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[109 Senate Hearings]
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S. Hrg. 109-566
THE TERRORISM RISK INSURANCE PROGRAM
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
ON
THE IMPLEMENTATION OF THE TERRORISM RISK INSURANCE PROGRAM, FOCUSING ON
THE ROLE OF THE FEDERAL GOVERNMENT IN ENSURING THAT INSURANCE TO
PROTECT AGAINST LOSSES FROM ACTS OF TERRORISM REMAINS AVAILABLE TO
AMERICANS
__________
APRIL 14, 2005
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate/
senate05sh.html
_____
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Mark F. Oesterle, Counsel
Alexander M. Sternhell, Democratic Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
----------
THURSDAY, APRIL 14, 2005
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Reed................................................. 2
Senator Hagel................................................ 3
Senator Dodd................................................. 3
Senator Martinez............................................. 6
Senator Schumer.............................................. 6
Senator Sununu............................................... 8
Senator Corzine.............................................. 8
Senator Crapo................................................ 9
Senator Bennett.............................................. 10
Prepared statement of Senator Allard..................... 36
WITNESSES
Douglas Holtz-Eakin, Director, Congressional Budget Office....... 12
Prepared statement........................................... 36
Howard Mills, Acting Superintendent, New York State Department of
Insurance...................................................... 13
Prepared statement........................................... 42
Ernst Csiszar, President, Property Casualty Insurers Association
of America..................................................... 15
Prepared statement........................................... 46
J. Robert Hunter, Director of Insurance, Consumer Federation of
America........................................................ 17
Prepared statement........................................... 51
Brian Duperreault, Chairman, Ace Limited, On Behalf of the
American Insurance Association................................. 18
Prepared statement........................................... 67
Franklin W. Nutter, President, Reinsurance Association of America 20
Prepared statement........................................... 71
Robert J. Lowe, Chairman of the Board and CEO, Lowe Enterprises,
On Behalf of The Coalition To Insure Against Terrorism, The
Real Estate Roundtable, and the United States Chamber of
Commerce....................................................... 21
Prepared statement........................................... 74
(iii)
THE TERRORISM RISK INSURANCE PROGRAM
----------
THURSDAY, APRIL 14, 2005
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, D.C.
The Committee met at 10:04 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Richard C. Shelby (Chairman of
the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing will come to order.
I want to thank our witnesses for appearing, especially
since this hearing had to be rescheduled from an earlier date
last month.
Today, as everyone knows, we are here to discuss the
Terrorism Risk Insurance Program, or TRIA, which was enacted in
the aftermath of September 11. The stated purpose of this law,
and I will quote, was to ``establish a temporary''--I am going
to say it again--``temporary'' Federal program that provides
for a transparent system of shared public and private
compensation for insured losses resulting from acts of
terrorism.
Now, as we are gathered here 2\1/2\ years later, the
program's scheduled termination date draws near us. I think we
are at a point where we can determine what, if anything, more
is required of this so-called temporary program. To make this
determination, I think we need to look at both the past and the
future. We need to understand where things stood in the
insurance markets at the commencement of the program and where
they stand today and in what direction they are headed.
Some of you will recall I did not vote for the TRIA program
initially since I prefer market solutions to Government
intervention. Nevertheless, I intend to approach this debate
with a critical but, I hope, open mind.
Should we determine that the insurance markets are now over
the initial shocks of 9/11, I think it would be best to
dismantle the Federal backstop. But if we see that insurance
markets are improving or still recovering but that they still
lack the necessary capacity to provide coverage, I think more
action may be required on our part. That begs the question of
what form such action would take. If there is need for
Government intervention in the markets, our priority must be to
develop a program that protects taxpayers and the economy while
helping to restore the efficient function of private markets.
I look forward to exploring these matters with the
witnesses today. I think we have a distinguished panel. I also
look forward to receiving more detailed information that is, as
you know, coming from the Department of the Treasury in the
near future. I appreciate all of you being here today, and I
will introduce the witnesses later.
Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. Mr. Chairman, thank you very much for holding
this hearing, and I look forward to working with you and
Senators Sarbanes, Dodd, Bennett, Hagel, and others as we
review the Terrorism Risk Insurance Act legislation this year
to ensure that a Federal terrorism insurance backstop remains
in place.
After 9/11, we enacted a number of measures to enhance or
stabilize the security of our citizens and our economy,
including the Terrorism Risk Insurance Act. TRIA provided a
high-level Federal backstop that allowed private insurance and
reinsurance markets to return and American businesses to
overcome the shock of September 11. TRIA seems to have
performed exactly as we intended, but as we all know, the
program expires at the end of the year.
I am getting concerned that we are fast approaching a point
where we need to take action. We cannot allow this program to
expire without at least a short-term extension or place a
longer-term solution on the legislative rolls--but as we
consider whether or not to extend TRIA, we should look closer
at the two main goals that we tried to accomplish with the law.
First, as I just noted, we wanted to make sure that the markets
and the economy functioned in the wake of 9/11 and in the face
of the continuing threat of terrorism. The second important
reason for this legislation was that many of us felt that we
needed to have a policy in place to allow the economy to
rebound more quickly in the unfortunate event of another
terrorist attack here in the United States. Fortunately, and
through the effort of many, many people, we have not seen such
an attack, but we all understand there are ruthless and very
clever people who are still at large planning such attacks.
Some opponents of an extension argue that TRIA should be a
temporary program because by ending it, private terrorism
insurance markets would be forced to stabilize and provide
adequate capacity to meet the demand for coverage. Even if this
had occurred--which it has not--they would ignore the second
goal of the act. As policyholders and insurers look to enter
agreements for the next several years, they are facing a very
uncertain future. It is important to remember that we still
live under a threat of attack. As a member of the Armed
Services Committee, every day we review information that I will
say gives us the distinct impression, again, that we are still
at risk.
As you may also know, the Treasury Department is required
to report to Congress by June 30 on issues associated with the
act and its purposes. While I look forward to the conclusions
of the Department's study, it will have little, if anything, to
do with the second aim of the law, namely, having a policy in
place in the event that there is another terrorist attack in
America. It is this reason that most compels me to believe that
we need to continue a Federal Terrorism Insurance Program.
I have joined Senator Dodd and Senator Bennett to introduce
the extension bill, S. 467, and I am an original cosponsor, and
I look forward to working with them.
In addition to extending TRIA to 2007, this legislation
would establish a Presidential working group on financial
markets to submit a report to Congress containing
recommendations to address the long-term availability and
affordability of terrorism risk insurance. So far the
administration has been silent on TRIA. I believe it is
essential that the administration lead rather than follow the
process. I would encourage them to get actively involved in
extending TRIA.
Furthermore, vacancies in key administrative personnel have
led to a vacuum in leadership and communication needed for good
policymaking, and I urge the administration to fill those
positions.
I believe extending TRIA is exactly the right thing to do,
and thank you, Mr. Chairman.
Chairman Shelby. Senator Hagel.
STATEMENT OF SENATOR CHUCK HAGEL
Senator Hagel. Mr. Chairman, thank you. I look forward to
the witnesses' testimony this morning.
Chairman Shelby. Senator Dodd.
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Thank you, Mr. Chairman. I am going to take a
minute or so, if I can.
Chairman Shelby. Go ahead.
Senator Dodd. I apologize for walking in a couple minutes
late, but I have a slight passing interest in the subject
matter.
Let me first of all thank you, Mr. Chairman, and thank
Senator Sarbanes as well for your efforts in holding a hearing
this morning, and thank our witnesses in advance for their
willingness to be here and shed some light on this subject
matter.
I recall that we spent quite a bit of time and effort 3
years ago to adopt the original piece of legislation creating
terrorism risk insurance. And while we did not agree on
everything, I believe that we managed to create a product that
has been very successful over the past 3 years and did what we
thought it would do.
I would like to, of course, welcome all of our witnesses
here this morning and thank them for their thoughts. Most of
the witnesses are likely aware that Senator Bennett and I as
well as a majority of this Committee, including Senators
Schumer, Hagel, Reed, Bunning, Bayh, Dole, Carper, Stabenow,
and Corzine have introduced legislation to extend terrorism
risk insurance for an additional 2 years. As a result, I would
urge all of our witnesses who support our legislation to speak
for as long as you would like this morning in your opening
statements.
[Laughter.]
Senator Dodd. As long as it is not over 5 minutes.
Senator Dodd. In all seriousness, I would like to thank all
of you for your testimony today. With the expiration of TRIA in
December of this year, your input is especially important. And
obviously waiting until December is what many of us worry about
because of the time that is necessary to gear up for this if we
are going to get the job done.
In November of 2002, the Terrorism Risk Insurance Act
passed both the House and the Senate by overwhelming margins
and was signed into law by President Bush, as most will recall.
Enacting TRIA was not an easy undertaking for those of you who
went through this. Our Nation and this Congress faced a new
reality that terrorism could occur on American soil. The
September 11 tragedy resulted in disbelief, devastation, and
economic dislocation. Previously, an attack on our country
seemed unimaginable. Few believed any significant major
terrorist attack would occur, no less than one horrific and
devastating event as the one that occurred on 9/11.
As a Nation, we were forced to quickly face the tremendous
loss of life and physical damage of that tragic event. And for
the most part, we were able to quickly recover with the
combined protection provided by insurance and from assistance
from the Federal Government. However, understanding the more
mundane long-term economic impacts of the terrorist attacks
took us a lot longer.
We eventually came to the realization that our current
domestic insurance marketplace was unable or would be unable to
sustain a second terrorist attack of that magnitude, and that
only with the backing of the Federal Government could we
protect our Nation from future acts of terrorism and the
economic impacts. And while recognizing that the Federal
Government needed to play a role to ensure economic stability,
the exact extent and nature of that role was not easily decided
upon. But we did persevere. We negotiated and had a very frank
exchange of views over numerous months, as the Chairman will
recall. In the end, even though it was a time of laborious and
difficult process, we produced a bipartisan bill that garnered
86 votes in this body and the strong support in the other body
as well.
September 11 changed everything, most visibly, of course,
National homeland security policy. But September 11 also
fundamentally changed the way insurers look at terrorism risks,
which suddenly started to resemble acts of war. As a result,
after 9/11, the insurance market for terrorism nearly
completely dried up. Coverage was unavailable. Many financial
transactions were unable to proceed, and construction workers
and other hard-working Americans suddenly found themselves
economic victims of terrorism.
In short, we wrote TRIA for a very simple reason. Hundreds
of thousands of American jobs and billions of dollars of
business investment hung in the balance. TRIA was created as a
3-year Federal program to help make sure the part of the
commercial insurance marketplace disrupted by 9/11 could work
again. Most Americans do not even know that TRIA provides a
crucial economic safety net for virtually every sector of our
economy. Transportation, real estate, utilities, construction,
travel, tourism, and financial institutions are just a few of
the sectors that need TRIA to protect them against economic
devastation that could come as a result of a terrorist attack.
Under TRIA, the Government shoulders a share of the
financial risk of future attacks. This makes sense. These
attacks are against us as Americans, against our democracy, our
way of life, and even our economic institutions. But TRIA also
required insurers to offer terrorism coverage on commercial
policies. In addition, insurance companies would have to bear
an escalating financial burden in future years.
Mr. Chairman, TRIA is working, as I said at the outset.
This public-private shared loss mechanism is making terrorism
insurance available to all businesses at reasonable costs.
Under TRIA, in the event of another terrorist attacks, private
insurers will still shoulder tens of billions of dollars of
terrorism-related risk. What TRIA does is act as a backstop to
the private commercial property casualty insurance system. It
gives the markets some certainty by establishing by law a limit
to insured terrorism losses for the insurance industry and the
Federal Government.
Acting Assistant Secretary Greg Zerzan from the Treasury
Department recently stated, and I quote him, ``By most
indications, TRIA has been successful in achieving the
fundamental goal of enhancing the availability and
affordability of commercial property and casualty terrorism
risk insurance, particularly for economic development
purposes.''
The Mortgage Bankers Association recently surveyed its 40
largest commercial, multifamily mortgage banking firms. A
substantial majority, Mr. Chairman, of them believe that TRIA
has made terrorism insurance both more available and less
expensive. But the mortgage bankers also noted that failure to
extend TRIA could hurt the commercial real estate market. If we
let TRIA expire, we will see, I think, the same uncertain
environment we saw before TRIA was enacted.
Former CEA Chairman Glenn Hubbard concluded in a recent
economic impact study that letting TRIA expire would increase
the overall cost to the Nation. Mr. Hubbard estimates that
allowing TRIA to expire would result in a lower economic
performance and greater economic disruption to the U.S. economy
in the event of a terrorism attack. He concluded that if TRIA
expires, even absent another attack, hundreds of thousands of
jobs are at risk and tens of billions of dollars in economic
development are in jeopardy. If we let TRIA expire, many
business consumers will be unable to get the coverage they
need. That can only hurt our economy, and I am sure and
confident that all of the Members of this Committee share the
goal of a growing economy.
Senator Bennett and I and other colleagues propose a 2-year
extension of TRIA that will help avoid destabilizing the
insurance market and in turn the National economy. In addition
to temporarily extending the program, the legislation mandates
that the President's working group on financial markets develop
recommendations to address long-term solutions to managing
terrorism exposure. It will give Congress, insurance, business,
and Government officials time to gather all available relevant
data. Collecting that data without fear of market disruption I
think would help us develop a more permanent solution for
managing our Nation's economic exposure to catastrophic
terrorism.
TRIA, Mr. Chairman, has a history of bipartisan support,
and I am extremely pleased to say that the robust support on
both sides of this Committee panel still exists as we consider
an extension of this program. It is my strong hope that we find
a solution to this problem in a bipartisan fashion. Protecting
our Nation from terrorist attacks is neither a Democratic nor
Republican issue. It is truly and fundamentally an American
one.
Again, I thank you, Mr. Chairman, for letting me go on a
little longer here in an opening statement, but having been the
co-author of the original piece of legislation and the author
of this one with Senator Bennett, I think it is important to
lay out here. Again, I would like the idea of a more permanent
bill, but I think we need to be realistic about where we are,
and the idea of developing the data and establishing the basis
and foundation for that I think are critically important. We
have a chance to do it with a limited bill here, with a goal in
mind, I would say very candidly to my colleagues here, of
establishing a more permanent program down the road, knowing
how valuable this is going to be, I think, in the 21st century
for our economy.
I thank you for listening.
Chairman Shelby. Senator Martinez.
STATMENT OF SENATOR MEL MARTINEZ
Senator Martinez. Chairman, I would look forward to
listening to the panel discussion, and I have no opening
statement. Thank you.
Chairman Shelby. Senator Schumer.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you, Mr. Chairman, and I appreciate
your calling this hearing in a timely way.
I rise in support of this legislation. It is extremely
important to my city. We were very involved, our whole
government structure in New York were very involved last time
and intend to be now. And I hope we can move this rather
quickly. I am going to make a few points.
First, I do hope we move it quickly. Last year, we had many
delays, and it cost us a great deal of economic activity,
particularly in the larger cities of the country, even though
we knew that when you came right up to it and looked into the
abyss, you had to do terrorism insurance. The alternatives are
worse, much worse than they have been.
What are the two alternatives? One is that there will be no
terrorism insurance, that the private market will not fill the
gap. That on itself will prevent tens of billions of dollars of
projects and hundreds of billions of dollars of economic
activity from occurring.
The second is that the market will fill the gap, but only
at such exorbitant prices and only in unique situations that
virtually the same thing would happen: large numbers of
projects would not go forward. So we should do it.
Those who say, well, maybe the private market now 2 years
after a terrorist attack will fill the gap cannot happen, will
not happen. Why? First, even though we are a few years from the
horrible day of 9/11, it is on people's minds all the time. Not
just on my mind as a member of New York City, or the Members of
this Committee's minds as Senators, or all of your minds. It is
on the rating agencies' minds. The rating agencies have said
that come December 31, if there is no terrorism insurance, they
are not going to be able to give any kind of decent rating to
any insurance offer. So things are gone.
These guys are insurers. They look for risk. They live with
risk. They wake up in the morning with risk and go to bed at
night with risk. So even if we can say, well, it is a few years
away and the markets will settle down, that is not what rating
agencies do. That is not what insurers do. And we will be back
where we were before.
My first point is we have to do this. We have no choice,
and we will do it.
The second question is when. Well, we can wait and delay
and do it at the last minute. But we all know that major
building projects take long planning, and very soon if we do
not renew this, lots of projects are going to be delayed, not
undertaken, postponed, and, again, we will suffer a significant
economic loss.
You cannot call up your insurance company and say, Hey, I
want to make sure that, you know, on December 31 you say write
me a policy January 1. It will not happen. Right now, there are
projects--I know; I speak to developers from all across the
country--that are being planned, and they are not happening
until we know what happens with terrorism insurance. So to
wait, as we did 2 years ago until--I do not remember when it
was, November, December--is going to cause us damage. We are
going to do it. We should do it. Let's do it now.
And, third, I would make a pitch that we do this
permanently. Why are we going to come back and do this every 2
years? Why are we going to disrupt the markets every 2 years?
We need this.
In Europe, an American company building in Europe, we
provide them terrorism insurance under OPIC, right now. Why is
it if you build a building overseas we are doing it but not
here? Point number one.
And point number two, we have had 3\1/2\ years since 9/11.
Here is what Alan Greenspan said to a House committee a few
weeks ago: ``I have yet to be convinced that the terrorism
insurance market can be made to work.'' If it is not going to
work 3\1/2\ years after 9/11, it is not going to work 5\1/2\
years after 9/11.
Let's make it permanent or at least do it for a much longer
period of time so that people can plan, that we do not come
back, that every 6 months out of every 2-year cycle we get a
halt in building, in construction, in planning, and the growth
we all love about America.
I hope we will pass this and pass it quickly. I also hope
we will do it for a longer period of time than the 2 years in
the very fine bill that my colleagues from Connecticut and Utah
have introduced.
One other note, Mr. Chairman. I want to welcome all of our
witnesses, a good number of New Yorkers, but particularly Mr.
Mills, the Insurance Commissioner of New York State, and
somebody who was my worthy opponent in the November 2004
election. He did such a good job running against me, he is now
seated at this table as Insurance Commissioner for New York
State.
Chairman Shelby. At least you are in the same room.
[Laughter.]
Chairman Shelby. Senator Sununu.
STATEMENT OF SENATOR JOHN E. SUNUNU
Senator Sununu. Thank you, Mr. Chairman.
I appreciate all of the witnesses being here today. For me,
the most important question actually is not whether or not we
pass legislation. That is an important question, and one we are
going to have to deal with. But for me, the really important
question is if we do decide to pass legislation, if we do, how
do we do it? Do we do it right? Structuring this kind of a
subsidy is important because we want to get the incentive
structure--to the extent that we leave one behind, we want to
get it right. This is a subsidy. This is a program that shifts
risks from property owners to taxpayers. But for a lot of
reasons, many people think this is important. People talked
about the economic impacts and the environment, the investment
environment, and the emotional everyone after September 11. So
for a lot of reasons, we felt it was important to do at the
time.
As we look at renewing it, I think it is important to ask
the questions about if we pass legislation, how do we structure
the legislation? And there are a lot of things we need to
discuss, we need to better understand: the structure of the
deductibles, the Federal cost share. We are at a 90-percent
Federal share, up to $100 billion. Is that the right number?
Should the private sector cost burden be greater? Should the
deductibles be structured different? CBO raises questions about
cost-based premiums, and is there a way to create better
incentives for adding cost-based premiums into the system? And
in a world where, I think as a few people have pointed out,
price regulation is often the norm, how do you create good
incentives? How do you take advantage of the incentives that
the marketplace can potentially provide in the insurance
market?
All of these things are important, and I think--I believe
most of the Members of the Committee would recognize their
importance in considering when we deal with this legislation,
and I hope that the panelists will try to address these points
as well. I am sure many on the panel are going to say from
their perspective for good reason we think this is an important
program and we should continue to have this program. But,
again, more important in my mind is that you provide the
Committee with substantive arguments for how we structure the
program and raise concerns if you think that there are
weaknesses in the programs that take us in the wrong direction,
because I would hope that most of you, you know, are involved
in industry, business and industry, and the regulation of that
industry, competitive industries. You want industry to be
healthy and to be competitive, and that means--I think it means
in the long run minimizing the subsidy and allowing markets to
do what they do well.
Thank you, Mr. Chairman.
Chairman Shelby. Thank you, Senator Sununu, for your
incisive observations.
Senator Corzine.
STATEMENT OF SENATOR JON S. CORZINE
Senator Corzine. Thank you, Mr. Chairman, and I welcome the
fact that you are holding this hearing. This is an issue that I
think is one that needs to be addressed if we are to continue
to see a relatively healthy economy. I think this is actually a
very important platform for making sure that occurs. I cannot
disagree that we need to review a lot of the variables, some of
us might even have different philosophical views about how we
might approach this. But I must say that given how things move,
this extension seemed to be a good idea until we dealt with
some of those fundamental questions and I think how much of the
risk is borne by Government in a world where we continue to be
told that we are at risk.
I also want to compliment Senator Dodd for his leadership
on this. This was not an easy product to put together in the
first instance. I think the health of particularly the
commercial real estate markets has benefited enormously from
the leadership and the actions that are taken by Congress. We
can always make things better, and we should examine that, and
we should be looking for the long-term solution as opposed to
interim solutions if we believe that we have a terrorism threat
that will extend beyond some limited time frame. Otherwise, I
think you are going to have a hard time seeing the marketplace
fill that hole.
I look forward to all of our panelists' comments on both
the variables that are involved here, the need to extend this,
and the importance.
I have a full statement for the record.
Chairman Shelby. Your full statement will be made part of
the record, without objection.
Chairman Shelby. Thank you, Senator.
Senator Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman. I, along
with everybody else here, appreciate your attention to this
issue. It has been one of the most thorny issues that we have
dealt with over the last 5 or 6 years, frankly, following the
9/11 attacks, and even in different contexts, trying to figure
out what to do with catastrophic insurance before 9/11.
It seems to me that right now we are faced with--when I
came into the hearing, I thought three options, and I heard
another fourth option as I came into the hearing. One option is
to simply do nothing and let the program expire at the end of
2005, as it is under current law projected to happen. The other
would be to temporarily extend the program with no changes or
with minor changes. A third would be to work out some kind of a
new program involving participation by the Federal Government
but a creative and effective solution working with the private
sector in trying to build a more permanent but different
program than we have right now. And then the fourth one which I
heard when I walked in the meeting here was to just permanently
extend the program to be done with it now and just have the
Federal Government continuing the current role that it has
assumed following 9/11.
My preference is to modify TRIA and work with the private
sector. I have become convinced--I am one of those who believes
we should do everything we can to move to a private sector
solution to this and not have the Federal Government be the
perpetual backstop. However, that is a very difficult
proposition to accomplish in the current climate that we have,
and I am one who has become convinced that there is a Federal
role here and that we need to find it.
I have had a lot of meetings with a lot of the industry
participants over the years, and like I say, even preceding 9/
11 as we were dealing with other catastrophic insurance issues
that we deal with Nationwide. And these are not easy. And the
arguments that are made about the economic implications of not
being able to have an effective insurance program in place are
real.
By the same token, the suggestion that the Federal
Government should just step in and always be the permanent
backstop without trying to do everything we can to build an
effective solution with the industry participants is also a
valid argument. And where I am on this is to continue working
with the Committee and with others who are involved in this
issue to try to find that permanent solution that we can adopt,
but one which I do not believe is going to necessarily be with
such a large Federal role as we have today.
Again, as I say, I have met with a lot of industry
participants who have told me that we can get there if we have
time and if we work together. And I am expecting that we will
have good-faith efforts on the part of everybody, on the part
of the Members of Congress, and on the part of the members of
the industry who can work with us to find that solution that we
have all been talking about, but which we haven't yet reached.
And so with that, Mr. Chairman, I am going to be very
interested in hearing the testimony of the panel today. Thank
you.
Chairman Shelby. Senator Bennett.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you very much, Mr. Chairman. Thank
you for holding these hearings. I know your personal position
is somewhat different from Senator Dodd's and mine.
