Terrorism and insurance
Insurance after 9-11
The US had been a virtual island in the sea of the world’s political attacks up to and until that day, and financial losses from terrorism were not on the list of an actuary’s most-likely or even -costly events. However, that changed dramatically when four planes were hijacked and three were flown into occupied buildings. It was a forty billion dollar blow to the insurance industry.
Most of the financial loss was shifted from primary insurance companies to what are known as reinsurance companies. Reinsurance companies are those companies that insure insurance companies against losses over and above a certain level. For example if a client has purchased a $1,000,000 liability insurance policy for his gas station, the primary insurance company may purchase from (or lay off to) a reinsurance company $900,000 of this risk.
Thus, if there are any losses the primary insurance company will pay the first $100,000 out of its own reserve, and the reinsurance company, through the primary insurance company, will pay any balance up to the policy limits over and above the $100,000. Like loan syndications by banks, reinsurance provides the insurance industry the opportunity to diffuse the effect of major losses by one insurance carrier to a number of insurance carriers.
After a forty billion dollar loss, the reinsurance industry began shedding its exposure to losses cause by terrorism. Losses caused by terrorism became a named exclusion to coverage. These changes occurred, for about 70% of the reinsurance policies, at midnight December 31, 2001. The remaining will incorporate terrorism as a named exclusion to their policies at midnight on July 31, 2002. As reinsurance companies walk away from coverage, it has exposed all of the primary insurance carriers to the losses caused by terrorism until the primary policies with clients have been re-written at the policy renewal dates to mirror the exclusions in the reinsurance contracts. This overlapping period has a regulatory hurdle to overcome: Before most carriers can change their policies, the changes must be approved by the insurance commissions for the states in which the policy is offered. This caused the Insurance Service Office (ISO), which develops standard policy contract language for use by property and casualty insurance companies, to file a request in every state for permission to exclude terrorism from all commercial insurance coverage. By February 22, 2002, forty-five states, including DC andPuerto Rico, had approved the exclusion. However, most states already provide that major or sophisticated purchasers of insurance can negotiate their individual policies directly with the insurance companies.
Thus, it is assumed – and feared – by many small business groups that most policies were renewed with the terrorism exclusion included, with most business policyholders wholly ignorant of this change.
While this may not seem like a big deal to most small business owners, legislators are already reviewing the “overly broad language” of these so called terrorism exclusions. Terrorism thresholds for exclusion are from twenty-five to fifty million in serious casualties, with an all or nothing threshold (insurance companies pay nothing if the threshold is reached), or the aggregate losses from multiple incidents with a 72 hour period and across most of North America into one event if the events “appear to be carried out in concert or to have a related purpose or common leadership.” Further, some exclusions go as far as to exclude coverage if their purpose behind the attack was to cause fear and or terror, and was an organized attack.
Interestingly, some states also require that fire insurance cover the losses caused by fire no matter what the cause. So, with the attack on the World Trade Center, a policy would not cover that damage done by the impact but would have to cover the loses caused by the fire, which has been blamed for the subsequent collapse of the towers.
The real problem has stemmed from our US legislators and their never ending campaigning to get their face on the TV or in the newspaper. Many states have passed bills and penalties for domestic terrorism. Many of these domestic terrorism events have to do with domestic incidents and refer to such things as a home or a dwelling and how the occupants in it behave poorly: Shouting, yelling, punching, shooting, etc…. They have nothing to do with political terrorism such as the Puerto Rican Nationalists shooting up DC, the bombing of the Oklahoma Federal Building, or the criminal acts at the Twin Towers and the Pentagon. All of these domestic terrorism bills have provisions whereby a person can be charged with anything from a misdemeanor to a felony for stalking, harming, and threatening to harm. So why is this important?
