SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 3318 words

COMMITTEE: HOUSE FINANCIAL SERVICES

HEADLINE: NEED FOR FEDERAL TERRORISM INSURANCE ASSISTANCE

BILL-NO:  
H.R. 3210             Retrieve Bill Tracking Report
                      Retrieve Full Text of Bill

TESTIMONY-BY: J. ROBERT HUNTER, DIRECTOR OF INSURANCE

AFFILIATION: CONSUMER FEDERATION OF AMERICA

BODY:
STATEMENT OF

J. ROBERT HUNTER DIRECTOR OF INSURANCE CONSUMER FEDERATION OF AMERICA

BEFORE THE OVERSIGHT AND INVESTIGATIONS

SUBCOMMITTEE OF THE HOUSE FINANCIAL SERVICES COMMITTEE ON THE TERRORISM INSURANCE MARKET SINCE SEPTEMBER 11TH

FEBRUARY 27, 2002

Madame Chair and Members of the Subcommittee, I appreciate your invitation to testify before you today. I am the Director of Insurance for the Consumer Federation of America. 1

You will recall that CFA was a prime supporter of legislation to back-up the insurance industry for terrorism. Indeed, I testified before two Senate Committees that I thought it was too risky to wait to see if the lack of federal back-up would produce significant economic damage to America.

But Congress failed to act. As a result, we now have some initial knowledge of how the market will respond. The problems we see in the insurance market due to the failure of Congress to enact a terrorism insurance back-up are far less than expected. CFA Study of the Insurance Market

To reach this conclusion, CFA undertook a major study of the insurance market after January 1, 2002. A copy of that study, which was released on January 23, 2002, is attached to my testimony. Our major findings were as follows:

1. The insurance industry is wealthy and overcapitalized.

2. High rates are a problem for mid-sized and larger firms.

3. The larger firms are finding alternative ways to deal with the problem such as self- insurance, creation of captive insurance companies and securitization.

4. The rate problem is caused by a classic turn in the economic cycle of the industry, sped up by - but not caused by --the terrorist attacks.

5. The hard market is anticipated to be shorter than usual because of the excess capital in the insurance industry.

6. Banks are freely loaning money to the vast majority of - if not all - businesses, regardless of the terrorism insurance situation in the nation.

7. There are presently no other widespread economic problems related to the terrorism insurance situation in America.

The losses from the World Trade Center attack will be about half to three-quarters of what the insurers predicted, amounting to $35 billion, or $23 billion after tax considerations, according to the New York Insurance Department. While this is the largest dollar loss ever, the impact on the industry's bottom line was 7.2% of the industry's cash surplus, not much more than the 6.3% hit from Hurricane Andrew."

A remarkable finding is that the insurance industry is at least as strongly capitalized as before September 11 th . The capital lost to terrorism was about $23 billion, but the new capital already booked by the industry since September 11 th in anticipation of large profits from large price hikes, is over $24 billion. To be sure, the "lost" capital and the "new" capital are not necessarily in the same insurance companies, but the industry as a whole is more strongly capitalized now than when the terrorists struck - surely a victory for capitalism over terrorism.

At least six new companies have been formed. The average stock price for the seven largest insurers has increased by 4.8% since the closing stock price of September 10 th , an annual rate of increase of 11.5%. 3

This is not to say there are no problems in the market. The biggest concern is high insurance rates for businesses.

Over the last year, CFA's research revealed that average prices rose by about 20% for small businesses, 30% for mid-sized businesses, and 40% for large businesses. But the averages hide very high jumps in prices for some specific businesses. The worst hit are large, "terrorist target" risks, such as skyscrapers.

Some large businesses also are having difficulty getting sufficient terrorism insurance in amounts similar to the levels of previous years. Homeowner and car owner insurance appears to be fully available with only modest price increases forecast for 2002 (in the four to six percent range). Terrorism coverage for smaller commercial accounts has been excluded for many risks if insured losses from a terrorist attack exceed $25 million. However, the coverage can be bought back at a price that is manageable for most small businesses.

