Industry Pays First $10 Billion of Future Terror Claims in Latest Fed Plan
The Bush administration and Congressional leaders hammered out a new version of a plan to provide reinsurance assistance to the U.S. insurance industry in the wake of the September 11th terrorist attacks, although discussions are ongoing as to what any final plan will entail.
The latest plan, worked out by Treasury Secretary Paul O’Neill, Senate banking committee chairman Paul Sarbanes (D-Md.), Senator Phil Gramm (R-Texas) and Senator Christopher Dodd (D-Conn.), attempts to resolve problems both industry and Congressional parties found with previous proposals.
Initially, the latest proposal would have the government pay 90 percent of future terrorist claims after they reach $10 billion. Insurers themselves would be responsible for all claims under that amount. By 2003, insurers would be wholly liable for the first $10 billion of losses, 50 percent of losses between $10 and $20 billion, and 10 percent of losses over $20 billion. By 2004, the industry would be 100 percent liable for the first $20 billion of losses, 50 percent liable for claims between $20 and $40 billion, and 10 percent liable for losses above $40 billion.
The industry had mixed responses to the latest proposal. According to Anne Sittmann, spokeswoman for the National Association of Independent Insurers (NAII), the plan would avoid creating any new government bureaucracy and prevent cross-subsidization across product lines by serving as a federal backstop with a specific sunset date.
The Alliance of American Insurers, however, took issue with the new plan’s approach. Organization spokeswoman Deborah Sherno stated, “We have serious concerns about an industry deductible rather than something based on individual company resources. The industry does not pay claims, companies do. This can’t help but affect the market.”
Despite the continued lack of consensus, both organizations anticipate that legislation will be passed soon.
This latest reinsurance proposal comes after senators from both parties criticized the Bush administration’s three-year assistance program proposed earlier this month for the insurance industry to help it manage terrorism risk.
According to an AFX report, while some Democrats said the industry needs a long-term solution, a number of Republicans expressed concerns about the government getting into the insurance business in a Senate Banking Committee hearing on proposed aid for the insurance industry.
Democrat Charles Schumer noted that, “We’re playing with fire,” warning that without a longer-term solution to the problem, property developers will be more reluctant to construct large buildings that could be at risk to terrorism.
About 70 percent of property and casualty insurance contracts expire at year-end, Treasury Secretary Paul O’Neill informed the committee. As reinsurance firms have said they will no longer cover acts of terrorism in contracts with primary insurers, this would leave businesses to deal with prohibitively expensive premiums or expose themselves to all such risk.
O’Neill indicated that leaving this problem unresolved threatens economic stability, as uninsured companies would face higher financing costs. Ratings agencies would likely downgrade the creditworthiness of such companies to take account of their exposure to terrorist acts.
While members of the committee agreed that some action should be taken, a number of them criticized the administration’s plan, which would make the government responsible for 80 percent of claims up to $20 billion and 90 percent of claims above $20 billion that stemmed from terrorists attacks. The government’s responsibility would phase out over the following two years.
The administration’s plan had been presented in response to a solution proposed by the insurance industry itself in which companies would form a state-chartered mutual insurance company, Homeland Security Mutual Reinsurance, to pool reinsurance for both commercial and personal lines. Under the industry proposal, insurers and the government would establish a uniform definition of terrorism applied to all insurance and reinsurance policies sold in the U.S., after which the Treasury Secretary would determine whether a given act resulting in a claim met that definition. If that criterion were met, affected insurers could then purchase retrocessional reinsurance through the Homeland Security system directly from the federal government. The Bush Administration rejected this proposal.
Democrat John Corzine claimed that a long-term solution would most likely be the answer, noting that credit spreads have risen significantly since Sept 11th. This rise would indicate that companies are finding it harder to raise capital. He said there is no reason to believe that reinsurance companies will step back into the market once the three-year plan is ended, given that insurers would still be exposed to potential terrorist attacks.
Republican Phil Gramm separately questioned whether the plan to include government coverage of 80 percent of the first dollar of insurance losses from terrorist events. He said having the industry exposed to 100 percent of the first portion of losses would offer a better incentive to the industry to transition towards assuming full responsibility itself.
Testifying before Congress, National Association of Insurance Commissioners president Kathleen Sebelius warned against too much federal intervention, saying that federal assistance to the industry should be limited in scope and duration. She also suggested that any federal assistance program enacted should utilize state regulatory systems already established to monitor insurer solvency and oversee claims-payment issues.
Regardless of what a final plan agreed upon by both the Bush administration and Congress entails, however, commercial premiums are likely to rise. According to a recent Conning & Company report, many insurers will have to reassess their Probable Maximum Loss (PML) estimates in the wake of September 11th. As these recalculations will increase insurers’ demand for more reinsurance, the companies will likely also start pricing terrorist attack risk coverage separately from other lines.