Webel.TRIA-2019

Reading: “Terrorism Risk Insurance: Overview and Issue Analysis for the 116th Congress,” Congressional Research Service R45707, Updated December 27, 2019 (responsible for summary page and pp. 1- 10, stop at The Terrorism Insurance Market.)

Author: Baird Webel, Specialist in Financial Economics

Forum

BA Quick-Summary: Terrorism Insurance The Terrorism Risk Insurance Act (TRIA) was enacted after the 9/11 attacks when terrorism coverage became scarce and expensive. It created a federal backstop for insurance claims related to terrorism, mandating insurers to offer such coverage. TRIA has been reauthorized multiple times, most recently extending to December 31, 2027, with provisions to adjust federal and insurer shares of losses and recoupment mechanisms depending on the scale of the losses. The act aims to: stabilize the insurance market ensure the availability and affordability of terrorism coverage preserve state regulation of insurance

Pop Quiz

List 5 reasons for governmental participation in insurance from the reading Germani.GovtIns. (These reasons are relevant for terrorism.) [Hint: FCC(ES)] Click for Answer

Multiple Choice (mini BattleQuiz 6) ← for general review of topic

Study Tips

Don't be scared when you click on the Full BattleQuiz and see 31 BattleCards. Most of them are easy. The only BattleCards that will take time to memorize are:

• TRIA criteria for loss-sharing ← that's the hard one!
• criteria for insurability ← this one isn't too bad

This reading is listed in the syllabus as NEW but it's really just an update of the terrorism reading that's been on the syllabus for a long time. It's mainly a concept reading but there is one easy calculation problem that could be asked. See the BattleTable for commonly asked questions. Most of the old problems are still valid, but I have indicated the ones that are not.

Estimated study time: 1 day (not including subsequent review time)

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• goals of TRIA
• insurability of terrorism - evaluate using C-MAC
• evaluate goals of TRIA - have they been met
• pros/cons of TRIA
• certification of terrorism
• TRIA versus private insurance

Past Exam Problems: Most of these previous exam problems are still relevant but some are not. Outdated problems are highlighted in  orange .

reference	part (a)	part (b)	part (c)	part (d)
E (2019.Spring #7)	Cook.Personal	market stability: - how TRIA promotes	loss-sharing: - how TRIA works
E (2018.Fall #8)	roles in TRIA: - fed / state / private ins.	goals: - of TRIA	evaluate goals: - have they been met
E (2017.Spring #10)	goals: - of TRIA	insurability of terrorism: - evaluate	reducing tax burden: - changes to TRIA
E (2016.Fall #6)	insurability of terrorism: - evaluate	goals: - of TRIA	evaluate goals: - have they been met
E (2016.Spring #7)	insurability of terrorism: - evaluate	goals: - of TRIA	pros/cons: - of TRIA
E (2015.Fall #10)	goals: - of TRIA	TRIA exclusion: - homeowner's insurance	TRIA exclusion: - reinsurance
E (2015.Spring #7)	private insurance: - crop / UI / TRIA 1	see Germani.GovtIns	pros/cons: - of TRIA
E (2014.Fall #8)	calculate: - reimbursement 2	certification: - of terrorism	insurability of terrorism: - evaluate
E (2014.Spring #12)	roles in TRIA: - fed / state / private ins.	govt involvement: - in TRIA 1	evaluate goals: - have they been met

¹ Cross-reference with Germani.GovtIns.

² The reimbursement calculation uses the old coinsurance percentage of 15%. This has been changed to 20% as of 2020. The adjusted answer is that the federal government now pays 136m (instead of 144.5m) and the company pays 34m (instead of 55.5m.)

Full BattleQuiz

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In Plain English!

Introduction

TRIA, or Terrorist Risk Insurance Act, was a response to the Sept 11, 2001 (9/11) terrorist attack on the World Trade Center in New York City. Prior to that, insurers did not exclude or charge separately for terrorism coverage. After this catastrophic event however, insurers and reinsurers withdrew coverage. This was due to lack of credible data for pricing & reserving, and the risk of catastrophic losses.

