TRIA Update: The Clock is Ticking

In October, we published an abstract and multimedia overview of one of our white papers “The Rippling Effects of Insurance Uncertainty on Commercial Real Estate”, which discussed how the terrorist attacks could have caused chaos in the insurance industry had it not been for a key piece of federal legislation. The Terrorism Risk Insurance Act, or TRIA came into effect in November of 2002 after it became apparent that the new reality of risk could potentially render the insurance industry insolvent without a federal reinsurance backstop. This legislation was of particular interest to large owners of centrally-located real estate, as conventional thinking suggests a heightened risk of terrorism in more densely populated nodes. There were strings attached, however, as TRIA was put into effect for a period of only three years until a better solution could be crafted. Almost sixteen months after the passage of TRIA, it seems the industry is no closer to a solution than it was prior to the legislation. Not good news - the clock is ticking and unless a new initiative is put together, TRIA will expire on December 31, 2005.

This emerging problem was highlighted in a public hearing conducted by The National Commission on Terrorist Attacks upon the United States on November 19th of 2003. The transcript of this hearing is quite lengthy, so we have isolated the portion where TRIA's future was discussed. The following assessment of emerging challenges was made by John Degnan, the vice chairman of Chubb Corporation. Chubb was one of the largest insurers at the World Trade Center and expected to pay $3.2 billion in gross losses arising out of the September 11 attack.

Mr. Degnan not only described the intricate relationship that exists between the insurance industry and reinsurers, but also how the dynamics of insurance have changed since the terrorist attacks.

“Before September 11…when an insurer looked at a workers' compensation risk for a financial services provider, as many of the companies in the World Trade Center were, the maximum probable loss of such a firm was relatively low compared to often other more dangerous lines of work. White collar workers generally don't experience the same incidence of claims or severity of claims that manufacturing workers experience, and we underwrote to that risk. But after September 11, even a moderate sized financial services company can face a maximum risk of more than half a billion dollars. So even under TRIA, each individual risk that we write has a probably maximum loss of up to the per company deductible, and insurers continued to be faced with staggering potential losses.”

It seems the emerging problem here is a uniquely American one vis-à-vis other developed countries, who have put strong public-private insurance partnerships into place and enacted legislation to mitigate the risks associated with catastrophic loss. An example of this is Pool Re in the United Kingdom. This reinsurance device mandates that all organizations take out terrorism insurance. Degnan points out that TRIA is voluntary, thereby creating a market condition described as Adverse Selection that forces only those people with the greatest exposure to terrorist events to take out terrorism insurance:

“Those who, for example, work in signature buildings, such as the Empire State Building in New York or the Sears Tower in Chicago, generally are buying the terrorist insurance. But if you live in a low -- or you work in a low-rise office building outside Des Moines, Iowa, you're less likely to buy terrorism insurance. And the only way insurance really works as a mechanism is if the fortunate many take care of the misfortunate few by allowing their money to be pooled to deal with catastrophic risk. But because terrorism presents such unique risk management issues and concerns, policyholder participation in a terrorism insurance arrangement should be compulsory.”

Degnan suggests that even those in Des Moines are not in the clear:

"However, our attention cannot be limited to those exposures. Terrorists, as we know, most often strike at soft targets in an attempt to disrupt everyday life. An effective federal terrorism insurance program, therefore, has to address the exposures presented by high profile, and to a terrorist, highly desirable targets, like sports arenas, universities, shopping malls, daycare facilities, and even hospitals

Regardless of the ongoing discussions and the national forums that have been established, one thing remains crystal clear: a new public-private initiative is required that constructively deals with the reinsurance backstop issue over the long term. In the absence of such an initiative, the burden of the terrorism insurance problem squarely rests on the shoulders of the private sector, and this could indeed prove too hard to handle alone.