Chairman Shelby. Mine is closer to Sununu's and Crapo's, I
think.
Senator Bennett. All right. But one common factor that we
have here is that we have a problem, and insurance companies do
not take risks. They analyze risks, they spread risk, they
create a circumstance in which risk can be ameliorated. But if
they are in a situation where they cannot analyze it and spread
it, they do not take it. And you cannot force them to.
The problem with TRIA is that we do not know the size of
the risk. We cannot quantify it. We had no basis prior to 9/11
to have any kind of a number as to what it would cost if
someone were to hijack an airplane and fly it into a building.
That was so foreign to protocol with respect to hijacking. In
fact, the instructions for pilots that were hijacked prior to
9/11 were very clear and very firm and part of their training,
which was you do whatever the hijackers tells you to do in
order to save the lives of your passengers. And, clearly, doing
what the hijacker told you to do was following the book, and it
cost the lives of the passengers and the pilots themselves,
except in those instances where the pilots were simply killed,
which is what I understand happened in the airplane that went
down in Pennsylvania, when the passengers themselves took over
the plane to the point of preventing it continuing on and
possibly reaching reaching the Capitol.
That is the dilemma we have here. We do not know the size
of the risk, and in that era of uncertainty, economic activity
does not take place. Markets can handle up and markets can
handle down, but markets cannot handle uncertainty. And it is
not just an insurance company problem. It is the economy's
problem. And if we cannot build some of the major capital
assets that we need in our economy because no one will quantify
the risks involved in case those centers become targets of
terrorism, the economy as a whole is paying a price. If it
turns out to pay the price in the form of a recession, the
Federal Government pays a price because the greatest threat to
Federal revenue is a recession. It is not tax cuts because tax
rates assume there is some income to be taxed. And if a
recession comes along, it does not matter what the rate is. If
there is no income, there is no revenue.
I feel this is a significant economic challenge that we
have to deal with, and we have dealt with it thus far by
removing a degree of the uncertainty from the equation by
virtue of having a Federal guarantee.
So the question is: What is the appropriate level of that
guarantee? What is the nature of the terrorist threat before
us? Do we understand it well enough that we can quantify it
with some kind of certainty, at which point the insurance
companies can then step in? Because once they have some degree
of certainty as to how big the risk is, they can figure out a
way to spread that risk and offer the appropriate insurance.
I think we are still in a period of sufficient uncertainty
that the Federal Government has a role. I think the impact on
the economy is significant that the Federal Government has to
step up to it. I thank Senator Dodd for crafting a bill that I
think is an excellent starting point for this, and I am happy
to be a cosponsor of the bill. But I think it is important that
we have these hearings and we look for additional alternatives
and we be open to additional ideas as we go along.
Again, Mr. Chairman, I am grateful to you for your
attention to this, your willingness to hold these hearings, and
to our witnesses for their willingness to come share their
expertise with us.
Chairman Shelby. Thank you, Senator Bennett.
I would just note for the record that our colleague Senator
Sarbanes is not able to be with us here today. He is attending
a funeral in New York, and he wanted me to note that for the
record.
I will introduce our panel: Mr. Douglas Holtz-Eakin,
Director of the Congressional Budget Office; Honorable Howard
Mills, Superintendent, New York State Department of Insurance;
Mr. Ernst Csiszar, product and Chief Executive Officer,
Property Casualty Insurers Association of America; Mr. J.
Robert Hunter, Director of Insurance, Consumer Federation of
America; Mr. Brian Duperreault, Chairman, ACE Limited; Mr.
Franklin Nutter, President, Reinsurance Association of America;
and Mr. Robert Lowe, Chairman of the Board and CEO of Lowe
Enterprises.
Gentlemen, welcome to all of you. Your written statements
will be made part of the record, and unlike what Senator Dodd
told you, you do not have all day.
[Laughter.]
Chairman Shelby. Try to sum up your testimony in 5 minutes
or less. This just gives us a chance to have a dialogue with
you.
We will start with you. Bring the microphone up close to
you. This is a big room with a lot of people here.
STATEMENT OF DOUGLAS HOLTZ-EAKIN
DIRECTOR, CONGRESSIONAL BUDGET OFFICE
Mr. Holtz-Eakin. Mr. Chairman and Members of the Committee,
the Congressional Budget Office thanks you for the invitation
to appear today. Over the past several years, we have produced
several analyses for the Congress in this area, most recently
in January. My remarks today will be a brief summary of the
most recent report.
The issue before the Committee and the Congress is whether
to extend TRIA, and if extended, whether to modify it. This is
obviously something that the Members have faced before, but one
of the issues that now arises is whether circumstances have
changed in a way that would lead the Congress to make a
different decision.
Our report highlights two dimensions along which
circumstances appear to be somewhat different. The first and
most important consideration is that TRIA is explicitly a
temporary program, and a primary consideration in the current
environment is the degree to which elevated terrorism risks
will be a more permanent feature of the landscape. If so, the
more durable the presence of a higher risk, the less a simple
extension of a temporary program appears to be merited.
Long-lasting terrorism risk does impose economic costs.
Substantially eliminating those risks and those costs are
largely the role of defense strategy, international affairs,
and homeland security. Financial markets have a role in serving
to manage whatever residual risks may remain. They do that in
two ways. Financial markets convey important information about
the costs of likely risks, aiding to the extent possible any
mitigation efforts that might be possible in the economy. They
also serve an important role in shifting the financial burden
of those risks, when desired, through such strategies as
diversification or direct purchase of insurance products. In
the presence of a more durable source of risk, thinking about
those roles of the private sector is important.
The second difference between now and the original
enactment is that the financial insurance markets are in much
better shape than they were then. Equity markets have rebounded
since NOvember 2002. In bond markets, credit risk spreads have
narrowed considerably. And in the property and casualty
insurance industry, net worth has risen by roughly a third, and
underwriting profitability has returned.
In the presence of TRIA's subsidy, prices for terrorism
coverage have fallen and stabilized. They are down from about
10 percent of insurance premiums to about 4 percent. It now
costs $50 to $80 to get $1 million of insured coverage. The
industry has developed and implemented to some extent improved
pricing models that distinguish between more and less risky
locations. And roughly 50 percent of firms have voluntarily
chosen to purchase insurance as part of their strategy to
manage risks, roughly doubling the coverage that was available
at the time of enactment.
Reinsurers have not been as active as some had anticipated
over this period, but have provided some coverage of billions
of dollars for terrorism risks from domestic sources that are
not covered by TRIA.
What are the lessons of this experience for decisions going
forward? Well, the Nation might adjust more quickly to a high,
sustained level of risk if premium reflected the higher
expected costs. This could be done by adding cost-based
premiums to the TRIA program, as was mentioned by Senator
Sununu.
Alternatively, one possibility would be to let the Federal
reinsurance program expire and let premiums rise. Letting TRIA
end would not increase the overall cost of terrorism. It is
important to note that. It would change who bears the ultimate
burden of that cost, and to the extent that mitigation of risks
is possible, lower costs overall.
If TRIA expired, reinsurers would most likely continue
their previous practice of not covering losses from nuclear,
biological, chemical, and radiological attacks. And it is
important to note that those exclusions would probably impact
the workers' compensation market most directly. If insurers are
unable to diversify that catastrophic risk--and State
regulation would make that difficult--prices for workers'
compensation policies could rise substantially, especially in
the near term.
In the event that TRIA ended and there was an unexpectedly
large terrorist attack, it is quite likely that insurance
markets would again be disrupted and coverage would be
unavailable for some high-risk properties. However, more
generally, if TRIA expired, the availability and price of
terrorism risk insurance would depend on several factors, one
of which is the degree to which continued innovation in
financial markets would produce new types of products, such as
mutual insurance pools, and catastrophe bonds, or participation
of new entities such as hedge funds in providing insurance
capacity to the overall market.
Availability would depend on the willingness of private
sector reinsurers to enter and take catastrophic risks. Recent
developments are suggestive, but not conclusive, that the
private financial markets could shoulder more of this burden.
The Congressional Budget Office is pleased to be here
today. I look forward to answering your questions. Thank you.
Chairman Shelby. Mr. Mills.
STATEMENT OF HOWARD MILLS
ACTING SUPERINTENDENT, NEW YORK STATE DEPARTMENT OF INSURANCE
Mr. Mills. Thank you, Mr. Chairman, Members of the
Committee. I would like to note for the record that I also
serve as the Chair of the Terrorism Insurance Implementation
Working Group of the NAIC, and on behalf of the NAIC, I thank
you for the opportunity to testify at this hearing.
Today I would like to make three basic points, Senators:
First, there is still a need for the Federal Government to
provide appropriate financial back-up to the private insurance
market in order to assure that segments of our Nation's economy
do not falter due to a lack of insurance coverage for
terrorism. The insurance marketplace is not yet ready to fully
cover acts of terrorism on its own because of capacity issues,
as well as extreme difficulty in developing appropriate rates.
Second, Congress should act immediately to extend coverage
under the Terrorism Risk Insurance Program or enact a
comparable Federal backstop for acts of terrorism, at least
through 2007, because the commercial insurance markets are not
yet prepared to underwrite sufficient terrorism coverage
without a Federal backstop. Further, a comprehensive, long-term
plan is being developed but will not be ready in time to
prevent market disruptions should TRIA expire.
Third, the CBO January 2005 Paper, ``Federal Terrorism
Reinsurance: An Update,'' contains some observations and
opinions on how markets will react to TRIA that are not borne
out by observations of how businesses and insurers have reacted
to TRIA.
TRIA has been successful. It has brought stability to a
uncertain market for insurance coverage for acts of terrorism.
TRIA through its make-available requirements appropriately
focuses on the insured's decision to buy coverage rather than
on the insurer's decision to sell it. Although the take-up rate
for terrorism insurance coverage mandated under TRIA has not
been widespread, coverage is currently available for those
businesses that want to purchase it and need it the most. TRIA
has operated exactly how the Congress intended. Those who
needed the coverage purchased it, and those who did not
declined, with the decision, again, always being made by the
insured.
The presence of the Federal backstop has provided an
appropriate mechanism to the insurance industry, enabling
insurers to offer coverage for acts of terrorism that otherwise
would not have been offered in the wake of the tragic events of
September 11.
Now, the Congress should know that insurers have filed
contingency endorsements or sunset provisions in many States.
In the event that Congress does not extend the TRIA Program
this year, insurers will reinstate terrorism coverage
limitations that were in effect prior to TRIA's enactment for
many policies written for coverage that extends into 2006.
Thus, we would be in the same position that we were in just
after 9/11 in terms of terrorism coverage.
These filings I believe demonstrate that the insurance
industry is not yet willing to assume the full risk of
terrorist losses at this time. Congress should be aware that
the private sector does not--does not--have unlimited capacity.
NAIC data shows that 2003 was a profitable year for property
and casualty insurers, with aggregated policyholder surplus
increasing approximately 26 percent to $375 billion. It should
be noted, however, that policyholder surplus decline each year
from 1999 to 2002, and that $375 billion figure is only 4.3
percent higher than the $360 billion in policyholder surplus
held in 1999. Less than half of those funds--and this is very
important. Less than half of those funds are used to support
commercial lines of writing.
The CBO study is flawed, with all due respect. It suggests
that TRIA weakens incentives for the private sector, for owners
of property, et cetera, to increase safety, to take
preventative measures. And in New York State, and indeed all
over the country, we see little evidence to support this
conclusion that TRIA has resulted in owners failing to take
appropriate steps to protect their assets from terrorist
attacks.
To the contrary, the evidence demonstrates that owners have
invested heavily in security, strengthening disaster
preparedness and response efforts in the wake of the 9/11
terrorist attacks, notwithstanding the existence of TRIA. The
CBO report suggests that business owners would be asked to bear
the lost costs, but you know much better than I that history
has shown that Congress will step in after a disaster if asked
to do so.
Insurance regulators strongly urge congressional action
immediately to extend TRIA or to enact an alternative form of a
Federal backstop system this year, immediately, in order to
avoid market disruptions. And the market disruptions are
inevitable if TRIA is not extended. The lack, the absence of
the Federal backstop will cause significant and very harmful
market disruptions.
The NAIC stands ready to assist the Congress in any way
possible as you grapple with this very difficult issue, and,
finally, I would like to state on behalf of the NAIC that we
are not urging the extension of TRIA on behalf of the industry.
We are urging the extension of TRIA on behalf of the consumers
of insurance and on behalf of the health of the American
economy.
Thank you.
Chairman Shelby. Mr. Csiszar.
STATEMENT OF ERNST CSISZAR, PRESIDENT
PROPERTY CASUALTY INSURERS ASSOCIATION OF AMERICA
Mr. Csiszar. Mr. Chairman, thank you for the opportunity
for appearing before you this morning. I think it is important
as we look at this to remember that I represent over 1,000
insurance companies in this country. These companies all are
engaged in providing economic security to its customers. It is
important to remember that economic security does not just
revolve around terrorism. Not only is it important to cover
terrorism, it is also important to remember that the day after
a potential terrorist event, that homeowner's claim, that
automobile claim still needs to be paid. We cover churches. We
cover football stadiums in Alabama. We cover many different
risks.
The problem, the fundamental problem with this is there is
nothing more than our members would like to do than to find a
thoroughly private, free-marketing, competition-based solution
to this. There is nothing more that they would want. The
problem with it is that fundamentally a terrorist event is
uninsurable. So the only solution that we see is a combination
of private and public partnership in which the Government plays
its role as backstop and in which private industry plays its
part, takes its role in at least contributing to that solution.
But ultimately to think that there will be purely a private
solution to the terrorist problem simply is not practical at
this point. Let me explain why.
First of all, the models that we currently have are
rudimentary, even if you look at the models that have been
seasoned and tested, let's say weather-related models or
earthquake models. For instance, no one predicted four
hurricanes in Florida this year, but yet the data we have on
hurricanes extends over the last 100 years or so. With
terrorism, we have no such data, so the best modeling cannot
really cover all the contingencies that might occur.
Frequency and severity are the issue. Severity to some
extent one can get one's hands around, but the severity is so
severe that it brings in a capacity issue. The issue then
becomes is there enough capital really to cover an event of
such severity as one might foresee.
The frequency is almost entirely unpredictable. The
irrational act of an irrational individual, impossible to
capture from a frequency standpoint. I think that is reflected
both in the fact that it creates capacity problems and it also
creates a pricing problem. How do you price a product when you
do not know what the frequency of that occurrence is and when
you really have a difficult time predicting the size and scope,
the severity of it?
What is different also is the fact that, as one looks
through the mirror to the back, September 11, and say, well,
you know, the industry coped with a $40 billion loss in a
fairly reasonable manner. But there was reinsurance available.
Today there is no reinsurance available.
I have heard about capital markets from my colleagues this
morning, but I am afraid after 3 years the capital markets
really have not stepped into it. And even if you look at our
history with capital markets in terms of catastrophic bonds,
bonds of a more general nature than terrorism-related bonds,
that market is quite small. After 10 or 12 years' experience,
$4 to $5 billion, the market has not been tested, and I do not
think it can be described as really being liquid.
The reality of it is that, as Mr. Mills has said, TRIA has
worked and TRIA has helped to take the uncertainty of this
uninsurable event, to some extent diminish that uncertainty.
We at the PCI, I can tell you, we are prepared to work with
you, and we are working. We have not been sitting on our hands.
We have had studies from Tillinghouse. We have worked with the
Treasury on renewals. We are prepared to do our part to try to
find at least partially private solutions to the problem, but
ultimately we come back to the fact that there has to be a
backstop. We have established a number of principles, for
instance, amongst our members. Certainly if we are to pursue a
private solution, I would suggest that the market be allowed to
work. Quite frankly, we now still have 19 States, for instance,
where, regardless of the cause, fire related events have to be
covered by mandate. We have three or four States that mandate
terrorism coverage regardless of whether there is a Federal
backstop. But the first principle that I would suggest for a
private market solution is that the markets be allowed to
operate freely, if that is the case.
Our second principle is that we are also looking at tax-
exempt entities for pooling, for instance. We are looking at
reserves, possibly combined with tax breaks on reserves. We are
looking at how capital markets, their role can be enhanced. But
fundamentally we keep coming back to the fact that there has to
be some back-up role that the Government has to play in all of
this.
Insurance is a foundation industry, and I urge you with the
greatest sense of urgency to give consideration to the fact
that this is about jobs, this is about economic growth, this is
all about what our country stands for.
Thank you very much.
Chairman Shelby. Thank you.
Mr. Hunter.
STATEMENT OF J. ROBERT HUNTER
DIRECTOR OF INSURANCE, CONSUMER FEDERATION OF AMERICA
Mr. Hunter. Thank you, Mr. Chairman. I would like to
congratulate you and thank you for holding off and waiting for
the Treasury report before we move ahead with this, because I
think it is absolutely essential, and I appreciate your
courage. Thank you. Because it really is too early for us to
know exactly some of the answers to some of the questions that
are being raised here today, and Treasury has done a
longitudinal-type review. We can see what happened at various
stages, and I think it is very important that you have that
before you make a final decision.
But there are some facts about TRIA that we can talk about.
For one thing, the insurance industry has become financially
flush compared to where it was when you enacted TRIA. It is no
longer in need of a handout. On September 11, there was a loss
of between $20 and $25 billion after taxes to the insurance
industry, and the retained earnings for the industry that year
fell by $28 billion. Since then, the industry has been
unusually profitable, and the retained earnings now stand at
$388 billion, an increase of almost $100 billion since the
terrorist attacks.
Remarkably, last year, with four hurricanes, the industry
earned $39 billion. The commercial segment of the industry has
seen retained earnings grow by $49 billion compared to what
they had before the September 11 attacks, enough to fund two
such terrorist events just in the profits that they have
retained.
While the industry has done wonderfully, taxpayers are
shouldering a lot of the financial risk. So far the subsidy to
the insurance industry, the actuarial value of the free
reinsurance is $5.8 billion, and I do not think taxpayers
should be asked to continue to shoulder that.
Chairman Shelby. Say that figure again.
Mr. Hunter. $5.8 billion for the program so far in
actuarial value. I was the actuary, by the way, who had to
calculate the reinsurance program because the Congress did
require it. We faced the same kinds of problems with low-
frequency, high-severity calculations. It is doable if Congress
requires the calculation of the risk.
CFA opposes S. 647. If it becomes law, the industry will
continue to get an unnecessary taxpayer subsidy at a rate of
almost $1 billion a year for an amount that could be passed
through to policyholders if it was charged for at an average
surcharge of less than 1 percent of premium, about seven-tenths
of 1 percent.
S. 647 also expands the financial risk by adding group life
insurance. There is absolutely no evidence that group life
insurance needs to be added, and wisely, the Treasury
Department refused to do so. I think you should ask them why,
and I think I know why. It is not necessary. Even the NAIC,
usually very sympathetic to the industry, refused to grant
licensure and exclusion for terrorism coverage because they
could not prove that group life needed it.
CFA opposes S. 647. Continuation of TRIA in anything like
the current form undermines the development of private sector
alternatives since insurers and reinsurers cannot compete with
a zero premium policy. And as CBO also indicated, below-cost
TRIA reinsurance undermines mitigation efforts.
This is not to say that private sector solutions have not
been developed to complement TRIA. Stand-alone policies are
plentiful. More TRIA policies are sold in conjunction with a
stand-alone policy than just TRIA alone. These policies offer
coverage such as domestic terrorism, acts outside of America,
et cetera, and reinsurance is plentifully blacking up these
coverages.
Some have said that regulation has hindered the development
of private terrorism policies. Policies have been developed. I
have yet to see anyone deny or any State turn down a rate
filing.
I attach to my testimony quotes from the recent trade press
articles indicating that insurers are preparing to handle the
demand for terror coverage should TRIA expire, sometimes under
the same terms and conditions with or without TRIA.
CFA, pending the Treasury Department's report, finds no
compelling reason to extend TRIA beyond 2005. The dire
predictions of what you hear might happen on January 1, 2006,
are very reminiscent of what we heard would happen if there was
no TRIA on January 1, 2002, and I had the same fears. But they
did not happen.
If TRIA, however, is extended, we would make several
recommendations.
First, you should ask that full actuarial rates be charged
for the reinsurance.
Second, the program should target only high-risk cities.
Third, the retention levels should be raised to $50 billion
after taxes, a level where GAO finds there may be need for such
support, particularly if nuclear, biological, and chemical is
covered.
CFA looks forward to receiving the Treasury Department,
report analyzing its implications, and sharing our perspective
on TRIA with you in light of what we expect to be significantly
clearer information and more information. Mr. Chairman, we
pledge a rapid response when we have that report.
Thank you.
Chairman Shelby. Thank you.
Mr. Duperreault.
STATEMENT OF BRIAN DUPERREAULT, CHAIRMAN
ACE LIMITED, ON BEHALF OF THE AMERICAN INSURANCE ASSOCIATION
Mr. Duperreault. Thank you, Mr. Chairman. I want to thank
you for holding this hearing. And I particularly want to thank
Senators Dodd and Bennett for introducing this very important
legislation.
I am from the insurance industry. I run an insurance
company. TRIA works, it worked. It was very important. But it
does not change the fact that terrorism is uninsurable. I echo
what Mr. Csiszar said, it is uninsurable. We cannot tell what
the frequency or severity is. We do not how many acts are going
to occur. We certainly cannot tell the size. As to modeling,
modeling has improved somewhat our understanding of how big it
could be, but frankly, as Mr. Csiszar says, these models are
always corrected after the fact, so you cannot be certain.
It is uninsurable by the size alone. I mean you can do
scenarios in which a nuclear event or one of the larger weapons
of mass destruction type events would cause losses of $250
billion. The capital that supports the commercial business is
about $176 billion. So it would dwarf our capital. We cannot
handle this risk period. It is uninsurable.
You know, even the deductible, the deductible now, roughly
is 15 percent. It translates to something like $35 billion.
Contrary to opinion here there is not much reinsurance market
available for terrorism, certainly not for nuclear or
biological, chemical, radiological. There might be 4 to 6
billion. I think it is probably closer to 4. That would leave a
loss of about $30 billion for support of $176 billion. It would
severely impair insurance companies.
So it is a significant problem for us, and the problem is
now. You know, TRIA expires on December 31, but in fact, we
have been issuing policies this year that extend past TRIA.
That situation means that we are growing our exposure to a
post-TRIA situation. We cannot let that continue. At some point
we have to start to cut back on the capacity, and that is now,
that is not at the end of the year. That is now when we have to
start doing this.
Endorsements have been issued where we can issue an
endorsement, but we do not have a free market here to the
extent that we have freedom to exclude these risks. Workers
Compensation, we must cover terrorism, period. In many States
if there is a fire following an event, regardless of the cause,
it is covered even if you have a terrorism exclusion. So we
have got to start reducing our exposures now.
Chairman Shelby. How about arson? Fires would not cover it
if there is pure arson there, would it?
Mr. Duperreault. Fire following an event is covered in many
States.
Chairman Shelby. Even for arson?
Mr. Duperreault. No, you would have to prove fraud to get
out of it.
I want to emphasize that the problem is now. It is not 6
months from now or 8 months now. It is now. And actions are
being taken in the marketplace.
There is some mention of profit, and maybe we have made a
windfall profit, or there is all this money. Frankly, you can
have this risk. I do not want this risk. It is uninsurable. If
an event happened tomorrow we would not have made any money. In
fact, we would have a whopping loss.
The risk reward on this thing is imprudent for us to take,
so we do not even want to be in this business. If we could not
be in this business, we would not. That does not mean that
there would not be some marginal coverages being placed, but
that is not a market. That is an occasional peripheral kind of
play, not a real market.
Has there been a capital market solution? The reinsurance
market is a great indicator of capital market solutions. The
reinsurance market did not come back. They are not restricted.
They do not have to issue these policies, and they are not.
There is no cat bond market, there is not any. There is not
even any for the other businesses, let alone for our business.
Frankly, we are the capital market. We are the indication of
whether there will be capital market solutions to this thing,
and frankly, none have arisen.
