Terrorism Risk Insurance Act Creates Effective Mechanism for Sharing Financial Risk

A RAND Corporation report issued today says the Terrorism Risk Insurance Act (TRIA), which will expire in December unless extended by Congress, creates an effective mechanism for sharing the financial risk that businesses face from terrorism.

The report by the RAND Center for Terrorism Risk Management Policy also suggests that the federal government consider encouraging uninsured businesses to buy terrorism insurance coverage, because somewhat less than half of all businesses now do so.

In addition, the study says that terrorism insurance provided under TRIA would not require federal subsidies unless there is a very large terrorist attack on the scale of the Sept. 11, 2001 terrorist strike on the World Trade Center, or a series of large terrorist attacks within a year. This is because federal subsidies to insurance companies are only triggered if TRIA-covered insured losses exceed $15 billion.

The report says that, in considering whether to extend or modifying TRIA, Congress should give concerns over the uninsured a higher priority than concerns about possible federal payments to insurance companies. This is because uninsured losses would be common in terrorist scenarios, while taxpayer funds would probably not be needed to support the terrorism insurance system.

The study estimates the pattern of payments for insured losses that might be triggered under TRIA in the event of three kinds of terrorist attacks: a hijacked aircraft hitting a major office building; anthrax being released inside a major office building; and an outdoor anthrax release in an urban area.

Under each of the scenarios RAND examined, TRIA-covered financial losses would not be large enough to trigger federal subsidies to insurers. Since less than half of businesses currently buy terrorism insurance policies, losses to businesses without the coverage don't cost insurance companies anything.

RAND researchers say one change lawmakers might consider as they debate whether to extend TRIA would be to decrease the cost of terrorism risk insurance to buyers by adjusting the cost-sharing formula for insurance providers and policyholders.

Another change to consider would be to require that all businesses purchase terrorism insurance coverage as a part of commercial insurance policies, the report says. However, such a requirement would be controversial and difficult to implement. But if enacted, mandatory coverage would enable more businesses to be protected and would enable insurance companies to collect premiums from more companies and to spread their exposure to risk.

“The nation's terrorism insurance system would not rely on payments from taxpayers under the terrorist scenarios we studied,” said Stephen Carroll, a RAND senior economist and lead author of the study. “There are questions whether the system should be changed to expand coverage.”

Because the Sept. 11 attacks caused substantial losses for the insurance industry, insurance companies began excluding terrorism coverage from commercial insurance policies shortly after the attacks. In response, Congress passed TRIA in 2002.

TRIA requires insurance companies to offer terrorism coverage as part of commercial policies, creates a risk-sharing arrangement among insurance companies and provides federal aid as a backstop to cover insurers' losses in excess of a deductible. The legislation was seen as a step to give insurance companies time to assess their exposure to terrorism, and to consider how to price and underwrite the risk.

While TRIA applies to commercial property and casualty insurance, insurance payments in future terrorist attacks also would come from other types of policies. Life, health and disability insurance would make significant payments under the scenarios studied, according to RAND researchers.

Even with the other types of insurance making payouts, researchers estimate the proportion of losses not covered by insurance would range from 13 percent in the indoor anthrax attack to 57 percent in the outdoor anthrax attack in the scenarios they studied.

Other authors of the study are Tom LaTourrette, Brian Chow, Gregory Jones and Craig Martin of RAND.

The RAND Center for Terrorism Risk Management Policy provides research to inform public and private decision makers on economic security issues created by the threat of terrorism. The center is a partnership of the RAND Institute for Civil Justice; the RAND Infrastructure, Safety and Environment unit; and Risk Management Solutions, the world's leading provider of models and services for catastrophe risk management.

Copies of “Distribution of Losses From Large Terrorist Attacks Under the Terrorism Risk Insurance Act” (ISBN: 0-8330-3865-6) can be ordered from RAND's Distribution Services (order@rand.org or call toll-free in the U.S. 1-877-584-8642).