One of the biggest challenges in risk management is the concept of things “probable” versus things “possible.” Traditional risk management has focused more on the probable, using historical losses and other data to actuarially forecast future losses and related costs. Naturally, the probable is much more in the comfort zone of insurance underwriters than the things that could “possibly” happen. Yet research shows that the most destructive risks are those that are much harder to forecast as there is typically limited historical data that might inform such forecasts. In fact, these most destructive risks tend to fall into the strategic category type and are reflected in events such as those related to merger and acquisition failures, competitive risks and new product offering risks, among many others.
While terrorism risk is typically classed as an operational risk exposure or in other schemes, “external” and notwithstanding its perceived commonality in our modern world, it remains more possible than probable. It also is likely to spawn reputational risk (a strategic risk) in its wake if not effectively managed. In fact, terrorism events have been falling in recent years in both frequency and severity according to Marsh’s 2019 Terrorism Risk Insurance Report. Among many conclusions of this report are that the market for terrorism insurance remains stable and healthy in part due to the U.S. Treasury “backstop” provided by the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) legislation (originally the Terrorism Risk Insurance Act; hereinafter referred to as the Act).
Apart from this debate about whether TRIPRA is needed and its renewal, the reality is that no terrorism claims against TRIPRA or its predecessor acts have ever been paid. This is not so much because of claim denial as much as the size of the deductibles and coinsurance built into its design. The substantial risk that “insureds” must assume before TRIPRA will pay, convincingly suggests that this risk transfer mechanism is for the truly unlikely event (i.e. what some think of as grey or black swan events) that most organizations are unlikely to ever experience. Nevertheless, 62% of U.S. companies purchased some form of terrorism coverage for property exposures in 2018 (1) and many organizations have included terrorism insurance in their captive insurance strategies. The latter would be so ideally designed as to enable them to access TRIPRA on a reinsurance recovery basis should the threshold requirements of the Act be met.
While the Consumer Federation of America estimates it would take $85 billion in total insured losses (a single event) before TRIPRA would be required to pay, recovery may not be as seemingly unlikely as one might think. (2) This is because this threshold is on a per event basis, therefore, it is calculated by aggregating the losses of all covered organizations affected by a single event. For example, in a nuclear event, an entire city or state may be exposed to losses wherein the $85 billion may seem small in this context. Yet, for the many captive owners that have written terrorism insurance for their facilities, in part because the U.S. Treasury backstop provides real insurance (reinsurance) protection from the truly catastrophic, a claim perfected and the potential recovery could mean the difference between failure and survival.
While the Act has been extended once and modified twice (2005, 2007 and 2015) as each expiration approached, the general design scheme was followed; that is, reinsure the primary market for terrorism, but require substantial primary losses before the U.S. Treasury payment could be expected.
The 2015 reauthorization (the current Act) brought a few more significant changes to the Act including the following:
- The insurer deductible was set at 20% of an insurer’s direct earned premium of the preceding calendar year and the federal share of compensation was set at 85% of insured losses that exceed insurer deductibles until January 1, 2016. Then, the federal share is decreased by 1 percentage point per calendar year until it reaches 80%.
- The certification process was changed to require the Secretary of the Treasury to certify acts of terrorism in consultation with the Secretary of Homeland Security instead of the Secretary of State.
- The program trigger was amended to apply to certified acts with insured losses exceeding $100 million for calendar year 2015, $120 million for calendar year 2016, $140 million for calendar year 2017, $160 million for calendar year 2018, $180 million for calendar year 2019, and $200 million for calendar year 2020 and any calendar year thereafter. Prior to 2015, it was a simple $100 million threshold.
- The mandatory recoupment of the federal share through policyholder surcharges increased to 140% from 133%.
- The insurance marketplace aggregate retention amount was established at the lesser of $27.5 billion, increasing annually by $2 billion until it equals $37.5 billion, and the aggregate amount of insured losses for the calendar year for all insurers. In the calendar year following the calendar year in which the marketplace retention amount equals $37.5 billion, and beginning in calendar year 2020, it is revised to be the lesser of the annual average of the sum of insurer deductibles for all insurers participating in the program for the three prior calendar years as such sum is determined by the Secretary of the Treasury by regulation.
