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While the insurance world may have hoped for an easy solution from the Bush administration on the renewal of the Terrorism Risk Insurance Act, federally backed guarantees connected to terrorism losses, all it got was a nasty fight and a lot of work to do on Capitol Hill.

If TRIA, which expires at the end of December, is allowed to lapse, doomsayers claim that prices could skyrocket and that coverage could shrink.

The Treasury Department, according to a June report, declared its opposition to an extension of TRIA in its present form. To be acceptable, it said, TRIA would need retooling, reducing government involvement in terrorism insurance and increasing the industry's exposure.

The trigger point for federal payout would need to be raised from $5 million to $500 million. The deductible and copayments would need to be increased. And commercial auto, liability and other coverages that the administration feels are less subject to risk aggregation would need to be excluded.

Despite these demands, some see a silver lining. The administration seems to be willing to find common ground with the industry. "I think they left it open that they are at least willing to talk about making some modifications in the current bill," says Fleming.

Yet the Treasury report may promote flawed assumptions that make common ground difficult to find.

Take the report's premise that the private market has the capacity to increase terrorism coverage if the federal backstop is diminished or removed. "Treasury is optimistic about private reinsurance, CAT bonds and other capital market instruments providing coverage against these losses," says Howard Kunreuther, professor of decision sciences and business at the University of Pennsylvania's Wharton School. "And we don't see any evidence (the insurance industry is) enthusiastic about doing it or are going to do it."

The hindrance, the industry claims, is that terrorism is an uninsurable risk. It combines the seeming randomness of a crime with the potential catastrophic losses of a natural disaster. Even if one could estimate the losses of particular types of attacks, which some modeling applications are starting to be able to do, it's virtually impossible to calculate the probabilities of such risks with any certainty.

Investors, for their part, have shown little interest in investing in financial instruments designed to protect against terrorism losses. Only two securitization transactions, both in 2003, have covered terrorism risk, explicitly or implicitly.

"A sustained market for financial instruments to cover terrorism risks has not yet emerged, and such instruments are not expected to substantially increase market capacity for terrorism coverage in the short term," says Cecile Vignial, principal administrator of the financial affairs division of the Organization for Economic Cooperation and Development, which released its own report on terrorism insurance recently.

One of the conclusions of that report, Vignial says, is that "while OECD member countries should rely, as far as possible, on private-sector solutions to cover terrorism risks, government intervention may nevertheless be needed to increase--or maintain--terrorism insurance availability at an affordable price, where there is evidence of private markets lacking capacity."

Scott Duncan, director of federal public affairs for the Property Casualty Insurers Association of America, agrees. "Now that TRIA is about to expire, the industry has worked very hard ... to come up with some kind of alternative to TRIA that does shift more exposure to the private sector," Duncan says. "However, that doesn't mean that the federal government doesn't have to be involved."

The Treasury report, though, not only claims that private industry could provide solutions for terrorism risk, but that TRIA stifles the development of such free-market solutions. Therein is another assumption that Duncan, and most others in the industry, take umbrage with.

"Everybody talks about operating in a free market and so forth," Duncan says. "But the problem is that insurance companies don't operate in a free market."

A case in point, says Kunreuther, are state regulations on workers' compensation and fire-following coverage, which force insurers to pick up the bill for fire damage regardless of the cause of the fire, thereby locking insurers into terrorism coverage.

"And so as a result," he says, "there is the potential for catastrophic losses that the industry does face, whether or not they marketed any policies separately."

Ultimately, Congress is vested with the power to solve these disagreements before TRIA expires.Rep. Michael Oxley, R-Ohio, and Sen. Richard Shelby, R-Ala., chairmen of the House Committee on Financial Services and the Senate Banking Committee, respectively, have stated their intent to pass some form of replacement before year-end.

September 1, 2005

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