Terrorism Coverage Unclear For Captives
Recent passage of the Terrorism Risk Insurance Act has left those in the captive insurance industry scratching their heads. Whether captives will be able to "opt in or opt out" of terrorism coverage and their ultimate exposure regardless of whether they write the risk is still to be determined, one association representative reported.
"Right now at VCIA were just trying to get a feel from members as to how they feel about participating or being required to participate," said Jon Harkavy, chairman of the legislative committee for the Vermont Captive Insurance Association.
"Initially, its all over the place," he said. "There are certain groups that very much want to be able to access the program and access the [federal] backstop. Then there are others who don't want the coverage, believe they are not capitalized or staffed sufficiently to underwrite it, or do not want to be subject to federal regulation or possible assessment."
When they reviewed both the Senate and House versions of the bill, said Mr. Harkavy, who is vice president and general counsel for Risk Services, LLC, in Arlington, Va., "we at VCIA were concerned for captives. The Senate bill was initially 100 percent backstop and the House was not," with the latter bill establishing a loan program instead.
Now that the law is in place, however, the concern, according to Mr. Harkavy, is that if the coverage is mandatory, many captives might not be prepared financially to carry the exposure.
"If you have to offer it, [consider that] many single-parent captives outside of Vermont are capitalized at as little as $125,000 to $150,000, and in Vermont a number of captives have under $1 million in capital and surplus."
The problem, he continued, is that "you're not capitalized to take on what is potentially a catastrophic terrorism exposure."
The three-year federal measure provides that the government reinsures commercial lines property-casualty insurers for cases where terrorist attacks cause a loss of $5 million or more.
In the first year, the deductible–the amount of exposure an individual carrier would have to pay out of their own reserves before the federal backstop would kick in–is 1 percent of an insurer's earned premiums. In 2003, this jumps to 7 percent; to 10 percent in 2004; and to 15 percent in 2005.
"So it's not a total federal backstop," he said. "What do you do if you have a single-parent captive capitalized at $250,000 and you have a multimillion-dollar hit?" Even with the deductible, he explained, 10 percent of $1 million is "potentially a very serious financial hit."
The law gives an insured the right to decline terrorism coverage, but the question is how such a give-and-take would be handled in the case of a single-parent captive, where the owner and the insured are one and the same, he said.
Group captives are in a situation similar to that of a non-admitted surplus lines insurer, he added. "Theoretically, surplus lines carriers are not regulated for rates, so that while the law might require coverage to be offered, the law may still allow the captive or surplus lines carrier to offer coverage including terrorism exposures at terms that are clearly unattractive to the insured," he said.
This still leaves the problem of the assessments called for in the law to replenish the federal Treasury for any terrorism claims, he said.
"If youre considered a mandatory participant in the program, the law permits the Treasury [Department] to require you to assess your insureds up to 3 percent of your premium" to reimburse the federal government for claims it has to pay. This is the case regardless of whether a particular insurer received any reimbursement for losses under the program. This might mean that captives could be called upon to pony up significant cash to help repay the federal government for terrorism claims, even if the captive offered no coverage and collected no premiums for terrorism risks.
As for captives that need a fronta significant number do not write direct"you're upping the price of fronting because the fronting carrier has to offer the coverage," he said. The fronting carrier will "either assume this exposure and charge the captive more for it, or insist that the captive assume it as part of the reinsurance cession."
What has to be determined, he said, "and I think its very much up in the air, is whether captives are required to participate."
Association members are varied in their opinions on the coverage. "Its tough because were getting mixed messages about who wants it and who doesnt," he said.
Terrorism coverage isn't as much of an issue for many risk retention groups because they can't offer property coverage, he said.
"And if you have someone doing title insurance or tanning parlors, is [terrorism coverage] that essential? On the other hand, if you are a captive group involved in building construction, it might be absolutely vital," Mr. Harkavy added.
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, January 6, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.
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