Insuring Against Acts of Terrorism Impact of September 11, 2001 Attacks Insurance Industry Response State Regulation Federal Intervention Terrorism Risk Insurance Act (TRIA) 2002 Current Situation

Property Insurance on the World Trade Center Cause of Loss –Aircraft –Explosion –Fire Type of Loss –Direct Real property Personal property –Consequential Loss of income Potential Exclusion –Act of War Additional Issue –One or two occurrences?

Other Covered Losses in World Trade Center Life Health Disability Workers Compensation Liability

World’s 10 Largest Catastrophes ( by insured loss) $ Billions, in 2001 $ *III Estimate; Includes life, liability and workers compensation losses. Source: Swiss Re, Insurance Information Institute.

World Trade Center Losses Current Estimate $40.2 billion Property – Towers 1 and 23.5 Other6.0 Business Interruption 11.0 Workers Compensation2.0 Aviation (Aircraft Hulls)0.5 Event Cancellation1.0 Liability Airlines3.5 Other 10.0 Life2.7

The Effect of the WTC Loss Primary insurers will pay approximately 1/3 of the WTC losses Reinsurers will pay approximately 2/3 of the loss The insurance industry can afford to pay for the WTC loss The industry cannot afford to cover another loss of this magnitude in the near future When capital levels are replenished, the industry would be able to withstand another major loss Significant price increases have occurred on all lines since 9/11

Excluding Coverage for Terrorist Acts Reinsurers are now excluding terrorism coverage –Many reinsurance contracts renewed 1/1/02 –These contracts do not provide coverage for terrorism Primary insurers filed for terrorism exclusions 45 states allowed terrorism exclusions Primary insurers are beginning to exclude terrorism as policies renewed In states that do not permit an exclusion, commercial property coverage will be difficult to obtain

ME NH MA CT PA WV VA NC LA TX OK NE ND MN MI IL IA ID WA OR AZ HI NJ RI MD DE AL VT NY DC SC GA TN AL FL MS AR NM KY MO KS SD WI IN OH MT CA NV UT WY CO PR Terrorism Exclusions Exclusions Approved, Mandatory Fire Following No Terrorism Exclusion Exclusions Approved, Fire Following NOT Mandatory Terror exclusions approved in 45 states + DC and PR

Factors Affecting Exclusion Workers Compensation –No exclusions for a particular event allowed Standard fire policy language –Laws in 30 states require use of standard fire policy –Covers all fire losses, regardless of cause

Coverage for Another Terrorist Act If another major loss had occurred early in 2002, primary insurers would have born most of the cost –Solvency concerns If the loss occurs after insurers have added the exclusion, the individuals and businesses would bear most of the cost

Examples of Problems Caused by Lack of Terrorism Coverage Property owners without adequate coverage –Particular problem for “trophy” properties Cost increases for property coverage are impacting companies of all types –Double the cost for 1/5 th of the coverage Lenders requirements for insurance coverage –Many borrowers are in violation of loan covenants Financing for new construction projects is being withheld Insurers are concerned over concentration of risk in Workers Compensation Construction work is slowing down Lack of terrorism coverage could cause economic problems

Federal Role in Terrorism Coverage House of Representatives passed bill in November 2001 Senate failed to pass legislation in 2001

The Issue Re-Emerges Summer 2002, President Bush makes renewed calls for legislation. Senate passes legislation in July 2002, but substantial differences from House bill remained. Finally the differences were ironed out

Terrorism Risk Insurance Act of 2002 (TRIA) Finally passed on 11/26/2002 Established program through 12/31/2004 Treasury Secretary can extend one year through 2005 This legislation overrides state regulation McCarran-Ferguson Act (1945) allows states to regulate insurance unless Federal legislation specifically applies to insurance

Impact of TRIA 2002 Insurers must offer policyholders the option of removing terrorism exclusions It is not mandated that anyone purchase the insurance Insurers had 90 days (late February, 2003) to quote price for this provision Insureds had 30 days to accept/decline

Results of Terrorism Coverage Provisions Cost of removing exclusion varied widely based on location and “target” value Examples ranged from 2-100% of basic property insurance coverage Typical cost – about 10% of property insurance coverage Fewer than 20% of policyholders are purchasing this coverage

When is Coverage Triggered? Treasury Secretary (State & AG) Certification “Act of Terrorism” –A violent act or act dangerous to human life, property or infrastructure –Results in damage within the US (or to US air carrier or vessel, or on premises of US mission) –Committed … on behalf of any foreign person/interest, as part of effort to coerce civilian population or influence policy of US government Excludes declared acts of war Loss must exceed $5 million in losses

What is Covered? Commercial lines of P&L insurance, including: –Property insurance (BPP policy) –Workers’ compensation –Business interruption Excludes: –Personal lines –Life & health insurance –Crop & flood insurance, PMI, etc.

Coverage Overview Company deductibles based on prior year U.S. P&L premiums –2003: 7% of 2002 direct earned premiums –2004: 10% of 2003 direct earned premiums –2005: 15% of 2004 direct earned premiums Below this amount, insurer pays 100% Government pays 90% of losses above this deductible, but may recoup some of these losses from the industry

Aggregate Retention Amount An industry wide deductible –$10 billion in 2003 –$12.5 billion in 2004 –$15 billion in 2005 Until aggregate industry losses exceed this amount, any government payments will be recouped through surcharges on future policies Government losses are capped at $100 billion

Example ABC insurer had $5 billion 2002 direct earned premiums –2003 deductible = $350 million U.S. endures a $15 billion terrorism loss in 2003 –ABC’s share of the loss is $1.35 billion Government reimburses ABC –90% of losses above $350 million (ABC’s deductible), or $900 million (.9x(1.35 billion- 350 million)) Similar payments to all other insurers with losses in excess of their deductibles –Assume deductibles and coinsurance total $3 billion –U.S. payments would total $12 billion Government surcharges on the insurance industry recoup $7 billion Net cost to U. S. government (all taxpayers) is $5 billion

Liability Provisions Provides for a Federal cause of action for property damage, personal injury, or death arising from terrorist event No caps on punitive damages, but punitive damage awards are not eligible for federal reimbursement

What Does the Future Hold? The 3 major risk modeling agencies (AIR, Equicat, RMS) have terrorism risk models The industry has incentive to make this work –They pushed hard for the legislation –Want to be viewed as “the only insurer” a company needs But some may prefer not to have exposure, especially in high risk locations (Ex: NYC, DC, Chicago) Most insured’s are choosing to “go without” Risk sharing for terrorism losses will develop

The Future – Longer Term Will program be extended for third year? –Highly likely because the decision will come a few months before 2004 Presidential election! Great consternation among insurers and insureds about sunset – will likely push for continued federal role beyond 12/2005 Brings to the forefront issues of federal versus state insurance regulation