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Federal Document Clearing House
Congressional Testimony
February 27, 2002 Wednesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 6119 words
COMMITTEE:
HOUSE FINANCIAL SERVICES
HEADLINE:
NEED FOR FEDERAL
TERRORISM INSURANCE ASSISTANCE
BILL-NO:
H.R.
3210 Retrieve
Bill Tracking Report
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Full Text of Bill TESTIMONY-BY: RICHARD J.
HILLMAN, DIRECTOR,
AFFILIATION: FINANCIAL MARKETS AND
COMMUNITY INVESTMENT
BODY: United States General
Accounting Office GAO Testimony
Before the Subcommittee on Oversight and
Investigations, Committee on Financial Services, House of Representatives
Wednesday, February 27, 2002
TERRORISM
INSURANCE Rising Uninsured Exposure to Attacks Heightens Potential
Economic Vulnerabilities
Statement of Richard J. Hillman Director,
Financial Markets and Community Investment
GAO-02-472T
Madam
Chairman and Members of the Subcommittee:
The tragic events of September
11, 2001 brought to light the huge potential exposures insurance companies could
face in the event of another terrorist attack. Faced with continued
uncertainties about the frequency and magnitude of future attacks, at the same
time government and military leaders are warning of new attacks to come, both
insurers and reinsurers have determined that terrorism is not an insurable risk
at this time. As a result, in the closing months of last year insurers began
announcing that they could not afford to continue providing coverage for
potential terrorism losses. The effects of this trend have yet to be fully
realized, but there is some indication that it has begun to cause difficulties
for some firms in certain economic sectors.
Considerable debate has
taken place on what the federal government can do to keep commercial
insurance companies involved in providing
terrorism
insurance, even without the protection that they normally receive from
reinsurance. While this Committee and the House of Representatives did pass H.R.
3210, the Congress as a whole did not adopt legislation. Today, two months into
a new year, uncertainty and concerns continue, both in the
insurance industry and the economy, over the issue of
terrorism insurance. As you requested, my testimony today will
describe how, in the absence of federal action, insurance companies and the
marketplace have reacted to the events of September 11th. I will also present
GAO's initial observations on the potential consequences these market changes
may have, both in the event of another terrorist attack and, as we all hope, in
the absence of one. Finally, I have included a discussion of the language
developed by the
Insurance Services Office (ISO) and adopted by
most states to exclude
terrorism from commercial property and
casualty (P/C) coverage (appendix 1).
My statement today is based on
discussions with a variety of insurance industry participants, regulators,
policyholders, and other affected parties. Because many companies were deeply
concerned about the possibility that their difficulties in getting terrorism
coverage might become general knowledge, they spoke to us only on condition of
anonymity. Finally, my statement primarily addresses the availability of
terrorism insurance coverage. Despite rising prices in the
remainder of the commercial P/C market, insurance coverage is still available,
though at prices above those in effect prior to September 11, 2001.
In
summary, because insurance companies believe that neither the frequency nor the
magnitude of future terrorist losses can be estimated, they are withdrawing
themselves from the market.
Insurance for losses from
terrorism is disappearing, particularly for large businesses
and those perceived to be at some risk. This withdrawal is happening fastest
among reinsurers. Direct commercial P/C insurers' withdrawal has been slower and
less complete because of regulatory constraints and legal requirements in some
states that preclude insurers from excluding terrorism from coverage for
workers' compensation and for fire (irrespective of its cause).
Because
the insurers' withdrawal has been gradual, the extent of the potential economic
consequences is still unclear. What is clear is that in the absence of
terrorism insurance, another terrorist attack would
dramatically increase direct losses to businesses, employees, lenders, and other
noninsurance entities beyond those resulting from September 11th. Furthermore,
should the government decide to intervene after a future attack, it would do so
without readily available claims-processing and payment mechanisms that exist in
the insurance industry.
Even in the absence of an actual terrorist
event, however, there are growing indications that some sectors of the
economy-notably real estate and commercial lending-are beginning to experience
difficulties because some properties and businesses are unable to find
sufficient terrorism coverage, at any price. If allowed to go unchecked, these
difficulties are likely to increase as more insurance contracts come up for
renewal over the next year. The resulting economic drag could slow economic
recovery and growth.
