Global Initiatives for Terror Coverage

Prior to the events of September 11, 2001, the U.K. had established a government supported program to cover losses due to terrorist attacks through Pool Re. After the September 11, attacks France and Germany developed government-supported programs to cover losses due to terrorist acts. Currently, the U.S. is expected to pass legislation in November of this year that will provide for federal participation in funding terrorism related losses.

Despite considerable effort last year on the part of Insurance Bureau of Canada (IBC) and a host of Canadian insurance leaders, the Canadian federal government was hesitant to move in this direction until there were clear and discernable obstacles to commerce and to cross border trade. While that does not seem to have arisen to any significant degree, there are certainly issues for Canadian insurers when it comes to covering U.S. locations. Furthermore, in the event of additional and sustained terrorist activity, either globally or in Canada, an interruption in commerce is a very real possibility. With this in mind, it is useful to review what is taking place elsewhere.

POOL RE

A number of suggestions for government involvement are based on the U.K.’s Pool Reinsurance Company (Pool Re), a mutual company comprising more than 200 private insurers and guaranteed by the British government.

Pool Re was formed in 1993, after repeated IRA bombings in London caused both British and European reinsurers to either limit or cancel coverage for terrorist acts. To ensure the continued availability of terrorism reinsurance, the U.K. government spearheaded Pool Re’s creation and agreed to serve as the “reinsurer of last resort”.

Under the Pool Re plan, primary companies can offer the first 100,000 of terrorism cover for property and business interruption risks, and they are solely responsible for any claims up to this amount. Terrorism cover above this 100,000 limit is available only through Pool Re. Pool Re has accumulated more than 1 billion in assets. Claims are paid out of this funding. If premiums do not cover losses, all members of the pool are liable for a 10% call. This 10% call applies to the amount of premium ceded in any underwriting year in which there is a loss. Thus, if an insurer cedes 1 million in an underwriting year, the maximum call to which it will be subject is an additional 100,000. Members are also entitled to a return of up to 10% of premiums ceded in profitable years. If payments are required beyond this level, the government will step in. Government involvement has not been necessary to date, but the U.K. insurance industry is concerned that Pool Re will not be able to respond to a loss of the magnitude caused by the September 11 terrorist attacks. Recently, the treasury department met with trade groups to determine whether coverage provided by Pool Re should be expanded.

FRANCE

As from the beginning of 2002, the French government established a reinsurance pool to respond to terrorism reinsurance shortages in that country. All insurers and reinsurers in France must register with this pool, called GAREAT (Gestion de l’Assurances et de la Reassurance des Risques attentats et actes de terrorisme), and must cede to it all terrorism coverage for local commercial policies that have combined property and business interruption values of more than $6 million.

Under the GAREAT plan, insurers writing property insurance in France will cover the first $250 million in aggregate annual losses, with a group of reinsurers providing capacity for annual aggregate losses above that amount, up to $750 million. If losses exceed $1 billion in any given year, pool members will fund an additional $500 million via a government-backed financial contract. The state-owned reinsurer, Caisse Centrale de Reassurance, will furnish unlimited stop-loss coverage for all damages totaling more than $1.5 billion.

GERMANY

Germany’s specialist company covering terror-caused property damage, Extremus Versicherungs AG, opened on September 3, 2002 and will begin operation once it receives regulatory approval. Developed along the lines of Pool Re, Extremus will offer up to $13billion of terrorism coverage-on an annual aggregate basis for commercial property risks in that country.

The total capacity that Extremus offers will be organized into three layers. The first $1.5 billion will be placed primarily with insurance and reinsurance companies operating in Germany. The second layer of $1.5 billion excess of $1.5 billion will be written by international insurers. The German government will provide up to $10 billion of coverage excess of $3 billion in any one year.

THE U.S.

Following lengthy negotiations between the Administration, Senate and the House, an agreement has been reached on a federal reinsurance backstop. It is expected that the new legislation will provide US$100 billion of support to the insurance industry for future terrorist attacks. Washington lobbyists give the bill an 80% likelihood of being passed when Congress reconvenes in mid-November.

The bill creates a three-year commercial property and casualty terrorism reinsurance program within the treasury department. The law would be triggered upon a certification determined by the Treasury Secretary and the Secretary of State, with concurrence of the Attorney General, that an act meets the definition of terrorism. Each participating insurance company (reinsurers excluded except for their direct business) would have an individual company deductible, based on direct premium, before the federal assistance kicked in (1% transition period for the remainder of 2002, 7% for the first year, 10% for the second year, and 15% for the third year).

Once a company has met its deductible the federal government would step in to cover 90% of the losses. Losses covered by the federal program would be capped annually at US$100 billion. Personal lines, life and health and group life are excluded from coverage. The Treasury Secretary may include group life based on the results of a study mandated under the legislation.

The Treasury Secretary is required to recoup any Federal compensation paid by the Federal government which is in excess of the insurer deductible plus the insurer 10% quota share retention and covered losses paid below an “industry-wide retention” of US$10 billion for the first year, and US$15 billion for the second and third years. The policyholder surcharge would apply to the difference between the industry retention and the total of the industry retained losses. The surcharge cannot exceed 3% of premium a year.

In this example, we take a company with a 1% market share of commercial lines premium. With total premiums estimated at US$150 billion, for 2002, this company would have US$1.5 billion in premiums.

We consider what would happen if there were to be a US$40 billion terror loss in 2003, in other words, an event on the order of 9/11. The company’s retention in 2003 is US$105 million (7% of US$1.5 billion). We then assume the company has a 1% share of the US$40 billion loss. The company’s gross loss would be US$400 million. It would retain US$105 million, and share US$295 million with the U.S. Treasury. At 10% its coinsurance share would be US$29.5 million. The net loss is then US$134.6 million to the company (US$105 million plus the US$29.5 million).

PROACTIVE STANCE

Prior to the events of September 11, 2001, other countries including South Africa, Spain, Israel, and Sri Lanka had government backed pools to support terror coverage. The recent terrorist attacks in Yemen, Indonesia, and Kuwait underscore the need for all nations to be proactive about the establishment of terror coverage. Terror is a massive and perilous exposure without the random and uncorrelated characteristics of the natural catastrophe. With a legitimate concern for the ability of insurers and reinsurers to financially respond to the next tragic loss, our industry has a logical responsibility to look to governments for support and assistance in identifying a solution.