Tuesday, July 12, 2005

A different threat from the terrorists

Babble on.

For all three of you who are actually interested in both terrorism and the property and casualty insurance industry, I point you to this editorial from The Washington Times:

TRIA's [Terrorism Risk Insurance Act] looming expiration date of Dec. 31 — combined with the recently released Treasury Department report that recommends that the current program not be extended and that the federal government's role in insuring terrorism risks be reduced — puts into focus the options Congress faces on this complex and critical issue. Congress must decide whether to allow TRIA to expire and let the private insurance market assume the entire financial risk of future terrorist attacks or replace TRIA with a long-term program that shifts more responsibility to the private sector.
Financial experts agree that a terrorist attack on the homeland is the biggest threat to the economy. These same experts, including Federal Reserve Board Chairman Alan Greenspan, agree that a private market for insuring terrorist attacks cannot be made to work without some level of federal involvement. In comments to the House Financial Services Committee Mr. Greenspan said, "There are instances in which markets do not or cannot work, and ...I have not been persuaded that this [terrorism insurance] market works terribly well."

So what's the best way to create a terrorism insurance market? In our view, the most effective solution is a long-term approach that utilizes market forces to transfer more responsibility for covering terrorism insurance losses to the private sector, while maintaining high-level federal participation. The federal government would only pay for losses in the event of a catastrophe that results in claims beyond the financial capacity of an individual insurer or the insurance industry.

I was visiting with two friends this weekend - one a lawyer, and the other a management consultant - who confirmed my belief that the general public, and even many in business, don't understand how important a lubricant insurance is to free-market economies. Many lenders won't provide credit without insurance. More importantly, many business would be much more averse to taking the sort of risks that drive our prosperity without the safety net of an insurance policy strung below their entreprenurial high-wire act. Insurance facilitates enterprise.

If the financial consequences of terrorism are practically uninsurable - and without any sort of predictability regarding either frequency or severity of loss, there's a good argument to be made that they are - it can act as sand in the cogs of business, slowing the economy, and bringing some segments of business to a grinding halt.

Although TRIA is exclusively a U.S. construct, it had repercussions for the global industry (and you won't find a more global industry than insurance - it's all connected) because the U.S. market represents nearly 40% of the overall premium paid worldwide. The provisions of the act that forced insurers to offer a quote for terrorism coverage to U.S. businesses in the wake of September 11th were an important brake on economic decline, and the backing of the U.S. government allowed the insurance industry to provide the coverage without the massive uncertainty of underwriting that risk destroying their stock value.

As you might expect from someone who works in the industry, I agree with the sentiments expressed in the editorial. I have only one small quibble. As an insurance broker, I work with big insurance companies every day, and as with every other industry, I can testify that some insurers are more trustworthy than others. So instead of allowing terrorism premiums to be lumped into the general premium pool at an insurance company, where it could be used in good years to subsidize non-terrorism losses, I would have the government enforce the segregation of those premiums. This discipline would allow for the development of a capital base outside of the rest of the relatively predictable, and thus highly competitive insurance market, which would in turn gradually reduce the overall risk to both the industry and taxpayers in the event of a terrorism loss. Otherwise, the insurers will use the capital of premiums paid for terrorism risks to finance their drive for competitive advantage in the marketplace, and fritter away the nest egg we really need to develop to guard against the wildly volatile financial risk posed by terror.

The principles at the foundation of TRIA should be ensconced in more permanent legislation, but the U.S. government should also force insurers driven by Wall Street's expectations to segregate terror premiums for the long-term good of both the industry, and the country.

Babble off.


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