- The Secretary of the Treasury is required, not later than nine months after the date of enactment of the Act, to conduct and complete a study on the certification process, including the establishment of a reasonable timetable by which the Secretary must make an accurate determination on whether to certify an act as an act of terrorism.
- Insurers participating in the program are required to submit to the Secretary of the Treasury for a Congressional report every June 30, information regarding insurance coverage for terrorism losses to evaluate the effectiveness of the program.
- The program trigger increased to $160 million and the TRIPRA quota share is now 82%, increasing the insurer quota share to 18%. While this may seem high, there is no reason captives couldn’t write $1 billion policy limits or higher, if designed properly.
- The U.S. Treasury issued guidance to clarify that the requirement of TRIPRA applies to cyber liability insurance policies reported under a TRIPRA-eligible line of insurance, bringing cyber terrorism perils more specifically under the Act.
- Captives are fully responsible for losses below USD $160 million for 2018. The trigger will increase $20 million a year until 2020, when it will reach $200 million.
- Captive owners should consider if supplementary “trigger protection” insurance is a viable option for their programs. Organizations should also review their cyber limits to determine if a captive can provide more capacity than their current cyber policies. The option to effectively buy down the deductible with reinsurance may be attractive to many captive owners.
- The U.S. Treasury’s recent clarification on cyber liability insurance allows for captives to expand the insurance protection. Captive insurers that access TRIPRA can offer broader coverage than would be available through a standalone policy. (3)
Now, midway through 2019, the conversation is beginning on the prospects for the federal government’s involvement in terrorism risk financing after 2020. This legislation is up for renewal once again as the current version expires on December 31, 2020. Interestingly, some consumer advocates believe TRIPRA and its predecessors have been unnecessary subsidizations of insurance markets that they believe are fully able to handle multiple 9/11 magnitude events, especially considering the current industry capitalization of $742 billion. In 2019 dollars, the attacks on September 11, 2001 produced $27 billion in insured losses. In the absence of private market innovations and solutions, sustaining a viable private market for terrorism insurance depends on a federal backstop of some kind and this now thrice renewed, albeit modified, legislation has served its primary purpose well – namely, keeping commerce operating smoothly by mitigating fear of the largely unpredictable.
If Congress were not to renew TRIPRA before it expires, there are various potential market impacts that could ensue. First, any gap such as occurred in 2014, would produce some market chaos. Contingency contracts are already being offered that would protect buyers from such a possibility. Another market response could have some insurers inserting sunset clauses in renewal policies while others may increase prices or limit their willingness to write some or all terrorism exposures. Still other insurers could have to purchase additional private reinsurance, which could be impacted by a flow of new reinsurance buyers into the market, likely driving rates up. In this latter scenario, reinsurers should then be expected to be selective in exposing their capital with no or reduced federal protections, which could pose a capacity problem for some businesses in high risk cities. Finally, employers with significant workers’ compensation accumulations could also experience disruptive market conditions under several scenarios.
Religious extremism is expected to remain the dominant terrorism threat globally, but the threat from “extreme right-wing groups” is also expected to rise in Western states, most likely in the form of “low-capability attacks that generate little property damage but pose significant risks to people.” The Marsh report says that attacks by lone wolves and small groups are happening more often and there is rising concern over terrorist incidents occurring in or near workplaces. Thus, it is safe to say we are not out of the woods on terrorism risk and while falling frequency and severity are always welcome results, there is little reason to believe that new methods and targets may not emerge that could materially change the terrorism exposure profile in the future. This should motivate risk managers to act with caution in designing terrorism risk transfer programs and solutions going forward. The good news is, buyers have a year and a half to figure it out. (1)
The American Property Casualty Insurance Association has also begun to publicize their preferences relative to TRIPRA renewal, which include making the program permanent and providing more clarity about coverage for cyber terrorism, an increasingly common exposure for a growing number of organizations. Regrettably, the legislative pattern has been for Congress to procrastinate and delay action until just before each expiration date. In fact, prior to the 2015 reauthorization, there was a two-week lapse that caused modest market chaos in its wake. There is evidence that some members of the Democratic House believe renewal is a priority and the Senate Banking Committee has declared reauthorization a priority. However, Senator Crapo, its chair, has suggested they may seek higher coinsurance and increasing government recoupment amounts through increased policyholder surcharges. That said, we are not likely to see substantive detail from legislators much before the fall of 2020, especially since it will be a national election year.
