Terrorism And Insurance

TERRORISM AND INSURANCE

(July, 2018)

Some loss exposures are difficult, if not impossible, to be handled by the private insurance industry. Large exposures are considered catastrophes and involve widespread devastating loss, unpredictable occurrences and costs that can’t be efficiently spread over the entire, property-owning public. Events that are considered to be catastrophic include:

  • Earthquakes
  • Floods
  • Hurricanes
  • Terrorism

INSURING CATASTROPHES

How does a catastrophe become insurable? Three ways – direct government insurance, state mandated private insurance pooling, and reinsurance.

Direct Government Insurance (Flood)

The government, using FEMA (Federal Emergency Management Agency), provides flood coverage. Its approach combines insurance with mandated risk management techniques to help communities in flood prone areas to mitigate such losses. FEMA enforces compliance with mitigation requirements by withdrawing federal assistance if the techniques are not implemented. Besides the loss of FEMA money to address future flooding, the homes and businesses in an area abandoned by FEMA will not be able to purchase insurance.

 

Example: A community on the Ohio River recently had a number of rental trailers located in an area designated by FEMA as a flood area. Their location violated a FEMA guideline and jeopardized that community's FEMA support. To preserve its FEMA eligibility, the community resorted to a declaration of imminent domain, purchased the land on which the mobile homes were located and then evicted the trailers’ residents.

 

Pooling System (Hurricanes)

These severe storms are insured by individual states which allocate losses among their insurance companies using their own, state-specific formulas. Each state has a unique way of funding its pool, defining high-risk areas and handling claims.

A state pool is a mechanism for spreading risk, so such programs can be actuarially sound. However, a state hurricane pool can fail if it suffers damage from several hurricanes. An insurance crisis can occur if insurers leave a state in order to avoid pool premium surcharges.

Reinsurance (Earthquakes)

The reinsurance market has been willing to work with the industry to cover earthquake exposures. Risk management techniques regarding building construction have been effective in reducing loss. Although the loss potential is significant, the industry has found a way to cover most earthquake exposures by spreading the risk among insureds, insurers and reinsurers. A notable exception is the California residential market. As insurers began to withdraw and restrict coverage following the Northridge earthquake in 1994, the state created the California Earthquake Authority as an earthquake pool.

DOMESTIC AND FOREIGN TERRORISM

Terrorism differs from other catastrophes because it is not an aspect of weather or nature. However, it shares the same problem of insurability with its natural peers. There are two distinct types of terrorism: domestic and foreign. Domestic terrorism involves terrorist acts (or plans) by citizens of the same country where the act is committed. The reason for the act (or planned act) generally involves some domestic political agenda.

 

Example: In the United States, the Unabomber (a U.S. citizen) sent bombs through the mail to protest the growth of technology.

 

Foreign terrorism involves acts of individuals from one (or more countries) who wish to disrupt the lives of another country’s citizens in order to advance a particular cause.

 

Example: A foreign student attending a college in the U.S. sets off a bomb in a bank in the town next to her college's campus. The bombing was planned by a foreign group that was trying to affect that bank's investment practices. The foreign student belonged to the militant group before leaving her home for studying in America.

 

Note: The original TRIA and the 2005 extension did not provide coverage for domestic terrorism. The Terrorism Risk Insurance Program Reauthorization Act of 2007 expanded coverage by no longer requiring that terrorism be conducted by a foreign party or on behalf of a foreign interest. This expanded coverage continues in the Terrorism Risk Insurance Act Reauthorization Act of 2015 (TRIPRA)

Terrorism and Insurance

Insurance policies do not specifically refer to terrorism; rather, insurers address the exposure indirectly. The policy provision with the closest possible application to terrorism may be the War and Military Action exclusion.

The Insurance Services Office (ISO) CP 10 30–Special Cause of Loss Form is a good example of the war exclusion's application to terrorists’ action. It is titled War and Military Action. The first item excluded is war. Because the term is not defined in insurance policies, understanding the exclusion relies on dictionaries. Typically war is described as a conflict or contest between political units. It may also be an armed conflict between sovereign powers. Although the action does not need to be formally declared, there must be a recognized government behind the action.

The next source of loss that is excluded is damage from warlike actions taken by a military force. No terms are defined but a military force implies the involvement of a nation or sovereignty.

The other ineligible causes of loss involve attempts to overthrow a government, such as insurrection, rebellion, revolution or attempting to usurp power. This exclusion is meant to bar coverage for actions of one country against another or of a shadow government attempting to gain control of the current government, not acts of terror, even if those acts are pre-meditated.

Similar to the U.S. riots of 1965, the industry was faced with a tough coverage situation. There was coverage for terrorism and the likelihood of suffering losses from terrorism became significant. Pricing was (and is) a major concern. Premiums for insurance did not take into consideration the terrorism exposure; therefore prices did not match total exposures.

The U.S. insurance industry had no criteria to quickly develop actuarially-based rates and no information concerning the possible occurrence of another major incident.

Industry reaction was initiated by the reinsurance market which promptly excluded the terrorism exposure. The primary carriers followed their lead. ISO and AAIS made it a priority to quickly draft and file terrorism exclusions with state insurance departments. Markets developed for terrorism coverage but it was only available at high premiums, significant deductibles and minimal limits.

Congressional hearings started within 30 days of the World Trade Center disaster to develop a plan. One of the first recommendations was to develop a plan very similar to the Riot Reinsurance Act. After considerable debate, Congress presented the Terrorism Risk Insurance Act (TRIA) to the President. He signed it into law on November 26, 2002. A key difference between TRIA and the riot reinsurance act was that TRIA have a termination date. Separate legislation had been required to end the riot reinsurance act when it was no longer needed. TRIA was originally scheduled to end on 12/31/04. However, the Secretary of the Treasury extended the Act to 12/31/05. Then on 12/26/07 it was extended by legislation to 2014.  The act was reauthorized in 2015 with an expiration date of 12/31/2020. TRIA continues to be a backstop for the U.S. insurance industry but the hope is that the industry will develop a private mechanism to provide coverage. As of the date of this article, the terrorism backstop has not been used.

Related Article: The Terrorism Risk Insurance Act.