The Impact on Workers' Compensation Insurance Markets of Allowing the Terrorism Risk Insurance Act to Expire

by Michael Dworsky, Lloyd Dixon

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Research Questions

  1. How would insurers who sell workers' compensation policies respond to the Terrorism Risk Insurance Act's (TRIA's) expiration?
  2. What are the potential consequences of growth in the residual market (or market of last resort) for workers' compensation insurance, both before and after a future terrorist attack?

Abstract

Congress enacted the Terrorism Risk Insurance Act (TRIA) in 2002, in response to terrorism insurance becoming unavailable or, when offered, extremely costly in the wake of the 9/11 attacks. The law provides a government reinsurance backstop in the case of a terrorist attack by providing mechanisms for avoiding an immediate drawdown of capital for insured losses or possibly covering the most extreme losses. Extended first in 2005 and again in 2007, TRIA is set to expire at the end of 2014, and Congress is again reconsidering the appropriate government role in terrorism insurance markets.

This policy brief examines how markets for workers' compensation (WC) insurance would be affected if TRIA were to expire. They explain that TRIA expiration would affect WC insurance markets differently from other insurance markets because WC statutes rigidly define the terms of coverage, such that in a post-TRIA world insurance companies would limit their terrorism risk exposure by declining coverage to employers facing high terrorism risk. Because WC coverage is mandatory for nearly all U.S. employers, employers that cannot purchase coverage would be forced to obtain coverage in markets of last resort. Migration of terrorism risk to these markets of last resort would increase the likelihood that WC losses from a catastrophic terror attack would largely be financed by businesses and taxpayers throughout the state in which the attack occurs, adding to the challenge of rebuilding in that state. TRIA, in contrast, spreads such risk across the country.

Key Findings

The Market for Workers' Compensation Insurance in the Absence of the Terrorism Risk Insurance Act

  • Compared with other insurance lines covered by the Terrorism Risk Insurance Act (TRIA), workers' compensation (WC) offers insurers less flexibility to control terrorism exposure through modifications in coverage: WC policies cannot exclude terrorism, impose policy limits, or exclude losses from nuclear, biological, chemical, or radiological (NBCR) attacks.
  • If reinsurers are unwilling to provide much more coverage for both conventional and NBCR attacks, insurers might respond to TRIA's expiration in December 2014 by declining to provide WC coverage to employers who present a high geographic concentration of potential losses.
  • Without TRIA in place, employers perceived to be at high risk for terrorism might have to obtain coverage in markers of last resort known as residual markets, which could charge higher premiums.
  • The higher cost of coverage would tend to reduce labor incomes and economic growth even if there is never another attack, though these effects are likely to be small.
  • Expiration of TRIA and growth in the residual market might also mean that WC losses from a catastrophic terror attack would largely be financed by businesses and taxpayers throughout the state in which the attack occurs, adding to the challenge of rebuilding in that state. TRIA, in contrast, spreads such risk across the country.

This work was conducted within the Center for Catastrophic Risk Management and Compensation. The center is part of RAND Justice, Infrastructure, and Environment, a division of the RAND.

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