Al-Qaida vs. Allstate

If the government doesn’t insure against terrorist attacks, who will?

Risky business
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Risky business

Ordinarily, extending the life of a government program that provides crucial support to a vital economic sector, works as it was intended to, is supported by the financial services industry, and hasn’t cost the taxpayer a dime would seem to be a no-brainer.

But the Terrorism Risk Insurance Act is in trouble anyway. The post-9/11 measure that guarantees the U.S. government would backstop terrorism coverage is set to sunset come Jan. 1, 2006. Now Republicans are making noises about letting it expire. At a hearing yesterday, Senate Banking Committee Chairman Richard Shelby said TRIA “impeded the development of broader solutions for the larger problems confronting the insurance marketplace.” And in testimony yesterday, Treasury Secretary John Snow said, “[E]xtending TRIA in its current form is likely to discourage the private market development needed to deal with the risk of terrorism.”

Of course, TRIA was necessary precisely because of the way the post-9/11 commercial insurance market developed. When President Bush signed TRIA in November 2002, the Treasury Department proudly noted that it was intended to force insurers to maintain terror insurance. That was because no market for terrorism insurance had developed in the year after 9/11. According to a studycommissioned by Treasury, in the confused days after the attacks, initial insured losses were estimated at anywhere from $25 billion to $70 billion. (The final total was $33.5 billion.)In that first year, the market responded to terrorism by seizing up. According to the study, “Reinsurers began excluding terrorism coverage from their commercial coverages, particularly for locales thought to be at risk—large urban locations and iconic properties—with the result that insurance coverage was less available for those properties. Insurers willing to provide the coverage were reportedly asking high prices.” This was a huge problem for companies that were constructing or refinancing buildings. Lenders wouldn’t extend credit to properties that didn’t carry sufficient terrorism insurance.

So, Congress acted. TRIA set forth a regime under which, by 2005, after insurers paid out a $15 billion deductible, the government would cover 90 percent of terrorism-related damages up to a maximum of $100 billion.

Since then, more insurers are offering terrorism coverage, and the percentage of policyholders with terrorism insurance doubled—from 27 percent in 2002 to 54 percent of policyholders by 2004.

TRIA has clearly accomplished its objectives. But has it outlived its usefulness? It’s unclear that a healthy and orderly market for terror insurance would develop absent the government’s backstop. Insurers write premiums based on the accumulation of tons of data—on mortality rates and probabilities, on actual damages, and on models of potential damages. But with terrorism, the ability to apply risk-lessening techniques would seem to be limited. Sure, an office building is more risky than a warehouse, and New York is more risky than a small town in Wyoming. But almost by definition, terrorist acts defy past history, modeling, and, frequently, imagination. The events in London last week provide a timely reminder of that. Unlike hurricanes, terrorist acts are willful. Another thing: Catastrophic events tend not to inspire orderly markets. After 9/11, no insurer for competitive reasons saw a chance to grab market share by offering terrorism insurance at low prices.

The experience of 9/11 doesn’t suggest that the industry would perform much better the next time.A reportfrom the Organization for Economic Co-operation and Development suggests that private companies can’t adequately fund terror insurance.In its report, Treasury found that “nearly 50 percent of insurers reported that they are not writing coverage for terrorism risks in 2006 (after the scheduled expiration of TRIA) that is similar to the coverage they write under TRIA.”

Opposition to extending TRIA in its current form has come largely from Republicans, but it’s hard to suss out their motivation. It’s not a case of the GOP kowtowing to financial services’ lobbyists. The American Insurance Associationwholeheartedly supports TRIA’s extension. It could be that Congress is worried about unfunded liabilities. Business Week in June tallied some $6 trillion in potential claims the federal government has assumed, ranging from the Pension Benefit Guaranty Corp. to the Federal Deposit Insurance Corp. to terrorism insurance. But given the potential economic damage that would ensue if the insurance market were to freeze up, acting as a catastrophic-terror insurer is one of the least objectionable forms of government intervention in the risk business. Another possibility: The areas that benefit most from affordable terrorism insurance are the areas that have the highest concentration of people and companies, and the most expensive property—i.e. the coasts and the big cities. Blue States.

After some uncertainty, it seems that calmer minds—and lobbyists—will prevail. It’s likely Congress will choose to mend, not end, TRIA. If we’re engaged in a war on terror, insurers shouldn’t be asked to bear the full cost of war damages. Each year, taxpayers already spend hundreds of billions of dollars on defense, intelligence, and homeland security. So the government is already in the business of insuring against terrorism attacks. In the end, TRIA is a slightly different kind of investment in homeland security.