We need a long-term solution. There is no question about
it. We are prepared to work. We have ideas. We supplied those
ideas. But I think one has to recognize that a long-term
solution, if the problem is uninsurable, then the long-term
solution cannot be an insurance industry solution. It has to
involve the Government. One way or the other it has to involve
the Government, and it is absolutely needed. If there is no
TRIA or a longer-term solution, then we will revert to the
situation that occurred right after 9/11, and that will be a
market disruption that none of us want to see, and it will do
what the terrorists wanted in the first place, and we cannot
allow that to happen.
Thank you.
Chairman Shelby. Mr. Nutter.
STATEMENT OF FRANKLIN W. NUTTER
PRESIDENT, REINSURANCE ASSOCIATION OF AMERICA
Mr. Nutter. Mr. Chairman, thank you very much. The
Reinsurance Association of America represents domestic U.S.
entities that principally assume reinsurance. Reinsurance
serves many roles for insurance companies, the most notable of
which and most relevant for this hearing is catastrophe risk.
It is largely associated with Natural catastrophes, but
certainly the World Trade Center losses and the other losses of
9/11 are a good example. Nearly two-thirds of the insured
losses that occurred on 9/11 were passed through to the
international reinsurance markets.
We believe that TRIA has worked well to fill a vacuum in
reinsurance capacity. We too are encouraged by and endorse the
leadership that Senator Dodd and Senator Bennett have provided
with regard to an extension bill with a commitment to develop a
long-term solution. We believe it will be essential that long-
term solution include a public as well as a private role.
Several people have addressed the challenges associated
with underwriting, terrorism risk, and I will not repeat that.
It is important to understand that under the current
legislation insurance companies have taken on greater and
greater risk as a result of the increases in the retention
required, the mandatory offer, the actions by some States not
to work with the industry with regard to exclusions in policy
forms. In addition, the industry is under increasing threat
from independent rating organizations with regard to capital
charges associated with the industry's exposure to terrorist
risk.
The reinsurance market, modest as it has been, has largely
should work with insurance companies to assess their risk
associated with the retention that they have under TRIA. TRIA
has not infringed the development of a private reinsurance
market. In fact the opposite is true. By defining the loss
parameters of terrorism risk, it has facilitated primary
companies and reinsurers in developing some coverage in the
reinsurance market.
Mr. Duperreault mentioned a figure of 4 to 6 billion
dollars of reinsurance coverage that appears to be in place for
U.S. terrorism risk. That is our estimate based upon a survey
of brokers. Even if we are wrong by 50 percent, it is still 6
to 8 billion, which would be modest compared to the needs of
primary insurers for terrorism risk reinsurance.
We think it is improbable that the private reinsurance
market could ever replace the full coverage provided under the
TRIA program.
Let me speak briefly to catastrophe bonds and catastrophe
reserves, both of which have been mentioned. Catastrophe bonds
are a well-established mechanism for transferring natural
catastrophe risk. These capital market products have been in
the market since about 1997.
Yet in 2004, based upon a knowledgeable industry estimate,
only $1.14 billion of coverage for natural catastrophe risk was
issued in cat bonds. Since 1997 only 59 transactions have taken
place, again dealing entirely with natural catastrophe risk,
with total limits under $9 billion. Only $4 billion of that is
still outstanding. There is no reason to believe that the
catastrophe bonds for terrorism will be a significant provider
of capacity.
With respect to catastrophe reserves, which were mentioned
earlier, this would require a change in accounting practice to
allow companies to set up reserves for future unknown losses
associated with risks and coverages that they have in place.
There are a variety of reasons why this should be considered as
part of a long-term solution, but no one should think that
allowing insurance companies to have catastrophe reserves will
provide any increase in capacity for terrorism, Indeed
catastrophe reserves may be a substitute for the risk transfer
such as with reinsurance.
We too look forward to working with the Committee, with the
policyholder community, with others in the insurance community
to find a long-term solution. We are encouraged by an extension
that would allow that to develop and take place over the next 2
years.
Thank you.
Chairman Shelby. Mr. Lowe.
STATEMENT OF ROBERT J. LOWE, CHAIRMAN OF THE BOARD
AND CEO, LOWE ENTERPRISES, ON BEHALF OF
THE COALITION TO INSURE AGAINST TERRORISM
THE REAL ESTATE ROUNDTABLE
AND THE UNITED STATES CHAMBER OF COMMERCE
Mr. Lowe. Mr. Chairman, I too add my thanks for your
holding this important hearing.
I am the Founding Chairman of Lowe Enterprises. Our company
is headquartered in Los Angeles, and we maintain offices
Nationwide. Over the past 32 years, we have developed, acquired
or managed more than $6 billion of real estate assets and we
currently employ approximately 8,000 employees Nationwide.
I also am the Chairman of the Real Estate Roundtable. I
testify today on behalf of the Roundtable and the Coalition to
Insure Against Terrorism, or CIAT. CIAT's membership includes
over 70 trade associations and businesses from across the
country, and includes not only real estate related firms, but
energy, transportation, professional sports leagues, theme park
owners, and of course, the U.S. Chamber of Commerce.
As Chairman of the Real Estate Roundtable I have the
privilege of working directly with the CEOs of major real
estate ownership and financing companies throughout this
Nation. We also count as membership the 15 major trade
associations representing different aspects of the real estate
industry, collectively an industry valued at about $5 trillion,
and that employs nearly 9 million American workers, an industry
that accounts for nearly 70 percent of all local tax revenues.
Obviously, the real estate industry and the jobs associated
with our industry is a cornerstone to the health of our
economy.
I am here to say that a Federal terrorism insurance program
is a cornerstone to maintaining a healthy, growing real estate
industry. Our message is simple and straightforward. The
reasons that prompted President Bush in 2002 to urge the
establishment of Terrorism Risk Insurance Act unfortunately
have not changed.
A survey we conducted during the aftermath of 9/11 showed
an excess of $15 billion of real estate related transactions
that were either stalled or canceled because of lack of
terrorism insurance. Studies further show that approximately
300,000 jobs were lost during this period due to this economic
slowdown.
Fortunately, in November 2002 the President and Congress
joined together to act. Almost overnight TRIA provided capacity
to the insurance markets, which in turn yielded economic
confidence for transactions to resume, in particular stalled
construction projects moved forward to the benefit of countless
workers in the construction trades. I do not believe that the
facts that brought about TRIA's enactment have changed.
Obviously, the threat of terrorism in our Nation remains. A
major even, without reasonable insurance, will once again
significantly damage the transaction markets, result in delayed
or canceled projects, the loss of thousands of jobs and reduced
economic activity.
I would like to share my personal situation. We have about
$1 billion in current loan commitments which contain terrorism
insurance requirements which are today supported by TRIA. This
represents about $2 billion in project value. If TRIA is
allowed to disappear, we most likely would be unable to
reasonably replace the insurance perhaps at any price.
Let me give you a specific example. We have been working
for 6 years on a major $320 million development project to
construct an ocean-front hospitality project in the county of
Los Angeles. It represents a much-needed facility in Southern
California, approximately 1,000 permanent jobs and hundreds of
construction jobs. It will produce in excess of $8 million of
annual local and State tax revenues. We are ready to break
ground late this summer. Without appropriate insurance our
lender will not fund and we will be unable to break ground.
Additionally, we have 8,000 employees in a dozen States. Our
insurance staff advises me our Workers Compensation coverage is
at risk without TRIA.
Last evening one of my associates on the Roundtable, who
services 7,000 real estate loans, explained that their
borrowers are having their insurance policies renewed only
until the end of 2005. After that they will be in default.
Another Roundtable member described how his insurance provider
has halted all new policies until the TRIA situation is
clarified.
Yes, we must keep markets operating while terrorist threat
exists. We must keep policies in place to make sure our economy
keeps on track in the event of another terrorist attack.
In conclusion, on behalf of the Roundtable and CIAT, I urge
this Committee to act quickly on extending the terrorism
insurance backstop. American businesses are now in the market
for terrorism insurance that extends into 2006, and are
increasingly facing difficulties. Transactions will be
unnecessarily stalled or canceled and jobs will be lost.
Therefore I urge you to continue the momentum started with this
hearing, stay focused on finding a solution to this problem,
and approve legislation providing for a Federal terrorism
insurance backstop. Personally I support an immediate extension
which includes the mechanism to develop a sound long-term
program.
Last, I add my thanks to Senator Dodd and to Senator
Bennett, as well as the 15 other Members of this Committee for
introducing Senate Bill 467.
Thank you.
Chairman Shelby. Thank you, Mr. Lowe.
I will direct these first questions to the General
Accounting Office, doctor, if I can, because you have done a
lot of work in this area. The temporary TRIA program that is
now in place does not, as I understand it, require insurance
companies to pay premiums for the Federal reinsurance backstop
that they receive. Is a premium free system sustainable if a
program should go forward in the future, and what incentives or
perhaps disincentive does a premium-free system create for
insurance companies and insurance policyholders?
Mr. Holtz-Eakin. Well, Senator, the TRIA program does not
have premiums, and as a result it passes up the opportunity to
convey to insurers and to the economy as a whole those
locations which are placed at greater financial risk versus
those which are a lesser financial risk. It thus passes up the
opportunity to convey the information necessary to mitigate
overall cost of any event.
Chairman Shelby. Mr. Hunter, you have a view on that?
Mr. Hunter. Yes. I think--I ran the riot reinsurance
program, and we had to charge premiums, and it was just as
difficult to create who is going to riot, when is it going to
be, what is the frequency going to be, what is the severity
going to be? And it was difficult, but we did it, and
ultimately the taxpayers actually received about a quarter of a
billion dollar profit when the program was finally terminated
during the 1980's. I believe that a premium at least should be
charged if the program is extended.
I understand why businesses who are receiving free
insurance would want to see it continued that way, but I do not
think Congress should do that.
Chairman Shelby. Doctor, I think one of the questions that
keeps popping up that does not go away, are there practicable
mitigation strategies that are relevant to terrorist incidents?
Are there things that could be done to reduce losses, and are
people implementing these strategies? And if so, what are some
of the examples, or what steps have been taken since the
enactment of TRIA, if there have been?
Mr. Holtz-Eakin. I think it is important to distinguish
between those actions which might prevent a terrorist attack
and actions which reduce losses from an attack. It is an
overstatement to assert that economic policy and insurance
premiums in particular are going to be the only means to wage a
war against terrorism. However, conditional on attacks, the
goal is to minimize economic cost. It is always better to, (A),
locate activity in such a way that it puts less in harm's way
where possible; and (B), there are steps that can be taken to
reduce losses.
There was a recent report by the National Institute on
Standards and Technology on the fact that in the World Trade
Center Towers the fireproofing came off the supports. This
suggests that steps could be taken to reduce costs such as
amending building codes. However, nothing is a panacea.
Chairman Shelby. Mr. Mills, what mitigation efforts have
you seen in New York?
Mr. Mills. Many, Senator, everything from companies
locating data backup centers outside of the city to secure
locations. The security efforts that the private sector has
undertaken in the city of New York are extraordinary, and I am
sure all of the Members of this Committee have had occasion to
see that personally when trying to enter a high-rise in the
city of New York. Local government of course has also invested
heavily in security measures. Where my office is located,
Senator, in downtown Manhattan, we have risers that come up out
of the streets, not just the concrete barricades but the actual
risers such as you have here in front of the Capitol to prevent
vehicles from getting too close.
So we are seeing the industry making significant
investments.
Chairman Shelby. You are reacting to it big time.
Mr. Mills. Yes, we are.
Chairman Shelby. Mr. Duperreault, can you or do you offer
rate discounts for terrorism insurance coverage to clients who
proactively take steps to reduce their loss exposure?
Mr. Duperreault. I think it is a natural process to
evaluate the risk and determine who is more at risk and who is
not. The answer is yes, and if it is an area that is low risk,
they will have a low rate, and if it is a high risk, they will
have a higher rate.
Chairman Shelby. Doctor, I will go back to you in a minute.
We have heard that the insurance industry lacks the financial
capacity to deal with a catastrophic terrorist event, such as
9/11, or we hope not another one, but you never know. Your
study, which is pretty comprehensive, discusses the possibility
of obtaining greater amounts of capital directly from the
securities or derivatives markets. Could you elaborate just for
a moment on your concept? In other words, how much capital
could be available? By what means could it be made available to
backstop terrorism risk, those kind of things?
Mr. Holtz-Eakin. I think that it is impossible to quantify,
based on the brief experience we have under TRIA, what the
total would be in the future. But it is clear that it would be
a mistake to view this as exclusively an insurance industry
issue. There are at the moment a wide variety of ways to
address the financial risks of terrorism. Shareholders can
diversify their holdings among many different firms. Firms can
diversify their operations among locations. There are
opportunities to access derivative markets, which are worldwide
in nature and enormously deep in capacity. Those markets could
bear losses far greater than any single terrorist event.
Chairman Shelby. Mr. Csiszar, I will direct this to you and
to Mr. Duperreault. First, in your testimony, Mr. Csiszar, you
indicate that you feel that there should be Federal support--
and the words of yours following--giving insurers and insurance
markets more freedom to negotiate terms and conditions of
coverage. Would you envision that an element of such freedom
would be the ability to set risk-based prices?
Mr. Csiszar. Yes, absolutely, that would be part of it,
yes.
Chairman Shelby. Could you elaborate just for a minute on
your testimony regarding the need for freedom in the
marketplace, which we all espouse, by providing the Committee
with a sense of some of the differences between current market
conditions and more free markets for which you advocate?
Mr. Csiszar. Let me give you several examples of that.
First of all, I think, as Mr. Duperreault mentioned, the fire
policy is an issue in 19 States, where coverage post event is
mandated regardless of the cause of the event. In Florida,
California and in Georgia, for instance, you have to cover
terrorism whether there is a backstop or not.
Chairman Shelby. This is mandated.
Mr. Csiszar. Mandated. Workers Compensation is mandated,
the coverage is mandated regardless of the cost.
Chairman Shelby. Mr. Lowe got into that.
Mr. Csiszar. Yes. So these are some examples of where a
market-based system simply cannot accommodate because there is
no market-based system.
Chairman Shelby. Mr. Duperreault, you have any comments on
this?
Mr. Duperreault. Yes. I think the important thing to
recognize there is that post--without TRIA those restrictions
remain, and that handcuffs a company's ability to deal with
this, and therefore, you know, if a State says you cannot issue
a Workers Comp policy unless it covers terrorism, you only have
one choice, you do not issue the policy.
Chairman Shelby. That is what Mr. Lowe was concerned with
among other things.
Mr. Duperreault. And that is very important to understand.
Chairman Shelby. Senator Dodd.
Senator Dodd. Again, thank you, Mr. Chairman. This is very,
very helpful, and I want to thank all of our witnesses for
their testimony here today. I think it has been helpful in
making the point. I think maybe not everyone here, but I
suspect most of us here, if there were a private sector
solution to this problem, we would not be here. And there are
those who I think may make the case I suppose that maybe just
the Federal Government should do all of this. I do not buy into
that at all, but there are those who may embrace that view.
And I think what our witnesses are suggesting here and what
a majority of us on this Committee are suggesting is that this
is--you need a hybrid here to get through this, to get this
right, and eventually at some point there may, there may in
time become a model that would develop where the Federal
Government would no longer need to be involved in this issue at
all. I do not think we are there yet.
One of the issues I wanted to raise with you, Doctor, if I
could, is your suggestion that the catastrophic bond market
might be a means by which this issue is--I do not know if you
are familiar with the most recent General Accounting Office
study that was done I think about a month ago here, but let
me--and Mr. Chairman, I will ask unanimous consent that not all
of this, but portions of it be included in the record. But I
thought it was worthwhile to note--
Chairman Shelby. Let us put it all in the record.
Senator Dodd. It is a rather extensive study.
Chairman Shelby. That is okay. You can refer to anything
you want to.
Senator Dodd. Let me just quote from it here. It says:
Moreover the catastrophic bond market has generally been
limited to coverage of natural disasters because the general
consensus of insurance and financial market participants we
contacted because they are developing catastrophic bonds to
cover potential targets against terrorism attacks in the United
States was not feasible at this time.
I am quoting now from the report. It goes on to say:
Although several modeling firms are developing terrorism
models that are being used by insurance companies to assist in
their pricing of terrorism exposure, most experts we contacted
said these models were too new and untested to be used in
conjunction with a bond covering risks in the United States.
And last it goes on, Mr. Chairman, to say:
Furthermore, a potential investor concerned such as risk of
information about issue or underwriting practices or the fear a
terrorist would attack targets covered by catastrophic bonds,
could make the costs associated with issuing terrorism related
securities prohibitive.
I would like to ask--all of you addressed to some extent
this issue--but anyone want to comment on this at all, this
question of the catastrophic cat bond issue?
Mr. Holtz-Eakin. If I could characterize the nature of the
comments in the report.
Senator Dodd. Sure.
Mr. Holtz-Eakin. It was not the case that we were
suggesting that there was an existing capacity in the
catastrophic bond market that would step in and replace
traditional sources of capacity in the insurance market. That
was not the intention. If it was interpreted that way, we will
write better next time. The question is, going forward, to the
extent the Congress decides to rely more heavily on private
capacity, what are possibilities that would be available? This
is one of them. As many members of the panel have mentioned,
these products and traditional products do not exist in
isolation. One of the key issues with catastrophic bonds is
familiarity and expertise in the modeling, and that would
develop more quickly and more expertly if there were greater
incentive to do so.
Second, there is a regulatory environment that matters. Our
understanding is that in many circumstances catastrophic bonds
would not qualify as reinsurance. In the absence of a
regulatory environment that supports it, it will not develop.
And so, there are issues on all sides.
Mr. Nutter. Senator Dodd, just to emphasize something I
said in my testimony. Reinsurers are frequently the
facilitators of catastrophe bonds. They use them. They work
with clients to use them for natural catastrophes. It is a
mature market. It has been around for a number of years yet, as
I mentioned in testimony, it is actually very modest in
providing capacity.
There really is very little evidence, as you suggest and
the GAO has said, that catastrophe bonds for terrorism are
likely to fill the gap or provide a substitute for TRIA's
coverage. Should they be made part of the consideration of a
long-term solution? Absolutely.
Senator Dodd. I think there was a suggestion--and again, I
think you point out, doctor, and rightly so, that there are an
awful lot of other obstacles to all of this, and the problem
is, in the interim trying to sort all of that out while we have
this problem lurking before us here. In the absence of doing
anything, the exposure is significant. That is the concern I
think. In an ideal world, I think your point--probably would
not disagree with your point. The question is, with the limited
amount of time we have, the potential exposure we face, the
economic implications of not doing anything, are too risky in a
sense for us to take. That is my view anyway. That is why we
are talking about this.
Let me ask you a question. One of the criticisms about this
program, and it may have some value and I want you to respond
to it, is that the current insurer retention levels are too low
in the present TRIA bill, and that as a result the Federal
Government is crowding out the reemergence of the reinsurance
market. How do you respond to that?
Mr. Duperreault. May I, Senator? I mentioned in my earlier
remarks the deductible is close to the mid 30s, 35 billion is
probably a good number given the current levels of premiums.
That is the World Trade Center loss effectively. So we are to
basically handle the World Trade Center loss. And if you
compare that to our capital, as I pointed out earlier, for the
industry at about 176 billion, that is a significant hit. The
difference between today and that hit to us and the 9/11 hit
was that there was a substantial amount of reinsurance
available. There is not a substantial amount of reinsurance
available today. So the net effect would be considerably larger
for the industry than it would--than it was at 9/11.
To give you an example, my company paid--incurred losses in
excess of $2 billion on 9/11. Our net loss was about a little
under 700 million, so we had reinsurance that covered--for
every $3 of payments, $2 came from the reinsurers. There is
nowhere near that capacity now. So it is not just a 9/11 loss,
it is a supercharged one, and it is one that cannot be handled
by our capacity at these levels of deductible.
Senator Dodd. Let me, Mr. Mills, if I may, in the last bill
we talked about dealing with the Workers Compensation, the life
issues, and we asked for studies should be done on this thing.
But in your testimony you described the unique concerns,
obviously, that exist within the Workers Compensation and group
life lines. With respect to Workers Compensation you related
nearly all State laws preclude any exclusion for specific types
of risk including terrorism risk. With respect to group life
you raised risk concentration issues. I wonder if you will
elaborate on this a little bit because I am sure we are going
to be asked about this again as we come forward with this
legislation. We have been down the road, one, of asking to be
looked at. I do not know how the Treasury study's going to
address this, if they are or not, but I think it is a very
important question. Certainly we saw it in New York, the 9/11
attack, the Workers Compensation issue, the life issues, group
life issues loomed very, very large, and I wonder if you might
address this?
Mr. Mills. We do support the inclusion of group life. We
feel that is--
Senator Dodd. I knew you did that. I just wanted you to
elaborate.
Mr. Mills. We separate from NAIC a bit in that area, but
the concentration that we see in New York buildings is
obviously a critical issue for us, and we feel it is something
that we would like very much to see included as this goes
hopefully forward.
Senator Dodd. Now put on your NAIC hat.
Mr. Mills. NAIC does have a different opinion on that. They
have taken a position that may not necessarily be one that has
to be included.
Senator Dodd. Mr. Hunter, you are chafing here at the bit.
[Laughter.]
Mr. Hunter. No. Well, my chafe was that I wondered who he
was--was he speaking for New York or NAIC because I knew they
had a different position.
Senator Dodd. He made it clear.
Mr. Hunter. So I was chafing over that. I do not think
group life is necessary. I think Treasury has concluded that.
NAIC has concluded that when they looked at whether it should
be excluded or not. I think everyone who has made the study has
concluded it should not be included.
Senator Dodd. Any other comments on this?
Mr. Nutter. Senator Dodd, if I could. This relates actually
to your last question. The value of TRIA with respect to the
reinsurance market is that it defines the box for these
insurance companies. It sets the loss parameters and allows the
reinsurer and the insurer to work out a catastrophe program
addressing terrorism risk. Group life, as you know, is not
included in the current program. Your bill of course proposes
to do that.
It seems to me including group life would have the same
positive dynamics on the market. It is now in the reinsurance
market in limited supply. It is very expensive, and it is
really very limited as far as an individual insurer is
concerned. Including group life would probably have the same
value, if you will, in defining the box, defining the loss
parameters and allowing reinsurers to work with the companies
to provide a risk transfer mechanism.
Senator Dodd. Yes?
Mr. Csiszar. Senator Dodd, if I could add to that from our
members' standpoint, the feeling also is that personal lines
should be included in this. For instance if you were to take
just the example of a dirty bomb, Chernobyl is an example, and
it certainly has impact on all homeowners and automobile
ownership as well, so we would ask that the consideration be
given to personal lines as well.
Senator Dodd. Mr. Chairman, maybe I was not clear, my staff
tells me. Workers Comp obviously is included in the present;
group life is not, if I did not make that clear.
Mr. Mills. Senator, if I could just clarify one thing. The
NAIC has actually not taken a position on the inclusion of
group life. They do not oppose, but they have not taken a
position.
Senator Dodd. That is very clear.
[Laughter.]
Mr. Mills. Thank you, Senator.
Chairman Shelby. Senator Bennett.
Senator Bennett. Thank you, Mr. Chairman.
The CBO report talks about TRIA undermining the incentives
for mitigation. Do you insurance types agree with that? Have
you seen a lessening, a mitigation since TRIA was enacted?
Mr. Duperreault. No.
Senator Bennett. I see some shaking heads. Who wants to
speak up?
Mr. Duperreault. I think if you look at every CEO running a
major company in this country, you know that they are concerned
about a terrorism risk and mitigation has taken place. They
have taken action to protect their employees and their
property, and it is almost insulting to talk about lack of
mitigation. I think the motivation has been very high and many
efforts have been taken. That does not mean that the
terrorists' efforts, you know, their job is to work around
those mitigation efforts, but it does not mean that mitigation
has not been taking place.