Insurers Are Shifting Terrorism Risk to Property
Owners and Businesses
Since the September 11th attacks, the key dynamic
taking place in the
insurance industry has been a shifting of
the risk for
terrorism-related losses from reinsurers to
primary insurers and then to the insured. Reinsurers and insurers have begun
shedding their exposure to
terrorism risk as
insurance contracts come up for renewal, leaving policyholders
increasingly exposed to losses from a terrorist attack. Prior to September 11,
2001, insured losses resulting from
terrorism in this country
were extremely infrequent.
Insurance companies considered the
risk so low that they did not identify or price potential losses from terrorist
activity separately from the general property and liability coverage provided to
businesses. But after the September 11th attacks, insurance companies recognized
that their risk exposure was both real and potentially enormous. As a result,
they began to express concern about continuing to include
terrorism coverage as an unpriced component of commercial P/C
insurance contracts. Insurers pointed out that experience with
major terrorist events has been so limited, and the potential losses so large,
that setting an actuarially sound price for such coverage is virtually
impossible. Many insurers now consider terrorism an uninsurable risk, at least
for the moment. Their response to any risk they consider uninsurable, as many
Californians living on fault lines have found, is not to offer
insurance. This trend has become evident in the case of
terrorism insurance. Reinsurers Are Withdrawing from
the Market for
Terrorism Insurance Reinsurers-companies
that routinely take on some of the risk that direct primary insurers face in
return for a share of the premiums-are now unwilling to participate in terrorism
coverage because of the enormous losses they suffered after September 11th and
the newly recognized difficulties of pricing
terrorism
insurance. Reinsurance is a vitally important element of the
insurance industry's capacity to provide coverage to
policyholders. As a mechanism for spreading the risks taken by insurance
companies, reinsurance allows primary insurers to accept large risks and, by
reinsuring a portion of those risks, to protect themselves from a potentially
catastrophic loss. Like syndications of large loans by groups of lenders,
reinsurance provides a way to insure large risks without exposing a single
insurer to the possibility that its entire capital base would be wiped out
because of a single event. Reinsurance companies also provide a channel through
which investors can introduce capital to insurance markets without having to
develop the extensive distribution channels required by direct primary insurers.
However, because reinsurance markets are global in scope and because reinsurance
transactions are considered to be contracts between sophisticated parties,
neither the prices nor the conditions of such coverage are subject to direct
regulation. As a result, after September 11th, reinsurers had little difficulty
excluding terrorism from coverage. Generally, these exclusions become effective
on the policy renewal date. As stated by witnesses before this Subcommittee in
October, a large share of those contracts expired at the beginning of January.
Industry sources confirm that little reinsurance is being written today that
includes coverage for terrorism. There are exceptions. Low and medium risks,
particularly in industries or geographic locations where there is little
perceived exposure to a terrorist event, are the least affected. However, large
companies, businesses of any size perceived to be in or near a target location,
or those with some concentration of personnel or facilities are unlikely to be
able to obtain a meaningful level of terrorism coverage at an economically
viable price. Where coverage is available, it tends to have high deductibles and
tight limits on the level of coverage. In general, reinsurers are being very
selective on the exposures they will accept, if any. The higher the risk, the
less likely it is that reinsurance coverage will be available. And even in those
limited cases in which some reinsurance coverage for terrorism is still
available, the prices are very high.
As Primary Insurers' Exposure
Increases, They Also Are Excluding
Terrorism Coverage
As reinsurers walk away from
terrorism insurance,
primary insurers' exposure increases, at least in the short run. However, while
reinsurance contract renewals tend to be concentrated at the beginning of
January and July, primary insurance contracts tend to renew at a relatively even
rate over the year. As a result, industry observers and participants have told
us that primary insurers' exposures have increased dramatically and will not
fall unless and until they can, in turn, exclude terrorism from their coverage.
