Insurers Prepare for a Post-TRIA World; ‘Baby Steps’ Toward Federal Regulation

Property/casualty insurers are coming to grips with the fact that a government-sponsored terrorism insurance backstop could expire at the end of next year, which would send pricing shockwaves through the market. Carriers have become accustomed to easy access to terror reinsurance because of the government-sponsored backstop created in 2002. But they are finding it difficult to imagine a world without the backstop, and are expected to make a big lobbying push as end-of-year renewals arrive.

However, brokers are already preparing clients for terrorism rates two to three times higher than current prices if Uncle Sam exits the stage, not to mention highly constrictive policy conditions.

“There is a viable commercial market for terror insurance, with about a half dozen [carriers] still writing policies,” said Gary Marchitello, managing director of Aon Risk Services. “There will be capacity [if the law expires], but at multiples of what people are paying now.”

Terror insurance was one of the hot topics among risk managers and insurers at the recent Risk and Insurance Management Society (RIMS) meeting in San Diego. The Terrorism Risk Insurance Act (TRIA) was signed into law in November 2002 as a federal guarantee for terrorism risk insurance. The law was designed to provide capacity for terrorism insurance, coverage that vanished from the commercial P/C industry following the Sept. 11 attacks. The government essentially became a reinsurer, offering carriers a backstop for their programs.

Under TRIA, the government reinsures carriers for terrorism acts, which have a minimum of $5 million in losses. Each carrier is responsible for an individual deductible, determined as a percentage of direct-earned premiums from the previous year. For losses above the deductible, the government guarantees 90 percent, while carriers contribute the remaining 10 percent. Total losses covered by the program are capped at $100 billion. So far, TRIA has not covered any terrorist acts. TRIA was designed as a temporary program set to expire at the start of 2006, and Congress may not renew it.

In addition, the Treasury Department will decide in September whether to renew TRIA’s “make-available” provision, which requires participating insurers to make coverage for terrorism acts with or without a federal backstop. The decision makes the TRIA issue even more urgent for the industry, lobbyists argue.

Some insurance industry lobbies have already begun efforts for renewal. The National Association of Insurance Commissioners (NAIC) sent a letter to Congress urging action, and several insurance industry groups are planning strategy.

In addition, industries with high terrorism risk are expected to lobby hard for TRIA renewal. “There is an active dialogue with members of both parties, and I think a growing awareness of the issue,” said John Amore, CEO of Zurich N.A. “As more real estate, transportation and entertainment companies see the impact, they will become more vocal.”
Aon’s Marchitello said that TRIA’s expiration will affect at least one in five Aon clients, mostly in industries with the greatest exposure, including real estate, financial services, entertainment and transportation.

Those industries may begin seeing the impact of TRIA’s demise sooner rather than later as next year’s renewal season kicks into high gear, Amore said.

“We will have to look at policies that have terror exposure and will have to go over those issues in the fourth quarter of this year,” Amore said.

The specter of TRIA’s demise comes just as the market for property insurance was beginning to soften, according to an Aon report. Premiums for the average commercial property insurance policyholder fell 10 percent in 2003, compared to a 42 percent increase in 2002. In addition, the “run rate” of rate reductions is currently 17 percent, and is expected to be between 20 percent and 23 percent by year end. In addition to prices, TRIA expiration could also have an impact on alternative strategies like captives that were set up during the hard market, said Nick Maher, chairman of Aon Group’s property global practice.

He explained that many companies that set up captive programs are unlikely to return to the traditional market. “They have reached a level of comfort with the alternative market,” Maher said. “I don’t think they would be comfortable with swapping dollars with insurance companies again.”

But companies that set up captives specifically to access TRIA directly rather than through a carrier may let those programs go dormant or put new risks in the pool to keep the captive running. There is still hope in the industry that Congress will renew TRIA. The question will gather momentum later this year, as the annual period of policy renewal approaches and carriers need to handicap the likelihood of the federal backstop remaining in place, said Scott Harrison, a managing director in KPMG’s Financial Risk Management practice in Washington, D.C.

“Since TRIA was put in place, the coverage market for so-called ‘trophy’ and other high-profile properties has adjusted, and now more or less assumes the program’s continued existence,” he said. “Although the bill was originally intended only as a temporary fix, these kinds of programs are difficult to terminate without creating the same type of market dislocation and coverage gaps that TRIA was intended to address.”

Frank Coyne, CEO of the Insurance Services Office (ISO), reinforced the industry’s need for TRIA to be renewed. “The pending expiration of TRIA is a critical issue. Just imagine what the terrorism market would be like without [it].”

Meanwhile, long-awaited federal insurance legislation is gaining critical mass, and a proposal may even come to a vote this year. But the industry endgame—a reliable, uniform system for insurers to register, market, and sell products in all 50 states—may be well down the road.

“It’s going to be tough for the states to come together to create uniform processes,” said Michael Blackshear, a manager with KPMG’s Financial Risk Management practice in Washington, D.C.

Currently, the insurance industry is regulated at the state level, and any attempt at federal regulation would certainly need the input or blessing of state insurance commissioners. It’s unclear if current proposals for a hybrid system will work. “Whether it will be useful and helpful for insurance companies is a different question altogether,” Blackshear said.

During last month’s NAIC meeting in New York, Rep. Michael Oxley, R-Ohio, chairman of the House Financial Services Committee, said he will introduce legislation creating a new federal-state advisory council to coordinate tax policy and uniformity issues affecting the insurance industry. Divided equally between federal and state officials, this group might also have a single federal appointee charged with approving council decisions.

Although the Oxley proposal falls short of the insurance industry’s push for an “optional federal charter,” a system in which an insurer could opt to be regulated at the national rather than state level, it could mean a stronger federal hand to steer states towards greater consistency.

“The whole system has been evolving for greater federal oversight,” Blackshear said. “The insurance industry is mainly concerned that the process of offering insurance products—from privacy to market conduct to speed to market—be made more uniform.”

One example of a breakdown between states has been the industry’s push for a “speed to market” solution. In 2000, the NAIC formed a committee to develop a single system to file and review life products, including annuities and long-term disability policies. State regulators and insurers have pushed for a uniform system across states.

As a result of their efforts, all 50 states are using the System of Electronic Rate and Form Filing (SERFF), with over 1,000 companies using the process.

But last year, insurance commissioners from California, Florida, and Texas—which combined represent over a quarter of the life insurance market—announced that they were developing a system called I-File. The system promises that insurers will be able to file a product and begin selling it within 60 days.

“Many companies that supported SERFF are upset about having a different system,” said Stef Zielezienski, assistant general counsel to the American Insurance Association at the NAIC meeting. “We have spent significant resources on [it].”

Texas Insurance Commissioner Jose Montemayor argued that the I-File system was developed to enhance and not replace SERFF. “Let me just say again that we are committed to modernization,” Montemayor said. “We are spending significant resources to integrate [I-File] fully with SERFF and we remain completely committed to it.”

That sort of debate is what the Oxley plan and other federal insurance proposals are hoping to curtail.

Article reprinted from KPMG’s Insurance Insider with permission of KPMG LLP. Copyright 2004 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Disclaimer from KPMG: All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity.