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WORLD TRADE TERRORISM --
REPERCUSSIONS FOR INSURANCE MARKET

Understanding how insurance policies will apply, and the future impact
on commercial insurance

It's important to understand how insurance applies in tragedies like this one, and to prepare for any shocks in the future in the cost of commercial insurance.

HOW POLICIES APPLY TO TERRORISM

War Exclusion

Many kinds of insurance policies contain a war exclusion. One in common use reads as follows:

"We will not pay for loss or damage caused directly or indirectly by :

(1) War, including undeclared or civil war;

(2) Warlike action by a military force...;

(3) Insurrection, rebellion, revolution,
usurped power, or action taken by governmental
authority in hindering or defending against any of these."

There is generally no exclusion for terrorism, although the difference between war and terrorism can be something of a grey area.

How will insurers respond? Up to now there has been no sign from the insurance industry that they will do anything other than honor their contracts.

When a terrorist bomb was detonated at the World Trade Center in 1993, insurers paid claims without question. A difference this time is that the monstrousness and severity of the event has seemed to push it to a new dimension. President Bush has called it an act of war. However, is it a war in the legal sense? Has the incident been tied directly to a government, and is that a necessary requirement for war. Timing will be important. Was the devastating event a precursor to war, but not war until the U.S. government's reaction to it? These would be some of the issues for the courtroom.

Various Policies Work Differently

Property Coverage -- Policies in the US that cover damage to buildings and contents, and resulting business interruption, usually contain exclusions similar to the one quoted above. This means there will be coverage for terrorism, but not for actual war. Property outside the US may be treated somewhat differently since foreign policies usually contain an exception to the war exclusion. Under that exception there would be coverage for loss caused an agent of a warring government if that agent is acting secretly and not in connection to the military operations in that country.

Specific war coverage can sometimes be purchased from insurers like Lloyd's of London. Coverage on imports and exports under ocean cargo policies is somewhat different. Because of the unique exposure, they are usually covered specifically for war, but the underwriter reserves the right to cancel the coverage on very short notice, 7 days for example, or even 48 hours. Shipments already in transit would continue to be covered until reaching destination, the cancellation notwithstanding.

Workers Compensation -- There would be coverage for employees injured or killed by an act of terrorism or by war itself, since workers comp policies do not contain war exclusions.

General Liability -- Companies could be subject to war-related liability claims based on various legal theories. General liability policies would respond since there is no exclusion for war, except for liability assumed by the insured under a contract. However, umbrella policies which provide excess limits generally do contain war exclusions of one form or another. Some track the language of the underlying policy, but others are broad war exclusions.

Each policy has to be reviewed individually to conclusively determine its terms. Another point of caution: insurers may reduce sope of coverage on future policies in reaction.

COMMERCIAL INSURANCE IN THE FUTURE

Latest credible estimates of insured loss are around $24 billion. These will undoubtedly be revised upward as time goes by, and this will be the largest single insured loss ever.

We are fortunate that the US insurance industry is large and well capitalized, but make no mistake about the impact -- it will be severe. The surplus (net worth) of the US property and casualty insurance industry is about $280 billion (this does not include the life insurance industry). The loss, then, will amount to around 8% of the surplus of the industry. Of course, some of the loss will be paid by insurers domiciled outside the country. Lloyd's of London for example has substantial exposure.

Impact will be felt far and wide. Prior to the World Trade catastrophe, property and casualty costs had been rising after twelve years of soft pricing. Recent P/C renewals had been subject to premium increases of 10 - 30%, with increases of up to 40 or 50% in extreme cases. The reinsurance industry has been pushing the pricing effect down to the primary insurers (much like wholesale pricing controlling ultimate consumer prices) and this effect will no doubt now be exacerbated. Reinsurers always pay more of any catastrophic loss than the primary insurers themselves. On buildings like the World Trade Center, a primary insurer may take a $100 million share, but then reinsure 95% of that exposure. Prior to this tragedy, the reinsurance industry had been generating a 115 % combined ratio ($115 in paid losses and expenses for each $100 in premium), a ratio which is unsustainable. Investment income is not sufficient to save the day at those numbers .

So an insurance industry that was already hardening without the need for further stimulus will now be hit with a giant loss eating into it's capital. Price increases on commercial property and casualty coverage will now accellerate.

WHAT TO DO

It is important to review all types of insurance policies so you will know where you stand and how to plan financially. In addition, facility security measures should be tightened including better control over access by individuals, along with screening procedures for incoming mail and packages and stronger employee selection. Building evacuation procedures should be reviewed.

Resources include The Federal Emergency Management Agency for information on disaster aid (www.fema.gov), and the US State Department for security information concerning assets and travel abroad (www.state.gov). We expect the US Justice Department (www.usdoj.gov) and the Small Business Administration (www.sbaonline.sba.gov) to publish security information for domestic exposures, although such is not online at this point.

Insurance renewals will have to be carefully managed. It will be imperative to have binding renewal terms in hand at least 60 days prior to policy expirations. This will allow some time for going back to the market in the event an offer is unacceptable. You should also consider insurance program structure. There are often opportunities to restructure to achieve cost advantages, e.g., higher retentions, layering to achieve higher limits, self-insurance, etc. Loss control will gain new respect now that the cleanest accounts will be the only ones able to drive deals with insurers.

Insurer ratings and financial statements should be consulted, as some insurers will be vulnerable as a result of losses incurred.

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.

Permission granted for distribution as is (with full attribution).

Contact us for risk management strategy and implementation.

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.

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