/regulatory needs of the state to address their findings. Unlike the majority of other states, New York has not approved the ISO terrorism exclusion language, which it views as overly broad, and will examine and approve such exclusions on a case-by-case basis. While the Department is working on a Circular Letter to provide insurers with better guidance as to how this case-by-case analysis will be applied, it remains unclear how this will work in practice. At this time, no exclusions have been approved. Moreover, New York State statutes further restrict an insurer’s ability to place terrorism exclusions on certain types of policies. 8
Reacting to an impending insurance crisis, numerous proposals focussing on property and casualty insurance were put forth in Washington to address the problem. Not surprisingly, these proposals were as different as the varied members comprising the White House, Congress, and the many interest groups affected by the federal government’s handiwork. Consequently, although sharp disagreement over liability issues is widely viewed as the primary obstacle to developing a legislative response, it is important to recognize that divergent opinions on several other important issues will render it difficult to reach an effective resolution.
Currently, two proposals have drawn the most serious consideration in Congress. The first is H.R. 3210, which was approved by the House on November 29, 2001 by a vote of 227-193. The other is known as the “Senate Compromise,” which is reported to have the backing of Senate Banking Committee Chairman Paul Sarbanes (D-MD), the Committee’s Ranking Member, Phil Gramm (R-TX), the U.S. Treasury, and a sizable portion of the insurance industry.
For analytical purposes, however, it is useful to keep other proposals in mind. As with most legislation, the two leading bills reflect an evolutionary process that incorporates certain features of other plans and is likely to include a few more if the legislative process moves this year. Moreover, insurance markets and state regulatory responses to terrorism have evolved since these proposals were first presented. Therefore, while general agreement may persist on the need for federal assistance, buyers, sellers, and regulators of insurance products may bring new perspectives and concerns to the debate. 9
Following are general descriptions of the major terrorism insurance proposals, including the two leading plans. A more in-depth critique of H.R. 3210 and the Senate Compromise also is provided, as well as a side-by-comparison of these two leading bills.
Following is a general description and background on the five major proposals before Congress.
1) Pool Re (Insurance Industry Proposal):
This was the first terrorism insurance proposal put on the table. It was a straight admission by the industry that it did not have the resources to pay for or commit to covering future catastrophic terrorist events without government help.
Modeled after a British government-backed facility, under this plan the U.S. Government would authorize creating a nationally chartered mutual insurance company that would offer reinsurance to members of the company. Member companies would pay into the mutual “pool” and the pool, in turn, would purchase reinsurance from the federal government to cover losses in excess of a designated aggregate amount. The proposal contemplated commercial property and casualty covers, but could have been modified to include personal property and casualty lines as well.
The Pool Re concept entailed numerous operational and regulatory questions, which could have taken months to resolve. This included how to define the term “terrorism,” whether participation in the pool should be mandatory or voluntary, and who should serve as the principal regulator of the nationally chartered mutual company.10 When the White House put forth its own streamlined proposal, the Pool Re concept was put aside.
2) White House Plan
In general, the White House proposed a three-year plan, covering personal and commercial property and casualty lines. The plan entailed an 80 to 90 percent federal share of payment for all terrorism related claims, starting with the first dollar in Year One, and up to $100 billion in claims in each year of the program. The Treasury Department endeavored to make its responsibilities primarily ministerial; its job was to pay the federal government’s share of claims as insurers submitted them.
However, to the extent the White House was willing to commit tax dollars to paying a share of claims, it was not willing to make those payments in today’s civil litigation liability regime. Consequently, numerous limits were proposed on claims eligible for federal compensation, such as prohibiting claims for punitive damages. Terrorism was not defined.
The White House was motivated primarily by concerns of significant adverse economic consequences resulting from decreased business activity and investment due to a lack of insurance availability. Rather than rush into an uncertain legislative scheme or take on a significant federal regulatory role, the Treasury Department viewed its goal as reassuring the marketplace that terrorism coverage would be available in the short-term while the markets and/or government worked on a more rational long-term solution.
3) Sarbanes-Gramm-Dodd: (the “Senate Compromise”) 11
These three Senators reached a tentative bipartisan agreement on a modified version of the White House proposal, although Senators Sarbanes and Dodd may have sought modifications to the more restrictive liability limits contained in their draft proposal circulated to outside parties.
The principal difference with the White House proposal was Senator Gramm’s insistence that the industry assume a substantial deductible before any federal monies were provided. Later versions of the bill established a one-year program (with an option for an additional year) covering personal and commercial property and casualty policies with an industry deductible of $10 billion ($15 billion in Year Two) apportioned among insurers on the basis of market share of gross premium written. While federal aid was capped at its share of $100 billion in losses during each year of the program, insurers were freed from liability for losses exceeding that amount. Personal property and casualty lines were covered only to the extent an insurer opted into the program within 21 days of enactment. State law was preempted concerning the definition of terrorism and on prior approval of rates and forms.
Covered terrorism was limited to terrorist acts committed by foreign entities.