Specific motivation for the introduction of terrorism insurance in the U.S. includes:

• Fill Unmet Need: private insurers and reinsurers withdrew coverage after 9/11
• Convenience: government can set up a program quickly and can work with the Treasury Department regarding compensation
• Social Purpose: lessen economic disruption from lack of terrorism insurance availability (new construction projects couldn't get required insurance)

Note that it was primarily reinsurers that suffered the heaviest losses and once reinsurers withdrew coverage, the primary insurers were left without protection. So there was a real and pressing need to address the issue. That's where TRIA comes in:

TRIA is a federal reinsurance mechanism designed to ensure availability & affordability of coverage to commercial insurance customers.

The TRIA legislation had 3 specific goals:

1. STABILIZE private market by providing temporary public/private terrorism insurance
2. PROTECT consumers by ensuring AA (Availability & Affordability)
3. PRESERVE state regulation of insurance

We'll discuss in the next section how TRIA meets these goals. TRIA has been amended and renewed several times since the original legislation was enacted and the current extensions expires on Dec 31, 2027. Interestingly, no acts of terrorism have been actually been certified by TRIA and no payments have ever been made. Is it just luck that there hasn't been another terrorist attack in the United States on the scale of 9/11, or was that truly a rare and unlikely event? It's hard to know. Note that in 2007 TRIA coverage was expanded to include domestic terrorism.

Goals of TRIA

Now that you have a general idea of what TRIA is about, let's start looking at some of the details. Let's look at how are these goals met.

Question: briefly describe how are the goals of TRIA met

1. to stabilize the market:
      - TRIA created a government-backed loss-sharing mechanism
2. to protect consumers:
      - TRIA requires insurers to offer commercial coverage
      - but insureds are not required to purchase
      - insurers must provide transparency (disclose terrorism premium separately, and potential federal share of compensation)
      - terrorism premium requires regulator approval (no specific premium limits however)
3. to preserve state regulation of insurance
      - this is explicitly written into TRIA
      - but with certain exceptions like: the state cannot enact its own definition of terrorism (otherwise they would create a lax definition to generate reimbursement)

mini BattleQuiz 1

Terrorism Loss Sharing Criteria

Let's look in more detail at point #1 above about the loss-sharing mechanism of TRIA. As you can see below, certain criteria first need to be met before loss-sharing can begin. Once these criteria are met, insurers are still subject to further conditions like deductibles, coinsurance, surcharges, and limits.

[1]   certification

• terrorist act must be certified
• certification is done by Secretary of the Treasury (SOT), in consultation with the Secretary of Homeland Security (SOHS) and Attorney General (AG)
• losses must be ≥ $5 million in the United States (or to U.S. air carriers or sea vessels)

[2]   federal government threshold

• aggregate insurance industry losses ≥ $200 million for federal assistance to begin (amount valid beginning 2020)

[3]   coverage

• covers only commercial P&C

[4]   deductibles

• insurer's deductible = 20% of direct earned premium

[5]   coinsurance

• insurer pays 20% of losses above deductible (federal government pays 80% and these are the percentages valid beginning in 2020)

[6]   federal government limit

• no federal coverage for aggregate losses ≥ $100 billion
• insurers are not required to provide coverage beyond this limit

[7]   surcharges

• SOT (Secretary of Treasury) must establish surcharges to recoup 140% of federal outlay when aggregate losses are ≤ $37.5 billion
• for aggregate losses > $37.5 billion, the SOT may establish surcharges but it is not mandatory

Example of Loss Sharing

If you read the above 7 points carefully, you'll see that after an act of terrorism has been certified the level of loss sharing depends on the size of loss:

• small losses (aggregate industry losses ≤ $200 million)

→ covered by private insurance

• medium losses

→ federal government makes loans to private insurance (but spreads the repayment across time & industry with future premium surcharges)

• large losses (aggregate industry losses between $37.5 billion & $100 billion)

→ federal government covers most of the loss without recoupment

There is a diagram in the source text illustrating initial loss-sharing under the TRIA program. Note that it is outdated because threshold for federal assistance was raised to $200 million in 2020.

