White Paper Analyzes Loss Retention Under Terrorism Extension Act

AIR Worldwide Corporation conducted an analysis of the potential impact on insurers of the Terrorism Risk Insurance Extension Act of 2005. The Act was signed into law last week and extends the Terrorism Risk Insurance Act of 2002 (TRIA) through the end of 2007.

“The law signed by the President amends the TRIA statute and includes higher insurer retention levels for 2006 and 2007,” noted Jack Seaquist, a senior manager at AIR. “However, while insurer retention will grow incrementally over the next two years, the program’s expiration at the end of 2007 will result in a dramatic increase in insurers’ loss retention in 2008, assuming no further government or industry solution is forthcoming.”

Under the extension, the trigger for payment of federal funds will increase from $5 million to $50 million for certified acts of terrorism occurring after March 31, 2006, and to $100 million for certified acts of terrorism occurring in 2007. The federal share of losses, paid only when certified insured losses exceed the trigger, remains at 90% in 2006, but is reduced to 85% in 2007.

Insurers’ deductibles will continue to be calculated as a percentage of the previous year’s direct earned premium in covered lines. However, the deductible will increase from the current 15 percent to 17.5 percent in 2006 and 20 percent in 2007. The new legislation excludes the following types of coverage from the program: commercial auto, burglary and theft, surety, professional liability, and farmowners multiple peril.

To illustrate the legislation’s impact, AIR modeled three scenarios based on the portfolio of a typical medium-size, multi-line property and casualty company. The sample company, with $2 billion in total annual premiums, is assumed to have a higher concentration of exposures in major cities. All losses are estimated using AIR’s Terrorism Loss Estimation Model.

— The first scenario is the detonation of a delivery truck bomb in a major U.S. city. The attack results in an insurance industry loss of almost $12 billion. In this case, the representative company retains 100 percent of its $230 million total loss, since the deductible will not be reached in any year.

— The second scenario involves the detonation of a large truck bomb in a major U.S. city. This scenario, which would be similar in effect to that of the Sept. 11, 2001 attack on the World Trade Center, results in a $40 billion loss for the insurance industry. Under the extension, the representative company would retain $345 million of its $760 million total loss in 2006, more than $400 million in 2007, and all $760 million after the expiration of TRIA.

— The final scenario is a chemical attack in a major U.S. city. This scenario results in an $85 billion insured loss for the industry. In this case, the representative company would retain $407 million of its $1.4 billion total loss in 2006, nearly $500 million in 2007, and the full $1.4 billion after the expiration of TRIA.

“The impact of these changes on insurers will vary depending on the severity, location and timing of any future attack and on an individual insurer’s actual book of business,” said Seaquist. “Therefore, it is essential that insurers re-evaluate their own terrorism risk assessment strategies with respect to industry best practices.”

A review of industry best practices for effectively managing terrorism risk is available in a recent AIR white paper, which can be downloaded at http://www.air-worldwide.com/_public/html/PR051229_redirect.asp.

The AIR Terrorism Loss Estimation Model is used by insurers, government agencies, and major corporations to assess terrorism risk in the United States from both international and domestic terrorist threats. The model simulates both conventional and non-conventional weapons effects, and resulting losses to property, workers’ compensation, and group life lines of business.