Faced with this kind of exposure and a risk they do not believe can be
priced, industry observers and participates mentioned that primary insurers will
need to emulate their reinsurance counterparts and exclude
terrorism coverage from some commercial
insurance policies. However, a number of factors are affecting
both the speed and the extent to which primary insurers can insulate themselves
from terrorism. First, in contrast to reinsurance, changes to the coverage
provided by direct insurers require regulatory approval in most states, at least
for low- and medium-risk companies. This regulatory hurdle caused ISO, acting on
behalf of P/C insurers, to file a request in every state for permission to
exclude
terrorism from all commercial
insurance coverage. As of February 22, 2002, 45 states and the
District of Columbia and Puerto Rico had approved the ISO exclusion, according
to information received by ISO and the National Association of Insurance
Commissioners (NAIC). The other five states either denied the suggested language
from ISO or are still considering the language for approval or disapproval.
States that have not approved the ISO exclusion expressed concerns about various
issues. Among them are the low thresholds for exclusion ($25 million or 50
serious casualties); the all-or-nothing nature of the threshold (insurers pay
nothing if either threshold is reached); the aggregation of all losses from
multiple incidents within a 72-hour period and across most of North America into
one event if they "appear to be carried out in concert or to have a related
purpose or common leadership"; fear that the exclusion would leave some small
and medium-sized businesses that could least afford the losses from a terrorist
attack totally unprotected; and worry that the included definition of terrorism
is overly broad. Nevertheless, because of regulatory concerns about the solvency
of primary insurers who cannot get reinsurance, ISO's exclusion language has
been approved in 45 states and the District of Columbia and Puerto Rico. Primary
insurers in those states can now exclude terrorism from coverage on various
lines of commercial policies. While only five states have not (yet) accepted the
ISO exclusion language, those five states account for more than 35 percent of
the total U.S. commercial insurance market.
Second, even though direct
insurers now have regulatory approval to exclude
terrorism from
commercial P/C
insurance contracts in most states, such a
change in coverage generally would have to wait until the renewal date.
According to some insurance regulators with whom we spoke, losing reinsurance
would not generally be a sufficient reason for canceling or changing coverage
for policyholders during the policy period. Moreover, even when an insurance
policy terminates, insurers generally have to give 30 to 60 days advance notice
to policyholders before non- renewing a policy or making a significant change in
coverage. As a result, it could be as much as a year after a direct insurer
loses reinsurance coverage for terrorism before a similar exclusion could be
passed on to all its policyholders.
Finally, even at renewal, laws
existing in some or most states will affect the extent to which insurers can
completely end their exposure to losses resulting from terrorist events. For
example, laws in nearly all states preclude a workers' compensation insurer from
excluding coverage for a particular type of event. Workers' compensation must
cover all the risks to which an employee is exposed while at work, irrespective
of the cause. Industry sources estimate that approximately 10 percent of the
losses resulting from the World Trade Center attack will be due to payments for
workers' compensation claims.
Similarly, insurance laws in approximately
30 states include what is called "standard fire policy" language, according to
ISO officials. In that language, insurers are required to pay losses resulting
from fire, irrespective of the cause. Thus, in an explosion like the World Trade
Center attack, a terrorism exclusion would protect insurers from liability for
losses resulting from the direct effects of the explosion, but not for the
losses caused by the resulting fire. Estimates suggest that the fire, rather
than the explosion itself, caused a substantial portion of the losses in the
World Trade Center attacks. Industry sources have said that they expect an
effort to change this requirement. In all of the states where the standard is
written into state statutes, an act of the state legislature would be required
to modify it.
Thus, even though many reinsurers can and have moved
quickly to exclude terrorism from reinsurance coverage, primary insurers'
ability to exclude terrorism is more limited, at least in the short run.
However, the rapid submission of the ISO exclusion language to state insurance
regulators, and their generally rapid and positive response, clearly indicate
the urgency of primary insurers' desire to be able to exclude
terrorism from commercial P/C
insurance
coverage. Early indications suggest that many businesses, particularly those in
large metropolitan areas, are already beginning to experience difficulty
obtaining
terrorism coverage as their
insurance policies come to renewal. In our discussions with
insurance industry participants, observers, and policyholders,
we found that large commercial enterprises were among the first to feel the
impact of terrorism exclusions. Some large property owners or developers
reported that they are having to underinsure or "go bare" by self-insuring for
terrorist risks because of the lack of available coverage or very limited
coverage for the quoted prices.
