Terrorism Policy Research

Terrorism Risk Insurance Policy

Background

Private insurers, and their reinsurers, may ultimately pay well in excess of $40 billion in claims resulting from the terrorist attack of September 11, 2001, making this event by far the largest single catastrophic loss the global insurance industry has suffered in its history.

Remarkably, this unprecedented payment of compensation has occurred with minimal dispute and without attendant bankruptcy of any major insurers. However, given the magnitude of losses from a risk for which the industry was unprepared, in the months after September 11, there was widespread belief that another comparable attack in the short term threatened many of the companies in the industry, if not the entire industry. As a result, most insurers and reinsurers took measures to dramatically limit their possible exposure to losses from a subsequent terrorist attack. In turn, there was anecdotal evidence that it was becoming difficult for developers to obtain project financing, threatening the construction industry and ultimately the economy.

In response, the federal government passed the 2002 Terrorism Risk Insurance Act, or TRIA. The TRIA created a three-year federal program to support the "growth and stability of the market for private insurance against losses from terrorist attacks." The program, often referred to as the "terrorism backstop," now provides excess-of-loss reinsurance to insurers for their certified losses that fall above a deductible that increases over time, subject to a maximum industry-wide recovery of $100 billion.

In return for this federal reinsurance program, commercial insurers are now required to offer coverage for losses from terrorist attacks to policyholders. The implicit expectation of the legislation is that, as insurers become accustomed to underwriting terrorism risks and developing strategies that balance their insureds' needs for coverage with their own needs to protect their balance sheets, the role for the government program may become increasingly unnecessary. In 2005, the program will be evaluated for renewal, although the administration has signaled that it intends for it to expire.

By any measure, TRIA was a hastily crafted piece of legislation, and many of its provisions and implications are yet to be fully understood. Many constituents have raised concerns that have ranged from the tactical, such as how to underwrite policies in light of the limited duration of the program, to the fundamental, such as whether terrorism is fundamentally an act of war (and therefore not insurable).

The proper role of government is another contentious issue. Some argue that the government has no role to play since the disruption after September 11 was short-term and healthy; others claim that it must play an active role since terrorism has many attributes (such as unpredictability) that undermine insurance markets if events are frequent. At the same time, many businesses, particularly smaller ones, have decided not to purchase the terrorism insurance offered to them, according to the Council of Insurance Agents & Brokers.

In the best-case scenario, there may be no terrorist attacks before TRIA expires, and the crisis atmosphere surrounding terrorism could subside. Coverage may be widely and efficiently available and the program may expire with little fanfare.

A more likely scenario is that the continued threat of terrorism will catalyze a significant public policy debate over the renewal of TRIA, and more broadly, the appropriate roles, responsibilities, and relationships between the private and public sector concerning the insurability of terrorism risk.

RAND Research Goals

To facilitate an informed deliberation of the costs and benefits of public policy alternatives and outcomes, the RAND Center for the Study of Terrorism Risk Management Policy will publish research that serves to analyze and quantify terrorism risk, and in doing so, will address the following types of questions:

Is the architecture of TRIA appropriate to the nature and scale of the terrorist threat? For instance, consider these questions:
- What are the prospects for domestic terrorism or for terrorist attacks for which attribution of responsibility will be difficult?
- What is the potential for losses in lines that are currently excluded from TRIA, such as personal lines, life and health?
- What are the prospects for large but infrequent attacks for which the backstop is invoked, or smaller and frequent attacks which may pose new challenges to the industry?
- What would be the human and financial impacts of different attack scenarios, including the impact of chemical, biological, radiological or nuclear weapons?
- What might be the compensation and liability consequences of these impacts?
- Is another model of government involvement more likely to encourage a stable terrorism insurance market that provides coverage at appropriate rates and pays compensation promptly?
- Does the fact that the current TRIA has a voluntary purchase imbedded in the plan contribute to adverse selection for the insurance industry?
How do these consequences and risks vary across various economic, demographic and geographic sectors of our economy? If a significant fraction of businesses do not purchase terrorism insurance, will they be uncompensated in the case of an attack? Are there victims whose losses will not be covered by insurance or other sources of compensation?
Based upon the latest research and analysis with respect to terrorist capabilities and motivations, what are the longer-term trends for losses? Given the trends in the market, is it likely that the insurance industry will be able to provide appropriate compensation to future victims and remain viable if the backstop is allowed to expire?

We intend for the research in the Center to inform the Treasury's own studies to evaluate TRIA, and ultimately to inform Congress's decision to renew or modify the program. At the same time, by focusing the world's foremost experts on terrorism and homeland security on the particular terrorism issues at stake in this policy area, we intend for the research to improve the risk management tools and capabilities of the buyers and sellers of insurance.