There appears to be little if any problem with loans in the current market for terrorism insurance. No federal bank regulator has issued any guidance on the terrorism insurance issue since they have not seen solvency problems developing from any real or perceived lack of coverage. Indeed, banks are acting as insurers of terrorism by taking risks with no terrorism coverage onto their books and charging a slightly higher interest rate in consideration of the increased risk.

The price jumps we are seeing is consistent with a classic cycle turn, accelerated by the events of September 11 th but not caused by them. The chart below shows the operating income as a percentage of premium from 1967 to 2001. The operating income of the industry falls below zero four times on the chart - in 1975, in 1984 and 1985, in 1992, and in 2001 (the last number estimated by CFA).

The price increases in the hard market caused by this cycle turn began in late 2000. The rate of change was accelerating upward before September 11 th . The terrorist attacks sped up the price increases into what some seasoned industry analysts see as gouging. Insurance executives have greeted the end of the hard market warmly. Mr. Dean R. O'Hare, Chubb chairman and chief executive said, "Happy days are here," at Chubb's February 7, 2002 conference for market analysts. 4

CFA does not anticipate that the current hard market will last long. The capital inflow exceeds the terrorism loss, leaving the industry overcapitalized.

The larger firms with the most problems in price and coverage availability have alternatives to traditional terrorism insurance such as self-insurance, "layering" (i.e., buying many small insurance contracts to replace one large one), creation of captive insurance companies and even securitizing the risk.

Insurance is largely available, even to the highest risks. Reuters reported that "Commercial insurance is available to airlines, but at huge cost. A source at a major international insurance broker said $1 billion of liability cover for war and terrorism would cost about $3.10 cents per passenger." 5

CFA has found no broad economic problems caused by the terrorism insurance situation.

For instance, Standard & Poor's believes that "The ratings implications for corporates are likely to be very limited and selective." 6 Even in New York, the epicenter of the terrorist attack, the economy appears to be improving, according to the Federal Reserve Board. 7

LEVERAGE RATIO (Target = 2.0) FOUND ON HARD COPY

The above chart shows the financial strength of the industry. A "leverage ratio" is the ratio of net premiums written (i.e., after reinsurance) to the surplus; the amount of money the insurer has to back-up the business (assets less the liabilities). Surplus differs from reserves, which are liabilities set up to cover claims. The leverage ratio has always been the key measure of insurer strength.

The rule of thumb used for decades by insurance regulators and other experts in determining solidity is the so-called "Kenny 8 Rule" of $2 of premium for each $1 of surplus as safe and efficient use of capital. Some now say that this rule is antiquated, given the new level of catastrophe possible, but new ways of spreading the risk, such as securitizing it, may offset this. CFA still believes a 2:1 ratio is safe. But even those proposing a lower ratio do not suggest ratios below 1.5:1. The NAIC uses a 3:1 ratio as the standard for determining if an individual insurer warrants solvency inspection. The chart shows that current and recent ratios fall well within these measures of safety.

Market Conditions Since Release of the CFA Study

CFA has continued to review the market since our initial report was finished in late January. The conclusions continue to hold in late February. We realize that there are some limited problems, but nothing requiring broad, immediate federal action.

For confirmation of this, consider a recent Prudential Financial survey. 9 The key findings of the Prudential survey of 120 major commercial businesses' risk managers were:

- Individual programs are going through an extensive re- underwriting process. Most risk managers surveyed said that insurers are asking more questions and the renewal process is taking much longer to complete than in previous years.

- Average price change statistics are meaningless. Rate changes vary considerably by program.

- 68 percent of risk managers surveyed reported tighter terms and conditions in recent renewals; 79 percent who have not renewed expect tighter terms and conditions.

- Business is moving to new carriers but not for a lower price. A larger number of programs are changing underwriters with the most frequently cited reason being less stringent terms.

- Brokers are not suffering unduly from the effects of the hard market-broker services are still in demand.

In its survey, Prudential Financial found that 70 percent of the participants who had renewed their insurance noted an average premium increase of 18 percent. Prudential reported comments of the risk managers who offered such thoughts. The comments show that lack of terrorism coverage is not a major concern compared to prices and even to other coverage cutbacks such as increased retentions (see chart below). The concerns are consistent with a normal hard market. The reason most often given for the price rises by the risk managers was opportunistic pricing by the insurance companies.

