SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 1998 words

COMMITTEE: SENATE BANKING, HOUSING AND URBAN AFFAIRS

HEADLINE: TERRORISM INSURANCE

TESTIMONY-BY: RONALD E. FERGUSON, CHAIRMAN

AFFILIATION: GENERAL RE CORPORATION

BODY:
OCTOBER 25, 2001

STATEMENT OF RONALD E. FERGUSON,

CHAIRMAN, GENERAL RE CORPORATION

SENATE BANKING, HOUSING AND URBAN AFFAIRS COMMITTEE

I'm one of the 2,400,000 people that work in the American insurance industry-life and health, property and casualty-day in and day out. I'm proud of our industry. I'm proud of the role we play in our society and in our economy. I'm proud of our team, the 2,400,000 people who are working hard, along with every other American, to get this great country back on its feet. And I'm- proud of the way we've stepped up to the losses of September 11 without complaint. Our sympathy and condolences go to the families and friends of all who have suffered tragic losses in the September 11 terrorist attacks on our country. We also express our deep gratitude and respect for the courageous emergency services, military personnel and volunteers for their heroic efforts in this time of great national pain.

I might add that for a lot of us in the insurance industry this isn't just about business, it's personal. We lost a lot of friends. People who worked in the insurance industry accounted for at least 490 of those killed in the World Trade Center. My family was fortunate -- our son-in-law was among those who escaped unharmed.

General Re, a wholly owned subsidiary of Berkshire Hathaway Inc., is among the four largest reinsurers in the world, and a market leader in the U.S. While General Re is also in the life reinsurance business, I'm here today to talk mainly about the property and casualty insurance and reinsurance business.

Let me first say that I believe that the U.S. insurance and reinsurance industry will be able to meet its policy and contract obligations, and to pay the losses arising out of the September 11 terrorist attacks, Insurers and reinsurers don't need a bailout for those losses from the Federal government, and they aren't asking for one.

We all know that the terrorist attacks of September 11, 2001 resulted in unprecedented losses of life, personal injury and property damage. It is difficult to estimate the total insured losses that the U.S. property and casualty insurance and reinsurance industry will ultimately pay as a result of those terrorist attacks. In addition to the normal problems involved in estimating large or catastrophic losses, in this case there may be liability issues that may take years to fully resolve.

Some recent analysts' reports have suggested that $25 billion to $40 billion is a reasonable range of estimated total insured losses (property, casualty, life and health) from the September 11 terrorist attacks. Some analysts have even suggested that the total insured losses could exceed the range of numbers I just mentioned. My own view is that total insured losses (property, casualty, life and health) will be at the high end of the $25 billion to $40 billion range.

Before September 11 the threat of terrorism within our borders seemed remote. Because of that, no insurance or reinsurance premiums were collected for terrorism coverages, and no assets or reserves were allocated to terrorism exposures. That means that the September 11 terrorism losses must be paid from the industry's capital account.

The, total capital and surplus of the U.S. property and casualty insurance and reinsurance industry at June 30, 2001 -- including both personal lines and conunercial lines writers -- was $298 billion. That figure includes $26.6 billion of capital in separately capitalized U.S. domestic professional reinsurers.

That total industry capital consists of required regulatory risk- based capital, as well as the additional capital needed to support operating and investment risks and to meet the reasonable expectations of policyholders and claimants, rating agencies, stockholders and others.

The exposure to loss from the September 11 terrorist attacks is not spread evenly across the total insurance industry capital base. The great bulk of those losses will fall on the capital base of the commercial lines insurers and reinsurers.

One way of looking at the commercial lines capital base is set out in Exhibit A. It shows that-after subtracting personal lines capital, the Berkshire Hathaway capital that isn't allocated to the affected lines, and the pre-September 11 third quarter declines in common stock values-the affected property and casualty commercial lines insurers and reinsurers (U.S. and non- U.S.) had a September 10 estimated combined total capital base of $126 billion. That $126 billion capital base has now been reduced by $25 billion to $40 billion of losses-pre tax and gross of non- domestic reinsurance.

Tillinghast, in a just-released study for the American Insurance Association, noted that the September 11 losses might rest on an even smaller capital base-perhaps $80 billion to $100 billion.

Three things stand out as being very clear to me:

First, the commercial lines capital base can obviously fund a total September 11 insured loss of $25 billion to $40 billion - or an even larger loss from that event.

Second, many actuarial and underwriting principles and practices will have to change. While not a complete list, here are five things that will change:

- We will have new and different notions about the size, shape and trends of insured losses and the required risk loads

-Most lines of business will require a greater capital allocation

-Risk-based capital standards will be revised by regulators and rating agencies to incorporate terrorism risk

The cost of capital for the insurance business will, other things being equal, go up

-We need to rethink risk diversification or its opposite, the correlation of risk

And there will be other actuarial and underwriting changes.