4) H.R. 3210 (Oxley Bill; Passed by House):
After several iterations, this bill passed the House on November 29 along primarily party lines, 227-193.12 Considered a “backstop” rather than a taxpayer “bailout” of the insurance industry, this bill enjoyed unusual support from both taxpayer and consumer rights groups. The “bailout” was avoided by characterizing federal assistance as a “loan” rather than direct aid. Although some Members of Congress expressed reservations over whether this type of program would work and voiced support for a Senate-like approach, the House felt it was necessary to “move the ball forward” and that it had the opportunity to revisit the issue in 2002.
In general, the bill provided what was characterized as a federal loan facility to pay 90 percent of aggregate terrorism related losses exceeding a certain amount. These “loans” are in the nature of a capital injection, which is to be paid back by assessments on the industry as a whole. That is, an individual insurance borrower does not repay the full “loan” amount. Rather, the federal “loans” would be repaid through assessments against all participating insurers on the basis of market share. If losses exceeded $20 billion, surcharges could be imposed on policies in order to repay any federal assistance. Total “loans” over the life of the program could not exceed $100 billion. The program would run for two years with an option to extend up to two more years.
Somewhat similar to the Sarbanes-Gramm-Dodd proposal, covered terrorism also was limited to terrorist acts initiated by an “international terrorist group” as opposed to foreign entities. The House also had strict limits on damages, limited jurisdiction to federal courts, and had a partial preemption of state laws.
The House bill appears to make it mandatory for commercial property and casualty insurers to participate in the reimbursement program.
This was the most pro-consumer bill proposed. Although it received little attention, Senator Hollings crafted a plan that fell within his jurisdiction as Chairman of the Senate Commerce Committee by creating a leading role for the Commerce Department and the Federal Trade Commission (FTC).
S. 1753 established a three-year program that would be funded prospectively up to $50 billion by a three-percent tax on gross written premium of covered lines (these costs could be passed on to policyholders). An additional premium could apply to insurers with a lower credit standing. If losses exceeded $50 billion, the program would be funded through direct federal aid up to $100 billion. For the first $50 billion in losses covered by the premium tax, insurer retention would be equal to its “average gross direct written premiums and policyholders’ surplus for covered lines” for the most recent calendar year. Up to 90 percent of losses beyond this retention amount would be eligible for federal reimbursement. If losses exceeded $50 billion, the federal government would pay 90% of losses in Year One and 80% in Years Two and Three above the retention amount.
Other provisions included the establishment of a Commerce Department led commission on rates. In addition, the FTC was authorized to review mandated reports from insurers on rate setting for covered lines for purposes of uncovering unfair methods of competition or unfair or deceptive act affecting commerce under the Federal Trade Commission Act.
The bill required mandatory offers of coverage for commercial property and casualty lines and voluntary participation for most personal property and casualty coverage.
The insurance industry may lack sufficient capital to cover losses arising from another catastrophic terrorist attack. Furthermore, the serious threat of additional attacks has made insurance coverage for terrorism, particularly commercial property and casualty risks, less readily available and significantly more expensive. This disruption to insurance markets negatively impacts business investment and harms our nation’s economic performance. Temporary federal assistance is needed to restore stability to insurance markets and promote economic growth; Congress should pass legislation to achieve this goal. While additional changes are warranted to improve the bill, the Senate Compromise most closely reflects the principles sought by the Committee on Insurance Law of the Association of the Bar of the City of New York and should serve as the foundation for any action Congress takes on this urgent matter.
H.R. 3210–House Passed Bill
On November 29, 2001, the full House approved H.R. 3210 by a vote of 227-193.
The House bill, which applies to most commercial property and casualty lines, contains a number of favorable provisions. However, on balance, the measure’s weaknesses overwhelm its benefits. The bill is fundamentally flawed in several respects. In addition to establishing a highly complex, uncertain, and arguably unworkable administrative structure, its fundamental tenets constitute bad public policy for promoting efficient insurance markets.
Specifically, the bill provides federal assistance to a harmed insurer in the form of “loans” that are to be repaid through assessments on all insurers and surcharges on policyholders. Essentially, it federalizes the worst features of the state guaranty on a massive scale. The Secretary of Treasury (the “Secretary”) has broad discretion in how assessments or surcharges are applied and can potentially shift millions of dollars of liability from one company to another without any clear standards. Moreover, the program is mandatory, meaning that insurers have no choice to opt-out of the program even if it offers little or no benefit to the insurer.
C. Policy Concerns
Following is a summary of major underlying policy concerns.
D. Operational Concerns
These items pertain to problems in administering the program.
E. Positive Components
Following are some positive aspects of the bill.
The “Senate Compromise” refers to a draft bill dated December 14, 2001. This bill was almost brought to the Senate floor at the conclusion of the 1st Session of the 107th Congress.
The Senate bill is far superior to the House bill in providing a clear federal backstop for catastrophic terrorism losses and limiting insurer liability for losses above $100 billion. Nonetheless, the bill contains a number of technical/policy problems, including a failure to cover domestic acts of terrorism and inadequate preemption of state law.
C. Policy Concerns
Following is a summary of major concerns relating to underlying policy concerns.
D. Operational Concerns
These items pertain to problems in administering the program.
E. Positive Components
Following are some positive aspects of the bill.
Maura M. Caliendo, Esq. (Chair)