What if they threw a market panic and nobody came?
The Property Casualty Insurers Association of America said it was “unconscionable” that Congress would adjourn without reauthorizing the 12-year-old terrorism reinsurance program.
The Risk and Insurance Management Society, which represents major buyers of commercial insurance coverage, predicted the “program’s expiration will have many negative repercussions for commercial insurance consumers, the countless organizations they represent and the U.S. economy as a whole.”
NAIOP, the trade association for commercial real estate developers, called failure to renew “more than a speed bump, it’s a stop sign.”
But a funny thing happened on the way to the panic. Despite headlines that blared the news would cause “chaos,” leave the “community stunned,” “bode ill,” “send shockwaves,””wreak havoc” and “roil industry,” actual prices in actual markets certainly suggest most market actors appear to be treating the news as a big ole nothingburger.
Indeed, the gift Congress offered to markets this Christmas is that most rare of commodities: genuinely new and surprising information. As Manhattan real estate developer Douglas Durst put it to the New York Times:
‘Everybody expected this would get done,’ he said, fuming. ‘These actions make it impossible to make investments in this country.’
One need not be a devotee of any particular variant of the Efficient Markets Hypothesis to recognize that an action which truly made it “impossible” to invest would be expected to be reflected in sharp and immediate declines in the share prices of those public companies most affected by the developments.
And yet, that’s really not what we’ve seen this past week. Instead, the market action appears to have been fairly modest, more reflective of the old trader’s adage, with respect to negative shocks, that one ought to “sell on the rumor, buy on the news.”
For instance, looking at the share prices of major commercial insurers like Chubb, Travelers and Ace, one sees just slight dips in their share prices from Dec. 11 to Dec. 16 – when word of Sen. Tom Coburn’s threatened “hold” on the TRIA extension started making the rounds – followed immediately by price jumps by the time Congress formally adjourned without action on Dec. 18.
This price movement tracked broad industry aggregates, like SNL Financial’s U.S. Insurance Underwriter Index, which is mostly comprised of companies with no appreciable exposure to terrorism, such as life insurers and writers of personal home and auto coverage.
The same basic trends can be seen among real estate investment trusts, as measured by the share prices of the largest exchange-traded funds specializing in REITs.
You see the same basic curve even in the share price of the company that arguably has been most vocal about the need to extend the TRIA program – hotel and hospitality giant Marriott International (which, to be fair, has seen real material losses as a result of terrorism, both on Sept. 11, and in other actions around the world.)
In case after case, one sees the same thing: a mild dip of only a few percentage points, well within the running 52-week range, during the week the terror bill’s fate was uncertain, followed by an immediate bump once Congress adjourned and the bill’s demise was settled fact.
What’s more, given that this period coincided almost precisely with uncertainty over a potential federal government shutdown, the degree to which any effect is ascribable specifically to TRIA, as opposed to broad macro variables, can never be known with any precision. The fact that share prices of the big U.S. commercial property insurers tracked closely with their industry at-large is further evidence that the signal, however feint it already was, could never be effectively separated from the noise.
Perhaps one reason the market panic has not quite materialized as anticipated is that, thus far, the credit rating agencies have been fairly sedate in their responses. Insurance rating agency A.M. Best Co. opted not to take any rating actions in response to the lapse, not even on insurers it previously had identified as “overly reliant” on the TRIA program:
All of the rating units deemed overly reliant upon TRIPRA were brought before a rating committee to evaluate action plans that would be implemented in the event TRIPRA was not renewed or if its protection was materially altered. After a thorough review of these action plans, it was determined that sufficient mitigation initiatives were developed to avoid a material impact on a rating unit’s financial strength.
Fitch said it has identified about 20 commercial mortgage-backed securities transactions that are likely to be placed on a negative ratings watch in the absence of TRIA, with the greatest impact falling on “office properties with loans in CMBS single-asset transactions.” Fitch did note that, over the past decade, “commercial property insurers have gradually enhanced their ability to measure and model exposure to terrorism events.” In the end, compared to the withdrawal of terror coverage in 2002 that prompted passage of TRIA in the first place, the rating agency said it “remains difficult to predict whether financial and property markets have a greater propensity to adapt to an environment without a government-sponsored terrorism insurance program.”
On the other hand, almost immediately after offering that guidance, Fitch affirmed (with a “stable” outlook) the A- rating of Greater New York Mutual Insurance Co., precisely the kind of mid-sized, geographically concentrated commercial property insurer that partisans of the TRIA program long have pointed to as needing the program. In February, GNY Chairman and CEO Warren Heck served as a key witness for the industry, offering testimony to the Senate Banking Committee pleading for reauthorization of TRIA.