Assume the following: An irate ex-husband throws a Molotov cocktail through the window of his ex-wife’s trailer. She escapes, but the trailer and all of the 10 trailers around it, and a Circle K, are burnt to the ground. Can the insurance company claim that because the perpetrator was charged with an act of domestic terrorism the insurance company is no longer obligated to pay?
Or take the case of a disaffected employee who begins threatening a company and its employees with harm, destruction, etc…. The ex-employ carries out such a threat by blowing up a small portion of the plant, killing 12 people and shutting down that portion of the business. Can the insurance company claim that since this was an act of terrorism none of the damages are covered? Further, can those companies that have insured the lives of those persons who were lost claim that since their demise was caused by an act of domestic terrorism they, too, are excluded from coverage? Can the liability policy for the company refuse to pay the claims made by those of the decedent’s family and of the injured survivors because this was an act of domestic terrorism? It is a thorny problem.
It will be interesting to see how the domestic insurance industry deals with the letterbox bomber who wanted to “put a smiley face on the map” through the plotting of where he put his bombs.
But can you get terrorism insurance? Yes, of course, but like residents in California who live on a fault line, the insurance will tend to have high deductibles and tight limits and criteria on coverage.
The owners of a small Midwestern shopping mall reported that when their all-risk insurance policy on the mall property expired at the end of 2001, they were forced to purchase a terrorism excluded policy because they could not find an all-risk policy that included terrorism. The mall’s mortgage lender objected to the terrorism-excluded policy stating that the mall was out of compliance with the “all-risk” policy required in the loan documents. The lender then purchased a “terrorism” policy to supplement the mall’s new policy and demanded to be reimbursed for the premium. The premium demanded for the terrorism policy was three times the previous year’s “all risk” (with terrorism not excluded) policy. The mall went to court and successfully obtained a temporary restraining order to prevent the lender from forcing repayment of the terrorism policy premium. The lender argued that it was now being forced to assume the risk that it had not previously priced into the mortgages, and is thus forcing the mortgage holders to obtain coverage. The lender also recognizes that the unavailability or the cost of terrorism insurance will negatively impact the mortgage lender’s ability to service the loans or even bundle and sell the loans.
A New York construction firm has been told by its financing sources that they will not provide financing for the 30-story apartment complex unless the construction firm can get terrorism coverage. Terrorism coverage is not available. The project will not proceed.
An Alexandria,Virginia, office building owner cannot get terrorism insurance as required by the lender for an $80 million office building. The building will be put into Chapter 11 and operated as a bankrupt entity to prevent the current mortgage holder from foreclosing.
The buyer for an office building in Chicago(for $300 million) could get terrorism insurance for six million dollars. The buyer had budgeted $75,000 for all of the building insurance needs, and this new premium represents over 11% of the gross rents of the building. The building is not saleable. The issues raised by this article are the heart of the debate that has been raised by the GAO and the risk managers of many portfolios whose assets, once thought to be protected, are now exposed by this uncertainty. Many projects have already been cancelled by the project owners when the financing requirements required protecting from terrorism. Projects such as new power plants and water faculties have been the hardest hit. These types of project bonds are typically purchased by very risk adverse funds managers for “widows and orphans” type investments, and require all-risk policies. Other existing projects have had to go bare, without terrorism insurance, since it was unaffordable or unavailable, thus shifting the risk once assumed by the insurance carrier to the owners and lenders. This has affected municipal power companies, water treatments facilities (public and private), ports, and harbors and bridges. The problems are particularly acute for businesses in central business districts, and for privately held facilities considered to be likely potential targets of terrorism such as power plants, water treatment facilities, and the like.
So how does a company today address and assess the potential losses caused by terrorism? Very poorly, if at all. The whole process is currently panic driven, as reflected in the increases in all of the PC rates including an average jump of 20% in homeowner policies.
We suggest that, for a start, you should read your policy and keep an up-to-date copy on hand. Further, require the insurance company to provide, in advance, a clear and meaningful definition of terrorism and its exclusions.