No matter how you look at it, any long-term solution to the problem of insuring against terrorism exposures will require a government reinsurance backstop of some kind, industry representatives warned federal lawmakers point blank last week.

"There is no one right way to do this," Liberty Mutual Group's chairman, president and chief executive officer, Edmund Kelly, told a joint hearing on "Protecting America from Catastrophic Terrorism Risk" before House Financial Services subcommittees.

A key issue at the hearing was the industry's inability to specifically provide coverage for nuclear, biological, chemical and radiological attacks.

Lawmakers as well as witnesses quoted a recently released Government Accountability Office study (see page 7) that said, "given the challenges faced by insurers in providing coverage for, and pricing, NBCR risks, any purely market-driven expansion of coverage is highly unlikely in the foreseeable future."

What is important, however, Mr. Kelly said, is that the private market does not have the knowledge or the resources to adequately underwrite terrorism risk. He suggested that any long-term solution include a partnership between the private sector and the federal government.

Ramani Ayer, chairman, president and CEO of the Hartford Financial Services Group, also noted the unique aspects of terrorism risk that make it impossible for insurers to price coverage.

"The insurance industry has no means of knowing when terrorists will attack," he said. "They have no means of knowing where they will attack, and they have no means of knowing what weapons they will attack with."

Sharon Emek, chair of the Independent Insurance Agents and Brokers of New York, said ensuring that terrorism coverage remains affordable and available is especially important for small businesses.

"It is crucial that all businesses have access to affordable insurance to protect them from this risk, and I personally have seen what can happen if they do not," Ms. Emek said in her testimony.

"In fact, after 9/11, a number of my friends had to close their businesses because they did not have sufficient business interruption coverage," she added. "Imagine how many businesses would go out of business without any business interruption coverage at all. Without a federal role for terrorism insurance, business interruption insurance will be further strained."

Leaders in the government, Mr. Ayer noted in his testimony, often remind the public that the threat of terrorism will not be going away soon, meaning that protections for the economy will have to be in place beyond the Dec. 31, 2007 expiration date of the current Terrorism Risk Insurance Act reinsurance program.

"The inescapable conclusion is that as long as this terrible risk threatens our way of life, we need to have a way to fortify our economy against it," he said. "The insurance industry is willing to play an integral role to finance this risk, working together with policyholders and the government, but we cannot do it alone."

While establishing a solution is important, the timeframe for doing so is also a major issue for insurers, noted Janice Abraham, president and CEO of United Educators, testifying on behalf of the Property and Casualty Insurers Association of America.

"We believe insurance policyholders and insurance markets generally will benefit significantly from the predictability and structure a long-term program would provide," she said. "In addition, we do not believe Congress wants to be, or should be, asked to revisit this issue every two years."

Mr. Kelly also spoke of the importance of providing insurers with a degree of certainty regarding how their terrorism coverage will operate--a factor he said should be considered as Congress debates its options.

When asked about the possibility of establishing a commission of stakeholders in the terrorism insurance issue, he replied that the potential of such a commission needing another temporary extension could become a problem. "This idea that every two or three years we're in limbo is not a desirable thing," he said. "If a commission delays a permanent solution, that is not desirable."

Many proposals have been offered to deal with the issue on a permanent basis, including mechanisms based on the current TRIA program's federal backstop, or the creation of a mutual insurer similar to the "Pool Re" facility established in the United Kingdom, which would provide terrorism coverage for insurers and buy reinsurance directly from the government.

Aon Corp. President and CEO Gregory Case offered a proposal that could provide coverage equal to two events on a scale of the World Trade Center attacks, which he said cost the insurance industry roughly $40 billion.

Under the Aon proposal, a pool would be established and funded by insurers, who would contribute a total of $2 billion annually for 20 years.

If that pool were overrun by damages from an attack--or if an attack occurred prior to the pool reaching the full $40 billion--an additional $40 billion could be drawn from the sale of bonds, which would be repaid over a four-year timeframe, which would cause an increase to policyholders of only 1.4 percent over the life of the bonds.

The federal government would then provide up to $100 billion in excess coverage for losses beyond that.

"The insurance industry is renowned for its ability to come up with new ways to solve problems old and new, and providing this type of flexibility should maximize the extent of that entrepreneurship that is so desperately needed here," Mr. Case said.

Another potential solution, mentioned by Capital Markets Subcommittee Chairman Richard Baker, R-La., would be to allow insurers to build up catastrophe reserves on a tax-preferred basis, enabling companies to increase their ability to absorb a major loss more swiftly.

This is a proposal that Rep. Mike Oxley, R-Ohio, who chairs the parent Financial Services Committee, said might have greatly improved insurers' current ability to absorb such losses had it been enacted with the original TRIA program in 2002.

Rep. Baker noted, however, that such a proposal would operate on a gradual basis, and the industry would be closely watched to ensure the tax-preferred reserving wasn't being abused.

"I want to make you reasonably uncomfortable," he told the witnesses. "We don't want to be funding the industry's profitability."

Mr. Kelly responded that such discomfort would not be a bad thing, and would be "the only way to ensure the private market works toward a solution" to ease the potential burden on taxpayers.

Throughout the hearing, however, Mr. Kelly and other witnesses also noted that building up reserves would be a solution for the long-term future--adding that a role for the federal government would still be required until reserves were adequate.

Jacques DuBois, president and CEO of Swiss Re America, raised another potential problem with the reserving solution--specifically that there is no way to know when insurers will have adequate reserves for terrorism coverage.

"How do you determine how much reserves you should put aside for something, when the frequency and severity can't be measured?" he asked.

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Uncle Sam Must Back Insurers On Terrorism Cover, Industry Warns

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