Mr. Lowe. On behalf of the real estate industry, which
obviously is a great consumer of this insurance product, I can
assure you that we are paying our premiums and we are also
doing everything we can do to prepare our properties for the
unknown future risks. The Roundtable specifically has
cooperated with the Homeland Security Department to develop a
communication network that allows the Homeland Security to
communicate directly with thousands of buildings around the
country and vice versa, for those buildings to communicate
directly to Homeland Security.
Last week we had 65 of our members participate in the
simulation of a terrorist attack in the Northeast. One of our
buildings in San Francisco specifically took part in those
exercises. Our personnel--we ran about 8,000 hotel rooms around
the country. Our personnel are trained weekly to be alert for
problems, and very importantly, how to respond when the
emergency occurs.
Mr. Holtz-Eakin. Senator, if I could, on the CBO report, I
think the important question about mitigation efforts is:
Compared to what? Compared to a world in 2000 where terrorism
risk was unpriced entirely? Certainly, no, we are not doing
less than that. Compared to a world where terrorism risk was
fully priced in the absence of free reinsurance? Incentives
will be less than that.
Mr. Mills. Senator, I would like to say again, reiterate
that the evidence that we see is absolutely contrary to that
contention. The private sector, the real estate sector in New
York City, the Real Estate Board of New York has taken
extraordinary steps to mitigate risk, but we are missing the
point. The real point is, whatever extraordinary steps the
private sector takes--and they are taking those steps--this is
still impossible to predict and impossible to entirely prevent.
But to contend that the private sector is not doing all that
they can I think is clearly false.
Mr. Csiszar. Senator, if I could add to that as well, it
goes beyond just New York State and New York City. Our members,
for instance, right in Iowa, well, Iowa--and one of the studies
identified Iowa as a problem child because of the number of
fertilizer plants in Iowa. These fertilizer plants are taking
active steps to mitigate the terrorist threat. I think it goes
beyond just New York City and major centers. It goes directly
into the heartland. I wholeheartedly agree with my colleague,
Mr. Mills here, and disagree with the report.
Mr. Hunter. I would just comment that you have to suspend
the laws of economics to say that free insurance will give a
greater or equal incentive to insurance priced at full
actuarial rates. It just makes no sense.
Senator Bennett. The only comment I would make, Senator
Dodd has been Chairman/Ranking Member of the Rules Committee
while I was Chairman/Ranking Member of Legislative Branch
Appropriations, and we did not have any insurance problems, but
we certainly have spent a lot of taxpayers' money on mitigation
around the Capitol. You cannot be an intelligent CEO without
paying attention to that.
Reference has been made to New York, San Francisco, Ohio
and so on. I remember when there was an orange alert. I was in
St. George, Utah, and the stores all sold out of duct tape. And
I said, ``I really do not think the terrorists are that likely
to strike St. George, Utah, and you probably are safe without
taping up your windows down here.''
Let us talk about the availability of terrorism insurance
with respect to businesses outside of the large cities. Is this
primarily a big city problem or does it affect the economy
everywhere?
Mr. Mills. Senator, if I may, Senator, one of the things
that we hear through the NAIC in the smaller markets, you have
to realize when you are looking at a major urban center the
market is there, the business is there. But where the lack of
insurance may hurt the smaller markets because the market is
just not that large enough that a lot of the writers will not
want to assume any risk because the profit just is not there.
So it will indeed affect all markets, not just the large, but
the small.
Senator Bennett. Give me an example.
Mr. Mills. A shopping mall. One of the things that we know
we have to do, what the Homeland Security people are doing, is
trying to predict how the enemy thinks. And one of the most
dangerous acts that has been identified as--you know, we all
know New York, LA, are likely places that they would strike.
What if a shopping mall in a small town anywhere in the Midwest
of the United States is bombed?
Senator Bennett. Try Utah.
Mr. Mills. Try Utah. That would have a devastating impact
on the market. That would be a huge disruption. A huge fear
would strike the market and would cause a massive disruption.
So I believe it affects all markets large and small.
Mr. Nutter. Senator Bennett, if I could offer a comment. I
am sorry if I interrupted you.
Senator Bennett. No, no.
Mr. Nutter. It seems to me your point goes to the heart of
the insurance industry's difficulty in underwriting this risk.
There is an information disconnect. The industry does not know
about potential terrorist activities, and yet terrorists can
very well act independent of prior experience. They can also
act based upon their assessment of mitigation efforts that
entities are taking. So it would seem that it is a broad
problem and reflects the problem the industry has in trying to
price and underwrite this risk throughout the country, not just
in the major urban areas.
Senator Bennett. Mr. Hunter, you--
Mr. Hunter. Yes. I just wanted to say the modeling that is
being used to underlie rate making does imply that there are
four cities with a very high risk, five others with a middle
size risk, and everywhere else is low risk. And obviously that
does not mean there cannot be an event anywhere. It could. But
in terms of risk, the low risk cities are being priced pretty
close to what they would be without any TRIA.
Mr. Csiszar. Senator, I--
Senator Bennett. Do the rest of you agree with that, that
they are being priced as if there were no TRIA?
Mr. Duperreault. No, I would not agree with that.
Mr. Csiszar. And I would also say that I am told that the
football stadium in Alabama holds 90,000 people, and that is a
terrorist risk, and that is--
Chairman Shelby. Then you had better insure that.
[Laughter.]
Chairman Shelby. First. And you have no risk there. The
risk is a fight, is it not?
Mr. Csiszar. Yes.
[Laughter.]
Chairman Shelby. It depends on who wins.
Mr. Csiszar. That is right.
Senator Dodd. If Auburn shows up, it is a risk.
[Laughter.]
Chairman Shelby. Auburn is doing quite well.
Senator Bennett. Mr. Duperreault, you--
Mr. Duperreault. Yes, if I could just comment a little bit
on this question of pricing pre and post-TRIA. We do not know
where these things are going to occur. If there is a market
dislocation, there is going to be a market dislocation that
affects the entire country. It is not going to be isolated to
major cities. It will affect all cities because we do not know
whether there is an event that was going to occur in a mall
somewhere in Utah, or a stadium in Alabama. We do not know. So
it will be a universal effect.
Senator Bennett. All right. Just one quick comment, Mr.
Chairman. Having lived through the Olympics in Salt Lake City,
I discovered something very interesting which may or may not be
true. We are back to the uncertainty circumstance. The Olympics
were, as Senator Dodd discovered trying to get credentials for
his 8-month-old daughter, pretty tight as far as security went.
And I stood in the command center. We actually had two, the
command center of all of the units involved with security in
the Olympics on the ground, and then one floor up we had a
command center of all the intelligence agencies, and it was
highly classified, and I will not tell you how many countries
were there, but it was not just American intelligence agencies
that were there.
I remember looking over this very sophisticated and
somewhat complicated command center, and the fellow who was in
charge of it said to me, ``Senator, this is boring. Nothing is
going on. And in the security business boring is good.'' We
spent an awful lot of money, Federal money, local money,
Olympic money, et cetera, to get that boring result.
But the interesting thing that applies here with respect to
this question of risk is that we were told that al Qaeda avoids
hardened sites, and one of the reasons there was no terrorism
activity at the Olympics is that we did go to the extent we did
for a hardened site. That is why I felt safe at the Republican
Convention in New York City because I knew how hardened the
site was so I figured they are not going to attack us. They
prefer to go someplace that is not hardened where you do not
expect it.
Now, they want something very splashy on television. They
want something recognizable around the world. So they might go
to the St. Louis Arch or some other symbol that could be
recognized if they could blow it up. But I think that becomes
your problem. If you harden, mitigate, if you will, certain
parts of the country, you, if you are dealing with the
mentality of al Qaeda, you make it far less likely that there
will be an attack there, but if they want to attack America,
they will then come to Salt Lake City when the Olympics are not
there and blow up the Mormon Tabernacle because that is a
symbol that people would recognize around the world from the
Mormon Tabernacle Choir, and when we are not holding the
Olympics we are not very hard in Salt Lake City. So I think
that is the problem that we face.
Thank you for your indulgence, Mr. Chairman. I did not mean
to overrun my time.
Chairman Shelby. Thank you, Senator Bennett, and I also
thank Senator Dodd, both of you, all your work on this.
Doctor, should we move forward with a Government program?
How can we also maximize market efficiencies? How can we--
Mr. Holtz-Eakin. The key issue here, I think, is not to
declare TRIA a success or failure in its incarnation. It was
designed for a particular problem as a temporary backstop to
restore capacity in the industry. Quite frankly, the data will
not be there to say if this is the right design or not. You
cannot distinguish between an economic recovery in general and
better performance in a lot of the business investments. So
that is problem number one, and no one at this panel will ever
be able to have enough evidence to definitively decide whether
this is the right solution.
The second problem is that going forward there are these
long standing terrorism risks that will be elevated. Compared
to a temporary program, I think that is the key design issue,
and in a perfect world, a private market would recognize those
risks, price them, and have capacity to insure against them. Or
in a perfect world, a Government backstop would have prices
that gave good incentives, and spread the risk efficiently
using the taxing powers of the Government.
The real issue is looking at the downsides in both cases.
What is the potential risk of a private sector that does not
develop a capacity to price at least as well as possible and a
capacity to insure the risks? And, what is the downside on the
Government programs with poor risk management such as the
Federal Savings and Loan Insurance Corporation?
The goal going forward is to make sure we minimize the
risks of bad design. For example, the savings and loans crisis
showed the risks of bad economic incentives embedded in a
Government insurance program. This is the kind of thing you
want to avoid.
Chairman Shelby. I think we all recognize that the risk of
terrorist attacks in the future somewhere are real, and it is
unusual, and it is not something the insurance, the private
market has had to deal with, at least to my knowledge, in the
past, and it is hard to put the product together. I see that.
In the very near future, as most of you know, we will be
receiving a report on the TRIA program from the Treasury
Department. I believe that this document should be informative
and helpful to our deliberations here in the Committee as we
consider what if any steps to take next. It is my understanding
that both the Government and the private sector, you, a lot of
you, did a great deal of work to compile the underlying
information that will form the basis of this study. We look
forward to obtaining this study. Senator Dodd alluded to it
earlier.
And we appreciate all of you appearing here today. I think
it has been a good hearing.
Senator Dodd. Mr. Chairman, just very quickly, a couple of
things. Well, I want to underscore the point that Senator
Bennett made and others of you have made here about where these
attacks can occur. If you understand the work, so much behind
it, not only--
Chairman Shelby. We hope they do not ever occur, no.
Senator Dodd. Of course not.
Chairman Shelby. But they may.
Senator Dodd. If you accept obviously having symbolic, but
also fear. I mean fear is the major, I think, emotion that
terrorists want to promote. So I always find it troubling that
we always go and prepare for the next event based on the last
event, and we underestimate the creative abilities of these
people. I have heard it said by others and I agree with it, the
attack on 9/11 was probably the most efficient and successful,
quote, military, if you want to call it that, attack maybe ever
executed. When you consider how limited amount of resources
were involved and the amount of damage done and the ripple
effects that it caused, you would be hard-pressed, I think in
my mind, to talk about another event you could think of that
has had that kind of an effect.
I think we underestimate. If we assume that just these
large cities and big targets are the natural places, I think we
make a tremendous mistake, tremendous mistake if we do that. I
just wanted to make that point.
Second, I wanted to make the point that while I am
impressed with what the private sector is doing to harden their
facilities and protect them against attacks, we have to go a
long way yet. There have been studies--and I know the Chairman
is aware of this as I am--done by reputable organizations that
feel as though we have not done as well as we could be doing to
provide the resources, the first responders and others to make
us better prepared. I think that is an acknowledgement all of
us would have to make, but we have to do a much better job in
the coming years if we are going to close that gap.
But also I think it is important, and I think all of you
implied this, but I think the record needs it stated. I think I
know the answer to this, but I think that the record should
have it. I want to ask you, Mr. Lowe, this because of your
extensive experience as a real estate developer.
What impressed me at the time when we first did this bill,
there was a very good argument made I thought by those who were
talking about how long should this temporary program be, and
you may have been one of them at the time, Mr. Lowe, suggested
that a two- or three-year program really was not adequate, you
needed more like a five- or six-year program. And I said,
``What do you mean by that?'' And they said, well, you need to
understand that when you start talking about a large real
estate development project, those are years in the execution.
The time windows on these things are not short, and so getting
the necessary capital, all of the work that needs to be done to
put together a large real estate development project takes
time.
And I wonder if you might in light of this--and I
appreciate what the Chairman is doing, by the way, with the
Treasury study; I am not in any way suggesting that we should
necessarily jump ahead of that, but our concern would be if we
got them--
Chairman Shelby. We jumped a little ahead of it with the
hearing, did we not?
Senator Dodd. Well, we did, but that is good. I think we
set the ground work, and I appreciate the Chairman doing that.
But if we get too late into the fall, start getting close to
this December 31st deadline, there are a lot of people saying
what difference does it make? If we did it on December 30, it
is done, it will be done by the time that the legislation would
no longer be valid, effective.
Could you address that issue I think as someone who has had
some experience in this thing, about the lead times necessary?
And again, I am preaching to the choir here to many of you who
understand this, but I think the record should reflect this.
Mr. Lowe. Business in general, the real estate industry
certainly specifically, need predictability in the business and
capital markets environment. We are making long-term decision
daily that affect our projects, our employees and our
customers. If we cannot depend upon, now 8\1/2\ months out, 1
year out, even 3 years out, we have trouble planning for our
projects and our employees. That is why I concluded by
personally recommending that your action, one, extend the
program quickly, but do it in a way that builds in a mechanism
that really encourages the public and private sector to get
together and come up with a permanent long-term solution to
this problem. It is not going to go away in 2 or 3 years.
Senator Dodd. I understand that.
Mr. Mills. If I may very quickly, Senator, I can tell you
that the Real Estate Board has already reported to us already
in anticipation of what might not happen, that multiyear
builders risk policies are becoming increasingly unavailable.
Mr. Duperreault. And, Senator, we are right now issuing
endorsements that say there is no coverage past the expiration
of TRIA on property risk where we can do it, so it is happening
now. It is not going to happen six or 8 months from now, it is
happening right now.
Senator Dodd. Mr. Chairman, I thank you.
Thank all of you very much.
Chairman Shelby. Thank you, Senator Dodd.
The hearing is adjourned.
[Whereupon, at 11:55 a.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow.]
PREPARED STATEMENT OF SENATOR WAYNE ALLARD
April 14, 2005
I would like to thank Chairman Shelby for holding this important
hearing. Many of us were on the Committee when we enacted the Terrorism
Risk Insurance Act (TRIA), and I appreciate the opportunity today to
revisit the program and review its implementation.
I reluctantly supported the legislation passed in 2002. I believe
in free markets, and thus am loath to inject the Federal government
into private markets. I became convinced that September 11, 2001 was
indeed an extraordinary event that required a temporary backstop in
order to give the markets time to adjust. I emphasize the word
temporary here. I came around to supporting the TRIA legislation only
after repeated assurances from the industry that this was a one time
request-simply buying time for the private markets to regroup.
There is no ambiguity as to the congressional intent that the
program should be temporary. In fact, in the conference report the
purpose section begins, ``The purpose of this title is to establish a
temporary Federal program that provides for a transparent system of
shared public and private compensation for insured losses resulting
from acts of terrorism .-.-. ''
Now the industry is back with the same arguments. Once again, we
are being told that the markets just need a little more time to adjust.
I'm not sure why we should believe it this time, though. If this is to
become a perpetual government program, like flood insurance, the
industry should be honest about it.
I will be following today's hearing carefully, and I will be
interested in hearing what progress the industry has made in once again
letting the free market take control. Again, Mr. Chairman, thank you
for convening this hearing. I look forward to hearing more about this
topic.
----------
PREPARED STATEMENT OF DOUGLAS HOLTZ-EAKIN
Director, Federal Terrorism Reinsurance
April 14, 2005
Chairman Shelby, Senator Sarbanes, and Members of the Committee, I
appreciate having the opportunity to discuss Federal terrorism
reinsurance with you today.
My statement, which draws heavily on the Congressional Budget
Office's (CBO's) paper Federal Terrorism Reinsurance: An Update
(January 2005), will elaborate on several points:
<bullet> By increasing the availability of terrorism insurance at
below-market rates, the Terrorism Risk Insurance Act (TRIA) has led
to a rise in the percentage of companies that buy terrorism
coverage, mainly in places thought to be at high risk of terrorist
attacks.
<bullet> In the absence of TRIA, an unexpectedly large loss from a
terrorist attack would be likely to produce another episode of
scarce coverage, rising prices, and uninsured assets.
<bullet> Some important changes have occurred since TRIA's enactment in
2002, however. The most significant seems to be a growing sense
that the threat of terrorism in the United States will continue for
the foreseeable future. That conclusion suggests that investment
and economic behavior needs to adjust further in response to the
greater threat of losses from terrorist attacks. For example, with
a continuing threat, it might be cost-effective for new structures
to be designed,
located, and built to better withstand such attacks. Existing
structures might benefit from having their safety features
retrofitted. And businesses could diversify the locations of their
operations. The extended duration of the threat is thus relevant to
the question of whether to extend TRIA in its current form, which
subsidizes insurance and dampens incentives for such adjustments.
<bullet> At a minimum, the speed with which the Nation adjusts to a
sustained high level of risk might increase if the premiums charged
for terrorism insurance more closely reflected expected losses.
That outcome could be facilitated by letting the TRIA program
expire or by adding cost-based premiums to the program.
<bullet> It is easy to exaggerate the overall costs to the economy of
reducing the Federal subsidy for terrorism insurance; in fact,
those costs are likely to be small. One reason is that TRIA does
not lower the total costs of terrorist attacks but rather shifts
them from property owners to taxpayers. Indeed, total costs might
be lower without TRIA because efforts to mitigate risk could pay
off in smaller losses from a terrorist attack.
<bullet> Alternatives to insurance would be likely to develop more
quickly if premiums were higher. That is, the expiration of TRIA or
the addition of cost-based
premiums could stimulate the development of alternatives, including
mutual reinsurance pools and capital instruments such as
catastrophe bonds. Another alternative to traditional insurance is
for owners of the largest assets at risk (and their creditors) to
protect themselves by diversifying among properties and locations.
What TRIA Does
The Terrorism Risk Insurance Act, enacted in November 2002, created
a temporary Federal reinsurance program to transfer most of the risk of
financial loss from acts of terrorism to taxpayers. At the time, the
attacks of September 11, 2001, had made insurers less willing to
provide terrorism coverage because of uncertainty about the risk of
future losses. Policymakers feared that a shortage of terrorism
insurance could expose property owners to uninsured risk, slow down
commercial construction, and reduce economic activity. Indeed,
anecdotal evidence suggested that some large construction projects had
been canceled or delayed in part because of the lack of terrorism
coverage. Many analysts expected that, in time, insurers would
reassess the risk of terrorism, raise capital, and re-enter the market.
TRIA was intended to fill the gap in the supply of terrorism insurance,
at least until private insurers could recover.
Under TRIA, companies that provide commercial property and casualty
insurance are required to offer terrorism coverage. In return, the
Federal Government agrees to pay 90 percent of an insurer's losses,
above a deductible, in the event of an attack by foreign terrorists.
Insurers would pay the deductible and the other 10 percent of losses--
up to a total limit for the program of $100 billion. The government
would then be required to recoup some of its costs by assessing
surcharges on commercial insurance policies sold after the terrorist
attack. Participating insurers pay no premiums for TRIA reinsurance,
which increases their ability to insure against catastrophes at low
prices. The law and the program it created are scheduled to expire at
the end of calendar year 2005.
Effects of TRIA on Insurance Markets
TRIA has served its purpose of immediately expanding the supply of
terrorism insurance. For owners of high-risk properties, the law has
succeeded in increasing the availability and lowering the price of
coverage for property and casualty losses from terrorism. As a result,
TRIA has led to an increase in the percentage of companies that buy
terrorism coverage. It has also given private insurers time to raise
financial capital, improve their models of risk, and reenter the
market.
The Treasury is scheduled to deliver a report to the Congress this
summer that should provide additional information about the effects of
TRIA. As part of that report, the Treasury is conducting a
comprehensive survey of insurers and policyholders about their
experiences under the program.
Effects on Prices of Terrorism Insurance
TRIA has contributed to the decline in the price of terrorism
insurance, which has fallen by half since the beginning of 2003. In the
third quarter of 2004, the typical premium for terrorism coverage
represented about 4 percent of the total premium for a property
insurance policy--down from more than 10 percent in the first quarter
of 2003, according to insurance broker Marsh Inc. That drop occurred as
insurers' own deductibles under TRIA were rising, which would normally
cause insurers to raise premiums. TRIA is probably not responsible for
the entire drop in rates in 2003 because private insurers were building
capital and learning more about pricing terrorism risks. In 2004, the
median cost of purchasing terrorism insurance ranged from $53 to $80
per $1 million of insured value.
Effects on Purchases of Terrorism Insurance
After the cost of terrorism coverage fell, the percentage of firms
buying policies nearly doubled. A recent survey indicates that 44
percent of large companies bought terrorism coverage in the third
quarter of 2004, compared with just 26 percent in the third quarter of
2003. Another survey found that 57 percent of commercial property
owners purchased terrorism insurance in the third quarter of 2004
versus 24 percent in early 2003. A majority of firms with terrorism
coverage are now also buying private insurance for events not covered
by TRIA, including acts of terrorism by domestic groups.
Despite those increases, roughly half of all commercial properties
still lack terrorism insurance, but that rate of coverage is not
necessarily a sign of market failure. Factors other than price affect
firms' decisions to buy insurance. For example, many companies that do
not buy terrorism coverage apparently do not consider themselves to be
potential terrorist targets. (Coverage is higher in cities thought to
be at greatest risk--such as New York, Washington, Chicago, and San
Francisco--despite higher premiums in those cities.) Moreover,
properties owned by shareholders who hold diversified portfolios of
such investments are effectively self-insured. If some firms have
decided that the costs of terrorism coverage outweigh the benefits,
then universal coverage may not be a desirable policy goal.
Financial Condition of Insurers
Insurers' capacity to provide coverage depends on their net worth
(assets minus liabilities) and the availability of reinsurance. The
largest component of net worth is insurers' accumulated stock of
retained earnings. The net worth of property and casualty insurers
dropped by nearly $30 billion in 2001 but has since recovered (see
Table 1). In addition, underwriting losses (the difference between
insurers' income from premiums and their expenses) have declined
significantly. In fact, property and casualty insurers are earning
underwriting profits for the first time in nearly 20 years--$2.8
billion for the first nine months of 2004--despite losses from four
hurricanes in the third quarter of 2004. The net worth of the industry
rose to $369 billion on September 30, 2004, from $285 billion at the
end of 2002. U.S. reinsurers have also seen a recovery in their net
worth and net income (see Table 2). Of course, not all of that net
worth will be available to back terrorism coverage because it will be
needed to support other types of insurance.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Modeling Insurance Losses
Among its other effects, TRIA has provided time for the insurance
industry to improve its ability to predict losses from terrorism and
thus price terrorism risk more accurately. Several competing models are
now available that predict the risk of losses from terrorism by zip
code or by individual location. The level of detail in those models
allows insurers to distinguish the higher risk faced by city centers
from the lower risk faced by outlying urban areas. Each model contains
a list of potential terrorist targets and produces estimates of the
severity of losses associated with different types of attacks.
Although substantial progress has been made in modeling terrorism
losses, the new models are not as reliable as those for natural
catastrophes, which are based on more than 100 years of data rather
than on two major events in the past 12 years (the September 11 attacks
and the 1993 bombing of the World Trade Center). Terrorism models are
hampered not only by a lack of data but also by the absence of an
established ``theory'' of terrorist attacks. However, a generally
accepted model of risk is not essential for providing private
insurance. Insurance
against natural disasters is widely available despite a variety of
estimates from competing models of losses from such events.