As Business Exposure to Uninsured Risks
Rises, so Do the Potential Economic Consequences
While the extent of the
negative economic impacts of a lack of terrorism coverage is not yet clear, the
potential for more severe economic impacts is increasing as the level of
uninsured risk climbs. Over the next year, the level of uninsured risk for
terrorism-related incidents is expected to continue to rise as commercial
policies renew between primary insurers and policyholders and insurers seek to
exclude terrorism-related coverage from policies they cannot reinsure.
Therefore, the economic burden of another terrorist attack would fall
increasingly on policyholders as the insurance industry sheds or limits its
risks to such exposures, raising the potential for more devastating economic
consequences should such an event occur. Additionally, as insurers exit the
market for terrorism- related coverage, so too does their claims-processing
capacity for administering recovery assistance to victims of a terrorist event.
Even in the absence of another terrorist event, adverse impacts due to
the lack of adequate terrorism coverage appear to be surfacing, although their
ultimate impact on the economy as a whole cannot yet be gauged. Additional cases
of adverse economic impacts to individual firms caused by the absence or high
price of coverage for terrorism-related events are likely to become more evident
as policies continue to be renewed over the next year.
Another Terrorist
Attack Could Have More Severe Economic Consequences
Many of the most
severe potential negative consequences resulting from the lack of
terrorism insurance coverage will only become evident if
another terrorist attack occurs. The shifting of risk from reinsurers to primary
insurers to commercial policyholders and other affected parties could place more
risk and economic burden on businesses and the public at large should another
terrorist attack similar to September 11th occur. Consequently, a lack of such
coverage in the event of another attack could have much broader effects on the
economy.
Recent estimates of the losses paid by insurers as a result of
the attacks on the World Trade Center are about $50 billion, of which reinsurers
are expected to ultimately pay about two-thirds. If another terrorist event of
similar magnitude were to take place, all those losses would still be incurred.
However, depending on the timing of the event, the effect would be very
different, because even today the reinsurers would be responsible for a much
smaller share of the losses. As the event moves farther into the future and
primary insurers successfully exclude
terrorism from insurance
coverage, the losses will increasingly be left to the affected businesses and
their employees, lenders, suppliers, and customers. Because these entities lack
the ability to spread such risks among themselves the way insurers do, another
terrorist attack similar to that experienced on September 11th could have
significant economic effects on the marketplace and the public at large. These
effects could include bankruptcies, layoffs, and loan defaults.
Another
significant consequence of the insurers' exiting the market for terrorism
coverage is the absence of a claims- processing mechanism that can effectively
and efficiently respond to victims of an attack. After September 11th, insurance
companies, working with public risk-management groups, are reported to have
mobilized extensive resources to pay many claims quickly. The administrator of
the special government program to compensate victims in the aftermath of the
September 11th attacks has noted the challenges of creating a mechanism for
identifying victims and properly disbursing aid, even several months after the
attacks. If, without insurers, the government should emerge as a principal
source of financial recovery after another attack, it would first have to create
the infrastructure to process claims and disburse financial assistance to
victims, duplicating the mechanism already in place in the insurance industry.
Therefore, the potential economic impacts of another incident on the scale of a
September 11th attack could become even more devastating absent insurance
mechanisms to quickly help businesses recover and restore economic activity. The
current movement by insurers to insulate themselves from terrorism- related
losses, however, means that their involvement in the recovery process after
another terrorist event would also likely be substantially lessened.
Some Examples of Adverse Impacts Are Surfacing Due to the Lack of
Adequate Terrorism Coverage
Even if no other terrorist attacks occur,
some adverse conditions are beginning to appear in the marketplace due to the
lack of adequate terrorism coverage, though the impacts on the economy as a
whole are still unclear. As noted earlier, commercial property owners and
businesses are now facing higher P/C rates coupled with substantially reduced
protection for
terrorism-related risks as P/C policies renew
over the coming year.
Insurance industry observers and
policyholders report that while limited coverage for
terrorism-related losses is currently available at very high
rates, full coverage is often not available at any price, forcing larger
commercial policyholders to operate with little or no coverage for such risks.
