House Republicans offer road map for the future of terrorism insurance
Though it doesn’t bring us all the way there, the House Republicans’ draft Terrorism Risk Insurance Modernization Act draws an outline of what conservatives see as the future of TRIA: a more-or-less volunteer program almost exclusively devoted to covering terrorist events involving nuclear, biological, chemical and radiological attacks. And perhaps most importantly, it’s one that will have a cost for insurers who participate.
It’s not that there haven’t already been notable changes to the $100 billion federal reinsurance backstop, set up in the wake of the Sept. 11, 2001 terrorist attacks. The program’s 2005 reauthorization, in particular, called for a fairly significant slimming down of its size and scope.
The original Terrorism Risk Insurance Act called on the insurance industry to retain just $10 billion of terrorism-related risks, with an obligation to pay back up to that amount of any federal outlays for terrorism events. That aggregate retention has risen steadily over time, to $12.5 billion in 2004, $15 billion in 2005, $25 billion in 2006 and $27.5 billion in 2007. Insurers’ individual deductibles also moved steadily upward, from the original 7 percent of earned premium in 2003 to 10 percent in 2004, 15 percent in 2005, 17.5 percent in 2006 and 20 percent in 2007.
The original law also had no aggregate “trigger mechanism,” with the federal government covering 90 percent of any terrorism event that caused at least $5 million in damages. A $50 million aggregate trigger was introduced in 2006 and bumped up to $100 million in 2007, when the federal share of losses also was reduced to 85 percent. The program also initially included essentially all commercial property and casualty lines of business, until the 2005 bill dropped commercial auto, burglary and theft, professional liability and farm owners’ multiple peril from coverage.
The seven-year reauthorization passed in 2007, with Democrats then controlling both houses of Congress, was far less ambitious in scaling back the program. But even that bill made changes to the mandatory recoupment of federal outlays for events that are less than the retention amount. Where previously, such outlays were to be recouped with a 3 percent surcharge on premiums, the 2007 bill removed the cap on surcharges and required that the government ultimately recoup 133 percent of any outlays the program made.
Nonetheless, all of these prior changes were met with the more or less tacit support of the industry. That will most assuredly not be the case for the kinds of sweeping reforms now being contemplated by the House Financial Services Committee with a three-year extension drafted by the committee’s chairman and the chair of its insurance subcommittee, Reps. Jeb Hensarling and Randy Neugebauer, both R-Texas.
Parts of the draft House bill follow the strategy of earlier reauthorizations (and a separate measure expected to be moved through the Senate will bipartisan support) by fiddling with the program’s various knobs and levers. It shifts the aggregate industry retention from a flat figure (currently $27.5 billion) to a floating benchmark that would be calculated by adding up all individual insurer’s deductibles, a total that should grow as industry premiums do. It also calls for the government to recoup 150 percent of any funds expended, up from the current 133 percent.
But more importantly, the bill introduces three new concepts to the program that, if implemented, will clearly shape any future reauthorizations:
- It creates distinctly different terms for NBCR and non-NBCR events.
- It provides a limited opt-out for smaller insurers.
- It would require insurers to begin building pre-disaster reserves for terrorist events.
In bifurcating how the program treats different types of terrorist events, the law essentially keeps the current program’s terms intact for the sorts of unthinkable, long tail cataclysmic events that most closely fit the definition of “uninsurable”: a dirty bomb in Times Square, sabotage at a nuclear reactor, anthrax spores distributed by a crop duster, sarin gas in a crowded subway. In particular, for workers’ comp insurers (who can’t exclude coverage for NBCR events) the potential for any of these nightmare scenarios is just simply crippling.
But for so-called “conventional” terrorism, which would include the Sept. 11 attacks, the draft proposes a new set of rules that could set the stage for phasing out the federal backstop altogether. The bill gradually ramps up the program trigger for non-NBCR events from $100 million to $500 million, while scaling back both the federal share of coverage (to 75 percent from 85 percent) and the cap for total taxpayer liabilities (to $75 billion from $100 billion.)
The limited opt-out for small insurers would (at least at first) be quite limited, indeed. It would grant small companies the ability to argue that the Terrorism Risk Insurance Act’s mandate that they make terrorism coverage available to any insured who requests it would impose a financial hardship, or that it would not be feasible to provide the coverage.
The draft does not lay out what the standards would be to define either “small” or “hardship,” leaving that task to the U.S. Treasury Department. But the details ultimately may be less important than the direction the bill would set. The change would establish the precedent of making offers of terrorism coverage voluntary for at least some insurers, and would offer lawmakers opportunity to expand the universe of companies who could opt-out in future iterations of the law.
Finally, and perhaps most importantly, the draft bill would require any insurer participating in TRIA to establish a “capital reserve fund,” equal to 50 percent of the terrorism-related premiums the company collects. Insurers would hold the funds in a “fiduciary capacity” on behalf of the Treasury, although they would be permitted to invest them in a limited number of approved vehicles or use them to purchase reinsurance.
While the funds would not, technically, constitute premiums paid for coverage, they clearly are intended to serve essentially that purpose. As the Consumer Federation of America has pointed out, by not charging the industry for its reinsurance coverage, congressional auditors estimate Treasury has forgone $3.1 billion of premiums from 2008 through 2012, with another $3.3 billion of subsidies through 2017. The “capital reserve fund” idea might be a somewhat half-baked (there are a raft of tax and accounting treatment rules that would need to be sorted out to implement it) but it does move us one step closer in the direction of setting a market-oriented price for terrorism reinsurance.
There are areas where we at R Street would part ways somewhat with the draft bill (for instance, we’d remove commercial liability from the program immediately) but all in all, this is a really thoughtful document that offers some out-of-the-box solutions to what have been fairly intractable problems. Most impressively, after years of kicking the can down the road, it sets out a long-term goal for where the terrorism program should go, and offers future Congresses some tangible legislative tools they can use to get there.