S&P Calls Terrorism Price Models Shaky

NU Online News Service Nov. 26, 2:04 p.m. EST? With ink barely dry on the Terrorism Risk Insurance Act, Standard & Poor's announced today that the measure may cause insurers to act irresponsibly, and called new pricing models for terrorism insurance "unreliable."

In what may be the most strongly-worded industry alert on the pitfalls of the measure, S&P said, "Although the legislation does much to ease anxiety among the insurance community, it cannot cure ignorance."

The New York-based rating agency said, "By and large, insurers do not know how to price terror risk and could use government backing as a crutch for taking on exposure irresponsibly."

In addition, the firm called claims for the effectiveness of terrorism pricing models that are now coming to market "wildly exaggerated."

"Bathed in an aura of invincibility by such obfuscatory phrases as ?fully probabilitistic,' [the models] are at best a blunt instrument that could nevertheless lull insurers into a false sense of security," S&P analysts wrote.

S&P also said that by mandating the adoption of terrorism risk by U.S. commercial property-casualty insurers, the Act "casts a shadow on ratings prospects" and compounds S&P's negative outlook on the industry.

"The legislation amounts to a command from the government for insurers to get back into the pool of terror risk," said Steve Dreyer, managing director in Standard & Poor's insurance ratings. "Compared to where they were, which was on dry land, the risk profile has to be worse with them in the water."

Explaining how insurers were on "dry land" between Sept. 11, 2001, and passage of the Act, S&P said that insurers had "very effectively" extricated themselves from terrorism risk through exclusions in standard policies (in lines other than workers' compensation) or by segregated risks in affiliated surplus lines companies.

Noting that the industry is now on the hook for greater risk (retained through deductibles and coinsurance features of the government backstop), S&P said that, from a ratings standpoint, it will call upon insurers and reinsurers to demonstrate a thorough understanding of their new exposures.

In addition, the firm said it plans to adjust its measure of capital adequacy to take those risks into account.

Besides the problems pointed out by other industry experts?such as high level of insurer deductibles in future years, which kick in before government loss reimbursement?S&P cited several issues relating to gray areas of the Act. They include:

? The question of whether acts committed by citizens or associates of Iraq, or of any other country with which the U.S. might be at war, would be excluded.

? How the Act applies if U.S. citizens are implicated in terror acts, since the Act applies only to terrorism that has been carried out by an individual or individuals acting on behalf of a foreign person or foreign interest.

? How long it would take for the government to reimburse insurers for their payouts.

Commenting on the latter, S&P said that any delay could cause a devastating liquidity shortfall and threaten the solvency of some insurers.

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S&P Calls Terrorism Price Models Shaky

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