Notwithstanding concern by some actuaries that existing tools
cannot predict losses from terrorism with the degree of accuracy
necessary to set prices for coverage, insurers have one benchmark
available for setting premiums. The Insurance Services Office (ISO), a
company that provides data and analytic services to insurers, currently
files advisory estimates of loss costs (expected annual losses over the
long term) with insurance commissioners in each state. Once state
commissioners approve an ISO advisory, insurance companies operating in
that state can use the estimates as a basis for setting premiums
without having to undertake the formal rate-filing process. In 2003,
all 50 states approved ISO's estimates of loss costs.
Economic Effects and the Cost of TRIA
TRIA was explicitly designed to reduce the short-term adverse
effects of terrorism on economic activity, at some cost to taxpayers.
Assessing TRIA's success in offsetting the macroeconomic effects of
terrorism is difficult because it is hard to know how the economy would
have performed in the absence of the law. No claims have been filed
under TRIA, but the program exposes taxpayers to substantial risks and
costs. In addition, the TRIA program may be increasing exposure to
losses by delaying cost-effective adjustments to a continuing risk of
terrorism.
Short-Term Macroeconomic Effects
TRIA is a temporary program adopted to avoid a contraction of
economic activity. Faced with anecdotal evidence that some major
construction projects had been halted because of a lack of terrorism
insurance, the Congress acted to keep such projects moving by
increasing the availability and lowering the price of terrorism
coverage.
After TRIA's enactment, some recovery in retail construction
occurred. But the law appears to have had little measurable effect on
office construction, employment in the construction industry, or the
volume of commercial construction loans made by large commercial banks.
Various factors complicate that assessment, however--for example, the
lingering effects of the 2001 recession could be masking positive
macroeconomic effects of TRIA.
In addition, it appears that the shock to the insurance market from
the September 11 attacks did not spill over to the general economy.
Surveys indicate that in the six months after September 11, banks did
not significantly tighten their commercial lending in response to the
shortage of terrorism insurance. Commercial lending may have been
little affected in part because firms have alternatives other than
insurance for spreading risk. Lenders and investors can reduce their
risk through diversification. Real estate investment trusts, which are
essentially mutual funds for real estate holdings, and commercial
mortgage-backed securities (CMBs) are especially useful for that
purpose. In fact, the extent to which interest rates on CMBs exceeded
comparable rates was smaller in the summer of 2002 than it had been
before September 11, 2001. That result is consistent with the idea that
investors were requiring only a small premium for bearing terrorism
risk, partly because CMBs are geographically diversified.
Cost to Taxpayers
No claims have been incurred under TRIA, but that does not mean
that the program has no cost. Indeed, the cost--in terms of risk and
expected losses--of having the Federal Government provide terrorism
reinsurance is approximately the same as the cost of having the private
sector provide it. With a Federal program, however, that cost is
shifted from owners of commercial properties (who pay for expected
losses and the cost of risk-bearing through premiums) to taxpayers. The
shift in the cost of risk and uncertainty would occur even if
surcharges on future policyholders ultimately offset all Federal cash
outlays under TRIA.
CBO estimates the expected value of Federal outlays from TRIA to be
$630 million over the 2005-2015 period (assuming that the law is
extended) and the value of governmental receipts from surcharges to be
$320 million over that period. (Expected-value estimates reflect CBO's
expectation of payments during the period based on the probability of
various outcomes, from losses of zero up to very large amounts.) The
outlay estimate does not include any charge for the risk and
uncertainty borne by taxpayers. Thus, the budgetary estimates are less
than the economic cost of such reinsurance.
Long-Term Effects
An increase in the risk of terrorism is analogous to an increase in
the risk of natural disasters: it lowers the value of some properties
in high-risk areas. Similarly, TRIA is equivalent to a policy of
subsidizing property and casualty insurance in an area that appears to
have an especially high risk of natural disasters. If the increase in
risk is only temporary, then a Federal program to provide low-cost
insurance might be justified as a means of avoiding an expensive and
excessive effort to reduce losses.
If the increase in risk is long-lived and significant, however,
such a program could increase the cost to the economy because it could
delay action by owners of assets to mitigate risk and reduce losses.
Since July 2004, when the report of the 9/11 Commission was published,
a consensus appears to have emerged that the current elevated risk of
terrorism is likely to continue for years. With a sustained change in
the risk of loss, spreading that risk through insurance is only part of
an economically efficient response. Taking steps to mitigate risk--such
as moving operations to safer areas, installing better security
systems, hardening buildings against external attack, establishing
disaster-recovery procedures, and setting up systems to
protect computerized information--is also important. Firms have been
making additional investments since September 11 to improve their
security and avoid losses, but the incentive to do so is muted by
subsidized terrorism insurance.\1\
---------------------------------------------------------------------------
\1\ See Congressional Budget Office, Homeland Security and the
Private Sector (December 2004).
---------------------------------------------------------------------------
If the Federal Government continued to subsidize terrorism
insurance, it could contribute to deferring the private sector's long-
term adjustment to the increase in risk. Less adjustment would mean
that losses from any future attacks would be greater than would
otherwise be the case. However, the extent to which TRIA may actually
be reducing efforts to mitigate risk is unknown.
Policy Implications
Three options for TRIA have been under discussion in the Congress.
One is to allow the program to expire at the end of 2005, as scheduled
under current law. A second is to extend the program as is. That
approach was taken in H.R. 4772 in the 108th Congress. A third option
is to modify TRIA. For example, H.R. 4634, which was reported by the
House Committee on Financial Services on September 29, 2004, would have
continued the program through 2007, raised
individual insurers' deductibles from 15 percent this year to 20
percent in 2007, increased the industry retention level from $15
billion now to $20 billion in 2007, and extended reinsurance coverage
to providers of group life insurance. CBO estimated that on an
expected-value basis, that legislation would have increased outlays by
$1.3 billion and receipts by $480 million over the 2005-2014 period. At
least two terrorism insurance bills have been introduced in the 109th
Congress--the Terrorism Risk Insurance Extension Act of 2005 (S. 467)
and the Terrorism Insurance Backstop Extension Act of 2005 (H.R.
1153)--but CBO has not yet estimated their cost.
Letting TRIA Expire
If the perception that the risk of terrorism is likely to remain
high is correct, then it would be desirable for property owners and
businesses to take measures to reduce their exposure to risk and lower
the cost of any attack. They would have a stronger incentive to take
such measures if the insurance subsidies conveyed through TRIA were
reduced or eliminated. Letting TRIA expire, however, might expose
property owners to onerous premiums to cover losses for which they were
not responsible.
Would Private Reinsurers and Investors Take Up the Slack? There are
indications that private reinsurers would eventually fill some of the
gap in supply left by the expiration of TRIA, but that outcome is not
certain. Like domestic insurers, global reinsurers have increased their
underwriting capacity since September 11, in part by adding capital.
Global reinsurers also earned underwriting profits in 2003 for the
first time in seven years, according to Standard & Poor's, and
shareholders' funds (capital and shareholders' reserves) increased from
$244.8 billion in 2002 to $338.3 billion in 2003. More recently, hedge
funds have entered the reinsurance business. However, in 2004, the
amount of coverage actually purchased in the private terrorism
reinsurance market remained low--between $4 billion and $6 billion, by
industry estimates.
The experience of other countries provides little evidence about
the role that private reinsurers can play. In Europe, public/private
risk-sharing agreements on terrorism insurance are common. Typically,
the government provides financial support for pools created by
insurers. With a pool system, individual insurers pay the first layer
of claims, private reinsurers cover middle layers, and a mutual
reinsurance pool pays higher layers. Generally, the government picks up
losses once a pool's resources are exhausted. For that reason, pure
free-market tests of the willingness of private firms to underwrite
terrorism coverage are difficult to find, leading to uncertainty about
how much coverage the market would provide.
Although capital markets are currently absorbing some terrorism
risk, the development of global financial instruments for spreading
that risk would probably be more rapid without TRIA's subsidized
prices. Further, international capital markets are larger than
insurance markets and thus have greater capacity to absorb losses.
Daily fluctuations in the overall value of traded capital assets
worldwide often exceed the losses incurred on September 11, 2001.
In the absence of TRIA, catastrophe bonds--which fully or partly
forgive the bond issuer from interest and principal payments in the
event of specified catastrophes--might be used for terrorism losses, as
they have been used to spread the risk of natural disasters. Two
international catastrophe bonds have been issued that combine terrorism
risk with other risks. However, before catastrophe bonds can play a
major role, tax and regulatory accounting issues will have to be
resolved.
How Would the U.S. Economy Be Affected? The immediate economic
effects of letting TRIA expire are likely to be small. The economy is
stronger now than it was in 2001 and 2002 and therefore is better able
to offset the drag from an increase in costs for terrorism insurance. A
study sponsored by the insurance industry concluded that failing to
extend TRIA would reduce economic growth by 0.4 percent, household net
worth by 0.9 percent, and the number of jobs by 0.2 percent in 2008,
even without another terrorist attack.\2\ That study predicted slower
economic growth because of the effect that higher insurance premiums
for property and workers' compensation insurance would have on
businesses' operating costs. However, the study implicitly assumed that
costs borne by taxpayers, unlike those borne by owners of commercial
properties, do not have adverse effects on economic growth. The study
also ignored TRIA's potential for delaying the economy's long-term
adjustment to a higher risk of terrorism and the possibility that other
policies could offset any economic slowdown.
---------------------------------------------------------------------------
\2\ R. Glenn Hubbard and Bruce Deal, The Economic Effects of
Federal Participation in Terrorism Risk (study prepared by Analysis
Group, Inc., for the insurance industry, September 14, 2004).
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Letting TRIA expire would not increase the expected cost of
terrorism to the economy but rather would change the incidence of that
cost. Under TRIA, the cost of terrorism risk is being shared by
taxpayers and the owners of commercial properties. If TRIA expired as
scheduled, more of the cost would be borne by private firms and
insurers, but the total cost would be unlikely to rise.
How Would Insurance Markets Be Affected? One disadvantage of
letting TRIA expire is that doing so increases the chances of a market
disruption after an unexpectedly large loss, as has been the pattern
for natural disasters. In particular, after a terrorist attack, the
availability of insurance and reinsurance would drop, and premiums
would be likely to spike. How long that effect would last is uncertain.
But in the aftermath of catastrophic events that deplete capital, high
prices and reduced availability of insurance can persist.
Reinsurers would also probably continue to exclude losses related
to nuclear, biological, and chemical attacks from their coverage. That
exclusion would be important mainly for the workers' compensation
market, since primary insurers for that type of policy must cover
losses from all causes. Without Federal reinsurance, insurers might be
unable to diversify that catastrophic risk, at least in the near term,
so premiums for workers' compensation policies could rise
substantially. Thus, TRIA's expiration would most likely create
shortages in the workers' compensation market. Because of the special
challenges posed by that market, policymakers might consider the option
of extending TRIA only for workers' compensation policies.
Another disadvantage of letting TRIA expire is that with higher
prices, the prevalence of insurance coverage would probably decline.
Thus, lawmakers might face the prospect of higher supplemental disaster
assistance for uninsured losses in the event of a major attack. In the
case of September 11, Federal assistance to businesses adversely
affected by the attacks exceeded $6 billion, out of total Federal aid
of more than $30 billion in response to the attacks.
Modifying TRIA
If the TRIA program was extended rather than allowed to expire, the
government could take steps to reduce the program's adverse effects on
risk mitigation. Charging premiums for Federal reinsurance would help
encourage property owners to adjust to the higher level of risk. When
TRIA was proposed, its supporters argued against premiums on the
grounds that not charging them would have only small effects in the
short run and would avoid the need to create a Federal entity to set
premiums. However, if the primary goal now is to prompt the economy to
adjust to a continuing threat of terrorism, then premiums might be set
as close as possible to expected losses. Alternatively, to ensure that
private insurers and reinsurers had room to compete with the
government, policymakers could set premiums higher than expected losses
(in other words, add ``risk loads''). In addition, periodically raising
the deductibles and coinsurance percentages that insurers must bear
would gradually remove the government from the market.
----------
PREPARED STATEMENT OF HOWARD MILLS
Acting Superintendent of Insurance
Terrorism Insurance Implementation Working Group
National Association of Insurance Commissioners
April 14, 2005
Introduction
My name is Howard Mills. I am the Acting Superintendent of
Insurance for the State of New York, and this year I am serving as
chair of the Terrorism Insurance Implementation Working Group of the
National Association of Insurance Commissioners (NAIC). We appreciate
the opportunity to testify regarding the role of the Federal Government
in ensuring that insurance to protect against losses from acts of
terrorism remains available to Americans.
Today, I want to make three basic points:
<bullet> First, there is still a need for the Federal Government to
provide appropriate financial back-up to the private insurance
market in order to assure that segments of our nation's economy do
not falter due to a lack of insurance coverage for terrorism. The
insurance marketplace is not yet ready to take on the risk of
providing coverage for acts of terrorism on its own.
<bullet> Second, Congress should act this year to extend coverage under
the Terrorism Risk Insurance Program (TRIP), or enact a comparable
Federal backstop for acts of terrorism, at least through 2007,
because the commercial insurance markets lack the capacity and
means to underwrite sufficient terrorism coverage without a Federal
backstop.
<bullet> Third, The CBO January 2005 Paper-Federal Terrorism
Reinsurance: An Update-contains some opinions on how markets will
react to the Terrorism Risk Insurance Act of 2002 (TRIA) that are
not borne out by observations of how businesses and insurers have
reacted to TRIA.
TRIA Has Been A Success, But Challenges Remain
Following enactment of TRIA, the NAIC established a Terrorism
Insurance Implementation Working Group of state regulators that has
worked closely with the Treasury Department to successfully implement
TRIA's provisions, as well as to monitor the impact it has had on the
insurance marketplace. There are many who believe the United States
economy remains vulnerable to terrorist attack. This is evidenced by an
increased take-up rate for terrorism coverage observed in recent
surveys. Indeed, those who need coverage the most are able to obtain it
because of the existence of TRIA.
We believe the presence of the Federal backstop has provided a an
appropriate mechanism for the insurance industry to make vital
terrorism coverage widely available to American businesses.. By
requiring insurers through the ``make available'' mechanism to offer
coverage for acts of terrorism they otherwise might not have offered in
the wake of the tragic events of September 11th, TRIA brought certainty
to the insurance marketplace.
The NAIC's Terrorism Insurance Implementation Working Group
believes that TRIA has been successful in stabilizing the insurance
market. In particular, TRIA's ``make available'' requirement has
contributed to the overall effectiveness of the program during its
first three years. American businesses--both large and small--have been
offered choices they might not otherwise have had. Through the ``make
available'' provision, TRIA has given them the opportunity to make an
informed choice regarding the purchase of coverage for acts of
terrorism.
During the first week of May 2004, insurance regulators began
receiving contingency filings from Insurance Services Office, Inc.
(ISO), the nation's largest insurance advisory organization. In the
event Congress does not extend the TRIA program this year, these policy
form filings would reinstate terrorism coverage limitations that were
in effect prior to TRIA's enactment for any policies that extend
coverage into 2006. In addition to protecting insurers from additional
terrorism liability, these filings demonstrate that the insurance
industry is not yet willing to assume the full risk of terrorism losses
at this time. If triggered by the expiration of TRIA, these limitations
will greatly reduce terrorism coverage in the states that have approved
the endorsements. In those states that have rejected these coverage
limitations, insurers will have to make the difficult choice of writing
the coverage and accepting the potentially catastrophic terrorism
exposure or not writing it at all. This could lead to availability and
affordability problems down the road.
Industry Capacity Limitations
One of the elements that Congress should consider is the capacity
of the insurance industry to accept the risk of losses from acts of
terrorism. Insurance capacity is generally measured by determining the
amount of capital and surplus available to insurers to support their
policy writings. Using that measure, NAIC data shows that 2003 was a
profitable year for property and casualty insurers, with aggregated
policyholder surplus increasing approximately 26 percent to $375
billion. It should be noted however, that policyholder surplus declined
each year from 1999 to 2002, and the $375 billion figure is only 4.3
percent higher than the $360 billion in policyholder surplus held in
1999. Less than half of those funds are used to support commercial
products in all lines of insurance, including terrorism coverage.
Moreover, the substantial losses incurred by insurers in responding to
claims from four major hurricanes during 2004 will erode some of the
recent surplus gains.
As part of considering whether the insurance industry has
sufficient capacity to underwrite the risk of terrorism losses,
Congress should consider whether the industry is willing to put its
capital at risk. At present, we believe the answer is no.
In addition, insurers and the marketplace-at-large are finding it
very difficult to accurately price coverage for acts of terrorism.
Unknown frequency, coupled with the potential for severe losses, make
insurers reluctant to provide coverage for acts of terrorism. Until
insurers and their reinsurers become more comfortable that government
efforts are adequate to protect citizens from terrorist acts, or at
least become more predictable than they are today, they will be
reluctant to accept complete risk transfers from American businesses
for this exposure. In particular, businesses viewed by insurers as
having a greater risk of terrorism losses, such as those located in
America's financial and commercial centers, will have trouble finding
terrorism insurance.
Congress Should Extend the Terrorism Risk Insurance Program
The NAIC urges immediate action by Congress on a Federal solution
to ensure continued marketplace stability when TRIA expires at the end
of 2005. Because some terrorism risks are largely uninsurable without a
financial backstop, state regulators are very concerned that
significant market disruptions will develop before TRIA's expiration.
This is due in large part to the deadlines contained in TRIA, which do
not match the business cycle for insurance renewals.
The commercial insurance business cycle operates in such a way that
insurers and their policyholders were required to make decisions as
early as September 2004 regarding coverage that extends well into 2006.
At present, annual policy renewals with effective dates of January 2,
2005 or later must contemplate there will be no Federal backstop for
any losses occurring in 2006. For this reason, state insurance
regulators have observed widespread insistence by insurers that
conditional policy exclusions for terrorism coverage be included in
renewal policies. This is the same situation we encountered in the
aftermath of September 11th, which prompted enactment of TRIA. While
this particular dynamic is not present in the New York marketplace, the
few states that have not allowed insurers to file coverage limitations
fear that without TRIA, insurers will be unwilling to underwrite many
businesses that want appropriate and reasonably priced terrorism
insurance coverage.
To address this situation, Congress should promptly act to extend
TRIA for two years. Time is needed for Congress to receive and review
the report from the Treasury on June 30, 2005, and then have roughly
fifteen months to digest and debate the future Federal role related to
acts of terrorism before reaching another milestone for insurers and
American businesses.
The NAIC stands ready to assist Congress in developing an
appropriate method for continuing the Federal terrorism reinsurance
backstop. The NAIC has begun to discuss a concept that would involve
the Federal Government only for mega-catastrophes. It would encourage
the use of the private sector to insure more moderate catastrophe risks
using traditional methods such as reinsurance, access to financial
market products, and risk diversification, along with changes in U.S.
law that would allow insurers to build tax-deferred catastrophe
reserves.
Workers' Compensation and Group Life Insurance
There are two major types of insurance that cause insurers special
concern about whether they can continue to underwrite them without some
form of assistance from the Federal Government. The first is workers'
compensation, which is a property-casualty product that provides
coverage for work-related injuries, illness, and death. It covers lost
wages, provides unlimited medical benefits and, in most states,
provides rehabilitation benefits to get injured workers back on the
job. In the event of death on the job, worker's compensation provides
monetary death benefits to the surviving spouse and children. It also
provides employers with liability coverage if an employee pursues legal
action against an employer in court. Workers' compensation is currently
included under TRIA.
State laws do not allow an insurer to exclude or limit worker's
compensation coverage, except as permitted by state law. As a result,
an insurer underwriting this risk without adequate reinsurance is
subject to a large potential loss if there are a significant number of
employees at a single location. The American Academy of Actuaries
estimates that ``a modest-sized insured with 200 employees could easily
generate a terrorism related event of $50 million. This presumes death
of all employees and typical death benefit of $250,000 per employee.''
\1\
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\1\ American Academy of Actuaries, P/C Extreme Events Committee May
4, 2004 Report, P/C Terrorism Coverage: Where Do We Go Post-Terrorism
Risk Insurance Act?, Page 14.
---------------------------------------------------------------------------
The second type of coverage causing insurers special concern is
group life insurance, which is not currently included in TRIA. Like
workers' compensation, this insurance coverage is vulnerable to risk
concentration problems. For example, if a business has 1,000 employees
at a given location, the pricing employed by life insurers for group
products probably assumes that three or four employees might die in a
given year. If on another instance, a location with 1,000 employees is
hit by a terror attack and all of them die, the insurer has an enormous
financial exposure from a single occurrence.
Unlike worker's compensation, there is no statutory requirement for
group life that prohibits an insurer from limiting available coverage
for acts of terrorism in some fashion. However, the employer, the
insurer, the insurance industry in general and the American economy
would suffer if an insurer is only able to pay a fraction of the policy
face amount in a mass casualty situation.
Insurance regulators are not inclined to approve exclusionary or
limiting language in those states that have approval authority over the
wording in group life insurance contracts. Although there is some level
of private reinsurance available for group life coverage, it is not
sufficient to cover catastrophic terrorism losses. While the NAIC has
not taken a formal position on whether group life should be included in
TRIA or another form of Federal backstop, regulators have heard these
concerns expressed by group life insurance underwriters.
The CBO Report
In January 2005, the Congressional Budget Office (``CBO'') issued a
paper entitled ``Federal Terrorism Reinsurance. An Update'' that
concluded, in part, that TRIA's ``zero premium'' coverage could serve
to dampen incentives for owner's of assets to engage in loss control.
The report stated that if the ``government continued to subsidize
terrorism insurance it would probably contribute to deferring the
private-sector's long-term adjustment to the increase in risk,'' and
this in turn would result in greater future losses than could otherwise
be avoided. I wish to inform you that in New York State, and indeed,
throughout the country, we see little evidence to support the
conclusion that TRIA has resulted in owners failing to take appropriate
steps to protect their assets from terrorist attacks. To the contrary,
the evidence demonstrates that owners have invested heavily in
strengthening disaster preparedness and response efforts in the wake of
the 9/11 terrorist attacks notwithstanding the existence of TRIA.
For example, since 9/11, most large commercial and many multi-
family residential buildings in New York and elsewhere regularly
subject entrants to security checks before permitting entry. Sensitive
locations may even require visitors to submit to background checks
prior to entry. Structural design has also changed substantially in
response to the terrorist threat not the least of which is the
ubiquitous use of barriers to thwart vehicle-borne explosive devices.
While risk mitigation and loss control efforts are important tools
to reduce exposure, the sad fact is that such measures can do little to
avoid the catastrophic consequences of a successful large-scale
terrorist attack. The country has taken such steps to improve airport
and aircraft security and to harden many of our commercial enterprises
and government facilities, but we still remain vulnerable to terrorist
attack. The steps taken to mitigate losses, however, may result in
countermeasures by terrorist that could lead to attacks on buildings or
infrastructure that we might not have previously considered targets.
This inescapable reality demonstrates the need for a Federal backstop
to help in dealing with potential losses of this magnitude. Of course,
loss control must be a part of any long-term solution in the private
sector to manage terrorism exposures. Mitigation techniques do not,
however, address the issue of financing the catastrophic losses should
such losses occur. No amount of mitigation can result in foolproof
guarantees that losses will not occur. Terrorism coverage in today's
world is an integral part of any businesses' risk management efforts.
Without a Federal backstop we could face market disruptions, and
terrorism insurance will likely become less affordable or even
unavailable to consumers. The insurance industry has not yet built the
capacity to respond adequately to the terrorism exposure and extending
TRIA for an additional period will allow the industry the time to
appropriately accept increasing levels of this risk.
Conclusion
We strongly urge Congressional action to extend TRIA or enact an
alternative form of Federal terrorism backstop this year in order to
avoid market disruptions likely to occur in the absence of a Federal
backstop program. Immediate action by Congress will help ensure the
insurance market's continued role in supporting economic development.
In addition, it will allow Congress adequate time to fully evaluate the
Treasury Department's June 2005 report and recommendations.
The NAIC stands ready to assist Congress in developing an
appropriate method for continuing the Federal terrorism reinsurance
backstop. The extension of TRIA will provide American businesses with
the essential insurance coverage needed to successfully operate in
today's uncertain global environment.
