Reinsurance and the Reaction to September 11

As I am writing this, President Bush is pushing Congress to consider the insurance terrorism bill that has been floating around Congress for months. When asked recently to describe what measures should be taken in order to reinvigorate the economy, Bush immediately pointed to the need to immediately pass the insurance/terrorism legislation. As the President, and presumably a goodly portion of the members of Congress who have worked on the proposal, believes that this legislation is necessary to buttress the reinsurance/ insurance industry, and ultimately the economy, one can ask why is it so important, and if it is so important, what is the debate regarding passage about?

In a recent “Legal Beat” column, I noted that one of the impacts of September 11 on the insurance industry was a dislocation between insurance companies who are subject to the states that closely regulate the insurance industry and reinsurers who most often are not subject to the same regulatory framework, particularly those who are foreign based. Specifically, the insurance departments of many states have refused to approve any type of exclusion for terrorism while at the same time many (if not most) reinsurers are requiring that terrorism risks be excluded from reinsurance agreements. This incongruity of coverage places insurers in the unenviable position of having to decide whether to continue to write coverage that would potentially include the risks of terrorist losses while at the same time being unable to obtain reinsurance for that risk. That gamble is one beyond the ability of many carriers to absorb.

The magnitude of this problem can be understood by looking at the extent of the losses from the September 11 attacks. Some industry analysts have estimated that the September 11 attacks have given rise to the largest insured losses ever recorded. The range of these losses has been estimated to be in excess of $40 to $70 billion, which dwarfs previous single event losses such as California’s 1994 earthquakes or Florida’s 1992 Hurricane Andrew. While the reinsurance industry has by and large absorbed this loss without federal aid, it is not clear that similar losses would, or could be.

The attempt to bridge the gap between the risks that reinsurers are willing to accept (or not accept) and the needs of insurers to provide coverage for terrorism risks is being addressed in several ways. For instance, some reinsurers and/or insurers either are, or are considering, providing insurance for terrorism risks. Other carriers may decide that the risk is acceptable or may be limited and essentially make a decision to go bare. For most, I premise this will not be an acceptable choice. Therefore, the most desirable option is the federal legislation being proposed that would create a “federal terrorism backstop” that would allow the insurance industry to cover terrorism risks with federal help. The insurers and reinsurers working on this legislation with Congress and the administration are hoping that its passage will restore confidence to the marketplace and protect against insurer insolvency if there are any further catastrophic losses due to terrorism.

How would such legislation affect reinsurers? Many reinsurers have argued that the reinsurance market cannot, without governmental help, provide the capital necessary to cover losses from a series of catastrophic events on the order of magnitude of the September 11 attacks. The idea of the backstop is that the reinsurance industry would provide capital that would allow insurance companies to purchase terrorism coverage as part of an integrated risk management program. The versions of the terrorism insurance legislation that have been discussed would provide federal reinsurance in cases of terrorism. Reinsurance would provide a pool of funds to minimize losses that could otherwise cripple the insurance industry. Even so, there is no guarantee that it will be affordable. Many insurers either may not be able to afford the pricing of this type of coverage or may decide to forego the option. Or, even if coverage is obtained, it may not be substantial enough to cover the magnitude of losses that later arise.

How crippling could the losses of a major attack be? My crystal ball is cloudy, but it is undisputable that it could be profound. Even now, U.S. Treasury Secretary Paul O’Neil has warned that a lack of affordable insurance for terrorism acts is a discernable drag on the economy. He argues that obtaining loans or credit for the construction of large buildings or for financing the purchase of real property, especially in high risk areas, has become more difficult because of a lack of terrorism insurance. Lenders and investors are unwilling to buy bonds to back commercial real estate property debt, especially loans financing large or landmark buildings in areas that may be targeted by terrorists, such as in Manhattan or downtown Chicago. The Secretary notes that the ability to resell notes as debt, which frees up capital, has been restricted because of insurance concerns.

So we return to the question, why has Congress not acted? The upcoming November election is of course one factor, and presumably many politicians do not want to vote for the vast legislation that may be seen as a bailout for the ever unpopular insurance industry. Even so, one would think that Congress could muster the backbone necessary to pass prudent legislation which is necessary not only for the health of the reinsurance/insurance industry, but is necessary to provide a greater sense of stability in the real estate, and ultimately financial, markets.

One can hope that Congress will take reasonable steps towards resolving these issues, whether before or after the November elections. Ultimately, however, the best hope we have is that domestic terrorist acts will decline and that catastrophes like September 11 are prevented from taking place at all. But as that risk can never be wholly discounted, the reinsurance/ insurance industry must continue to evaluate how it will respond when, and if, another September 11 occurs.

Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and product cases. Martin is a frequent author and CLE speaker on insurance topics, including coverage and bad faith issues.

Topics Catastrophe Carriers Profit Loss Legislation Reinsurance Market