PRUDENTIAL SURVEY: Risk Manager Comments FOUND ON HARD COPY

What Congress Should Do to Help Consumers, Businesses and Insurers

As I said, CFA supported the House terrorism insurance approach (H.R. 3210) that passed the Financial Services Committee. 10 CFA commends the committee members for their work on the bill, particularly Chair Oxley, Subcommittee Chair Baker and Ranking Member LaFalce. CFA testified that, while we were unsure what would happen if Congress did not act to provide back-up for terror coverage, we thought that the potential consequences were ". . .severe enough that Congress should worry. . ." 11

However, after January 1st of this year, when 70 percent of reinsurance contracts came up for renewal, the "sky did not fall," contrary to some of the predictions that were made. The private sector seems to be adjusting to the reality of the hard market and limited unavailability of terrorism coverage. Given the actual situation, here is what CFA recommends that Congress do now:

A. Don't Rush Into Passing a Back-Up Bill

Congress has ordered the General Accounting Office (GAO) to review the insurance market and determine if there is a problem. This is an excellent first step. It would be a good idea to hold hearings, not only to examine market conditions, but also to look into private alternatives to federal back-up.

If a terrorist event occurs again there will be terrorism insurance in place on the vast majority of risks. That is now clear. Even the Olympics, surely a prime target, secured coverage. 12 Stand-alone terrorism coverage is "easy to obtain for good risks." 13 Terrorism reinsurance is available on a facultative basis, but getting it on a treaty basis is harder. 14 "Greater leniency on terrorism cover in particular seems to have won the (reinsurance) start-ups market share at the expense of other markets, especially Lloyd's," says a report issued by the London- based reinsurance intermediary, Benfield. 15 Even target risks such as new construction projects can usually get it. 16 And large reinsurers are contemplating setting up a separate company to write terror risks. 17 Insurers are developing ways to rate terror coverage, including developing new computer models for that purpose.

Even some of those risks not securing "normal" insurance have found ways to effectively cover the risk of terrorism. Some are using the Liability Risk Retention Act to cover the liability part of the terrorism risk. Terrorism and even war liability are being covered by airlines, through a risk retention group formed in Vermont. 19 Captives are forming to cover terrorism, for instance for construction trades. 20 And banks are freely loaning money, often at somewhat higher rates so they are bearing some of the risk in that way. 21

Thus, inaction by the Congress, which CFA thought was a mistake last year, has had a very positive result - it has fostered private sector innovation. Are there problems in the market? Sure. But they are being resolved. And Congress can always act after an event, even quickly, as you did with the airline bailout bill. We urge Congress to go slow and allow these private sector alternatives to develop. Indeed, as I suggest below, you should consider ways to encourage such developments.

B. No Handouts are Warranted

If one thing is clear, it is that Congress should not do a taxpayer-funded bailout of this well-capitalized industry. If any federal back-up is required, it should be a loan program modeled after the House bill, not a hand out that does not require assistance to be paid back.

C. Create Incentives for the Development Of Private Sector Alternatives

Instead of spending time working on what appears likely to be an unnecessary taxpayer back-up of the insurance companies, Congress should provide incentives for the creation of the fast-developing private alternatives to the over-priced insurance in today's market. Consideration should be given to such ideas as:

-Expanding the Liability Risk Retention Act to cover property insurance.

- Determining if there are any tax disincentives for the development of captive insurance or self-insurance mechanisms.

-Developing proposals to encourage the securitization of risk.

Congress has created incentives for private sector alternatives before, with the Risk Retention Act (RRA). The Product Liability Risk Retention Act of 1981 was developed by Congress as a direct result of the product liability insurance hard market of the mid- 1979s. The current version of the Act, the Liability Risk Retention Act of 1986, 22 was passed to expand the Act to all commercial liability coverages as a direct reaction to the hard market of the mid-1980s. It allowed businesses to join together to form purchasing groups to buy liability insurance as a unit or to form self-insurance combinations by getting approved in only one state. The airlines are already using the act to create a private solution for terrorism coverages for liability. They should be able to cover their property (hulls) in a similar manner.