Cases of adverse economic impacts to individual firms caused by the absence or
high price of coverage for terrorism-related events are likely to become more
evident as policies continue to be renewed over the next year.
Some
examples of large projects canceling or experiencing delays have surfaced, with
the lack of terrorism coverage being cited as a principal contributing factor.
Overall, it is still unclear to what extent financing arrangements for existing
or planned projects will be jeopardized as lenders and investors are faced with
the prospect of absorbing additional terrorism-related risks that cannot be
insured. These financing arrangements encompass both development and resale
markets, where financing is contingent upon full insurance coverage for
collateral assets backing the loan or investment. Some industry observers
believe private markets will eventually develop and expand the capital available
for
terrorism insurance coverage, but whether or how quickly an
adequate market can materialize is not yet evident.
Our contacts with
various industry and regulatory sources indicate that some financial problems
are surfacing due to the lack of terrorism coverage, though it is still too
early to gauge how widespread these problems will become. Though we could not
independently validate each of the assertions provided, we found consistency
among the sources in the reasons contributing to delays or cancellation of
projects. These reasons can be attributed to uncertainty and an unwillingness
among lenders and investors to accept risks that cannot yet be reasonably
estimated and that insurance companies are unable to price.
Property
Owners and Developers
Two of the most common adverse impacts being cited
by commercial sources, particularly owners and developers, are the conditions of
having to go bare or only partially insure assets against terrorism due to the
inability to obtain meaningful terrorism coverage. Even when limited coverage is
available, uncertainties about the frequency and cost of future events cause
insurers to set premiums very high. This condition appears to be particularly
acute for properties located in central business districts of major metropolitan
areas.
Specifically, several property owners that we spoke to with
properties across the United States reported not being able to purchase the
amount of terrorism coverage they need because the capacity they require is not
available in the current market. As a result, these owners are largely bare for
terrorism risks and liable for any uninsured damages that would result from a
terrorist attack on their properties.
For instance, a major North
American commercial real estate firm that owns trophy properties and office
buildings in the central business districts of several major U.S. cities
reported that it cannot find enough
terrorism insurance to
cover the value of its properties. This firm previously had a blanket property
insurance policy providing $1 billion of total
coverage-including
terrorism- that expired in October of 2001.
Since that time, the firm has been able to find only one insurer who would offer
it a quote for stand-alone
terrorism insurance for a maximum
$25 million of coverage. The firm stated that minimal damage to its buildings
could surpass $25 million in claims and that this limit was inadequate.
In another example, a New York
insurance brokerage firm
reported that it tried to obtain
terrorism coverage for a
client's portfolio of non-trophy office buildings in New York City. The
incumbent insurer agreed to provide $100 million of
insurance
coverage on the portfolio that included
terrorism, at double
the cost of the previous year's $500 million policy. The broker could not find
more terrorism coverage for these properties. Industry consultants also reported
that their clients were experiencing difficulty finding sufficient liability
insurance for
terrorism risk.
An owner
and operator of a midwestern city's principal airport and several smaller area
airports reportedly experienced a 280 percent increase in its aviation liability
premium for 2002. The new policy does not include war risk. The insurer offered
$50 million in war risk and terrorism coverage back to the airport owner in a
stand-alone policy for a premium of $1 million. The owner needs $500 million in
coverage to satisfy its obligation to customers.
Lenders and Borrowers
Property owners' search for terrorism coverage has been driven not only
by the fear of personal liability for terrorist attacks to their properties, but
also by the fact that lenders are requiring this coverage on the collateral
backing existing mortgage loans. Therefore, the shifting of risk back to the
policyholders is also creating adverse business conditions for lenders and
investors. Lenders typically require borrowers to carry all-risk insurance
coverage to protect the value of loan collateral.
Lenders and investors
are now voicing their concern over their increasing exposure to
terrorism-related risks as collateral assets on mortgages become uninsured for
such risks. Post- September 11th, many lenders began notifying borrowers with
properties considered at risk for
terrorism of the requirement
to carry
insurance for the risk of
terrorism.
