FROM THE OFFICE OF PUBLIC AFFAIRS

March 20, 2002
po-2016

REMARKS BY THE HONORABLE SHEILA C. BAIR
ASSISTANT SECRETARY OF THE TREASURY FOR FINANCIAL INSTITUTIONS
BEFORE THE AMERICAN CONFERENCE INSTITUTE REINSURANCE: GLOBAL SOLUTIONS AND OPPORTUNITIES CONFERENCE
TERRORISM RISK INSURANCE

Good afternoon and thank you for inviting me to speak today on an economic issue of great importance to our country - the continued provision of insurance for terrorism risk.

As you know, the Administration has been a strong proponent of a Federal backstop for terrorism insurance. Secretary O'Neill provided an outline of the Administration's proposal in testimony before the House and the Senate last fall. The House passed legislation that would have provided a Federal backstop for terrorism insurance in late November. We worked closely with a number of Senators on terrorism insurance legislation, but unfortunately the Senate did not act before adjourning in December.

Part of the motivation for enacting terrorism insurance legislation last fall was that the majority of reinsurance contracts were coming up for renewal on January 1. Reinsurers had made clear that they were no longer going to cover terrorism risk or that the cost of limited terrorism coverage would be very expensive. Without access to reinsurance coverage, primary insurance companies would be subject to the full exposure of terrorism risk. In response, state insurance commissioners in 47 states (with the exception of New York, California, and Georgia) have permitted terrorism coverage exclusions in commercial lines. While the state-level terrorism coverage exclusion is fairly broad, most states do not allow an exclusion from fire damage following a terrorist attack and all states require terrorism coverage be included in workers' compensation insurance. Mandatory terrorism coverage requirements along with other factors have resulted in some insurers exiting the workers' compensation market.

As January 1 passed without any dramatic disruption in economic activity, it appears that some members of Congress have concluded that the lack of insurance coverage for terrorism is no longer a pressing issue. The Administration disagrees with this assessment and continues to support enactment of a Federal backstop for terrorism insurance.

Documenting the extent of the problem is difficult. Many businesses and property owners are hesitant about highlighting the fact that they have inadequate insurance coverage. But as Treasury Deputy Assistant Secretary Warshawsky and the GAO recently testified, problems in insurance markets are having a negative impact on economic activity. It is clear to us that many commercial property owners and business owners are unable to find coverage for terrorism risk or are paying very high rates for limited coverage. In some instances, the cost of a policy with limited terrorism coverage is reported to be roughly double the cost of a policy without terrorism coverage. We also have heard of cases where separate limited coverage for terrorism risk costs more than twice the premium for insurance coverage for all other risks.

Such widespread dislocations in insurance markets are starting to have an impact on businesses' ability to finance economic activity. Reports to us indicate that financing is limited for new construction and/or acquisition of high-profile properties that are inadequately insured and thought to be at higher risk of terrorist attack. Lenders are carefully screening the location and size of buildings. Some are simply refusing to lend on trophy properties that are not fully insured. Others will lend on underinsured properties, but only if the owner will provide recourse.

The impact on existing financial arrangements and structures for financing commercial mortgages is equally troubling. While, technically, properties without adequate insurance are in default of financing covenants, lenders may well not foreclose but, rather, raise their fees to cover their own risk. Rating agencies have indicated that they will substantially increase subordination levels on new issues of commercial mortgage backed securities that are collateralized by properties having inadequate insurance coverage. They are also in the process of establishing risk criteria that would lead to the downgrading of securities collateralized by properties that are inadequately insured and thought to be at an elevated risk of attack.

The combination of higher insurance costs and higher financing costs associated with inadequate insurance coverage has the real potential to reduce economic activity. These effects will not likely dissipate in near future. More reinsurance treaties will come up for renewal. More primary insurance contracts will come up for renewal. And investors will more seriously evaluate their risk exposure to terrorism if it becomes clear that Congress will not take action.

Lack of Federal action on terrorism insurance, in addition to placing a drag upon our economic recovery, paralyzes private sector initiatives to address terrorism risk. The lack of firm government action, one way or another, is itself costly as insurers, financiers, and businesses wait to see what if any new institutions the government might set up before going forward with new plans to address terrorism risk.

Finally, there is a real concern about the potential costs to the Federal government and the economy in the event of another attack if no backstop is place. Private insurance covered a significant percentage of losses arising from the September 11 attacks in an efficient and timely manner. Trying to devise such a scheme on short notice and in the aftermath of another terror attack would be considerably less effective and would slow the recovery.

We must continue to clearly make the case to Congress that Federal inaction on terrorism insurance is causing economic disruptions that need to be addressed now. Perhaps even more importantly, Congress needs to consider the adverse economic consequences that could ensue in the event of a future terrorist event, given the unavailability of terrorism coverage, particularly for properties viewed as potential targets. A federal terrorism insurance program is an essential part of our nation's defenses against this insidious new threat. We stand ready to engage in negotiations with the House and Senate to develop consensus legislation that can be signed into law.