July 23, 2005

Government-Underwritten Terrorism Insurance Is Set to Expire At Year-End, and It Should

Filed under: Business Moves,Economy,Taxes & Government — Tom @ 1:58 pm

When everyone across the political spectrum is for something that involves a lot of government money or government commitment, BizzyBlog’s instinctive reaction is to say “wait just a minute.”

So it is with government-provided “terrorism insurance,” which is set to expire on December 31. USA Today’s article is a good starting point:

A $100 billion insurance safety net that makes up the losses of American workers and businesses caused by a terror attack is set to disappear at year’s end amid growing concerns that no replacement is in the offing.

Insurance analysts fear that an attack on the USA could badly disrupt the economy, displace thousands of workers and bankrupt dozens of insurers if Congress does not renew or overhaul the Terrorism Risk Insurance Act of 2002 (TRIA), which temporarily makes the federal government shoulder most terror losses.

But the Treasury Department recently signaled that private insurers and the capital markets should now step in to price terrorism risk and provide coverage against losses. Last week’s terrorist bombings in London lent urgency to the debate. Several European governments are wrestling with how to protect their economies from what many deem an unquantifiable risk.

“If terrorism is a national security issue, then planning how to recover from a terrorism attack should also be a national security issue,” says Erwann Michel-Kerjan, a terrorism researcher at the Center for Risk Management and Decision Processes at the University of Pennsylvania’s Wharton School.

With all due respect for M. Michel-Kerjan, planning to recover from terrorism is largely unrelated to national security. Did Europe fail to rebuild because it didn’t have WW2 insurance?

Continuing:

OECD (Organization for Economic Co-Operation and Development) researchers also found that although investors have displayed some appetite for what are known as catastrophe bonds — high-yielding securities underwritten to provide a financial cushion against such natural disasters as earthquakes and hurricanes — they have almost no interest in terror bonds.

“The private market capacity is inadequate,” says Peter Ulrich, managing director of Risk Management Solutions, which designs catastrophic risk models.

…. Under the U.S. terrorism insurance program, the government pays about 90% of an insurer’s post-deductible losses, capped at $100 billion a year.

The Insurance Information Institute reported last year that insured losses from the 9/11 attacks approached $32.5 billion. That was 30 times more costly to the insurance industry than any prior terrorist attack and nearly 1-1/2 times more expensive than the $21 billion cost of Hurricane Andrew in 1992, the USA’s most expensive natural disaster. The insurance industry’s 9/11 losses did not stop there. OECD researchers found that claims payouts combined with downturns in the stock and bond markets, in which insurers are heavily invested, cost them about $200 billion in capital.

There appears to be bipartisan and industry support for extending TRIA. Senator Joe Lieberman’s support column is in Forbes (link does not require subscription for now). Republican Michael Oxley is a supporter. Not surprisingly, industry spokespersons, such as this one in the Washington Times, support extension, and in some cases expansion.

This is showing signs of turning into the Mother of All Money Pits if a truly disastrous attack occurred (Wall Street Journal link requires subscription):

Currently, the law covers 90% of claims stemming from foreign terrorist attacks in the U.S., after the industry pays $15 billion in property, workers-compensation and business-interruption damages. Edward Liddy, chairman of Allstate Corp., of Northbrook, Ill., the second-largest home and auto insurer, recently called on Congress to also apply the backstop to losses of cars and homes due to terrorism. In addition, a bill recently introduced in the Senate would add coverage for life insurance — which the Treasury Department opposed as unnecessary during the debate on the original bill.

To me, the problem lays out like this:

  • As with war, large-scale terrorism is a risk that is inherently uninsurable (shown by the inability of the private sector to take it on, with isolated exceptions, beyond minimal levels). We might as well just face that unpleasant fact.
  • A truly disastrous terror attack would bust the government’s $100 billion limit wide open and still take down the insurance industry. A back-of-the-napkin calculation shows that:
    - The payout per death for the Sept. 11, 2001 attacks
    was over $10 million ($32.5 billion
    divided by 3,000 victims = $10.8 mil).
    - If the claims paid out per death that occurred in the
    9/11/01 attacks had to be paid out in a disastrous
    nuclear attack where 150,000 people died (an
    unfortunately not-inconceivable scenario), the
    losses involved would exceed $1.5 trillion.
    - Uncle Sam’s “share” of that loss, after the $15 billion
    “deductible” and 10% “co-pay,” both in theory paid
    by the insurance industry, would be over $1.3
    trillion, or more than 13 times TRIA’s $100
    billion “limit.”
    - The insurance industry would go down in flames
    (or ashes) anyway, as it doesn’t have the $150
    billion or so in capital lying around to pay out its
    share, even if the government somehow came up
    with its $1 trillion-plus.
  • If TRIA continues, the people and families affected by such a disastrous attack would expect recovery of all losses regardless of the cumulative amount (they will anyway, but TRIA’s existence makes the expectation much stronger).
  • There would be a brutal fight between those affected and everyone else that would deeply divide the country. Look at how much the entitlement mindset of some of the World Trade Center victims’ families, some of whom thought that settlements of $1.8 million and up weren’t enough, turned people off. Multiply that by 50 times as many victims and all of the associated businesses, and stir. The whole sordid scenario, combined with the precedent of the too-generous payouts to 2001 victims, could conceivably take down the government, even if the disastrous attack itself didn’t.

I believe that the solution, as difficult as it sounds, is to let TRIA expire, and to make sure there is no expectation of recovery beyond what private insurance and private charity are willing to provide. The resources simply aren’t there, and we shouldn’t pretend that they are.
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UPDATE: Those interested in more background can go to the Congressional Budget Office report on TRIA and issues surrounding its continuation.
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UPDATE 2: Official Wizbang Trackback Carnival participant.