NAIC Resolution to Extend TRIA
June 12, 2004
RESOLUTION
Whereas, the Terrorism Risk Insurance Act of 2002 (TRIA) was
adopted by Congress to provide a temporary Federal shared loss
program for incurred losses resulting from certain acts of
terrorism to protect American businesses by minimizing market
disruptions and ensuring the widespread availability and
affordability of property and casualty insurance for terrorism
risks;
Whereas, the TRIA was adopted by Congress to allow a
transitional period for private markets to stabilize, resume
pricing of terrorism insurance, and build capacity to absorb
any future losses, while preserving the benefits of state
regulation and consumer protections;
Whereas, the presence of the Federal backstop has provided a
measure of security to the insurance industry and has enabled
them to extend offers of coverage for acts of terrorism in the
wake of the tragic events of September 11th;
Whereas, insurance regulators do not believe the insurance
marketplace is ready to take on the entire risk of providing
coverage for acts of terrorism;
Whereas, insurance regulators have received contingent filings
from advisory organizations and insurers that would reinstate
the coverage limitations that were in effect prior to TRIA's
enactment, in the event Congress does not act this year to
extend TRIA;
Whereas, there are many who believe that the U.S. economy
remains vulnerable to terrorist attack;
Whereas, the take up rate for terrorism risk insurance has
increased in recent months;
Whereas, unknown frequency, coupled with the potential for
substantial severity of a loss makes coverage for acts of
terrorism one that insurers might choose to avoid if given the
opportunity; and
Whereas, insurers and their reinsurers remain uncertain that
the efforts of the U.S. Government are sufficient to protect
citizens from terrorist acts, or at least have become more
predictable than they are today, and as a result they will be
reluctant to accept complete risk transfers from American
businesses, particularly those businesses that they view as
having a greater risk of loss from acts of terrorism.
Now, Therefore, Be It Resolved, That:
State insurance regulators urge Members of Congress to adopt a
short-term extension of TRIA to avoid market uncertainty this
fall. The short-term extension would provide sufficient time
for the next Congress to consider longer-term solutions to the
terrorism insurance risk and the nation's economic security. An
extension of two years would provide Congress with the time it
needs to evaluate the study and report required of Treasury on
the effectiveness of TRIA and the insurance industry's capacity
to provide terrorism insurance. It will also provide sufficient
time to review and evaluate information provided by others.
Be It Further Resolved, That:
The NAIC urges Members of Congress to encourage the Secretary
of the Treasury to extend the ``make available'' requirement
into Year 3. This will avoid any market disruptions that would
occur in the absence of the mandated coverage offer. Such
action will ensure the insurance market's continued role
supporting economic development.
----------
PREPARED STATEMENT OF ERNST CSISZAR
President, Property Casualty Insurers
Association of America
April 14, 2005
Introduction
My name is Ernie Csiszar and I am President of the Property
Casualty Insurers Association of America. PCI is a trade association
representing over 1,000 property/casualty insurers that write almost 40
percent of all the insurance policies in the United States. PCI was
founded on the philosophy that consumers are best served by free, fair,
and well-regulated insurance markets in which a wide variety of
financially healthy companies compete for business on the basis of
price, product innovation and quality, and customer service.
I would like to commend the members of this Committee for
recognizing that terrorism insurance is a national, economic, and
homeland security issue, for your commitment to seeking a long-term
solution to this problem, and for understanding the critical role of
the federal government in solving this problem. I am here today to give
you our views of this issue. I am also here to commit to you that PCI
will work with this Committee to explore all aspects of this problem
and all possible solutions in order find a program that will protect
our nation's economic security and our policyholders.
The Importance of a Federal Role in Terrorism Insurance
Our members believe in the power of free markets and support
competition-driven solutions to public policy problems. We think
consumers are best served, wherever possible, by markets that are free,
fair, and well regulated. That being said, there are some instances--
terrorism insurance clearly being one of them--where there is clearly a
need for federal involvement.
This fundamental point has been underscored recently when Federal
Reserve Board Chairman Alan Greenspan said in his testimony before the
House Financial Services Committee, ``There are instances in which
markets do not or cannot work, and....I have not been persuaded that a
private market for terrorism insurance works terribly well.''
We all know that the threat of a terrorist attack on our nation and
our economy is still very real. CIA Director Porter Goss recently
testified that an attack on our nation is ``only a matter of time'' and
that our enemies continue searching for ways to make future attacks
much more devastating than September 11, including the use of nuclear,
biological, chemical, or radiological weapons.
We believe our nation must fight terrorism on all fronts, using
military action, homeland security measures, and programs that protect
our economic security. We believe that a public/private partnership,
harnessing the power and security of the Federal government with the
innovation and agility of private markets, is the best way to protect
our economy.
The Impact of TRIA
I would like to offer several comments on the Terrorism Risk
Insurance Act of 2002. TRIA was adopted in November 2002, more than a
year after the September 11 attacks. It was debated significantly in
the House and the Senate and emerged from long and thoughtful
consideration of the issues involved, observation of the response of
private markets to terrorism risk, and evaluation of alternative
approaches. Ultimately, TRIA was not done in haste and reflects the
well-considered wisdom of the Congress and the Administration. We
believe it was a tremendous achievement by the 107th Congress.
TRIA provides essential support and confidence to private insurance
markets. The program has created a degree of certainty about the
maximum losses that any individual company or the entire insurance
industry could suffer and, in doing so, has helped foster what market
there is for terrorism insurance. According to the latest statistics,
roughly 44 percent of all business insurance consumers buy terrorism
coverage. Some have feared that TRIA would ``crowd out'' the
development of a meaningful private market for terrorism reinsurance.
On the contrary, we believe it gave the support needed to allow such a
market to begin to develop. Without TRIA, we don't believe we would
have seen the limited development that has occurred.
Our members write insurance policies for individuals and businesses
in every state and virtually every community in our nation. Their
commercial insurance policyholders--real estate developers, builders,
manufacturers, retail stores, malls, apartment complexes, churches,
mosques and synagogues, schools, and universities--have benefited
enormously from TRIA. They know the threat of a terrorist attack is
real and many have made a deliberate and considered decision to protect
themselves from the economic risks of future attacks.
As you know, TRIA will expire at the end of this year. Given the
many benefits it has provided, I am here to tell you that all of us--
Members of Congress, insurers, and policyholders--must act now to
develop a long-term solution to the problem of insuring terrorism risk.
We commend Senators Bennett and Dodd and their cosponsors for
introducing S. 467 to extend TRIA for another two years. They have
recognized the very serious nature of this problem and are working to
solve it in a constructive way. We favor the modifications they have
suggested--including a ``soft'' landing to allow policies written in
the second year to naturally expire, including group life insurance
under the program, and keeping individual company retentions level.
At the same time, we also believe that a short-term extension of
TRIA can and should be seen as the basis for developing a long-term
solution to the terrorism insurance problem. I commit to you today the
resources of PCI to work with members of Congress and the business
community to develop an effective, market-driven system that
establishes a long-term, public/private partnership to address the
issue of terrorism insurance once and for all.
The Unique Challenge of Underwriting Terrorism Insurance
Our members are in the business of assessing, pricing, and
underwriting risk. They work closely with their policyholders to reduce
their exposure to all types of loss, including terrorism. Insurers have
always risen to the challenge of underwriting and paying for
catastrophic losses. Our industry paid nearly $35 billion in claims
from the September 11 attacks, not to mention the enormous payments we
have continued to make, as always, from ``normal'' natural disasters
such as hurricanes and earthquakes.
When we tell you that terrorism risk is different from other
catastrophes, we do so for several reasons. The differences arise
mostly from differences in severity and predictability. The size of the
potential losses from a terrorist attack dwarfs the financial resources
of the insurance industry. The cost of the September 11 attacks was by
far the largest insured loss in history. The amount of insurance
industry capital devoted to insuring the lines of business most likely
to be affected by terrorist attacks (commercial property, workers
compensation, etc.) amounts today to approximately $148 billion or 40
percent of the total capital of the industry. Since September 11,
insurers and catastrophe modeling experts have modeled many potential
terrorist attack scenarios--these experiments convince us that there
are many attacks, especially those involving the use of nuclear,
biological, chemical, or radiological weapons, that are well beyond the
financial capacity of our industry to withstand. CIA Director Goss'
recent testimony underscored our concerns.
Second, this risk is impossible for insurers to assess and price
based on our current knowledge. Weather-related catastrophes are much
more predictable. We have years of experience with sophisticated models
that tell us not only where these losses are likely to occur, but on
average how large they might be and how often they might happen. We
know none of this about terrorism. Without a distribution of either the
ultimate cost or the probability of loss, we don't have a method to
develop the appropriate charge for the coverage nor do we know what
losses to expect.
These problems are the reasons that a vibrant, substantial, and
healthy private market for terrorism reinsurance has not emerged since
September 11. We are concerned that there appears to be a belief in
some quarters that allowing TRIA to expire with nothing in its place
will automatically spur the development of a significant private market
that can handle all terrorism risk. We see no reason to expect that
will happen.
Limits on the Private Sector Role
I have spoken above of our support for the greater use of private
sector responses to this risk. At the same time, it is critical that
policymakers also recognize the limits of the private sector response
and why a federal role is essential. As already noted, insurers face
significant problems underwriting this risk because of the enormous
potential losses and because we don't know size or frequency
distributions for the risk.
In addition, private markets require that buyers and sellers are
able to determine for themselves whether a product will be offered and
under what terms and conditions. If there is to be a greater private
role in solving the terrorism insurance problem, there must also be
federal support for giving insurers and insurance markets more freedom
to negotiate these terms and conditions. Let me offer some examples of
the problems we face:
<bullet> In 19 states, insurers writing commercial property insurance
are still required to cover losses from a ``fire following'' a
terrorist attack, due to restrictions in 1940s-era laws enacted for
a very different world. This is true even if insurers and
policyholders would prefer to alter coverage.
<bullet> State regulators in three key states (New New York, Florida
and Georgia) continue to refuse to allow insurers to exclude or
limit coverage for terrorist attacks after the expiration of TRIA
this year. This refusal continues even if the insurer and the
policyholder both might want the flexibility of a free market.
<bullet> TRIA itself provides state oversight and control of the rates
insurers can charge for terrorism coverage, with the result that
insurers cannot truly experiment with the appropriate price for
this coverage and, if they try, must fear potential future
requirements that they return supposedly ``excessive'' rates.
<bullet> No state allows an insurer writing workers compensation to
exclude or limit coverage for losses caused by terrorism. The only
way workers compensation insurers can avoid this risk is to stop
writing certain insureds--i.e., to walk away from policies they
think may pose excessive risk. However, even when they do so, they
face exposure in many states to losses from those same policies
through mandatory residual market pools and guaranty funds.
We understand the desire for consumer protection behind many of
these requirements, however, we must emphasize that it is inconsistent
to urge a more robust private sector response without giving the
private sector the tools it must have to build that response.
Guiding Principles for a Long Term Solution to the Terrorism
Insurance Problem
As you consider how to proceed, we believe there are several
important principles to keep in mind when evaluating long term
solutions to the terrorism insurance problem:
<bullet> Terrorism is the most significant risk facing our nation's
economic security today. It is critical that it be addressed. It
requires uniform protection and a nation-wide response (not state
by state). The fight against terrorism is a long-term battle and we
should now build on the steps initially taken by Congress to
provide a long-term solution.
<bullet> The insurance industry does not have the financial capacity to
bear the total risk of terrorism losses due to the nature of the
exposure and the scale of the risk. Addressing this risk to our
nation's economic security requires a partnership between the
private sector (and its infrastructure) and the Federal government.
This partnership must protect the public, the nation's economy and
insurers' ability to meet their many obligations to their
policyholders.
<bullet> A long-term solution should minimize cross-subsidies by line
of insurance and by insurer, maximize incentives for sound economic
underwriting and pricing, and cover exposures most seriously
threatened by terrorism. There should be an equitable distribution
of costs based on geographical location and risk of loss, which
includes potential losses to life, property and agriculture, and
critical economic infrastructure.
<bullet> The program should cover losses from both domestic and foreign
terrorism events.
<bullet> The program should be consumer friendly and implementation
costs kept reasonable by following standard industry business
practices.
Components of an Alternative Solution
I want to emphasize the need for us to develop a long-term solution
to the terrorism insurance problem. PCI believes that all reasonable
ideas should be considered and, to that end, I'd like to offer several
thoughts on such a design. Such ideas might include:
<bullet> Federal support for giving insurers and insurance markets more
freedom to negotiate terms and conditions of coverage. This point
has been discussed above and I would only add that if solutions are
going to be based on free market principles, then the market must
be allowed to work freely.
<bullet> Treating the unique exposures resulting from use of nuclear,
biological, chemical and radiological weapons differently that
those involving other terrorist tactics. These risks have never
been part of the insurance industry's assumed risk profile--there
has never been a true, private market for this insurance and there
is no reason to believe one will arise now in the face of the
threats we face. Such attacks pose the risk of damage and losses
far beyond the financial capacity of the insurance industry to
sustain and may require a different approach to solve.
<bullet> There is also a need to recognize and, in the longer term, to
deal with the exposure faced by homeowners and their insurers due
to the risks of a devastating attack using nuclear, biological,
chemical, or radiological weapons.
<bullet> We understand that some want to see individual company and/or
industry-wide retention levels increase so that private insurers
accept more of the responsibility for paying terrorism insurance
losses. We have significant concerns about this and want to make
clear that any such change must be coupled with a program that
allows insurers to reduce their own individual retention levels.
Moreover, such increases would have to be gradual so that each
insurer can manage the increase in its own exposures. A sudden,
ill-planned transition could have a catastrophic impact on
America's economy. Finally increasing the exposure of private
markets must be coupled with more freedom to underwrite and a way
to allow insurers to collectively access wider capital markets
supported by the federal government.
<bullet> Enabling the industry to form a tax-exempt entity or entities
to provide reinsurance or to allow companies to reduce their
individual company retention level to some manageable level. The
tax-exempt entity might also be allowed to issue post-event bonds
or to use some other financing mechanism to pay for losses and
allow the use of longer time horizons to absorb those losses.
<bullet> Allowing the accumulation of funds through the establishment
of individual company tax-deferred reserves.
<bullet> Ensuring that market-based solutions are built on the concept
of risk-based pricing. Cross-subsidies by line of insurance and by
insurer should be minimized, and sound underwriting and pricing
should be rewarded.
<bullet> Allowing group life insurers to gain access to the public/
private partnership, given their very serious exposure to
catastrophic losses from terrorism, and ending the arbitrary split
now in TRIA between foreign and domestic terrorism losses.
Right now these are just ideas, not fully developed solutions. PCI
has been reviewing the merits and consequences--including unintended
ones--of each and the association is committed to working with you to
explore these options and to create a solid, long-term public/private
partnership to address this critical problem.
Conclusion
Our members again commend you and your colleagues for addressing
this issue and for offering ideas for a solution. We believe terrorism
is the most significant threat today to America's economic security and
we applaud your efforts to address this very serious problem.
We believe TRIA represents the considered will of the Congress and
has worked well at very low cost to the government. It has been a
success and has promoted the ongoing development of private markets for
terrorism coverage.
Finally, we want you to know that our members are committed to
addressing this issue. We have been working closely and diligently with
them, and will continue to do so, to identify and explore potential
solutions to this problem. We look forward to continuing to work with
you and your colleagues to find a solution.
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STATEMENT OF BRIAN DUPERREAULT
Chairman, ACE Limited
On Behalf of the American Insurance Association
April 14, 2005
Chairman Shelby, Ranking Member Sarbanes, and members of the
committee, my name is Brian Duperreault. I am Chairman of ACE Limited
(ACE). I appear before you today representing ACE and our national
property-casualty insurance trade association, the American Insurance
Association (AIA).
I would like to first thank the committee for its leadership on the
important issues related to terrorism insurance. The Terrorism Risk
Insurance Program--created by the Terrorism Risk Insurance Act of 2002
(TRIA)--is part of our nation's critical infrastructure, strengthening
and securing our economy against the clear and present danger we face
from terrorists bent on destroying our way of life. I would also like
to particularly thank Senators Bennett and Dodd for recently
reintroducing legislation to temporarily extend TRIA. Clearly the bill
recognizes the critical importance of TRIA in stabilizing the market
for terrorism risk insurance by making terrorism insurance broadly
available to all businesses by requiring insurers to make terrorism
coverage available in the policies they issue. A temporary extension
will help prevent market dislocation and provides an opportunity for
the industry to continue analyzing options for a long-term solution.
Specifically, the Dodd-Bennett bill establishes a mechanism to consider
long-term public/private solutions for managing terrorism risk. We
continue to devote considerable time, energy and effort to work through
ideas that could serve as long-term solutions, and we remain fully
committed to working with Congress and the Administration to craft a
workable long-term solution that all stakeholders can support. We
endorse the Dodd-Bennett bill, especially as it contains a mechanism
that will ensure development of a long-term public/private partnership,
a goal that we all share and that we will all continue to work toward.
On behalf of ACE and all of AIA's member insurers, I would like to
urge you to continue providing a federal terrorism risk insurance
mechanism to protect the United States from the potential economic
devastation that can come from catastrophic terrorist attacks.
The ACE group of property-casualty insurance companies conducts
business throughout the United States and in more than 50 other
countries. We employ more than 4,000 employees here in the U.S., and
trace our long, proud history in this country back to 1792, with the
establishment of the Insurance Company of North America, the first
investor-owned American insurance company. ACE is among the largest
property and workers' compensation insurers for businesses and
municipalities of all sizes. Our customers include a broad array of
organizations that rely on a stable market for terrorism insurance.
These customers include many financial institutions, energy companies,
hotel chains and professional sports leagues.
Congress enacted TRIA to ensure that our nation could prepare for,
and recover from, financial devastation caused by catastrophic
terrorism attacks. The public/private ``shared loss'' program
established by TRIA also helps prevent terrorists from accomplishing
one of their key objectives--undermining America's economic security.
TRIA has helped stabilize the private market for terrorism risk
insurance, and has made terrorism insurance broadly available to all
businesses that want and need this vital coverage. However, TRIA
provides only a temporary backstop; it expires at the end of this year.
Unfortunately, our nation's exposure to the terrorism threat will not
expire at the end of this year. Every day, new information about this
continuing threat is revealed.
For example, two weeks ago, the Final Report of the Bipartisan
Commission on the Intelligence Capabilities of the U.S. Regarding
Weapons of Mass Destruction, concluded, ``We still know disturbingly
little about the weapons programs and even less about the intentions of
our most dangerous adversaries.''
On February 16, Federal Bureau of Investigation (FBI) Director
Mueller and Central Intelligence Agency (CIA) Director Goss testified
before the Senate Select Committee on Intelligence at a hearing on
``Current and Projected National Security Threats to the United
States.'' The FBI and the CIA emphasized their concerns about the
threats of nuclear, biological, chemical, and radiological (NBCR)
attacks, with Director Goss specifically stating that ``[i]t may be
only a matter of time before al Qaeda or another group attempts to use
chemical, biological, radiological and nuclear weapons.'' Director
Mueller echoed this prediction, saying that he was ``very concerned
with the growing body of sensitive reporting that continues to show al
Qaeda's clear intention to obtain and ultimately use some form of
chemical, biological, radiological, nuclear or high-energy explosives
material in its attacks against America.'' Certainly, the threat of
terrorism will not diminish before December 31, 2005, when TRIA is
currently scheduled to expire. What Congress does now to address these
catastrophic threats, including NBCR, will serve as an economic legacy
for future generations.
We urge you and your colleagues to continue to focus on the
fundamental importance of a federal backstop. As TRIA's end date nears,
insurers are making decisions now whether or not to write terrorism
insurance without the certainty of a federal backstop. There are those
who suggest that TRIA should be allowed to expire and that the ``free
market'' should respond to fill the need for terrorism insurance.
However, property-casualty insurers do not operate in a free market
environment. In the existing state regulatory structure, insurers:
<bullet> cannot exclude or limit terrorism coverage in certain
commercial lines such as workers' compensation insurance or
statutory ``fire-following'' coverage for property insurance
policies in many states; and,
<bullet> cannot exclude terrorism coverage in certain states whereby a
government backstop is absent.
And, in virtually all of the states, there is no ``free market''
because of a complex system of government price and product controls
that artificially suppress terrorism insurance rates and deny product
choices to consumers.
Under these regulatory conditions, failure to provide a federal
backstop is tantamount to conscripting insurers to cover terrorism risk
when they cannot adequately price for this potentially ruinous exposure
and, if provided a truly free market, may prefer to avoid entirely. The
insurance industry simply does not have the capacity to be the nation's
insurer of all terrorism risks. Unfortunately, insurers are faced with
a conundrum--take on this uninsurable risk at pricing suppressed by the
states--or stop writing insurance altogether. This is not a free
market; it is a forced market, and it is one important reason why the
federal government should continue to play a role in managing this
exposure.
The insurance industry can play a vital role in a post-attack
recovery. Indeed, we are proud of our ability to put thousands of
``boots on the ground'' immediately after the tragedy of September 11.
We stand ready to provide those claim evaluation and processing
services again. The insurance industry also offers a wide-ranging
network of contacts with U.S. businesses that can be used to
communicate with our policyholders to further assist in post-event
reconstruction. However, insurers simply can't afford to gamble our
solvency on the bet that there will never again be a major terrorist
attack on the United States.
The ``all or nothing'' proposition facing the industry benefits
neither insurance customers nor the economy. As Standard & Poor's
recently noted, ``[m]any policyholders are now inking deals for
property-casualty coverage that exclude terrorism coverage after TRIA
expires. . . .[F]or every day that such coverage is in effect between
January 1, 2006, and the day their policies end, they will be without
terrorism coverage if TRIA is not extended.'' This will, in turn, have
a severe, negative effect on the national economy, including job loss,
stalled commercial transactions and delayed construction projects.
Market stability provided by a federal backstop will be replaced by the
market uncertainty that characterized the post-September 11, pre-TRIA
economy. Accordingly, we urge Congress to act as soon as possible to
provide a continuing federal backstop and to consider long-term
solutions for managing our nation's economic exposure to catastrophic
terrorism.
The United States is in a critical phase of the global war on
terrorism. This war involves urgent national security issues coupled
with a long-term commitment from the government, industry and public to
reduce and, hopefully, eliminate threats and risks associated with
terrorist activity. As a key component of national economic security,
the challenges facing the private terrorism insurance market are
similarly critical and stretch well beyond TRIA's expiration.
While I do not use the term ``war'' lightly, we are certainly
engaged in a war, and terrorism and war share certain features that
make it extremely difficult, if not impossible, for private markets to
bear their risk. War and terrorism are not fortuitous. Acts of
terrorism, like acts of war, are premeditated, planned and executed
with a specific purpose by individuals (in the case of terrorism) and
governments (in the case of war) that actively seek to defy
predictability, discernable pattern or advance warning. In addition,
war, like today's brand of catastrophic terrorism, is waged against
America, not against particular businesses.
In this context, we also urge you to further consider several
underlying characteristics of terrorism risk in the United States that
make catastrophic terrorism uninsurable as you debate the best way to
secure our economy against terrorists in the years to come.
First, while the private sector has made significant progress in
terms of accumulation management of terrorism risk, we continue to lack
both the necessary capacity and sufficient marketplace data to handle
catastrophic terrorism losses on our own. Under certain plausible event
scenarios, estimated insured losses from future catastrophic terrorist
attacks on U.S. soil could exceed $250 billion.\1\ These levels greatly
surpass the entire commercial property-casualty industry's estimated
capacity of about $176 billion. Importantly, this capacity is not just
dedicated to terrorist attacks; it is needed to back all commercial
risk in order to cover claims from such things as natural disasters or
workplace incidents unrelated to terrorism. In 2004 alone, hurricanes
took approximately $25 billion of industry capital for losses.
---------------------------------------------------------------------------
\1\ Tillinghast Towers Perrin, Workers' Compensation Terrorism
Reinsurance Pool Feasibility Study, Summary of Study Findings and
Conclusions, p. V (2004) (``Terrorism experts have developed plausible
scenarios in which the estimated total insured losses from a single
event could exceed $250 billion.'').