If the airlines, surely a target, can find private solutions, the NFL and other large commercial businesses with the ability to spread risk could take this approach, rather than seeking a taxpayer-backed handout 23 .

The NAIC describes the RRA as follows:

The purpose of the RRA is to increase the availability of commercial liability insurance which became severely restricted in the market crisis of the mid-1980s. . .An RRG 24 is a risk- bearing entity that must be chartered and licensed as an insurance company in one state. . .Once the group has obtained a license, it may operate in all states. . .and is regulated almost exclusively by the domiciliary commissioner. . .The RRA requires that the RRG be owned by its insureds and requires the insureds to have similar or related liability exposure. The only type of coverage an RRG is permitted to write is commercial liability insurance for its members and reinsurance with respect to the liability of any other RRG. . .A PG 25 may purchase only commercial liability insurance for its members. . . 26

CFA believes that the creation and expansion of the RRA helped to overcome the problems of the two previous hard markets and would do so again in the current hard market.

Not only would expansion of the Act enable small- and mid-sized businesses to get together to cover other risks, the alternative puts pressure on the insurance industry to stop the price gouging now underway or risk losing market share.

CFA calls on Congress to expand the RRA to cover all lines of property/casualty insurance, including property and workers' compensation. Consideration should be given to expanding the Act to cover group life and group health contracts, since many businesses getting together would eliminate the aggregation problem in these lines of insurance.

Finally, the hearings on expanding the RRA should also consider the creation of a personal lines version of the Act because, even though the terrorist problem is not severe in personal lines, there are obstacles to the use of efficient group sales of home and auto insurance that RRA would overcome.

D. Address Rate Gouging in any Bill that Passes

If a back-up bill is considered, the bill must adequately address the problem of the price of insurance. It would be foolish to pass a back-up bill and not assure that insurance rates are rolled back to reflect the reduced level of insurer risk that would occur from the creation of the federal back-up.

Hearings held on terror insurance legislation should include consideration of:

- Requiring rate reductions equivalent to the amount of back-up provided. For example, if terrorism coverage is 10% of the rate increase, and the taxpayer is backing up 90% of that subject to later pay back, the premium increase should be rolled back by 9%.

- Requiring states to certify that rates are not excessive. Certainly, any bill that is considered should not prohibit pre- approval of rates, as one Senate draft contemplated.

- Requiring a terror insurance line item on the bill. It is very important that businesses can see the price differences for terrorism and other coverages. This would allow business to determine if other coverages are being unduly hiked vis-a-vis the businesses' claims experience.

What the States Should Do

The CFA report made several recommendations to the states, including:

A. Reject Exclusions for Personal Lines of Coverage

The states adopted this recommendation.

B. Reject Exclusions for Commercial Lines for Small and Mid Sized Insureds

Many states allow exclusions, even for small business. CFA has asked the states to revisit this decision since small business should be treated in the same way as personal lines.

C. Require the Cost of Terror Insurance Coverage as a Line Item on The Bill

The states could do this now under their current authority. (See discussion under federal proposals, above.)

D. Review Pricing in the Marketplace, to Prevent Price Gouging, Particularly for the Non-Terror Part of Rates for Smaller and Mid Sized Commercial Insureds.

The actuarial considerations are well known for these coverages. There is no reason why the states should not step into the current non-competitive market and assure the business insurance consumers of their states that the rates meet the "not excessive" requirements of state statute. The states should undertake rigorous analyses of ratemaking methods and rate filings and make sure such an analysis is available to the public.

E. Reject the Model Commercial Lines Deregulation Bill Now Before the NAIC for Approval in March, or at Least Delay it Until Price Gouging is Not Present in the Market. The states need to assure the buyers of business insurance that they are doing their job to protect them. Certainly, with price gouging occurring in the market even for large risks, now is not the time to be deregulating commercial lines. The NAIC should table or reject this Model Bill. Madame Chair, I will be happy to respond to questions at the appropriate time.

LOAD-DATE: October 20, 2002