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Although there have been no successful attacks on U.S. soil in the last 10 years, the threat of a terrorist attack in the U.S. has not abated. Two of the nation's top economists in the workers' comp space reflect on the changes since 9/11, the lessons we've learned, and what the future may hold, given recent economic news.

What changed. "No event has transformed the way property/casualty insurers think about risk more than 9/11 over the past decade," said Robert Hartwig, president of the Insurance Information Institute. "That includes events such as Hurricane Katrina, the Japanese earthquake, or this year's tornadoes."

"Particularly in larger metropolitan areas and higher risk structures, we have explicit factoring in of terrorist attacks," Hartwig said. "That will continue to evolve."

In addition to locations and so-called marquee structures, the 9/11 attacks resulted in an underwriting change in terms of the numbers and types of workers covered. "Some insurance companies started requiring their underwriting data to include the number of employees by location," said Harry Shuford, practice leader and chief economist for the National Council on Compensation Insurance. "A second impact was the fact that the clerical class, which generally was viewed as relatively low risk, became identified as probably the most significant class with exposure to this kind of risk."

Predictive modeling for terrorist attacks began to take shape after 9/11 with organizations trying to analyze and estimate costs -- not an easy task. "The dynamic nature of terrorism and the uncertainty in identifying the targets and frequency of attacks requires a different approach to manage the risk," according to a recent report from Guy Carpenter & Co. LLC, a risk and reinsurance specialist.

There are three basic techniques modeling companies now use to quantify the losses from a terrorist attack, according to the report:

• Probabilistic modeling, which estimates losses based on a large number of events. A key factor is the estimated frequency a modeler applies to all the possible events that could occur. Due to the difficulty in predicting the probability of terror events, there is considerable uncertainty associated with probabilistic terrorism modeling.
• Exposure concentration analysis, which identifies and quantifies concentrations of exposures around potential terrorist targets. Target-based accumulation assessment locates potential targets, typically with high economic, human and/or symbolic value, and aggregates an insurer's exposures in and around various distances from these targets.
• Deterministic modeling, which represents a compromise between the lack of accuracy in accumulation analysis and the uncertainty surrounding probabilistic models. By imposing an actual event's damage "footprint" at a specified target, a specific -- yet hypothetical -- scenario can be analyzed with some certainty.

But terrorism modeling is still in the early stages, compared to catastrophe modeling for natural disasters. That's not surprising since there is little information to use as a basis.

"You could argue, probably, the models today are relatively crude, given we only have one major event," Hartwig said. "We're basically more in the dark with respect to modeling this type of event than any other. That's not likely to change."

TRIA. Paying for terrorism coverage became tricky following the 9/11 attacks. Insurers began excluding terrorism risk from their policies, mainly because of the withdrawal of terrorism risk coverage by the reinsurance market.

Workers' comp insurance, however, automatically covers terrorist acts. With reinsurers under no similar mandate, workers' comp insurers became concerned about how to maintain solvency in the face of this costly risk. Many in the industry breathed a collective sigh of relief when President Bush signed the Terrorism Risk Insurance Act on Nov. 26, 2002.

It was intended to be a temporary solution to allow the insurance industry to develop products to insure against acts of terrorism. With an impending expiration date of Dec. 31, 2005, Congress extended it for two years.

As that deadline loomed, there was yet another call to extend the program, if not make it permanent. As the U.S. Chamber of Commerce said at the time, "despite efforts to better protect the homeland, not enough has changed since the attacks of September 11, 2001, to justify allowing the Terrorism Risk Insurance Act to expire. Catastrophic terrorism remains an uninsurable risk because, unlike most insurable natural disasters, its frequency and location cannot be predicted, and its potential scale can be devastating." On Dec. 26, 2007, the act was again extended under the Terrorism Risk Insurance Program Reauthorization Act, which continues the federal program through Dec. 31, 2014.

