Private Workers’ Comp Terrorism Pool Falls Short

The private insurance industry for workers’ compensation would not have enough capital to withstand potential losses on its own should a catastrophic terrorism event, or multiple events, occur, according to the Workers’ Compensation Terrorism Reinsurance Pool Feasibility Study conducted by the Tillinghast and reinsurance businesses of Towers Perrin.

According to Tillinghast, the study is one of the first serious efforts the industry has taken toward exploring the viability of private market solutions to help manage the threat of terrorism for workers’ comp insurance.

The Terrorism Risk Insurance Act (TRIA), which expires on Dec. 31, 2005, was enacted in 2002 in part to provide a temporary window of relief so insurers could develop private market solutions to manage the ongoing risk of terrorism. Terrorism and insurance experts have conceived of plausible catastrophic terrorism events that generate workers’ comp losses of $90 billion or more, roughly three times the $30 billion capital backing in the workers’ comp line of business.

The study acknowledges the potential value of a voluntary reinsurance pool to some individual insurers, but points to its limitations as a meaningful industry solution, particularly absent some form of ongoing federal backstop protection. A voluntary workers’ comp industry reinsurance pool would not create new capital in and of itself to support catastrophic terrorism losses, though it would diversify risk and thereby increase the efficiency with which existing capital is deployed, according to the report.

“Although the idea of an industry risk-sharing pool has been considered one of the most promising private market solutions for managing terrorism risk to date, the study concluded that this alone falls well short of addressing industry needs,” said Charles Wolstein, who led the Workers’ Compensation Terrorism Study on behalf of the firm.

“Terrorism is still very much a concern for U.S. business, and the recent bombings in Madrid further underscore the possibility of future attacks. A public/private partnership is critical to managing future terrorism risk for workers’ comp insurance post-TRIA,” said Stephen Lowe, Global P/C Insurance Practice Leader. “The industry needs to begin working with Congress now on developing such a partnership to avoid the potential for significant marketplace disruption in the event of major losses from future terrorist attacks.”

The statutory nature of workers’ comp insurance makes it fundamentally different from other lines of insurance, creating a unique situation for the workers’ comp market. Unlike property insurance, workers’ comp providers cannot introduce terrorism coverage exclusions, nor can they limit their potential losses on any policy. Workers’ comp insurers are obligated to pay wage loss and medical benefits to workers injured on the job—without regard to cause and without limit.

“The complexities and magnitude of terrorism risk are extraordinary and there would be vast implications for the workers’ comp insurance market and U.S. businesses should a major terrorism event occur without a federal reinsurance mechanism in place. A major event could be greater than the entire base of capital that is supporting the workers’ comp insurance market, tearing away a structurally critical piece of the economy,” said Lowe. “Since workers’ comp insurance is required in virtually all states, the absence of a functional workers’ comp insurance market would interfere with the conduct of business throughout the economy.”

“Post-TRIA, insurers will be left with two options to manage the risk of catastrophic losses from terrorism—curtail workers’ comp policies or obtain catastrophic protection from a third party,” said Bruce Hockman, principal and workers’ compensation practice leader for the firm’s reinsurance business. “However, without a federal backstop in place, it is unlikely that commercial reinsurance—the industry’s traditional source of catastrophe protection—would be available in sufficient quantities, or at affordable prices, to meet marketplace demand.”

What’s next?
“We’re now midway through TRIA and are starting to see the industry thinking about how their businesses will work without it, as the very real prospect of TRIA’s expiration looms.” said Wolstein. Although TRIA remains in effect until Dec. 31, 2005, policies written as early as Jan. 1, 2005, will extend beyond TRIA’s coverage, presenting a significant dilemma for insurers, he added.

“The study laid the foundation for future work on an industry pool,” said Wolstein. “It’s a reasonable possibility that a pool could be created someday; however, the sponsors concluded that it would only make sense to pursue further dialogue ‘if and when’ the form of ongoing federal backstop protection becomes clearer.”

He further noted, “Hypothetically, a pool can only address 10 percent of the problem. Until the other 90 percent is addressed, it wouldn’t make sense to undertake the considerable effort necessary to develop the pool. Currently, a federal mechanism appears to be the only viable means of addressing the lion’s share of terrorism risk for workers’ comp.”