Public-private partnership still needed to insure against terrorism

The Terrorism Risk Insurance Act, also known as TRIA, was approved in the aftermath of the 9/11/01 attack. Its purpose was to stabilize the market, ensure that private terrorism coverage would be widely available and provide for an orderly recovery in the event of future catastrophic losses. The partnership created by TRIA has enabled a private market to exist that has provided the certainty and capacity needed while also protecting taxpayer interests.

There is little doubt that TRIA has worked well. Since its enactment, Congress has extended the program twice – in 2005 and again in 2007 – and the public-private partnership continues to serve the interests of policyholders, industry and federal taxpayers. Under the program, insurers would have to absorb significant losses -- approximately $30 billion in industry-wide deductibles -- before government steps in. In addition, the government recoups any federal dollars it spends up to the first $27.5 billion of terrorism losses and is enabled to recoup any additional federal share of losses up to the program’s cap.

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With TRIA set to expire at the end of next year, lawmakers must decide whether to extend the program again. This week, the House Financial Services Housing and Insurance Subcommittee will discuss whether changes should be made. Lawmakers rightly want to explore whether insurers and the private sector have developed the financial ability and the significant levels of capital to create the necessary capacity to cover large-scale losses that result from a terrorist attack. The simple answer is no.

Today, private reinsurance capacity for terrorism is $6 billion to $8 billion. This is far short of the approximately $30 billion in exposure retained by insurers that write terrorism coverage. Contrary to those who assert that TRIA is “crowding out” the private reinsurance market, there remains a significant gap in the industry’s capacity to handle the peril. Reinsurance is essential because it helps stabilize the insurance market. Reinsurance enables insurers to spread risk, which creates the additional capacity needed to write policies in an uncertain world.   

A report by the consulting firm Marsh confirms that no private insurance mechanism is sufficient to cover the risk of unconventional or large-scale losses from terrorist attacks. Another report by Swiss Re states that the “insurance industry remains more vulnerable to terrorist events than to natural catastrophes” because terrorism risk can be covered only by “TRIA and a limited amount of reinsurance.”

Some will argue that the recent increase in capital, in the form of insurance-linked securities, available to protect against the risk of natural disasters means that the private sector is ready to take on terrorism risk as well. However, unlike natural disasters, terrorism is considered “directly correlated,” which means that a significant terrorism event will also adversely impact the broad financial markets. Risks that are correlated to adverse market reactions are generally unattractive to investors. We are unaware of any terrorism-linked property casualty insurance securities being issued in the U.S. since 9/11.

There may be some interest by the capital markets in financing terrorism risk, but it is nowhere near what would be necessary to support a fully private terrorism insurance market.

No one wants to contemplate the aftermath of another catastrophic terrorist attack like 9/11 or something even worse. But insurers must do so. While some critics might contend that insurers can handle the risk of terrorism on their own, they are ignoring basic facts. TRIA remains a successful and necessary public-private partnership and the best way to protect both the economy and American taxpayers.

Pusey is president and CEO of the American Insurance Association.