Moreover, fellow rating agency Standard & Poor’s opined that, given the currently overcapitalized state of the global reinsurance market, it actually is possible that private coverage could step in to fill the gap almost entirely. S&P pegs the market’s current capacity at between $3 billion and $4 billion per risk, although that drops down to closer to $1 billion in dense Tier One cities like New York, where insurers have issues of excessive aggregation risk. But the longer the TRIA program remains expired, the more likely it is that both traditional reinsurance and alternative sources of capital will be deployed for terrorism coverage, S&P said:
They (insurers) will seek to limit their exposures in peak risk areas like downtown Manhattan by purchasing additional reinsurance and targeting underwriting actions. In addition to exclusions and sublimits, commercial property and workers’ compensation policies may see rate increases, if not nonrenewals, where exposure is concentrated. We do not expect NBCR coverage to be available on any lines except those like workers’ compensation where regulation expressly requires it. Currently available private-market capacity could leave buildings in peak zones underinsured.
If TRIA legislation remains dormant for long enough, however, well-capitalized insurance companies, compelled by market demand and a desire to deploy excess capital, may begin providing terrorism coverage for higher premiums. Also, stand-alone terrorism coverage providers are likely to provide additional capacity for the right price.
Early reports suggest that underwriters and managing general agents are responding well to the anticipated uptick in demand for standalone terror cover from the private market. Broker USI Holdings has been among those flagging a new terrorism facility solution, with limits of up to $200 million, flexible deductibles, individually underwritten premiums and terrorism definitions that are much broader than those offered under TRIA. Competitor Willis noted “there does remain a vibrant stand-alone terrorism solution which can be explored once clients have evaluated their needs,” while Marsh, the largest commercial insurance broker in the world, said the standalone terror insurance market “has large but limited capacity.”
Bermuda-based XL Group, which earlier this month introduced a standalone U.S. terror policy, more recently rolled out a product that would even cover chemical and nuclear attacks. Meanwhile, infamous former longtime AIG Chairman and CEO Maurice R. “Hank” Greenberg, now the chairman and CEO of Starr Insurance Holdings, was quick to respond to news of the TRIA program’s expiration with the declaration that Starr is “ready to respond to the needs of our clients.”
We have capacity for stand-alone coverage for a broad array of Property, Casualty and Aviation exposures. We would also like to take this opportunity to emphasize that many of our policies already provide for terrorism exposure. We encourage you to contact us immediately to create solutions for your needs.
Even in the workers’ comp market – generally considered most vulnerable to TRIA’s expiration, both due to the mandatory nature of the coverage and the fact that exclusions cannot be written for nuclear or other WMD-type attacks – significant expansions have been seen this year in private terror coverage options. Writing at PropertyCasualty360, Safety National Vice President Mark Walls noted that while some workers’ comp policies could expire due to end of TRIA, “I do not get the impression that this is a widespread issue.”
Carriers are likely paying more attention to their geographic concentration of exposures, which means employers will have fewer choices, and may see higher pricing. But, at the end of the day, employers should be able to obtain workers’ compensation coverage without the TRIA backstop in place.
None of this should be interpreted as a claim that TRIA’s expiration will have no effect on the insurance market or the commercial real estate market. Certainly, terrorism insurance should be expected to be more expensive and somewhat less available going forward. In some cases, policyholders who believed they had bound new insurance contracts, which in many cases renew on Jan. 1, will need to reassess whether that includes coverage for terrorism.
Contract forms developed for the industry by ISO (available in all states except New York and Florida) have since 2004 included conditional language that allows terrorism coverage to become excluded or limited in the middle of a coverage term, in the event the TRIA program were to expire. ISO said last week it would be monitoring developments in the 114th Congress closely, including “a potential retroactive renewal of TRIA.”
Kroll Bond Rating Agency added that, for CMBS and REITs, master servicers could conceivably have to force-place coverage for certain properties, raising the potential for additional servicing costs or even litigation. Kroll said it “has identified 27 CMBS single borrower securitizations within our rated universe where we believe the master servicer may be inclined to force-place insurance.”
We haven’t changed our stance on the issue. The federal terrorism insurance backstop should be phased out in a way that is steady and predictable. Sudden capital shocks do not make for wise public policy.
At the same time, always take the hyperbolic claims of special interests bearing tales of chaos and panic with a significant grain of salt. In this case, the numbers don’t lie.