Study Says Workers’ Comp Terrorism Reinsurance Pool Not Enough

The private insurance industry for workers’ compensation would not have enough capital to withstand potential losses on its own should a catastrophic terrorism event, or multiple events, occur, according to the Workers’ Compensation Terrorism Reinsurance Pool Feasibility Study conducted by the Tillinghast and Reinsurance businesses of Towers Perrin.

According to Tillinghast, the study is one of the first serious effort the industry has taken toward exploring the viability of private market solutions to help manage the threat of terrorism for workers’ comp insurance. The Terrorism Risk Insurance Act (TRIA), which expires on Dec. 31, 2005, was enacted in 2002 in part to provide a temporary window of relief so insurers could develop private market solutions to manage the ongoing risk of terrorism. Terrorism and insurance experts have conceived of plausible catastrophic terrorism events that generate workers’ comp losses of $90 billion or more, roughly three times the $30 billion in capital backing the workers’ comp line of business.

The study acknowledges the potential value of a voluntary reinsurance pool to some individual insurers, but points to its limitations as a meaningful industry solution, particularly absent some form of ongoing federal backstop protection. A voluntary workers’ comp industry reinsurance pool would not create ‘new’ capital in and of itself to support catastrophic terrorism losses, though it would diversify risk and thereby increase the efficiency with which existing capital is deployed.

“Although the idea of an industry risk-sharing pool has been considered one of the most promising private market solutions for managing terrorism risk to date, the study concluded that this alone falls well short of addressing industry needs,” said Charles Wolstein, who led the Workers’ Compensation Terrorism Study on behalf of the firm. “The study serves as a starting point for further discussion; its analysis should help those evaluating the need for a federal backstop to understand the magnitude of the problem and the limitations of the private market’s capacity to manage this risk. It also will be an excellent resource for those looking to structure any new federal backstop program.”

“Terrorism is still very much a concern for U.S. business, and the recent bombings in Madrid further underscore the possibility of future attacks. A public/private partnership is critical to managing future terrorism risk for workers’ comp insurance post-TRIA,” said Stephen Lowe, Global P/C Insurance Practice Leader. “The industry needs to begin working with Congress now on developing such a partnership to avoid the potential for significant marketplace disruption in the event of major losses from future terrorist attacks.”

Why Workers’ Compensation?
The statutory nature of workers’ comp insurance makes it fundamentally different from other lines of insurance, creating a unique situation for the workers’ comp market. Unlike property insurance, workers’ comp providers cannot introduce terrorism coverage exclusions, nor can they limit their potential losses on any policy. Workers’ comp insurers are obligated to pay wage loss and medical benefits to workers injured on the job — without regard to cause and without limit.

“The complexities and magnitude of terrorism risk are extraordinary and there would be vast implications for the workers’ comp insurance market and U.S. businesses should a major terrorism event occur without a federal reinsurance mechanism in place. A major event could be greater than the entire base of capital that is supporting the workers’ comp insurance market, tearing away a structurally critical piece of the economy,” said Lowe. “Since workers’ comp insurance is required in virtually all states, the absence of a functional workers’ comp insurance market would interfere with the conduct of business throughout the economy.”

“Post-TRIA, insurers will be left with two options to manage the risk of catastrophic losses from terrorism – curtail workers’ comp policies or obtain catastrophic protection from a third party,” said Bruce Hockman, Principal and Workers’ Compensation Practice Leader for the firm’s Reinsurance business. “However, without a federal backstop in place, it is unlikely that commercial reinsurance — the industry’s traditional source of catastrophe protection — would be available in sufficient quantities, or at affordable prices, to meet marketplace demand.”

What’s Next?
“We’re now midway through TRIA and are starting to see the industry thinking about how their businesses will work without it, as the very real prospect of TRIA’s expiration looms.” said Wolstein. “Although TRIA remains in effect until Dec. 31, 2005, policies written as early as Jan. 1, 2005 will extend beyond TRIA’s coverage, presenting a significant dilemma for insurers.”

“The study laid the foundation for future work on an industry pool,” said Wolstein. “It’s a reasonable possibility that a pool could be created someday; however, the sponsors concluded that it would only make sense to pursue further dialogue ‘if and when’ the form of ongoing federal backstop protection becomes clearer.” He noted, “Hypothetically, a pool can only address 10% of the problem. Until the other 90% is addressed, it wouldn’t make sense to undertake the considerable effort necessary to develop the pool. Currently, a federal mechanism appears to be the only viable means of addressing the lion’s share of terrorism risk for workers’ comp.”

The industry sponsors of the study decided against pursuing the development of an industry pool at this time because participants:

Discovered that an industry reinsurance pool lacks meaningful capacity. The pool would fail to offer enough capacity to meaningfully help the industry absorb losses from major terrorism events — the primary reason for its formation — without some form of a more permanent federal backstop.

Agreed on the proper measure of terrorism risk exposure; but did not agree on final pricing formula. The sponsors agreed that the best way to measure terrorism risk exposure is via a census of employee headcount by geographic location (rather than by workers’ comp premium or payroll). Developing a final pricing formula for pool members’ premium contributions would require further work, if a pool were to be formed.

Concluded that further development of design specifics needed to wait. Sponsors concluded that, since the pool could not provide sufficient capacity on its own, further investment in its development should be deferred until an ongoing federal backstop was in place. In addition, some elements of the pool design could not be finalized without knowing how ongoing federal backstop protection would work to enable the pool to integrate sensibly with a federal program.