---------------------------------------------------------------------------
While other commercial risks can be spread through reinsurance,
reinsurers have no significant appetite for terrorism risk. Reinsurance
plays a critical role in the financial management of catastrophic
losses by limiting primary insurer liability on specific risks,
increasing insurer capacity and stabilizing insurers' financial
results. As a result of this lack of appetite to reinsure terrorism
risk, current terrorism reinsurance capacity, according to the
Reinsurance Association of America, is limited to between $4 billion
and $6 billion. Only a small amount of this limited reinsurance
capacity is available for NBCR terrorism risk. Because of this
withdrawal of the largely unregulated global reinsurance network from
the terrorism risk--a sign of the ``free market's'' negative evaluation
of the terrorism risk--U.S. insurers have few external partners with
which to spread this catastrophic risk.
Moreover, private market mechanisms remain insufficient to spread
the risk of catastrophic terrorism in a meaningful way. In a 2004
Workers' Compensation Terrorism Reinsurance Pool Feasibility Study,
Tillinghast Towers Perrin cited ``lack of capacity'' as the primary
reason why a voluntary workers' compensation terrorism reinsurance pool
would not be a viable mechanism to handle mega-terrorism risk. This
conclusion is not surprising because pooling does not introduce new
capacity for the terrorism risk--it merely moves it around for marginal
increased efficiency. This conclusion is not unique to workers'
compensation insurance, but would apply to the ability of a pool to
address catastrophic terrorism in other lines of business, such as
property insurance, including business interruption coverage.
The same conclusion holds true for other capital market tools. For
example, some academics have discussed catastrophe bonds as a source of
new capital for terrorism risk. To date, however, there have been only
two bonds underwritten, and those included terrorism as a small
component of risk among a number of traditional natural catastrophe
exposures; in fact, one was only to cover the risk of event
cancellation. Despite the confidence of a few theorists who feel that
catastrophe bonds represent promising, untapped sources of profit-
seeking capital that could be used for terrorism risk, the reality is
that debt and securities markets remain unconvinced and reluctant to
provide such capital instruments. Put simply, investors are simply
unwilling to gamble capital on an unforeseeable, unique event such as a
catastrophic terrorist attack when there are other attractive, much
less risky, investment alternatives.
Second, the threat of catastrophic terrorism remains real and
unabated. The Bush Administration has repeatedly alerted Americans to
the increased possibility of terrorist attacks. Since September 11,
2001, the United States has been on a constant, elevated state of alert
for terrorist activity. Recently, as noted above, top intelligence and
law enforcement officials from the Administration have reported that
terrorists are regrouping and planning possible new attacks against the
United States.
Third, private sector information about terrorism risk is
incomplete. Contrary to traditional evaluation of insurance risks,
information availability and sharing about terrorism risk is
asymmetric. Insurers and policyholders do not have--nor should they
have--access to classified generalized or specific threat information
in the hands of the U.S. government. Therefore, insurers cannot
properly evaluate the many complex risks associated with terrorism.
This ``information vacuum'' makes all risk transfer and management
decisions about terrorism a dicey proposition.
The relative infancy of terrorism modeling also contributes to the
risk's uninsurability. While modeling firms have worked diligently to
produce terrorism risk models to predict terrorism events in the United
States, they have not been able to model accurately for the frequency
of terrorist attacks, the terrorists alone control that variable. These
models instead focus only on predicting the impact terrorism has on its
victims. Office towers can be built or retrofitted to withstand
earthquakes in Los Angeles or hurricanes in Miami (making them more
insurable), but few businesses would want to turn their offices into
hardened bunkers. Even then, terrorist excel in adapting to overcome
such loss mitigation measures, or turn their attention to ``softer''
targets.
Unfortunately, natural catastrophe modeling--which is a much more
mature science--does not aid the terrorism modeling process. Past
natural catastrophes are predictive of the nature, frequency and
severity of future natural catastrophes. Most natural disasters also
occur with at least some prior warning. Because of this element,
insurers can track when and where natural catastrophes are likely to
strike, the type of damage they will cause, and which areas are most
vulnerable, and can exercise loss control measures to protect against
catastrophic loss.
In contrast, past terror attacks are not predictive of future
terror attacks, and the full range of possible methods of attacks can
never truly be known. Terrorists rely on surprise to maximize the
impact of an attack, so the attack usually comes without warning. In
fact, whether an event is a ``terrorism'' attack might not be known
until after it occurs. This ``man-made'' threat, which is limited only
by the imagination of a terrorist, is one that simply cannot be
forecast. In addition, terror attacks can be opportunistic or carefully
planned for years--or both, which can change the outcome of the attack
and the resulting losses.
Fourth, while insurers strongly support risk mitigation efforts and
are working with policyholders on terrorism risk analysis, mitigation
alone cannot remove the terrorist threat or significantly reduce losses
from certain types of terrorist attacks, such as those involving NBCR
weapons.
Also, unlike other risks, terrorism is a wholly interdependent risk
that defies traditional loss control methods. Loss control or
mitigation techniques employed by one commercial business may not be
sufficient to protect that enterprise from catastrophic loss. The World
Trade Center is the most compelling-but not the only--example of the
interdependent nature of terrorism risk. The World Trade Center was a
model of security and disaster planning after the 1993 truck bombing,
yet nothing done at the World Trade Center could have prevented planes
leaving airports in other cities with hijackers aboard, and nothing
done at the World Trade Center could have prevented planes being used
as weapons from flying into the towers, and destroying them along with
neighboring buildings. The interdependent nature of terrorism risk,
with vulnerability measured by the weakest link in the chain, minimizes
the effectiveness of even the best business-by-business loss control
programs.
Finally, the challenges facing insurers with respect to
catastrophic ``conventional'' terrorism risk are greatly magnified by
the potential for NBCR terrorism. NBCR terrorism demonstrates that even
the severity component of a terrorist attack is difficult to predict.
Potential terrorism scenarios now routinely include discussion of NBCR
events. Recent intelligence reports by the Administration have centered
on the possibility of a so-called ``dirty'' bomb or a suitcase nuclear
explosive; weapons capable of producing precisely the type of
catastrophic terrorism that is difficult to quantify and whose
emergence threatens the solvency of the property-casualty insurance
industry. The anthrax attacks perpetrated through the U.S. postal
system, (including the U.S. Senate's own mail facility), even though
limited in scope and severity, only serve to underscore the random
quality and myriad potential consequences associated with such events.
As a result, insurers remain reluctant to provide NBCR coverage for
terrorism risks in their policies beyond that required by state law.
Key federal officials have also acknowledged the difficulty of
private markets addressing the risks associated with terrorism. Just
weeks ago, Federal Reserve Chairman Alan Greenspan told the House
Financial Services Committee that, ``there are regrettable instances in
which markets do not work, cannot work.'' Chairman Greenspan added:
``You cannot have a voluntary market system and the creation of
markets, especially insurance markets, in a society subject to
unanticipated violence .-.-. And while I think you can get some
semblance of terrorism insurance [without government involvement], I
have not been persuaded that this market works terribly well.''
Having established the characteristics of catastrophic terrorism
that render it uninsurable, AIA and its members also understand that
TRIA was designed as a temporary stabilizing mechanism, and that a
long-term shared responsibility program must be developed, enacted, and
implemented. The Dodd-Bennett bill paves the way to such a program by
tying a short-term extension to mandatory study of a long-term public/
private solution, utilizing the Presidential Working Group on Financial
Markets to facilitate that discussion.
We also have been working diligently with the rest of the industry
and the policyholder community to identify potential long-term options
for shared responsibility in managing catastrophic terrorism risk.
While our progress has been slowed during the implementation phase of
TRIA and by impediments to the free market that are a product of our
state insurance regulatory structure, the structural elements of a
long-term program can be gleaned from our experience in a post-
September 11th world. That experience has shown us that catastrophic
terrorism poses the greatest threat to the insurance industry and the
economy at large, led by the dynamic uncertainty of NBCR events.
To be workable, we believe any long-term public-private partnership
to manage terrorism risk must recognize the need for public--rather
than private market--responsibility for NBCR risks. In addition, we
believe there should continue to be a risk-sharing mechanism for
catastrophic terrorist attacks using conventional weapons that go
beyond available industry capacity. Both of these conceptual elements
of a long-range program would be aided by a true ``free market''
environment for terrorism risk insurance--an environment that fosters
more opportunities for insurers to provide coverage and more options
for policyholders to obtain coverage. While a free market environment
for terrorism risk insurance may not change the underlying
characteristics of catastrophic terrorism that make it uninsurable, it
will supply the flexibility that the current regulatory structure
lacks.
ACE and AIA stand ready to work with Congress and other interested
stakeholders to translate these long-term concepts into legislation,
but our commitment should not prevent this committee from moving
legislation as quickly as possible in order to avoid the expiration of
a federal backstop. The committee's important work today on the future
of terrorism risk insurance will ensure that terrorists fail in their
mission to undermine this nation's economic security.
----------
PREPARED STATEMENT OF FRANKLIN W. NUTTER
President, Reinsurance Association of America
April 14, 2005
Good morning Chairman Shelby, Ranking Member Sarbanes, and members
of the Committee. My name is Frank Nutter and I am President of the
Reinsurance Association of America. Incorporated in 1969, the RAA is a
national trade association based here in Washington, D.C. We are the
sole organization representing the U.S. property and casualty
reinsurance industry. Our membership consists of U.S. domestic
reinsurers and reinsurance brokers.
Reinsurance is commonly referred to as the insurance of insurance
companies. Reinsurance plays a critical role in maintaining the
financial health of the insurance marketplace and ensuring the
availability of property and casualty insurance for U.S. citizens.
Reinsurance can be used by insurers for several reasons. One of the
most common purposes is to transfer losses from catastrophic events
such as hurricanes, earthquakes, and in the case of September 11, acts
of terrorism. To that end, reinsurers have financially responded to
virtually every major U.S. catastrophe over the past century. For
natural disasters typically one-fourth to one-third of the insured
losses are passed on to reinsurers and in the events of September 11,
2001, two-thirds of the losses were absorbed by the reinsurance
industry.
As the Committee has called this hearing to discuss ``the Oversight
of the Terrorism Risk Insurance Act (TRIA),'' I am here to share with
you the reinsurance industry's perspective on TRIA. The RAA strongly
supported the adoption of TRIA in 2002. We believe the program is
working well to fill a vacuum in reinsurance capacity, keep premiums
paid by consumers at affordable levels, provide insurance coverage to
support economic activity, and to minimize disaster assistance should
there be other terrorist acts in the U.S. We support the recent
introduction of a TRIA extension bill by some Members of this
Committee. The RAA believes that an extension is appropriate and will
provide the industry and Congress a window of time to consider long-
term solutions for managing catastrophic terrorism risk.
My comments are intended to provide the Committee with: (1) a
better understanding of the significant challenges the reinsurance
industry is facing in providing private terrorism reinsurance capacity,
and (2) why the reinsurance industry strongly believes that a public/
private partnership is necessary on a going forward basis to help
stabilize the commercial insurance markets that underpin our free-
market economy.
Creation of TRIA
As you are very well aware, TRIA was enacted in response to the
tragic attacks of September 11, 2001. In the history of our nation, no
hurricane, earthquake or other catastrophic event so fundamentally
changed the American landscape and the insurance industry.
These attacks forced all Americans to confront the previously
unforeseen realities associated with a catastrophic terrorist attack on
U.S. soil. Although the insurance and reinsurance industry responded in
an unwavering manner to the catastrophic losses associated with
September 11, the events shook the financial foundation of the industry
and forever changed the way it views this risk. The simple fact is
that, on its own, the U.S. insurance and reinsurance industry does not
have adequate capital to assume the potentially unlimited exposure to
loss arising from insuring against catastrophic terrorist attacks. The
industry cannot predict the number, the scale or the frequency of
future terrorist attacks that we may face as our nation continues to
execute the ``war on terror.''
TRIA was created to provide a federal backstop, which was essential
to allow the primary insurance industry to provide terrorism coverage
to our nations' businesses. The RAA believes that TRIA has principally
fulfilled its purpose of allowing primary insurers to provide terrorism
insurance coverage that is widely available and affordable to U.S.
commercial policyholders in both urban and rural areas. By limiting
insurers' exposure to catastrophic terrorism losses, TRIA has improved
the market for such coverage and has had a stabilizing influence on the
economy.
Reinsurance Challenges to Underwriting Terrorism Risk
Over the last several years, reinsurers have worked hard to develop
a better understanding of terrorism risk. Reinsurance companies have
created task forces, consulted military and intelligence experts, hired
specialty risk modeling firms, invested in research and development,
and developed new underwriting standards all with the intention of
trying to determine if a private market could develop to absorb this
risk. Despite these efforts, a key struggle in the development of a
private market is that terrorism risk is not conventional. It has
characteristics unlike any other peril or insured risk:
1. The number one plan of terrorists is to inflict maximum damage.
These are not random or fortuitous acts.
2. Terrorists learn from their attacks and thus will attempt to defeat
loss reduction methods used by policyholders, insurers and
reinsurers.
3. The potential size of loss is enormous, with total destruction of
multiple insured properties likely.
4. The potential size is compounded by the aggregation of losses
arising from multiple clients and from multiple insurance products
covering the occurrence. This is difficult to predict and thus
difficult to measure.
5. The frequency of loss is unpredictable, with little historical track
record to project future loss experience.
6. Risk of loss is inter-dependent. Individual policyholders can take
all appropriate risk management actions, but still be rendered
vulnerable by actions of others outside their control.
7. Unlike natural disaster risk, reinsurers achieve virtually no spread
of risk with terrorism coverage. Hurricanes in Japan and Florida
are not correlated. Premiums can be collected and risk assumed
knowing that one loss will not lead to another. Writing terrorism
coverage in Europe and North America may well lead to closely
related loss events, thus minimizing any benefit of risk spreading
around the world.
8. Terrorism events can lead to major disruptions in the financial
markets. At a time when reinsurers will be liquidating assets to
pay claims, the asset values themselves will be declining due to
the likely downturn in the markets. This is not the case with
natural disasters.
9. The U.S. government warns us that we are in a war on terrorism,
which may increase the risk of loss.
10. Nuclear, biological, chemical and radiological weapons can create
large losses of property and life. These extreme loss scenarios
would cause losses that outstrip insurer financial resources and
are uninsurable.
Reinsurance company underwriters must consider all of these factors
and more when deciding whether to take on this risk. The result has
been a development of a very limited private market for terrorism.
Reinsurers' Role Under TRIA
TRIA provides a large amount of reinsurance-like protection for
primary commercial insurance exposures. For 2005, 90 percent of the
commercial terror loss for primary insurance companies is covered up to
an industry total of $100 billion, subject to individual company
retention of 15 percent of 2004 direct earned premium on commercial
lines. These individual company retentions and the 10 percent co-pay
for losses above the retention require commercial insurance companies
to absorb significant losses before TRIA funding is available. The
primary industry is under increasing financial risk and exposure to
acts of terrorism because of: (1) the significant retentions under
TRIA, (2) the mandatory offer of coverage required of insurers under
the program, (3) state regulatory action or refusal to act on rates and
exclusions, and (4) the scrutiny of independent rating agencies. In
certain instances under TRIA, some insurance companies have to absorb
losses greater than the losses they sustained during the World Trade
Center attacks before the federal funding is provided. This is
precisely where the private reinsurance industry role fits under TRIA.
Primary insurers are actively seeking private reinsurance to help
reduce the large un-reinsured gap in terror exposure they face from the
retention and loss-sharing provisions under TRIA. Reinsurers are being
asked to ``buy down the primary company retentions.''
Some have expressed the concern that TRIA has infringed on the
private reinsurance market. This is absolutely not the case. In fact,
the opposite is true. By establishing definitive loss parameters, TRIA
has provided a defined layer for reinsurers to participate in sharing
the retained risk of loss that primary companies face under the federal
terrorism program.
Reinsurance Terrorism Capacity
Working with their client primary companies to manage their
substantial retained exposure under TRIA, reinsurers have been willing
to put limited capital at risk to manage terror-related losses.
Reinsurers typically seek to manage the risk by offering terror
coverage in a stand-alone contract rather than within a traditional all
peril catastrophe treaty contract, especially for insurers writing a
national portfolio. Some regional carriers, with exposures limited to
rural or suburban areas far from target risk cities and business
centers, have secured terrorism coverage within their standard
reinsurance programs, usually with some limitations as to the nature of
the subject risk or size of subject event.
With regard to workers' compensation, some insurers have been able
to add the terrorism peril to their reinsurance programs, but this
coverage typically excludes nuclear, biological, chemical, and
radiological (NBCR) losses. It is important to point out that there is
very little reinsurance appetite for NBCR risks. When it is available,
pricing for coverage including NBCR is at a significant premium and
coverage amounts are restricted. This presents a major problem for
primary insurers since states do not allow them to exclude this peril.
The RAA surveyed both reinsurance brokers and reinsurance
underwriters to estimate how much terrorism reinsurance capacity the
private reinsurance marketplace is providing. The survey suggests
terrorism capacity for a reinsurance program may range from $300
million up to $600 million on an occurrence basis for property and
workers' compensation. This coverage includes TRIA ``covered acts'' as
well as domestic terrorism and personal lines exposure. Overall, our
estimates are that the global reinsurance capacity available in the
United States for 2005 is about $4-6 billion for stand-alone and treaty
reinsurance. Some experts predict that given favorable loss experience
this supply could increase to $6-8 billion in private reinsurance
coverage within several years. This projected growth is still very
modest and will not fill the capacity needs of the primary industry,
with or without TRIA.
We understand some in Congress are disappointed that the private
reinsurance market has not provided more capacity. Most market
participants believe, as we do, that reinsurers may never be able to
provide enough capacity to replace TRIA.
Although much progress has been made trying to model terrorism loss
scenarios, forecasts of the frequency and the magnitude of terrorism
losses are extremely problematic. Reinsurers are only able to provide
limited capacity for terrorism because the potential losses would
otherwise place these companies at risk of insolvency. To that end, it
is important to point out that the global reinsurance industry does not
have the capital necessary to absorb losses of up to $100 billion which
are contemplated by TRIA. Reinsurers' capital is necessary to support
all outstanding underwriting commitments reinsurers face, including
natural disasters, terrorism, workers' compensation and other casualty
coverages.
Capital Markets Limited Impact Under TRIA
We know some Members of Congress and the Congressional Budget
Office have suggested the possibility of the capital markets assuming
terrorism risk. Catastrophe bonds are a known mechanism for using
financial markets to absorb and spread natural hazards risk. Indeed,
reinsurance companies are one of the most frequent users and
facilitators of catastrophe bonds. Yet, hurricane and other natural
disaster ``cat'' bonds are currently in limited use. According to a
Marsh McLennan Corporation (MMC) Securities Corp. 2005 report, total
cat bond issuance in 2004 was only $1.14 billion, a decline from 2003.
The report notes that since 1997, when cat bonds first were issued, the
total number of transactions has only been 59 with total issuance
limits of $8.66 billion of which only $4.04 billion is outstanding.
This is a very small amount in comparison to the industry's catastrophe
exposure. Although many in the industry had hoped the cat bond market
would provide significant additional capacity for natural disasters, it
simply has not. Factors such as cost, complexity, regulatory and
accounting issues, high risks, lack of analytical capacity and
liquidity concerns are often cited as reasons the catastrophe bond
market has not developed further.
Acts of terrorism present much greater underwriting and pricing
challenges to the insurance and reinsurance industry and of course to
those issuing and investing in catastrophe bonds. There is no reason to
believe terrorism bonds are likely to be a significant provider of
terrorism coverage in the foreseeable future. The capital markets face
the same problems as insurers: inability to assess frequency of attack,
a lack of predictive experience, correlation of loss to other exposures
such as a stock market decline, and potentially devastating financial
loss.
Likewise, some have suggested allowing tax-free catastrophe
reserves might be a solution to increase the industry capacity for
terrorism risk, but, as GAO reported, this proposal is controversial.
The GAO notes that Treasury officials are concerned that not only would
such a proposal lower federal tax receipts, but there would be no
assurance that the increase in capital would result in the allocation
of more capacity toward terrorism risk or other catastrophe risk. GAO
also notes that it would be difficult to determine the appropriate size
for such reserve because the modeling used to determine terrorism risk
is not sufficiently reliable. Furthermore, both proponents and
opponents of catastrophe reserves alike agree that insurers might
substitute the reserves for other types of capacity such as
reinsurance. So in effect there would not be an increase in capacity.
Private/Public Partnership Necessary to Address Terrorism Risk
Mr. Chairman, even without a federal backstop, the reinsurance
industry remains committed to working with primary insurers to cover
terrorism exposure. Our companies will continue to explore private
market solutions to terrorism risk. Due to the nature of this peril,
however, we believe that private market mechanisms are insufficient at
this time to spread the risk of catastrophic terrorism loss in a
meaningful way. Without a federal backstop we would expect less
coverage available at the policyholder level, rising prices for
terrorism cover and more limited private reinsurance capacity.
The RAA continues to work with task forces from both our
reinsurance companies and the primary industry national trade
associations to determine what the most effective and less intrusive
federal role would entail beyond TRIA. Key to these ongoing discussions
is the participation and consensus from the policyholder community. No
single solution has emerged but we welcome the opportunity to work with
the Congress and all private sector stakeholders to craft a public/
private partnership to address this most important national issue.
----------
PREPARED STATEMENT OF ROBERT J. LOWE
On Behalf of The Coalition To Insure Against Terrorism
And The Real Estate Roundtable
And The United States Chamber of Commerce
April 14, 2005
Good morning, Chairman Shelby, Ranking Member Sarbanes and members
of the Committee. My name is Robert J. Lowe. I am Chairman of the Board
and Chief Executive Officer of Lowe Enterprises. I am also the current
Chairman of The Real Estate Roundtable.\1\ I am appearing today on
behalf of the Coalition to Insure Against Terrorism, or CIAT, which
includes The Roundtable, the United States Chamber of Commerce, and 73
other major trade and professional associations and businesses,
representing the nation's major consumers of commercial insurance
lines. A list of the 75 CIAT member organizations accompanies this
statement.*
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\1\ The Real Estate Roundtable and its members lead an industry
that generates more than one-third, or $2.9 trillion, of America's
gross domestic product, employs more than 9 million people, represents
capital investment of over $4.6 trillion, and produces 70 percent of
the taxes raised by local governments for essential public services.
Our members are chief executives from the nation's leading private and
publicly-held income-producing real property owners, managers and
investors, the key executives of the major financial services companies
involved in financing, securitizing or investing in income-producing
properties, as well as the elected heads of America's 15 leading real
estate trade associations.
* Held in Committee files.
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Over the past 32 years, Lowe Enterprises, which I founded, has
developed, acquired or managed more than $6 billion of real estate
assets nationwide. Our privately owned firm currently employs over
7,000 people, with a management team of approximately 250 men and
women.
The members of CIAT were pleased to work with all the members of
this Committee to help develop and enact the Terrorism Risk Insurance
Act of 2002 (TRIA). We thank the members of this Committee for their
continuing leadership in addressing this national problem.
Today we urge the Committee to act promptly to provide continuity
to the terrorism insurance market for next year. Most immediately, that
means the Committee should take up and approve S. 467, which would
extend TRIA for two additional years beyond the current scheduled
expiration on December 31, 2005 and set up a presidential commission to
report back to Congress and the Administration on a more permanent
solution to the long-term need for terrorism insurance protection. CIAT
also supports developing the new more permanent structure this year, if
possible; but in order even to keep that option open, we believe this
Committee must move forward on S.467 now. The American economy is
already being adversely affected by the anticipated year-end expiration
of TRIA. If we want to avoid a repeat of the near-paralysis of major
construction and interruption of other business activity which we
experienced in 2001-2002 before TRIA was in place, then Congress needs
to act well in advance of year-end.
