This paper summarizes the U.S. program for terrorism insurance, outlines its advantages and disadvantages, and describes the current proposals for extension of the program. The program, generally referred to as a “Federal Backstop,” functions in some ways that are similar to reinsurance, but it does not require participants to pay premiums ex ante. Instead uses an ex post recoupment mechanism to recover some or all of the Federal payments made under the program. This approach has the advantage of reducing the cost and increasing the availability of terrorism insurance. Some have criticized the program for its interference in market mechanisms, but the program facilitated the development of the market underneath the backstop. The program does not cover NBCR risk, and some types of insurance are excluded. In addition, the program does not preempt state price regulation or the mandated use of the standard fire insurance policy, which provides coverage for ensuing fires after terrorism events. These weaknesses are not addressed by current proposed legislation to extend the program for seven years without any changes. The strong, bipartisan support for the proposed legislation suggests that it is likely to pass.
Keywords: Terror, Terrorism, Insurance, Insurers, September 11, Terrorism-related loss, Reinsurance, Terrorism Risk Insurance Act, TRIA, CNBR
The September 11th terrorist attacks in the United States triggered a crisis in the market for terrorism insurance. After reinsurers paid out billions of dollars to cover terrorism losses, they stopped providing coverage for terrorism going forward. This caused primary insurers to exclude terrorism losses from their coverage. Because of a perceived drag on the U.S. economy from the unavailability terrorism coverage, the U.S. adopted the Terrorism Risk Insurance Act (“TRIA) in 2002. TRIA created a unique government-industry partnership to support the development of the terrorism insurance market. This program functions like reinsurance in that it will reimburse participating insurers for a portion of terrorism losses covered by their policies, but it does not charge ex ante premiums or maintain reserves like a reinsurer would. The program has been labeled a Federal “backstop” for terrorism insurance.
This paper describes the U.S. program for terrorism insurance, and explains the basis for the government’s involvement. Because of the unpredictable nature of terrorism, the Federal backstop is needed to limit the risk sufficient to reduce the price and availability of terrorism insurance. The paper addresses some of the objections to and weaknesses of the program.
II. Summary Description of the Terrorism Risk Insurance Program
A. Legislative History
TRIA was adopted in 2002 after insurers and reinsurers began excluding terrorism risk from insurance coverage in the wake of the September 11, 2001, terrorist attacks.(2) The exclusion of terrorism risk created a drag on the U.S. economy because banks were unwilling to lend on major construction projects without terrorism insurance.(3) In 2005, TRIA was extended for two years with an increase in the amount of insurers’ aggregate retention. (4) In 2007, the Act was extended to 2014 and modified to include domestic terrorism, to increase the amount of insurers’ aggregate retention again, and to raise the program trigger. (5) In 2015, the Act was extended to 2020, modified to increase the insurers’ aggregate retention, raised the program trigger, and revised the program in several other relatively minor ways.(6)
B. Coverage Under the Terrorism Risk Insurance Program
Under current law, the terrorism insurance program requires that commercial property and casualty insurers(7) offer terrorism coverage in the policies they are selling.(8) The program does not set the price of the insurance (though state regulation may apply), and does not require that insureds purchase terrorism coverage.
For a terrorism loss to be covered by the program, the event giving rise to the loss must be certified as an act of terrorism by the Secretary of the Treasury in consultation with the Secretary of Homeland Security, and property and casualty insurance losses from the event must exceed $5 million. (9) For the program to be “triggered” (giving insurers benefits under the program), insurance industry losses from the terrorism event must exceed $200 million in 2020. (10) In addition, for an individual insurer to receive benefits under the program, its losses must exceed a deductible equal to 20% of its annual direct earned premiums from the previous year.(11) Once the deductible has been met, as of 2020 insurers will be reimbursed for 80% of insured terrorism losses (12).
The program has an annual cap of $100 billion (13) (more than twice the losses from the September 11th attacks). If total insured losses exceed $100 billion in a calendar year, the program will not make additional payments,(14) and insurers that have met their deductible are relieved of any liability that exceeds the cap.(15)
Figure 1, adapted by the Congressional Research Service from an illustration prepared by the Congressional Budget Office, provides a graphical representation of the basic structure of the program, although it shows the aggregate loss trigger of $100 million and the individual insurer retention (coinsurance) of 15% in force in 2015. As of 2020, the program trigger is $200 million, and the individual insurer retention is 20%.