Complacency. While TRIA has mitigated the financial risk of terrorism, it apparently has had at least one unintended consequence. "To the extent there is complacency, part of it actually is directly related to the existence of TRIA -- many employers and insurers that perceive potential exposure find that the TRIA program reduces significantly their level of concern," Shuford said. "What TRIA did was really take away in effect the very small probability of a massive underwriting loss so that solvency was not the concern that it would be without TRIA."

The sense of complacency among insurers and business owners is a concern to Hartwig. "There is no question workers are covered," he said. "The question is, are we doing everything we need to do, not only as insurers but policyholders in protecting themselves against terrorist attacks."

Hartwig says a good deal of money and effort has been spent on better building design and new security measures. "But you have to wonder, does the average person think about this anymore?" he said. "Insurers haven't forgotten about this, but it's clear it's not as high priority an issue as it was in the two years after [9/11]."

The lack of concern about terrorism and its potential impact on the insurance industry could be problematic when the federal program is due to expire in three years, although both economists say it's premature to speculate what will happen.

"We have significant discussions in D.C. about what to do about government spending," Shuford said."There's uncertainty about just what the political makeup will be of the federal government after the 2012 elections."

The economic environment has changed substantially since 9/11, a fact that could weigh significantly on the decision about whether and how long to extend TRIA.

"It will be interesting," Hartwig said. "Even though it hasn't cost the federal government anything, the reality is all these programs are in effect assigned a cost by the Congressional Budget Office under some expected loss scenarios. Depending on the federal budget situation, there could be issues rising -- federal budgetary issues in 2014, that will add a dynamic that wasn't there in the past."

Economic woes. Recent economic news is a concern for the workers' comp system right now. For example, the Federal Reserve's recent announcement that it will hold down interest for at least two years could lead to higher workers' comp rates.

"One of the bigger problems for workers' comp is it's a long tail line. What this says is you're going to earn very little on investment over the next couple of years," Hartwig said. "That puts more pressure on workers' comp rates immediately for the next several years, even in the absence of increases in frequency and severity.

"Underwriting results are so bad and continue to deteriorate. There are no redundant reserves, meaning excess reserves to release, by and large," Hartwig said. "So everything is pointing to the need to push rates up in workers' comp sooner rather than later."

Shuford believes a hardening market will occur across all property/casualty lines.

"Over the past 30 years or so, the property/casualty industry in general and liability lines in particular -- longer-tail lines, including workers' comp -- seldom made an underwriting profit. The reason they can stay in business is because the investment income has been more than sufficient to cover their underwriting losses," Shuford said. "But if you look at long-term trends, you'll see that investment income in the property/casualty industry relative to surplus has been falling rather steadily. At the same time, underwriting losses relative to surplus have been getting smaller."

The health of the workers' comp system is intricately connected to the labor market. The current unemployment rate of over 9 percent also does not bode well for the immediate future of workers' comp.

"For a significant portion of the actual and potential workforce it's not even clear that there has been any meaningful recovery," Shuford said. "For them the recession really isn't over."

Shuford believes the economy will continue to "limp along," but it will likely be two to four years before it is robust again. "The key reason is so many sectors of our economy are burdened with debt and they need to get their debt loads down before they can significantly increase spending," he said. "Without strong spending, you're not going to get strong growth."

One question at the moment concerns the potential impact on workers' comp from the debt ceiling agreement and the upcoming federal budget spending cuts. A congressionally appointed panel of 12 must identify $1.5 trillion in deficit reductions by Nov. 23.

Because Medicare and Medicaid account for a large portion of the deficit, there is speculation the committee will focus on provider reimbursement for the cuts. That could mean workers' comp reimbursement reductions in states that use Medicare for their fee schedules.

But that is not the more likely scenario. "Depressed compensation of medical providers in Medicare may result in cost shifting to workers' comp as medical providers struggle to maintain their revenues," Shuford said. But . . . this is speculation."

Read more at the WorkersComp Forum homepage.

September 6, 2011

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