Third, the commercial lines capital base can't take the hit from another sizeable terrorist event without seriously compromising the ability of the property and casualty commercial lines industry to meet its commitments for losses arising from other underwriting and balance sheet risks.

The simple fact is that, on its own, the U.S. insurance and reinsurance industry can't afford to take on the potentially unlimited exposure to loss arising from insuring against terrorist acts. The commercial lines capital base I've described, while able to absorb the losses from the September 11 attacks, simply won't be able to sustain multiple events like those attacks. No one at present can reasonably predict either the number or scale of future terrorist attacks we might face before our war on terrorism is won.

We support and applaud the steps that the Federal government is taking to combat terrorism. But until those efforts have borne the fruit of significant reduction in the potential for terrorist attacks, it is close to impossible for many insurers and reinsurers to responsibly underwrite or assume terrorism risk. We simply can't evaluate the frequency and severity of terrorism losses using traditional underwriting and actuarial techniques. There are no models that would let us price the risk with confidence, and the consequence of error is ruin.

That is why as an industry we need to explore alternative ways to cover losses arising from terrorism.

The September 24,2001 edition of The Wall Street Journal (at p. B 1) featured this quote from Warren Buffett, Berkshire's chairman:

I think in the future, the government is going to have to be the ultimate insurer for acts of. terrorism..... An industry with very large, but finite, resources is not equipped to handle infinite losses.

In some very important ways, insurance is the grease that lubricates the American economic machine. Insurance and reinsurance coverage for terrorism risks is necessary for our economic recovery - so that lenders will lend, and builders will build, and employers will hire. It is that simple.

Going forward, we need to find a way to provide insurance against terrorist acts that assures both the continued financial viability of the U.S. insurance and reinsurance industry, and the continued availability and affordability of the wide range of products and services provided by that industry.

In a rare-if not unique-show of unity, the property and casualty insurance and reinsurance industries universally agree that the best way to do that is to have the Federal goverrunent act as the "reinsurer of last resort" for terrorism insurance and reinsurance coverage, similar to the plan used in the United Kingdom.

Federal Reserve Chainnan Alan Greenspan appears to agree. On October 17, 2001, he said:

What hostile environments do is induce people to withdraw, to disengage, to pull back. It's quite conceivable you could get a level of general hostility that would make viable market functioning very difficult,... I can conceive of situations [where] the premiums that would be necessary to enable a private insurance company to insure against all those risks and still get a rate of return on their capital would be so large as to inhibit people from actually taking out that insurance,.....

Therefore you're led to what is an unusual conclusion that the viability of free markets on unusual occasions, when you are dealing with violence, ... [that it is necessary that] the costs of insurance are reinsured by the taxpayers,....

Free markets and government reinsurance, in this very unusual circumstance they are indeed compatible....

(Source: Bloomberg)

It is increasingly clear that state regulators, the Administration, members of Congress, and a broad swath of Americans and American businesses also agree that we need a solution.

All of these interests may not currently agree on the right way to structure that Federal reinsurer role-we've all heard the several proposals that have been advanced, But there is nearly universal agreement on the fact that this is a significant and urgent problem that needs to be solved before Congress recesses.

While the size and scale of the September 11 terrorist attacks are unprecedented, there are precedents for government involvement-here and abroad-in the solution of temporary insurance market disruptions. The Federal government ran an insurance program during World War II. FAIR plans were developed to deal with insurance scarcity in the wake of the 1960's urban riots. More recently, the United Kingdom and other countries have developed government backed solutions to terrorism insurance.

When the need for these kinds of programs abates, they tend to fade away. When we are successful in our war against terrorism, we fully expect that any Federal terrorism insurance solution also fade away as normal market solutions return.

We're eager to work with this committee, other members of Congress, the Administration, state insurance regulators and others to find a solution that makes sense for the Country and for the faltering economy, which badly needs an injection of confidence. The solution must also make sense for frustrated and injured policyholders and claimants, for the insurance industry and its regulators, and for you. Insurance is, after all, a critical part of the central nervous system of this economy and this society.

We are not looking for a bailout for the insured losses flowing from the tragic events of September 11. We are looking for a way forward to serve our clients and fulfill our role in the economy.

I am reminded of a quote from Winston Spencer Churchill, one of my personal heroes. Slightly more than 60 years ago, as Britain was engaged in the early stages of WWII, Churchill said: " Give us the tools. We will do the job".

As we face a different kind of war, and as we find the way forward for the insurance industry, I couldn't possibly say it any better to you and to the Congress: give us the tools.

I'm grateful for the opportunity to speak to you today, and would be pleased to answer any questions you may have.



LOAD-DATE: November 16, 2001