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Insurers potentially have huge deductible exposures under TRIA, which provides that after a $5 million industry loss, the government starts paying 90 cents on the dollar after each insurance company exceeds a threshold, based on 7 percent of its gross direct earned premiums in 2002, 10 percent in 2004 and 15 percent in 2005.

During the coming April renewal season, insurers will be examining potential coverage for these exposures.

Mr. Huxol believes the solution to the problems of allocating the benefits of the federal backstop to reinsurers on the treaty will be solved, if ceding companies purchase separate "deductible buy-down" coverages, protecting against their deductible exposure.

The most dangerous solution for the deductible exposure, he said, is for insurers and reinsurers to leave nebulous language in the treaty contract that says the "federal backstop benefits will inure to the benefit of the treaty without specifically stating how." (See accompanying chart compiled by GE ERC, which demonstrates the problems that could occur with allocation of the backstop benefits among reinsurers A, B, C and D if interpretation is made after a loss, rather than when the contracts are being signed.)

Reinsurers exposure under the treaty would be contained within the middle band of the various pillars of loss, said Mr. Huxol, explaining the chart. Reinsurers with different exposures, different numbers of treaties or the most terrorism losses, could argue over who gets the benefits of the federal backstop, unless the question is handled ahead of time, he added.

My concern is that the entire reinsurance community is not on the same page with regards to this issue, Mr. Huxol said. . "We could end up in court for the next 20 years."

"If the treaties are done in a traditional manner and all the reinsurance agreements say, the federal backstop will inure to the benefit of the treaty, thats not enough clarity," he said.

If each product line gets a certain amount of backstop, how does the insurer allocate the benefit of the backstop to the reinsurance companies? He asked.

Mr. Huxol suggested the terrorism coverage could be kept within the treaty, as long as all parties to the treaty agree up front how the backstop benefits will be allocated, but "that will be very hard to do."

Deciding allocation of the backstop benefits is still difficult even with pre-agreements, he said. "Even with pre-set allocations, its difficult to know how one line will be affected by a potential loss."

Further, he said, keeping the terrorism exposure within the treaty leaves potential for gaps in coverage.

"I think there is the potential for insurance companies to be surprised, by having a loss and finding out that they do not have reinsurance coverage on the deductible part of the exposure or the 10 percent quota share," he said.

"For example, there may be a timing difference between the calendar year basis of the backstop and the fact that all treaties are not on a calendar year basis," he said. "Another example would be if an insurer decides to not buy reinsurance for terrorism and non-terrorism events on certain products and those product lines get hit with a terrorism loss."

The solution in our mind is to pull the risk out of the treaty and basically buy a deductible buy-down, which says, if you have 7 percent exposure to the deductible in the first year, well provide coverage for all terrorism losses, with no exclusions, up to 7 percent," he said. "There would be no gaps, no concerns of trying to allocate premium and no concerns in trying to allocate the federal recovery."

A deductible buy-down would take this whole mess off the table. You dont have this issue. The benefit of the backstop will go to the insurance company and the reinsurers will not get a part of it and theyre not expecting a part of it."

He suggested that a deductible buy-down could be done on a pro-rata basis with other reinsurers. "It becomes very equitable because three or four reinsurers for one ceding company can allocate the exposure to the 7 percent deductible among them," he said. "This way there are no gaps and its very easy to contract."

However, one reinsurance buyer has suggested that the buy-down coverage is expensive and capacity is hard to find.

David Robb, executive vice president for the Hartford in Hartford, Conn., did not think that a meaningful affordable reinsurance market has emerged to supply broad-brushed terrorism coverage.

In his view some facultative reinsurance is available where reinsurers can isolate risks and pick and choose between them. He said he thought most national insurance companies would probably not purchase reinsurance and retain the exposure net on their books.

Mr. Huxol admitted that finding capacity will be difficult for large national companies, which have billion dollar deductibles under TRIA.

"Im estimating that about $5 billion is available currently in capacity for the entire industry for an estimated industry deductible of $15 billion," he said. . "So youre going to have about a third of the coverage you need for the marketplace."

For smaller, regional companies interested in buy-down coverage, the capacity will be there to meet their needs," he said. "Its not expensive if were doing it on a pro-rata basis, which basically says, were going to get a percentage of the premium you take in."

For a GE ERC report on TRIA, see www.geercgroup.com/gpc. A TRIA white paper is referenced on the homepage under title "News Spotlight."

Reproduced from National Underwriter Edition, February 3, 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.