CIAT remains committed to working with you, Chairman Shelby,
Senator Sarbanes, the entire Committee, the rest of Congress and the
Administration to find a longer term solution to the terrorism
insurance problem so that the terrorism insurance needs of the
country's businesses can continue to be met. We wish to express CIAT's
special thanks to Senator Bennett and Senator Dodd for their
introduction of S.467.
As consumers of commercial property and casualty insurance,
policyholders are pleased with the success of TRIA and the terrorism
insurance program it instituted. With virtually no cost to the
taxpayer, the terrorism insurance program has worked as intended. It
put the economy back on track after 9/11 and restarted the stalled
construction industry putting some 300,000 people back to work. Since
then it has allowed businesses across America to continue operating and
growing, saving countless jobs in the process. Although there are still
some gaps in coverage, TRIA has made terrorism insurance broadly
available to all businesses that want and need this vital coverage.
The terrorism insurance program has achieved two major national
goals envisioned by bipartisan leaders in Congress--including many on
this Committee--and shared by the Administration. The terrorism
insurance program has helped enormously to keep the economy going in
the face of terrorist threats. The terrorism insurance program also
serves as an important tool to minimize the severe economic disruption
that almost certainly will occur from a future terrorist attack.
As you know, the terrorism insurance program created by TRIA was
intended to be a temporary measure to ``backstop'' the market until the
private insurance markets could fully assess and price the risk.
Unfortunately, the situation the Nation is in today does not make that
possible. Our most senior government officials tell us that the threat
of terrorism remains undiminished. Our Nation has had a great deal of
success at dealing with and deterring terrorist threats over the past
three years. Paradoxically, that success makes it impossible for the
government, the insurance industry, or insurance policyholders like
CIAT members to determine where, when, or with what frequency future
terrorist attacks might occur. As a result, the private insurance and
reinsurance markets are no more able to assess risk or price terrorism
insurance policies than they were able to do prior to TRIA's passage.
What that means for policyholders like the members of CIAT is highly
troubling. Our Nation's businesses, large and small alike, will not be
able to get adequate terrorism insurance in a purely private
marketplace if the TRIA program ends. That was our experience in 2002,
when there was no program and the reinsurance industry was not writing
policies. And that will surely be our experience if a terrorism
insurance program is not permitted to continue beyond this year, at
least for a limited time.
The risk of further catastrophic terror attacks appears to be as
acute as before. Just weeks ago CIA Director Porter Goss told the
Senate Intelligence Committee that al-Qaeda is intent on finding ways
to circumvent U.S. security enhancements to attack the homeland. He
said, ``the terrorist threat to the U.S. in the homeland and abroad
endures . . . [i]t may be only a matter of time before al-Qaeda or
other groups attempt to use chemical, biological, radiological or
nuclear weapons.'' In the same hearing, FBI Director Robert Mueller
expressed concern about the risk posed by radicalized Muslim converts
inside the United States and said that he worries about a ``sleeper
operative'' who may have been in place for years, awaiting orders to
launch an attack: ``I remain very concerned about what we are not
seeing,'' he said.
Just this week indictments against three men were unsealed which
show they are charged with plotting to blow up major financial center
buildings in New York, New Jersey, and Washington, D.C. Both the United
States and the U.K. intend to prosecute these individuals.\2\ These new
indictments illustrate the continuing threat which our nation faces.
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\2\ See Associated Press wire story, ``Three Men Are Indicted In
Financial-Building Plot,'' (April 12, 2005).
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While the highest levels of government tell us that the threat of
terrorism in the United States continues, not surprisingly the
insurance and reinsurance markets have not reestablished an ability to
handle this problem alone. Federal Reserve Chairman Alan Greenspan, in
one of his recent appearances before the House Financial Services
Committee, said he has yet to be convinced the private market alone can
adequately insure against the continuing threat of terrorism. Chairman
Greenspan said, ``[t]here are regrettable instances in which markets do
not work, cannot work,'' and added ``I have yet to be convinced'' that
the terrorism insurance market can be made to work. Even with the
terrorism insurance program in place, the most severe risks cited by
the CIA Director Goss--chemical, biological, radiological and nuclear
attacks--are almost wholly uninsured today, aside from workers'
compensation.
The business continuity issue becomes more urgent with each passing
month this year. Commercial insurance policies covering businesses of
all sizes and types will extend past the December 31, 2005, sunset date
of the terrorism insurance program. Insurance regulators in most states
already have approved conditional terrorism exclusions for these
policies which will be triggered when TRIA expires. As explained in
detail below, with each passing week, commercial policyholders and the
capital markets concerned with asset values are seeing and more renewal
policies which provide for a ``sunset'' of terrorism coverage at year's
end if TRIA is not renewed. Thus we already have an answer to the
central question--we know that the market will not be adequate next
year without some Federal backstop.
All these factors--the likelihood of future terrorist attacks; our
success in thwarting more attacks to date; the impossibility of
assessing where, when, and how terrorist attacks may occur; and the
severe consequences for the economy without the continued availability
of coverage--combine to make it imperative for Congress to act promptly
to provide for the availability of terrorism insurance beyond this
year.
The bill introduced recently by Senators Bennett, Dodd and other
members of this Committee, S. 467, sets an appropriate course by
extending the current TRIA program for a short period of time while
also setting up a commission to work on a long-term solution. We look
forward to working with Members of Congress to develop, adopt and enact
legislation that makes certain that the nation's citizens and
businesses are able to secure truly comprehensive coverage against
terrorism after 2005, and that we as a nation have a reasoned and
supportable policy in place to enable the economy to recover, should
another terrorist attack occur in the U.S.
Five Reasons Why America Needs A Terrorism Insurance Backstop
The Unique Nature of the Risk
Terrorism is a man-made risk--intentional, organized and adaptive.
It is unlike any of the other, usually natural or fortuitous, risks
that the insurance industry typically underwrites. Terrorism is much
more akin to war risk, both in its man-made characteristics
(intentional, organized, and adaptive) and its potential for massive,
unpredictable destruction. Experience has shown that war risk insurance
is not (and will not be) readily available on most ordinary commercial
property and casualty insurance policies; most such policies carry war-
risk exclusions and have done so for decades. \3\ Thus, there is little
reason to believe that insurers, or their reinsurers, will develop any
time soon the ability, much less an appetite, to write terrorism
insurance on a wide scale without some government role.
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\3\ ``War Risk Exclusion Legal History Outlined,'' Massmann, Susan,
National Underwriter (Property & Casualty-Risk & Benefits Management
Edition), September 24, 2001.
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While war-risk exclusions on most policies have been tolerable to
insurance buyers (and their lenders) because the advent of, or at least
the proximity to, military operations is relatively uncommon and
generally avoidable,\4\ exclusion of terrorism risk from commercial
policies today would be a significant deterrent to economic activity
because of uncertainty and unavoidability of the risk. This is what we
saw in the months between the September 11 attacks and the
establishment of the TRIA program. Lack of coverage in those months
significantly impaired economic activity and chilled financial markets
and lending sources for large-scale development, until TRIA created the
ability for insurers to fill the gap (or most of it).
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\4\ Where the lack of private war-risk coverage has been
commercially significant, e.g., for ocean shipping or commercial
aircraft that must either traverse or come near war-risk zones, the
U.S. government has traditionally provided a standby war-risk insurance
program which is triggered when commercial markets withdraw or
dramatically raise prices. See, Merchant Marine Act of 1936, 46 U.S.C.
Sec 1202, et seq.; FAA Aviation War Risk Insurance Program authorized
at 49 U.S.C. Sec. 44302, et seq. Moreover, when the threat of war
damage to the general U.S. economy has become pronounced, the U.S.
government has also intervened to keep economic activity moving. During
World War II, for example, Congress created the War Damages Corporation
which, with the participation of private insurers, provided a universal
war risk add-on to virtually all property insurance policies, both
commercial and personal lines, during WWII. See discussion of War
Damages Corporation on page 7, infra.
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There is another reason the current terrorism risk is so difficult
for private markets to handle without some government role. Insurers
have few data points (e.g., the attacks on September 11) by which to
attempt to model the risk. With other potentially large catastrophic
risks such as hurricanes and other natural phenomena, there is
significant historical data on past events which can be used to model
the frequency, severity, and locations (or paths) of future events.
This modeling in turn can be overlaid with historical loss data and
with policyholder location or density information to calculate each
insurer's maximum probable loss for certain statistically probable
events. With terrorism, however, there is a deficiency of data about
potential attacks.
This deficiency of data is exacerbated by an important additional
fact. The Federal government is the most informed source of information
about terrorism risks; presumably assessing such risks are a primary
focus of our national intelligence organizations. That is, the Federal
government may well be in possession of such intelligence or other
information regarding likelihood or nature of future terrorists acts,
but it is unlikely that the government would share such information
with the insurance and reinsurance industry as well as their customers.
Given the unique nature of the risk, the paucity of useful data to
model future events and the controls in place on relevant information
concerning terrorism, it is entirely understandable that the insurance
and reinsurance industries have not yet developed an ability to
underwrite intelligently on their own the complete amount of terrorism
insurance necessary for the U.S. businesses to operate effectively and
the U.S. economy to achieve its full potential.
The State of the Insurance Market
In the debate over a terrorism insurance mechanism three years ago,
there was much concern expressed about government intervention in a
``free market'' of insurance. Free market principles are a laudable
starting point for most economic policy discussions. The insurance
industry, however, is a sector which the courts and legislatures have
long recognized as ``affected with the public interest'' and therefore
subjected to heavy government regulation. Indeed, it is one of the most
pervasively regulated of all industries. Both entry into and exit from
the industry is strictly controlled by government licensing and
regulation. While there seems to be real competition for some of the
easy-to-write lines of insurance, both the form of product and often
the price in most lines of property and casualty insurance are subject
to state-by-state regulation (and sometimes Federal creation). The
latitude of insurer actions in many aspects of their business is to a
large degree a function of state solvency regulation. It is also an
industry where various government actions (both state and federal)
require or encourage the pooling of certain risks, and where, in many
cases such as workers' compensation insurance, the insurable risk is
itself created and defined by government mandate. So, to assume that
there is a market otherwise unaffected by government action or that
unfettered market forces will somehow be prepared to respond to the
threat of terrorism in the absence of a federal backstop seems to
ignore the reality of that industry.
The state-by-state nature of insurance regulation and therefore
market conditions means that, in the absence of Federal backstop,
availability of coverage and industry response to a catastrophic event
may be quite variable from jurisdiction to jurisdiction. In the event
of a multiple-jurisdiction attack following TRIA's expiration, the
regulatory patchwork could result in businesses in one location with
effective coverage and those in another location without coverage or
with coverage from an insolvent carrier.
This is not to say that there is no role for private capital or
entrepreneurial spirit in this line of the insurance business. TRIA
proved that the presence of some form of Federal backstop enables the
private sector to respond in various ways to their customers' needs (if
far from completely in the case of nuclear, biological, chemical and
radiological risk). All of the responsible studies and reports produced
since TRIA was put in place show that the private insurance and
reinsurance sector do not have the capacity to underwrite this risk
without the Federal backstop. Reinsurers this year have available
terror-related capacity of only $4 to $6 billion dollars.\5\ To provide
some context, the World Trade Center attack resulted in insurance
payments exceeding $32 billion. Moreover TRIA does not appear to have
``crowded out'' the development of private capacity. To the contrary,
all data show that private reinsurance capacity has not even been able
to cover the primary industry's collective deductibles and retention
layers which the TRIA backstop leaves to the private sector. Any
thought that reinsurers will commit additional resources now to
terrorism coverage in the absence of a backstop defies logic. More
time, and perhaps a re-thinking of the division of risk between the
Federal backstop and the private sector, is needed in order to better
develop private capacity for terrorism coverage.
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\5\ R. Glenn Hubbard and Bruce Deal, The Economic Effects of
Federal Participation in Terrorism Risk (prepared by Analysis Group
Inc., September 14, 2004), p. 40, available at www.iii.org/media/
lateststud/TRIA. See also Congressional Budget Office, Federal
Terrorism Reinsurance: An Update (Congressional Budget Office, January
2005), p. 17.
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The Proper Role of Government
When terrorists target symbols of a nation's economic, political
and military power, they are attacking the nation as a whole, not just
the symbol itself. We need to recognize that the terrorism risk is
different from other types of insurance for other reasons. By its
definition, terrorism is an effort to effect changes in government
policy and public attitudes. Terrorists target places and properties on
American soil in an effort to change U.S. government policy and our
behavior as a society. While we may not be able to truly understand the
motivation of such actors, whether it is our way of life or our
government policy which they attack, it does seem that the risk has
little to do with the particular policyholders who need protection. How
is a business owner in Baltimore or an insurer in Birmingham expected
to cope with that threat without some role by the government? We look
to the Federal government to protect us from this threat militarily;
why not, in some limited way, economically?
Other leading nations on the forefront of the war against terrorism
have found it necessary to adopt national programs to help manage this
economic risk. Most involve a mix of both government and private sector
roles. These include government programs in at least the following
countries: the United Kingdom, Germany, France, Spain, South Africa,
Austria, and Israel. Recently the Government Accountability Office
released a report entitled, ``CATASTROPHE RISK: U.S. and European
Approaches to Insure Natural Catastrophe and Terrorism Risk,'' \6\
which gives a detailed description of the governmental guarantees
provided for terrorism coverage in the first four European countries
mentioned above. In every one of these cases, the program extends
beyond the current expiration of TRIA.
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\6\ CATASTROPHE RISK: U.S. and European Approaches to Insure
Natural Catastrophe and Terrorism Risk, GAO-05-199 (February 2005).
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A Matter of Fairness
The Federal terrorism insurance backstop does not exist in a
vacuum. TRIA was part of a comprehensive set of policies which comprise
the war on terrorism which President Bush rightly declared after the
September 11 attacks on our country. These in turn fit with already
existing policies, some of which found heightened purpose in the post-
9/11 world. The PATRIOT Act is one example of the new set of actions
launched after 9/11. Like TRIA, much of the PATRIOT Act was originally
authorized for three years, and the Administration is now calling for
renewal of those provisions because the war on terrorism is far from
complete. Just as the PATRIOT Act will be re-examined this year in
light of three years' experience, we do not insist that an automatic
extension of TRIA is the only appropriate response to the continuing
insurance market failure. However, some Federal insurance backstop
mechanism is surely a necessary component of this continuing war to
protect America's economy from these enemies.
An example of a pre-existing government policy which has found new
importance in the post-9/11 world is the Overseas Private Investment
Corporation (OPIC). Founded in 1971, and recently reauthorized through
2007 by Congress, OPIC provides insurance against political risks--
including terrorism--for U.S. businesses' overseas operations.
Currently, OPIC provides insurance and financing to U.S. investors for
projects in approximately 150 developing countries and emerging
markets. Among the most recent projects insured by OPIC are the
construction financing of $250 million for a natural gas pipeline in
Israel and a $300 million development of Egypt's natural gas industry.
To take another example, OPIC recently issued long-term government-
backed political risk coverage (including for terrorism and other
``political violence'') for a commercial facility in Uzbekistan. It
would be a sad and hard-to-explain irony if TRIA were to expire this
year and no Federal terrorism insurance role was in place within the
U.S. next year, but OPIC continued to provide next year Federally-
backed terrorism insurance for U.S. businesses and facilities abroad.
Such a development would mean that American businesses and facilities
just down the street from the Capitol, as well as anywhere else in the
Nation, could be left without sufficient and adequate terrorism
insurance, but that, thanks in part to the Federal government, U.S.
businesses doing business outside the U.S., ranging from operations in
Afghanistan to Zimbabwe, would have all the terrorism insurance
coverage that they require.
OPIC is an example of a long-standing program which serves
continuing U.S. foreign policy objectives. To be sure, there are some
domestic Federal insurance programs which deal with long-standing
marketplace failures, most notably Federal flood insurance and some
forms of crop insurance.\7\ However, there are also examples of Federal
insurance programs which were authorized to deal with immediate and
acute problems at the time, which were then de-commissioned when the
emergency subsided. These include the Federal crime insurance \8\ and
Federal riot reinsurance programs \9\ which were established in
response to the insurability problems arising out of the urban
disturbances in the late 1960s. Both of these programs were
administered by the Federal Insurance Administration, an office within
FEMA, but were allowed to expire by the 1980s.
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\7\ The National Flood Insurance Program was created in 1968 (42
U.S.C. '' 4001-4129) and reauthorized as recently as 2003 (Pub. Law
108-3, Jan. 13, 2003). The Federal Crop Insurance Corporation was
created in 1938 (Pub. Law 75-430, Feb. 16, 1938) and is currently
overseen by the Risk Management Agency under USDA.
\8\ The Federal Crime Insurance Program was established by the
Housing and Urban Development Act of 1970 (Pub. Law 91-609, Dec. 31,
1970) to provide limited burglary and robbery coverage to property
owners unable to buy private insurance coverage on property located in
``blighted or deteriorating areas.'' The FCIP was abolished in
September 1996.
\9\ The Federal Riot Reinsurance Program was established by the
Urban Property Protection Reinsurance Act of 1968 (12 U.S.C. Sec. 174-
9bbbb-21). This provided federal riot reinsurance to insurance
companies which participated in State-administered residual market or
``FAIR Plans.'' The riot reinsurance program was terminated in 1983
with funds on hand of over $100 million.
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The precedent which perhaps most closely parallels the current case
of terrorism risk is the War Damages Corporation (``WDC'') which was
authorized by Congress within days after the December 1941 attack on
Pearl Harbor. This government-owned corporation provided direct war
risk coverage to both personal and business property owners throughout
the United States and its overseas possessions for the duration of
World War II. Approximately 8,700,000 polices were issued for property
values totaling $117 billion. WDC collected premiums of approximately
$221 million, returning most of this to the U.S. Treasury as profit.
WDC conducted its business with remarkable efficiency by
authorizing private insurers to attach the war risk rider to existing
multi-peril insurance policies, and working with representatives of the
industry to develop policy forms and pricing guidelines within a matter
of months after its authorization; the first policies were issued
effective July 1, 1942. The WDC premium insurance program was
terminated in March 1946 and WDC assets were liquidated before June 30,
1949, although its capital stock was not returned to the United States
Treasury until the 1950s. Net income of approximately $211 million had
been remitted to the Treasury by 1947-48, even after payment of all
claims (mostly arising in the Philippines or from the 1944 explosion of
the destroyer USS Turner in New York harbor) and after sharing
commissions and profit-incentive payments with private insurance
industry which had acted as its agents.\10\
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\10\ See, e.g., ``A Documented Account of the Establishment and
Activities of War Damages Corporation,'' (1950) in the Records of the
War Damages Corporation held at the National Archives.
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Sunset Clauses In Insurance Policies Are Already Hurting Our
Homeland's Economic Security
The threat of terrorism will be with us for the foreseeable future;
in the words of President Bush, delivered on February 14, 2005, ``We
must not allow the passage of time or the illusion of safety to weaken
our resolve in this new war.''
If TRIA is allowed to expire, and is not replaced with another form
of Federal backstop, the nation will be more exposed economically than
was the case after September 11. There will be a scarcity of terrorism
insurance and what is available will be at an exorbitant price. There
is no doubt that without a Federal backstop, fewer businesses will have
such terrorism coverage than today with TRIA in place or before 9/11.
In fact, the evidence is already in front of us. Most major insurers
already appear to be imposing ``sunset'' clauses in their policies
being renewed this year. Appendix 1 to this testimony is a selection of
the sunset clauses from many of the largest insurers in the U.S. and
globally. All of these documents come from renewal quotation packages
actually received by policyholders or their brokers in recent weeks.
These sunset clauses make it clear that there will be no terrorism
coverage under the policy after 12/31/2005 unless Congress renews TRIA.
In some cases, there is no promise to provide the coverage even if
Congress acts--presumably the policyholder and insurer will have to
take some action in these cases to restore the coverage if TRIA is
renewed between now and year-end. With each passing week, more and more
of these ``sunset'' disruptions are being built into the nation's
business insurance picture, and more economic effects are being felt.
The extent of the problem is illustrated by Appendix 2, a chart showing
the actual results of an April renewal program of $1 billion of
property insurance for a major real estate company with assets
throughout the U.S., which shows substantial holes in its terrorism
coverage after December 31 of this year.
Multi-year construction and financial markets which depend on
commercial mortgage-backed securities are being affected adversely by
the year-end sunset of terrorism coverage. Appendix 3 is a chart
showing a limited sampling by the Real Estate Board of New York of
construction project in just two areas of the country-metropolitan New
York City and South Florida. In all eighteen projects sampled, the
builders' risk insurance either was subject to a sunset clause, renewal
was overdue/delayed, or the policyholder was required to secure
dramatically more expensive stand-alone terrorism cover from a limited
market to satisfy lender requirements.
Aon is the world's second largest insurance brokerage firm. Aon has
been actively tracking the terrorism insurance market and, in
particular, TRIA coverage with the potential expiration of TRIA on
December 31. We understand that an update to Aon's 2004 Terrorism
Mitigation & Risk Transfer Overview will be published later this month
based upon first quarter 2005 performance. Aon estimates that 80% to
90% of the available TRIA property insurance capacity will resort to
the use of Absolute TRIA exclusions or low sub-limits for top tier
metropolitan areas/target risks effective January 1, 2006. In short,
insurance market behavior during the first quarter 2005 indicates that
there will be a substantial shortfall in terrorism capacity both for
existing properties and for new projects. At the same time, Aon
confirms that lenders are requiring terrorism coverage for the full
loan values or for a stipulated amount within loan covenants--whether
or not TRIA is reauthorized. We will be pleased to provide the
Committee with copies of the Aon report when published.
The important commercial mortgage-backed securities (CMBS)
marketplace ($432 billion outstanding) is also at risk of credit
downgrades. As one prominent publication \11\ put it, ``the possibility
[of TRIA non-renewal] re-ignites the threat of downgrade for certain
CMBS transactions and has the more macro and ominous potential of
reducing property valuations and the attractiveness of commercial real
estate as an investment vehicle. Without TRIA and with little
confidence that reinsurers and primary property and casualty insurers
will offer affordable terrorism coverage without a Federal backstop,
it's highly probable that at least two of the major rating agencies
will place certain CMBS transactions on watch for possible downgrade.''
The extension of TRIA would serve to remove a significant credit risk
from the CMBS marketplace. Moreover, it would help the market avoid the
ratings volatility experienced from late-2001 through 2002 as it
related to terrorism insurance.
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\11\ ``CMBS CREDIT UPDATE'' (March 1, 2005), RBS Greenwich Capital
CMBS Strategy.
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This sunset problem not only dampens economic activity now and for
as long as the non-renewal persists, but, in the event of another
attack, there will be substantially less insurance coverage in place--
and therefore fewer and less insurance industry payments than were
available for the 9/11 losses. This means, most likely, that--in the
absence of a program like TRIA--the government's costs, one way or the
other, following a new event similar in size to 9/11, would actually be
greater than after September 11th. Continuation of some form of Federal
backstop which maximizes the involvement of the private insurance and
reinsurance industry is in fact the policy which is best able to
encourage economic activity in the near term while minimizing the
government's own exposure in the event of another catastrophic event.
Planning the day before for the day after an attack should be
viewed as equally important to efforts to protect ourselves against
such an attack.
Conclusion
CIAT is unanimous in its belief that the Federal government must
continue to provide a reinsurance backstop beyond 2005 if we are to
avoid major disruptions to the economy. Indeed, these disruptions are
already beginning to occur as major insurers cut off coverage at year-
end in absence of a clear signal from Congress. We urge this Committee
to act promptly to approve the Bennett and Dodd bill, S.467, which
already has as co-sponsors a majority of this Committee. Committee
approval will advance the process towards a longer term solution. Only
a seamless continuation of the Federal backstop in some form in the
meantime will avoid the more severe economic impacts, some of which
already are emerging with the widespread use of sunset clauses in
current renewal policies. Chairman Shelby, Ranking Member Sarbanes,
CIAT thanks you for holding this hearing and for giving us the
opportunity to testify. We look forward to working with you and the
rest of the Committee on this important subject in the coming weeks.