By Thomas A. Player
In 1954, the Spanish government established Corsico de Compensación de Seguros in response to Basque terrorism. Since that time, most catastrophic risks have been added as covered risks in this national program which enjoys unlimited backing by the Spanish government. In 1994, the United Kingdom established Pool Re as a voluntary terrorism insurance program, backed by the British government. This was in response to the IRA bombings. In early 2002, our Terrorism Risk Insurance Act (“TRIA”), was put into place as a combination of private coverage with a government backstop. Similar state supported responses were established in France and Germany that same year. The implementation of each such program quieted jittery market conditions and provided stability.
Just recently, Senators Hillary Clinton and Bill Nelson introduced The Homeowners Defense Act of 2007. A companion bill has passed the House. The legislation provides for a voluntary state catastrophe pool for federal catastrophe reinsurance and for low interest loans. In addition, much discussion has occurred concerning an expansion of the Federal Flood Program. Limited support has been garnered for sub-prime mortgage-holder relief, as well as a wildfire pool.
Such political talk and action only underscore the deep-seeded notion that a federal bailout is viewed in many cases as the answer to a large unreimbursed loss. Most experts believe in a market-driven economy, private insurance should always be primary, with a federal bailout only becoming necessary if the private sector is unable to handle the risk or social issues drive us as a society to conclude that a federal bailout is required. In September, 2006, a Government Accounting Office (“GAO”) report on terrorism to the Chairman on Financial Services of the House of Representatives cited four criteria indicating private coverage should be preferred. The risk profile is:
- Past occurrences sufficient in number and homogeneity;
- Definite and measurable in dollar value;
- Occur by chance (exception: terrorism); and
- Will not result in an enterprise-ending loss for an insurer.
In my view, a leading criteria has been omitted: political pressure or support.
Government involvement in satisfying economic or financial losses is deep-seeded in our nation’s history. President Franklin Roosevelt created the Works Progress Administration (“WPA”) in 1935 in response to the Great Depression. Farm support, subsidies and price controls were born in the 1930’s driven by the drought conditions in the Midwest. More modern bailouts were evidenced by government support during the Savings and Loan crisis and during the impending failure of Chrysler Corporation. After 9/11, the airlines sought a federal bailout but were unsuccessful. However, no federal backstop program has approached the $100 billion Terrorism Risk Insurance Act of 2002.
In other countries, programs were instigated for different reasons. Since inception, the Spanish program has built a substantial surplus and now covers most natural catastrophes as well as terrorism. Since its inception, Pool Re has also grown substantial surplus as the IRA bombings have subsided.
These facilities, together with our TRIA, provide confidence for the financial markets. Since 9/11, there have been several noteworthy terrorist attacks: the 2004 Madrid commuter train bombing, the 2005 London subway bombing, and the 2006 Madrid airport garage bombing. Interestingly, my information is that none of these losses triggered a state response. In essence, all these high profile, but manageable losses, were handled within the capacity of the terrorism programs without accessing state funds.
We are now in a deep debate about the extension of TRIA. Most think it will happen. The most problematic area of coverage which is being debated is whether our terrorism coverage should include coverage for so-called NBCR (nuclear, biological, chemical and radiological) losses. The latter may need some explanation. A radiological loss does not involve a nuclear bomb. It involves destruction by a conventional bomb spreading radiological debris. The House Bill requires that carriers “make available” limited NBCR coverage. The Senate Bill does not.
It seems the issue, even with limited NBCR coverage, is whether or not carriers can find reinsurance in order to cover their deductible and co-pay responsibilities. I am under the impression that whereas there is limited chemical and biological reinsurance, and perhaps a very limited amount of radiological reinsurance, there is almost no nuclear reinsurance. Perhaps in recognition of this, the House Bill requires the Secretary of the Treasury to establish a “terrorism buy-down fund” through which insurers may purchase coverage and pool risks for terrorism losses.
Many other state terrorism funds include reinsurers as part of the private sector solution. For example, the following schematic of the French system provided by the GAO report on catastrophe risk prominently relies upon reinsurance. Is it fanciful to believe that Congress might establish a blue ribbon study group, much like the 9/11 commission, to analyze the most efficient and fair method in which to cover societal risks? Whether such risks are terrorism, hurricane, flood or earthquake, a comprehensive plan might establish parameters for the private sector and set an attachment point or level at which we, as a people, believe society should respond to a natural disaster or act of terrorism. Wouldn’t it be better to have federal backstop programs in place for market stability, even if not called upon? As an illustration, would we respond with federal assistance in the event of a reoccurrence of the 1906 San Francisco earthquake? Certainly. So why not engage in a thoughtful debate and enactment of corridors for private coverage and attachment points for federal backstops before a calamity occurs?
Otherwise, we are doomed to address politically motivated government support by passing the hat in Congress for large sums of money following a major loss. On a more realistic scale, we can only hope that Congress seriously addresses the need for a degree of NBCR coverage in the extended Terrorism Risk Insurance Act.
Thomas Player is a partner and chairman of the insurance and reinsurance group. His areas of expertise include insurance and reinsurance, mergers and acquisitions, complex regulatory issues and dispute resolution. Tom received his bachelor’s degree from Furman University and his law degree from the University of Virginia.
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