On Nov. 25, 2002, President Bush signed into law the Terrorism Risk Insurance Act. The act established a program within the Department of the Treasury under which the federal government would share the risk of loss from future terrorist attacks with the insurance industry.

The immediate impact of the bill was that insureds automatically had terrorism coverage, to the extent that coverage is provided under the plan, for a minimum of 30 days after the bill was signed.

Insurers have 90 days from the signing of the bill, until February 24, 2003, to tell policyholders how much the coverage will cost.

Buyers have 30 days after receiving a quote to accept or decline the coverage. In the interim, the insurers would have to foot the bill for any terrorist damage that could occur. The act provides only a short-term backstop; it terminates on Dec. 31, 2005.

Almost immediately after Sept. 11, 2001, the previously insured peril of terrorism – coverage never before considered important by most businesses – became an excluded peril for most if not all property insurance policyholders.

This exclusion presented a particular problem for the commercial real estate industry. In effect, the industry had been a target of the Sept. 11 attacks and many commercial locations were immediately dubbed “marquee” locations susceptible to potential follow-on strikes. In addition, many lending institutions felt this loss of coverage presented a major issue in their ability to continue as lenders or to finance the construction of new projects or acquisitions.

Shortly thereafter, niche-market insurers came forward to offer terrorism insurance as a stand-alone cover. However this cover was offered with limits normally well below what many insureds needed to protect their larger locations and at prices considered high when compared to natural catastrophe perils, such as earthquake and wind.

Real estate firms were now faced with market offerings that lacked sufficient capacity to protect major locations, large unbudgeted additional costs if they should purchase this cover, and pressure from lenders. Soon the economy began to feel the impact. Construction projects were being delayed and transactions were being cancelled. These forces drove the U.S. Congress to pass and the president to sign into law the Terrorism Risk Insurance Act on Nov. 25, 2002.

Terrorism exclusions on all but a few specified types of policies now became invalid if insurers, as defined in the law, underwrote those policies. These insurers were now required to provide terrorism cover as defined in terms not materially different from the terms they offer for other events.

While the law is silent on the rates that insurers could charge for this cover, it does provide a set retention insureds must pay: a percentage of their premiums written, as well as a financial threshold for a loss to be considered for coverage under the law.

Insureds being the immediate recipient of this grant of cover fall into three separate categories, as far as the action insurers have to take and the decisions insureds have to make: (1) those with terrorism exclusions in their policies – the largest group, (2) those with no terrorism exclusion in their policies and (3) those with upcoming renewals.

Many insureds also have to deal with what to do with the stand-alone terrorism policies they had purchased; all insureds have to deal with ambiguities in the law and the Treasury Department’s continued issuance of interim guidance on the law.

For those with terrorism exclusions, the law states that insurers must as soon as possible send notice directly to the insured or their brokers, giving notice of the increased premium due if the insured desires to keep this cover. The insured then has 30 days to make a decision and pay the premium.

If the premium is not paid or the insurers return the notice stating they do not wish to have the cover, then the terrorism exclusion would be reinstated. If an insured does not meet the time deadlines, there is no requirement that the insurer has to re-offer this cover.

It is interesting to note that although the insurers must notify the insured as soon as possible, there is no set time frame for this notification. There is a set deadline for the insured to respond, which is 30 days from the receipt of the notice.

While this may not seem like a large issue, consider insureds with multiple insurance markets on their placements. Once the first notice is received the clock on that notice starts and there is no guarantee that any of the remaining notices will be received before a decision must be made on the first notice. This can leave the insured in a position to make a decision on the entire program before all the quotations are received. Compound this with an insured that is simultaneously making the decision on what to do with a previously purchased stand-alone terrorism policy.

Therefore, the insured may make the decision to cancel or keep and later, when all the quotes are in, find out that the decision was wrong.

For the second group, those with no terrorism exclusion, the insurers must, within 90 days, provide clear and conspicuous disclosure of the premium allocated to the terrorism cover. The insured is under no obligation to respond to this letter, as there is no change in cover requested by this endorsement – only an acknowledgement of premium allocation by the insurer for the peril of terrorism.

For the third group, upcoming renewals, the insured must be offered terrorism cover as a separate premium. The decision to buy terrorism must be made and the premium for it paid under the same conditions as the insurance policy that is being placed. Insureds who have purchased stand-alone terrorism cover, not only have to deal with the issues of whatever action category they fall into, but they also have to review the terms of the stand-alone policy.

With this law coming into effect, they are in the position of having duplicate cover for certified acts of terrorism. Whether the stand-alone policy is to be considered primary or excess of the newly provided TRIA, cover must be discussed with the underwriters so that in the event of a claim this is clearly understood. Also the insured needs to make a decision to either cancel the stand-alone policy or not accept the TRIA cover. Complicating this decision is that stand-alone policies normally have a broader definition of terrorism than the TRIA mandated cover. They could have been written as non-cancelable by either party, which was normally done to preclude an insurer from canceling a policy should more terrorist acts occur.

Defining Terms

Ambiguities, which every insured has to deal with, run a wide range.

First the definition of “insurer” has to be reviewed against every carrier on a program. As an example, most of the Bermuda markets have questioned whether the law applies to them and they currently appear confident that they are not covered by the law’s reinsurance and not required to offer the cover. Although the Treasury Department is reviewing this, a time frame for the decision is not known. While offshore captive and insurance carriers also are not clearly defined in the law, the Treasury Department issued interim guidance that definitively states that all U.S. domiciled captives are “insureds” under the law.

With no set rating-mechanism, insurers are free to charge what they feel is a premium commensurate with the risk while also taking into account the government reinsurance. To date, insurers have been taking very different approaches to pricing the risk. While the law requires direct markets to be governed by the law, there is no requirement for reinsurers to participate. This has greatly impacted fronted programs – those where one insurance company acts on behalf of other insurance companies who provide reinsurance to the front company – and reinsured domestic captives who must now provide the TRIA cover but not necessarily receive reinsurance support for it.

Clearly, the law has provided insureds the option to purchase terrorism cover, markets to price the cover that will attract enough buyers to establish the large number necessary for insurance to be economical over time, and it has also created an economic model that will assist the commercial real estate market along with other sectors of the economy. However, it is also clear that there are significant challenges for buyers of terrorism insurance to overcome in a very short time-frame. Buyers should do all that they can in advance of the first notice so that they have the most time to make the best decision. This situation will continue to evolve as the Treasury Department issues more interim guidance and as more quotations are received from insurers and evaluated. Buyers would be wise to address these issues with their risk managers and their brokers to make an informed decision.