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February 27, 2002. 

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United States General Accounting Office: 


Before the Subcommittee on Oversight and Investigations, Committee on 
Financial Services, House of Representatives: 

For Release on Delivery: 
Expected at 3:00 p.m. EDT: 
Wednesday, February 27, 2002: 

Terrorism Insurance: 

Rising Uninsured Exposure to Attacks Heightens Potential Economic 

Statement of Richard J. Hillman: 
Director, Financial Markets and Community Investment: 


Madam Chairman and Members of the Subcommittee: 

The tragic events of September 11, 2001 brought to light the huge 
potential exposures insurance companies could face in the event of 
another terrorist attack. Faced with continued uncertainties about the 
frequency and magnitude of future attacks, at the same time government 
and military leaders are warning of new attacks to come, both insurers 
and reinsurers have determined that terrorism is not an insurable risk 
at this time. As a result, in the closing months of last year insurers 
began announcing that they could not afford to continue providing 
coverage for potential terrorism losses. The effects of this trend 
have yet to be fully realized, but there is some indication that it 
has begun to cause difficulties for some firms in certain economic 

Considerable debate has taken place on what the federal government can 
do to keep commercial insurance companies involved in providing 
terrorism insurance, even without the protection that they normally 
receive from reinsurance. While this Committee and the House of 
Representatives did pass H.R. 3210, the Congress as a whole did not 
adopt legislation. 

Today, two months into a new year, uncertainty and concerns continue, 
both in the insurance industry and the economy, over the issue of 
terrorism insurance. As you requested, my testimony today will 
describe how, in the absence of federal action, insurance companies 
and the marketplace have reacted to the events of September 11th. I 
will also present GAO's initial observations on the potential 
consequences these market changes may have, both in the event of 
another terrorist attack and, as we all hope, in the absence of one. 
Finally, I have included a discussion of the language developed by the 
Insurance Services Office (ISO) and adopted by most states to exclude 
terrorism from commercial property and casualty (P/C) coverage 
(appendix 1). 

My statement today is based on discussions with a variety of insurance 
industry participants, regulators, policyholders, and other affected 
parties. Because many companies were deeply concerned about the 
possibility that their difficulties in getting terrorism coverage 
might become general knowledge, they spoke to us only on condition of 
anonymity. Finally, my statement primarily addresses the availability 
of terrorism insurance coverage. Despite rising prices in the 
remainder of the commercial P/C market, insurance coverage is still 
available, though at prices above those in effect prior to September 
11, 2001.[Footnote 1] 

In summary, because insurance companies believe that neither the 
frequency nor the magnitude of future terrorist losses can be 
estimated, they are withdrawing themselves from the market. Insurance 
for losses from terrorism is disappearing, particularly for large 
businesses and those perceived to be at some risk. This withdrawal is 
happening fastest among reinsurers. Direct commercial P/C insurers' 
withdrawal has been slower and less complete because of regulatory 
constraints and legal requirements in some states that preclude 
insurers from excluding terrorism from coverage for workers' 
compensation and for fire (irrespective of its cause). 

Because the insurers' withdrawal has been gradual, the extent of the 
potential economic consequences is still unclear. What is clear is 
that in the absence of terrorism insurance, another terrorist attack 
would dramatically increase direct losses to businesses, employees, 
lenders, and other noninsurance entities beyond those resulting from 
September 11th. Furthermore, should the government decide to intervene 
after a future attack, it would do so without readily available claims-
processing and payment mechanisms that exist in the insurance industry.
Even in the absence of an actual terrorist event, however, there are 
growing indications that some sectors of the economy—notably real 
estate and commercial lending—are beginning to experience difficulties 
because some properties and businesses are unable to find sufficient 
terrorism coverage, at any price. If allowed to go unchecked, these 
difficulties are likely to increase as more insurance contracts come 
up for renewal over the next year. The resulting economic drag could 
slow economic recovery and growth. 

Insurers Are Shifting Terrorism Risk to Property Owners and Businesses: 

Since the September 11th attacks, the key dynamic taking place in the 
insurance industry has been a shifting of the risk for terrorism-
related losses from reinsurers to primary insurers and then to the 
insured. Reinsurers and insurers have begun shedding their exposure to 
terrorism risk as insurance contracts come up for renewal, leaving 
policyholders increasingly exposed to losses from a terrorist attack. 
Prior to September 11, 2001, insured losses resulting from terrorism 
in this country were extremely infrequent. Insurance companies 
considered the risk so low that they did not identify or price 
potential losses from terrorist activity separately from the general 
property and liability coverage provided to businesses. But after the 
September 11th attacks, insurance companies recognized that their risk 
exposure was both real and potentially enormous. As a result, they 
began to express concern about continuing to include terrorism 
coverage as an unpriced component of commercial P/C insurance 
contracts. Insurers pointed out that experience with major terrorist 
events has been so limited, and the potential losses so large, that 
setting an actuarially sound price for such coverage is virtually 
impossible. Many insurers now consider terrorism an uninsurable risk, 
at least for the moment. Their response to any risk they consider 
uninsurable, as many Californians living on fault lines have found, is 
not to offer insurance. This trend has become evident in the case of 
terrorism insurance. 