TRIPRA and captives
Since its original inception in 2002, the Act has allowed captive insurance companies to access this federal reinsurance mechanism of the U.S. Treasury, enabling a more robust and potentially efficient terrorism risk financing program. While only 182 captives took advantage of this mechanism, that number was up 10% in 2018. (4)
Whether you’re one of the 182 or just contemplating using a captive for terrorism, here are a few of the more relevant changes to the Act (effective in 2018) impacting captives:
As companies assess what the potential non-renewal of TRIPRA may mean to them, here are several questions you might ask to form meaningful conclusions for action:
- What is your current exposure to terrorism risk?
- What current lines of coverage in your program include terrorism and to what extent?
- Have you summarized the various sources of coverage and identified gaps that might need closing relative to your terrorism risk financing strategy?
- Does your captive include terrorism coverage?
- Does your captive coverage align with sources of coverage in your primary lines?
- To what extent can you afford a full terrorism limits loss in your captive without reinsurance?
- Do you have sufficient protection from nuclear, biological, chemical and/or radioactive events?
- Is your captive terrorism program strategically aligned with your organizational financing strategies, and have you leveraged expert and regulatory resources available from brokers, consultants, the National Association of Insurance Commissioners (NAIC) and others where applicable?
For example, the NAIC Property and Casualty Insurance Committee and its Terrorism Insurance Implementation Working Group recently adopted a model bulletin including an expedited filing form intended to help state insurance regulators advise insurers about regulatory requirements related to providing terrorism insurance under the revised program. The bulletin provides guidance to insurers related to rate filings and policy language that state regulators would find acceptable to protect U.S. businesses from acts of terrorism. It describes important changes that are contained in the 2015 Act modifications and informs insurers regarding whether rate and policy form filings might be needed. The NAIC also adopted the Model Disclosure Forms that insurers can use as drafted or modify to meet their individual needs. These well-designed tools can be quite helpful in developing a captive terrorism program, whether all inclusive or supplemental to your primary, regular market lines.
While Congress could choose to finally kill their involvement in terrorism risk financing, few believe it is likely in this next cycle. So, what might a “renewed” Act look like after 2020? To some degree, it will depend on what happens in the next 18 months in the way of events. Counterintuitively, if no significant terrorism events occur during this period, the Act may be at more risk than is currently thought. If on the other hand, significant events occur, a new urgency to renew and perhaps even strengthen the Act could occur. In the latter case, what might this version look like?
Considering the historical pattern of three extensions/renewals across both Democratic and Republican administrations, the best prediction might be more of the same, adjusted for economic conditions at the time (e.g. the emergence of a recession, more federal budget deficit growth) and the emergence of new or aggravated exposures (e.g. an actual nuclear loss event somewhere in the world, God forbid); only time will tell. Your best move now is to consider the potential for market disruption (i.e. rates, coverage availability and/or sufficiency) and prepare for contingent actions that will cover the range of possible outcomes from TRIPRA termination to renewal/extension with enhancements, or more likely, more risk sharing among insurers.
1.Federal Terrorism Reinsurance Program is Keeping the Market Stable. Marsh. Carrier Management. May 23, 2019.
2. Consumer group opposes terror backstop renewal. Matthew Lerner. Business Insurance. May 29, 2019.
3. Several Changes to TRIPRA Will Impact Captives in 2017. Marsh. Research and Briefing.
4. Number of captives accessing TRIPRA increased 10% in 2018. Captive International. May 23, 2019.
- Industry Eyes Renewal of U.S. Terror Reinsurance and Alternatives Should Congress Fail. Suzanne Barlyn. Insurance Journal. March 5, 2019.
- U.S. Department of the Treasury. Terrorism Risk Insurance Program.