If borrowers cannot obtain the requisite
terrorism coverage,
lenders may find them in violation of their loan covenants. Lenders and
investors are now being faced with the dilemma of either allowing their risk
exposure to increase or acting to terminate existing loan agreements because
terrorism coverage is not available to satisfy
insurance requirements on the agreement. Overall, it is not yet
clear how financial institutions will react to borrowers that cannot satisfy
insurance requirements on existing loans.
In one case, a firm that
develops large-scale buildings and that owns over a hundred non-trophy office
and residential buildings both in the suburbs and central business districts of
cities in several East Coast states reported that it cannot find enough
terrorism coverage to cover the replacement value of its
holdings and satisfy the lenders'
insurance requirements. The
firm currently has mortgage loans on each of its properties with over 30
different lenders ranging from local savings banks to investment banks, pension
funds, and the securities market. All of the firms' lenders notified the firm
that
insurance policies on the properties must include the risk
of
terrorism. As the firm's current umbrella policy expires in
March 2002, the firm began looking for the requisite insurance coverage to
maintain compliance with the lenders' terms. For fiscal year 2001-2002, the firm
had purchased a blanket property insurance policy covering $300 million per
property per occurrence for a premium of $1 million. The firm reported that the
same amount of coverage was available for 2002-2003 for $5 million, but it
excluded terrorism. The firm found only one insurer who would offer a quote for
a stand-alone
terrorism insurance policy. This quote specified
a maximum coverage of $75 million for a premium of 1.5 percent, or $1,125,000.
As $75 million is not enough to cover the replacement value of any of the
buildings it owns, the firm stated that it would be in technical default of its
loan covenants when its current insurance policy expired.
In another
case, the owners of a major midwestern mall reported that when their all-risk
insurance policy on the property expired at the end of 2001,
they purchased a
terrorism-excluded
insurance
policy because they could not find one that would cover the risk of
terrorism. The mall's mortgage lender objected to the policy's
terrorism exclusion and argued that it violated the "all-risk"
insurance requirement stipulated in the loan documents.
Consequently, the lender notified the owners that it had purchased a stand-alone
$100 million
terrorism insurance policy to protect the mall
from this risk. Furthermore, the lender demanded repayment by the mall of the
$750,000 premium. The mall owners protested the lender's action, arguing that
they could not be required to purchase insurance that was not available to them
or other owners of similar properties. The owners successfully sought a
temporary restraining order from the courts to prevent the lender from forcing
repayment of the insurance premium.
Similarly, another lender described
the adverse business relationships created as the bank responded to the
technical default of mortgages when full
terrorism insurance
was not in force. From the bank's perspective, it is being asked to absorb risk
that it had not previously priced into the mortgages and is therefore putting
pressure on its mortgage holders to obtain terrorism coverage. At the same time,
the bank recognizes that the unavailability or increased cost of terrorism
coverage will also negatively impact the mortgage holder's ability to service
the loans. Consequently, the bank's likely course of action will be to review
each loan on a case-by-case basis.
New Lending and Investment Activities
While owners with existing mortgages are not sure what actions lenders
will take if sufficient terrorism coverage is not available, firms interested in
buying and selling properties reported that the lack of adequate
terrorism coverage has delayed or prevented certain projects.
Several developers, financiers, and
insurance industry
observers noted a number of examples where lenders or investors were reluctant
to commit resources to projects that could not be insured against terrorist
acts. A common financing requirement places the responsibility on borrowers to
fully insure the assets used as collateral in lending arrangements. In these
instances, lenders and investors were unwilling to supply financing because the
buyer or seller could not obtain adequate terrorism coverage on the property.
For instance, a general contracting firm in New York City reported that
its bank will not provide financing for a proposed construction project unless
it obtains all-risk
insurance that includes
terrorism coverage. The planned project is a 30-story apartment
building in a high-risk area in New York City. The firm reported it has not been
able to find an insurer that will sell it terrorism coverage at any price.
Without this coverage, the firm cannot obtain the financing needed to hire
construction workers and begin construction. The firm stated it typically hires
500 construction workers for projects such as this one.