Example

Suppose that for a certified terrorism event in 2020:

• losses in the U.S. (or air carriers or vessels) ≥ $5 million
• aggregate insurance industry losses = $80 billion
• ABC Insurer losses = $250 million

Calculate how much of ABC Insurer's loss is paid by the federal government and how much is paid by the insurance company according to TRIA?

line of business	ABC Insurer's direct EP (2020)
personal auto	30 million
commercial property	100 million
WC	80 million

Solution

First, note that the criteria for loss-sharing have been met:

• the terrorist act has been certified
• losses in the U.S. (or to U.S air carriers or vessels) ≥ $5 million
• aggregate insurance industry losses are ≥ $200 million

Then:

• federal government reimbursement = (loss - deductible) x (1 - coinsurance%)

loss = 250 million

deductible = 20% X (direct EP) = 20% x (180 million) = 36 million (recall that TRIA includes only commercial insurance, so auto is excluded)

coinsurance = 20%

→ federal government reimbursement = (250 - 36) x 80% = 171.2 million

• insurer share of loss = loss - (federal government reimbursement) = 250 - 171.2 = 78.8 million

Take a look at the following problem: (but note that the formulas are outdated because it's from 2014 and uses the 2007 version of TRIA.)

E (2014.Fall #8)

Here are 4 Excel practice problems similar to the example:

• Note: In these problems "auto" refers to "personal auto" not commercial auto. See this brief forum discussion.

Excel Practice: Webel.TRIA-2019 (010) - Loss-Sharing

mini BattleQuiz 2

Coverage for Nonconventional Terrorism Attacks

NBCR stands for Nuclear / Biological / Chemical / Radiological and these are considered the most likely methods for attacks causing large-scale losses.

Question: are NBCR events covered by TRIA

• not explicitly included or excluded so should be covered by TRIA
• but most primary policies covered by TRIA have exclusions for NBCR
• note that NBCR coverage has never been legally tested

Question: are cyber-terrorism events covered by TRIA

• yes, but only 50% of standalone cyber insurance policies included terrorism

Programs in Other Countries

U.S. experience with terrorism is limited compared to some other countries. The experience of other countries can be used to further develop protocols and insurance structures for responding to such events.

Question briefly describe terrorism insurance programs in Spain, U.K., Germany, Canada

Spain: government-owned reinsurer that has provided coverage for catastrophes since 1954

U.K.: privately owned mutual insurance company with government backing (Pool Re)

Germany: private insurer with government backing

Canada: considered, but rejected, creating a government program following September 11, 2001

Insurability of Terrorism

Terrorism is a low-frequency, high-severity risk. That means there is a lack of credible data for pricing.

Question: identify 1 way of addressing the lack of credible data for pricing terrorism risks

• use a terrorism model (this is done with other low-frequency, high-severity events like hurricanes)

Terrorism models may provide some degree of information in the absence of credible pricing data but is terrorism even considered an insurable risk?

Question: identify 4 elements of an insurable risk [Hint: C-MAC]

Credible - need a large number of customers and events to make losses predictable

-

Measurable - losses must be definite & measurable

Accidental - losses must be fortuitous & accidental

Catastrophic - losses must not be catastrophic

Question: evaluate the insurability of terrorism using C-MAC

C → fail → applies only to commercial insurance, coverage is not mandatory, number of events is too low

-

M → pass → a terrorism event is certified and can be measured in dollars

A → fail → terrorism attacks are planned

C → depends → insurer can control their concentration of risk through underwriting and avoid catastrophic losses

The fact that terrorism is not really an insurable risk is the reason that government involvement is required. Otherwise insurers and reinsurers might be unwilling to provide coverage.

mini BattleQuiz 3

Extra Problems

Here is a mixture of exam and extra non-exam questions:

mini BattleQuiz 4

Here are some previous exam questions:

mini BattleQuiz 5

Full BattleQuiz

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POP QUIZ ANSWERS

5 reasons for governmental participation in insurance: FCC(ES)

for FILLING NEEDS unmet by private insurance (Ex: terrorism)

- may occur when private insurance is not economically viable (after 9/11 terrorist attack in NYC, private market withdrew coverage)

when insurance is COMPULSORY

- if insurance is compulsory but not offered by the private market (for whatever reason) then government must be the provider

for CONVENIENCE (Ex: flood)

- government may already have necessary structures in place (government already provides disaster relief after floods)

for EFFICIENCY (Ex: auto)

- agent commissions eliminated → lower expense ratio → lower premiums for consumer

for SOCIAL purposes (Ex: medical coverage)

- private market is motivated by profit, sometimes at the expense of social purposes like universal medical coverage

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