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LEAVING TERRORISM COVERAGE ON THE TABLE

Many Are Rejecting the Coverage --
Is this a Wise Move?

More companies than not are declining the mandatory offer of terrorism insurance under the federal Terrorism Risk Insurance Act. This may be due to complacency that has taken hold in the year and a half since the World Trade Center attack. Consider that another event (or two) will result in a chaotic environment in which the coverage will be impossible to obtain. Think strategically rather than impulsively on this subject.

"Let us not look back in anger or forward in fear, but around in awareness." --- James Thurber

Insurance is not the cure for every risk, and risk management is more than just insurance. However terrorism has the characteristics for which insurance is ideally suited: high severity and low frequency. This combination serves the make the coverage necessary, and should serve to make the premium reasonable. In some cases, though, unreasonable premiums are being quoted. This problem can be managed.

DETERMINING THE RISK

We need to have a feel for the risk in order to evaluate the premium. The insurance industry trade organization Insurance Services Office (ISO) has established guidelines for its members that evaluate exposure geographically and by target class:

Geographic Risk Categories:

Tier 1 (High Hazard)

New York City
San Francisco County, CA
Washington D.C
Cook County, Ill (Chicago Area)

Tier 2 (Moderate Hazard)

Boston, MA
Seattle, Washington
Los Angeles, CA
Houston, TX
Philadelphia, PA

Tier 3 (Low Hazard)

Remainder of U.S.

"Primary Target Types" are listed as follows:

" Airport, Amusement Center, Bus Terminal, Capitol Building, Church, Clinic, Electric Power Facility, Event Stadium or Arena, Federal Building, Forbes 500 Corporate Headquarters, Foreign Embassy, Higher Education Institution, Hospital, Lower Education Institution, Marine Terminal, Medical Center, Natural Gas Facility, Oilfield, Post Office, Prominent Building, Railway Bridge, Religious Institution Excluding Church, Shopping Center or Major Retail Center, Train Station."

Additionally, there are certain specific "trophy targets" which are famous buildings or facilities that have some special high profile. Proximity to any of these creates exposure as well, of course .

SOME INSURERS NEED TO BE HELD TO TASK

The law allows the market to establish pricing, but not without some oversight. State insurance departments do have the right to determine whether rates are "excessive" and therefore against public policy, and to enforce a lowering of those rates. There has been little enforcement action to date and many insurers are abusing the situation; they may be forced at a later date to disgorge excessive premiums. Insurers may need to be reminded of this in the negotiation process.

What's a reasonable premium? The insurers' trade group has offered the following guidelines to its members (many insurers are exceeding these guidelines):

PROPERTY

Rates are per $100 of property value insured, and are only "loss costs." Insurers will add their overhead and profit factors and miscellaneous charges:

Tier Building Contents

1 .     108 .       078

2 .      018       .012

3 .      001 .      001

These rates must be adjusted for characteristics of individual risks.

According to the above, the loss cost (subject to the adjustments mentioned) for $10 million of building coverage in Boston would be $1800. The full premium could be around $2800. Outside of Boston, the loss cost would be only $100! This is a basis on which to have a rational discussion with an underwriter.

LIABILITY

Liability terrorism premiums are expressed as a percentage of the basic general liability premium that a company would pay without the terrorism coverage. The exposure is high for companies in the security business, for owners of high exposure buildings who are responsible for the security
function, and for other special situations. For others, the premium should be affordable. For example a Boston company in an "average exposure class" should pay a premium equal to 3 1/2 % of its general liability premium. In Massachusetts outside of Boston, the percentage would be only 8 tenths of one percent.

The costs for "above average exposure classes" will be considerably higher. Insurers are not all following the suggestions of ISO, as previously stated. However, ultimately insurers with an excessive price and a "take it or leave it" attitude may come to regret that posture.

In risk management a short attention span is hazardous. We look to protect against the severe event. Because they happen only infrequently, this doesn't give us license to ignore them. Such large events seem almost predestined when looking at them in hindsight.

Given the inevitability of losses, you'll be judged not by whether you were the victim of an event, but by how well you planned for it.

Licata Kelleher is a risk management and insurance advisory firm. The firm does not sell insurance, but does counsel clients on the effectiveness of insurance, on reducing the cost of insurance and on the risk management process.

The above is intended to be general information, and should not be construed as specific recommendations.

Other Articles:

INSURANCE BROKER SUED BY NEW YORK ATTORNEY GENERAL
Fall 2004

UNDERSTANDING THE DYNAMICS OF THE INSURANCE MARKET-
Summer 2004

WORLD TRADE CASE UNVEILS INNER WORKINGS OF INSURANCE BROKER-Winter 2004

A RISK MANAGEMENT APPROACH CFOs (AND THEIR ACCOUNTANTS) CAN LOVE-Fall 2003

PRESERVING COVERAGE FOR INNOCENT INSUREDS-Summer 2003

LEAVING TERRORISM COVERAGE ON THE TABLE -Spring 2003

COMPUTER SECURITY IS NOT A BLACK HOLE -Winter 2003

"LET'S BE CAREFUL OUT THERE" -Fall 2002

WHAT WARREN BUFFET KNOWS ABOUT
INSURANCE COMPANY FINANCIALS-Spring/Summer 2002

OPPORTUNITIES ABOUND IN DEVELOPMENT
OF CONTAMINATED PROPERTIES -Spring 2002

"YOU CAN'T PAY US THIS MONTH?
WHAT DO YOU MEAN 'NEW DEVELOPMENTS?" Winter 2001

WORLD TRADE TERRORISM --
REPERCUSSIONS FOR INSURANCE MARKET-Fall 2001

ENERGY AVAILABILITY: CURRENT REALITY OR FOND MEMORY?
-Summer 2001

"HOLD THAT BALLOT UP TO THE LIGHT" -Spring 2001

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