Similarly, a
firm stated that it could not obtain mortgage financing on an office building it
owns on the East Coast because the firm could not purchase enough
terrorism insurance to cover the replacement value of the
property. Only one insurer offered a quote-for a premium of $800,000, at a level
far below what the lender is requiring. Before September 11th, the
insurance for this building, including
terrorism coverage, was $60,000 for $80 million of coverage.
The firm stated the mortgage lender refused to lend the money, despite the fact
that the building had a guaranteed multimillion-dollar cash flow for the next 20
years. Without this loan and others like it, the firm's future growth potential
is severely limited.
In another case, an insurance broker stated that a
client who was interested in purchasing a major property found terrorism
coverage available in the needed amount to satisfy the lender, but the coverage
was too expensive to make the deal economically viable. This buyer needed $300
million in
terrorism insurance to cover the replacement value
of the asset and satisfy the lender' s
insurance requirements.
According to the broker, the buyer received a quote of $6 million for a $300
million stand-alone
terrorism insurance policy. Although the
buyer was able to find coverage, he was unable to purchase it, as the building
in question generates only $75 million annually in rent. The buyer had budgeted
$750,000 for all of the building's insurance needs. Given all the other expenses
associated with the building's operation, maintenance, and loan service, the
buyer believed that he could not afford
terrorism insurance at
that price. However, without that
insurance, the buyer could
not obtain financing for the deal and it was not completed.
Again, a
mortgage broker reported that a client interested in the purchase of a trophy
property in New York City could not obtain the $200 million necessary to finance
its purchase. The broker stated that arrangements for financing with one lender
were almost complete before the events of September 11th. After the terrorist
attacks, the lender's credit committee reportedly decided it would not approve
the loan unless the client could get enough terrorism coverage to cover the
replacement value of the property. The prospective buyer could not find coverage
or another bank that would lend the money without it.
In some cases
investors have been unwilling to buy securities when the availability of
terrorism coverage on assets backing the securities is uncertain. One example
included a large insurance company with a loan of approximately $250 million on
an office building in New York. An investment firm reported that this loan was
scheduled for securitization as a way for the company to reduce exposure.
Potential investors in the loan reportedly said they would not buy shares of the
loan without
terrorism coverage. The investment firm stated
that since the
insurance company cannot reduce its exposure in
this type of loan, it is unlikely to provide capital for similar projects in the
future unless terrorism coverage becomes available. In a second example, a
capital management firm stated that it led the marketing effort for a domestic
commercial mortgage-backed securities deal in the United States at the end of
2001. Investment firms in the United States and Europe chose not to purchase
these securities primarily out of concern that
terrorism
insurance would not be available in the future.
The examples
cited above do not allow definitive conclusions about the ultimate economic
effects of the ongoing risk shift from reinsurers to insurers and on to property
owners and businesses. However, they do indicate greater uncertainty, which may
affect both financial decisions and real economic activity.
The
Potential Negative Consequences of Not Having
Terrorism
Insurance Are Cause for Concern Contacts and Acknowledgments
Our government leaders continue to warn of imminent and credible
terrorist threats. Should one of these threats become a reality in a world where
insurers are no longer the first line of protection for businesses, the economic
consequences could be very different from those following September 11th. As
businesses both large and small are faced with uninsured losses that threaten
their ability to survive, Congress could be faced with a time-critical decision
to intervene or not. A decision not to act could have debilitating financial
consequences for businesses, together with their employees, lenders, suppliers,
and customers. At the same time, a decision by Congress to act could be
difficult to implement quickly-and extremely expensive.
Even if, as we
all fervently hope, another terrorist attack does not occur, there are
indications that the lack of adequate
terrorism insurance is
beginning to affect firms in some sectors of the national economy. The ultimate
scope of these effects is uncertain at this time, but they could become
potentially significant in an economy recovering from a recession. Deciding
whether Congress should act to help businesses obtain
insurance
against losses caused by
terrorism is properly a matter of
public policy. The consequences of continued inaction, however, may be real and
are potentially large.
Madam Chairman, this concludes my statement. I
would be happy to respond to any questions that you or other members of the
Subcommittee may have.
LOAD-DATE: March 1, 2002