Terrorism Risk Insurance

Act of 2002

Christopher YaureRisk Manager, Terrorism and Emerging RisksGE ERCPresentation to the Annual Meeting of the CASNovember 10, 2003

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OVERVIEW

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Terrorism Insurance Program

Mandatory participation Mandatory availability Federal compensation Cap on liability Preemption and nullification Disclosure requirements Reporting Recoupment and surcharges Federal cause of action Treatment of terrorist assets Federal Reserve Board provisions

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FindingsThe ability of businesses and individuals

to obtain property and casualty insurance at reasonable and predictable prices, in order to spread the risk of both routine and catastrophic loss, is critical to economic growth, urban development, and the construction and maintenance of public and private housing as well as to the promotion of United States exports and foreign trade in an increasingly interconnected world

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Findings (2)Property and casualty insurance firms

are important financial institutions, the products of which allow mutualization of risk and the efficient use of financial resources and enhance the ability of the economy to maintain stability, while responding to a variety of economic, political, environmental, and other risks with a minimum of disruption

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Findings (3)

The ability of the insurance industry to cover the unprecedented financial risks presented by potential acts of terrorism in the United States can be a major factor in the recovery from terrorist attacks, while maintaining the stability of the economy

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Findings (4)Widespread financial market

uncertainties have arisen following the terrorist attacks of September 11, 2001, including the absence of information from which financial institutions can make statistically valid estimates of the probability and cost of future terrorist events, and therefore the size, funding, and allocation of the risk of loss caused by such acts of terrorism

(4) widespread financial market uncertainties 16have arisen following the terrorist attacks of Sep- 17tember 11, 2001, including the absence of informa- 18tion from which financial institutions can make sta- 19tistically valid estimates of the probability and cost 20of future terrorist events, and therefore the size, 21funding, and allocation of the risk of loss caused by 22such acts of terrorism; 2316O:\AYO\AYO02.952

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Findings (5)A decision by property and casualty insurers

to deal with such uncertainties, either by terminating property and casualty coverage for losses arising from terrorist events, or by radically escalating premium coverage to compensate for risks of loss that are not readily predictable, could seriously hamper ongoing and planned construction, property acquisition, and other business projects, generate a dramatic increase in rents, and otherwise suppress economic activity

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Findings (6)The United States Government should

provide temporary financial compensation to insured parties, contributing to the stabilization of the United States economy in a time of national crisis, while the financial services industry develops the systems, mechanisms, products, and programs necessary to create a viable financial services market for private terrorism risk insurance

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Purpose (1)

The purpose of this title is to establish a temporary Federal program that provides for a transparent system of shared public and private compensation for insured losses resulting from acts of terrorism, in order to—

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Purpose (2)

Protect consumers by addressing market disruptions and ensure the continued widespread availability and affordability of property and casualty insurance for terrorism risk

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Purpose (3)

Allow for a transitional period for the private markets to stabilize, resume pricing of such insurance, and build capacity to absorb any future losses, while preserving State insurance regulation and consumer protections

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Act of Terrorism An act of terrorism Violent act or act dangerous to human life,

property, or infrastructure Damage in the US

Applies outside of the US for certain air carriers, vessels, and missions

On behalf of any foreign person or interest Effort to coerce the civilian population or

influence the policy or affect the conduct of the government by coercion

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Limitations Does not apply to act committed as

part of declared war Exception for workers compensation

Aggregate losses $5,000,000 or less

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Process Certified by Secretary of Treasury Determination final Not subject to judicial review

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Property and Casualty Insurers

Receives direct earned commercial property and casualty insurance premium

AND Within specified categories

Licensed or admitted in any state NAIC Quarterly Listing of Alien Insurers Approved to offer certain insurance by Federal agencies State residual market insurance entity or workers’

compensation fund Captives and other self-insurance arrangements, if

determined by Treasury Affiliated insurers treated as one insurer

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Property and Casualty Insurance

Commercial lines only Specifically includes

Excess insurance Workers’ compensation Surety

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Lines Excluded Crop or livestock insurance Private mortgage insurance Financial guaranty insurance issued

by monoline financial guaranty insurance corporation

Medical malpractice Health or life, including group life National Flood Insurance Reinsurance

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Mandatory Availability An insurer “shall make available”

coverage for losses from acts of terrorism All property and casualty insurance

policies “[C]overage for insured losses that does

not differ materially from the terms, amounts, and other coverage limitations applicable to losses arising from events other than acts of terrorism.”

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Federal Compensation 90% of insured losses in excess of a

deductible Deductible

Direct earned premium in prior calendar year

Multiplied by 7%/10%/15% Special rules for insurers without a full

year of operations in relevant calendar year

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Temporary Support Effective November 26, 2002 Federal compensation applies to

losses through December 31, 2005 Mandatory availability applies

through December 31, 2004 May be extended through December 31,

2005 Determination by September 1, 2004

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Cap on Liability Maximum aggregate industry losses

in one year is $100,000,000,000 Losses pro rated among insurers

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Preemption and Nullification

Policies in force on November 26, 2002 Exclusion for insured losses void State approval of exclusions for insured losses void Written notice to insured of additional premium Reinstatement of exclusion after 30 days

Rates and forms not subject to prior approval Through December 31, 2003 State can invalidate rate as excessive, inadequate,

or unfairly discriminatory Subsequent review of forms

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Disclosure Requirements Policies in force on November 26,

2002 New policies

At time of offer, purchase, and renewal Premium charged for insured losses Federal share of compensation Separate line item on policy

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Reporting State Federal

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Additional Items Recoupment and surcharges Federal cause of action Treatment of terrorist assets Federal Reserve Board provisions

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ADDITIONAL PRICING ISSUES FOR TRIA

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Pricing Adequate Not excessive Not unfairly discriminatory

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Expected Losses – Policy Level

Historical losses Models

Pure premium Frequency of events Severity of losses Relative likelihood of targets Game theory

Additive or multiplicative

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Aggregate Losses Company historical Industry historical

Market share Models PML vs. MPL Allocation to policies Take up rate

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Federal Compensation MPL = $10B + 0.9 * Direct Earned Premium

* Deductible Rate (but not more than $100B)

Market share * $100B Fund the retention

How many years Credit for federal program Debit for federal program Different impact on same policy for different

companies

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Accumulation and Diversification

Geographical Weapons of mass destruction Swarm attacks

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Other Methods and Issues Cost of reinsurance Cost of capital Cat analysis Excess vs. primary Impact on non-terrorism insurance

pricing

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MARKET RESPONSE Insurers Insureds Reinsurers Sunset

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ADDITIONAL ISSUES

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Underwriting Moral hazard – very low Morale hazard – moderate Adverse selection – mixed

If pricing flexibility is limited, significant issue

With respect to cancellation - high

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NRBC Nuclear Radioactive Biological Chemical TRIA requirements Pricing

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Non-TRIA Coverage Include automatically Exclude automatically Additional premium Include with TRIA Pricing

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Reinsurance TRIA

How much to cede Avoid wasting federal compensation Post-2005

Non-TRIA Non-US

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Claims and Coding Catastrophe processes Centralization Coding TRIA requirements

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Additional Issues Correlations with other items Fire following Reserving Tax issues Filing issues