Reinsurers Are Withdrawing from the Market for Terrorism Insurance: 

Reinsurers—-companies that routinely take on some of the risk that 
direct primary insurers face in return for a share of the premiums—-
are now unwilling to participate in terrorism coverage because of the 
enormous losses they suffered after September 11th and the newly 
recognized difficulties of pricing terrorism insurance. Reinsurance is 
a vitally important element of the insurance industry's capacity to 
provide coverage to policyholders. As a mechanism for spreading the 
risks taken by insurance companies, reinsurance allows primary 
insurers to accept large risks and, by reinsuring a portion of those 
risks, to protect themselves from a potentially catastrophic loss. 
Like syndications of large loans by groups of lenders, reinsurance 
provides a way to insure large risks without exposing a single insurer 
to the possibility that its entire capital base would be wiped out 
because of a single event. Reinsurance companies also provide a 
channel through which investors can introduce capital to insurance 
markets without having to develop the extensive distribution channels 
required by direct primary insurers. 

However, because reinsurance markets are global in scope and because 
reinsurance transactions are considered to be contracts between 
sophisticated parties, neither the prices nor the conditions of such 
coverage are subject to direct regulation. As a result, after 
September 11th, reinsurers had little difficulty excluding terrorism 
from coverage. Generally, these exclusions become effective on the 
policy renewal date. As stated by witnesses before this Subcommittee 
in October, a large share of those contracts expired at the beginning 
of January.[Footnote 2] Industry sources confirm that little 
reinsurance is being written today that includes coverage for 
terrorism. There are exceptions. Low and medium risks, particularly in 
industries or geographic locations where there is little perceived 
exposure to a terrorist event, are the least affected. However, large 
companies, businesses of any size perceived to be in or near a target 
location, or those with some concentration of personnel or facilities 
are unlikely to be able to obtain a meaningful level of terrorism 
coverage at an economically viable price. Where coverage is available, 
it tends to have high deductibles and tight limits on the level of 
coverage. In general, reinsurers are being very selective on the 
exposures they will accept, if any. The higher the risk, the less 
likely it is that reinsurance coverage will be available. And even in 
those limited cases in which some reinsurance coverage for terrorism 
is still available, the prices are very high. 

As Primary Insurers' Exposure Increases, They Also Are Excluding 
Terrorism Coverage: 

As reinsurers walk away from terrorism insurance, primary insurers' 
exposure increases, at least in the short run. However, while 
reinsurance contract renewals tend to be concentrated at the beginning 
of January and July, primary insurance contracts tend to renew at a 
relatively even rate over the year. As a result, industry observers 
and participants have told us that primary insurers' exposures have 
increased dramatically and will not fall unless and until they can, in 
turn, exclude terrorism from their coverage. 

Faced with this kind of exposure and a risk they do not believe can be 
priced, industry observers and participates mentioned that primary 
insurers will need to emulate their reinsurance counterparts and 
exclude terrorism coverage from some commercial insurance policies. 
However, a number of factors are affecting both the speed and the 
extent to which primary insurers can insulate themselves from 
terrorism. First, in contrast to reinsurance, changes to the coverage 
provided[Footnote 3] by direct insurers	require regulatory approval in 
most states, at least for low- and medium-risk companies.[Footnote 4] 
This regulatory hurdle caused ISO, acting on behalf of P/C insurers, 
to file a request in every state for permission to exclude terrorism 
from all commercial insurance coverage.[Footnote 5] As of February 22, 
2002, 45 states and the District of Columbia and Puerto Rico had 
approved the ISO exclusion, according to information received by ISO 
and the National Association of Insurance Commissioners (NAIC). The 
other five states either denied the suggested language from ISO or are 
still considering the language for approval or disapproval.[Footnote 
6] States that have not approved the ISO exclusion expressed concerns 
about various issues. Among them are the low thresholds for exclusion 
($25 million or 50 serious casualties); the all-or-nothing nature of 
the threshold (insurers pay nothing if either threshold is reached); 
the aggregation of all losses from multiple incidents within a 72-hour 
period and across most of North America into one event if they "appear 
to be carried out in concert or to have a related purpose or common 
leadership"; fear that the exclusion would leave some small and medium-
sized businesses that could least afford the losses from a terrorist 
attack totally unprotected; and worry that the included definition of 
terrorism is overly broad. Nevertheless, because of regulatory 
concerns about the solvency of primary insurers who cannot get 
reinsurance, ISO's exclusion language has been approved in 45 states 
and the District of Columbia and Puerto Rico. Primary insurers in 
those states can now exclude terrorism from coverage on various lines 
of commercial policies. While only five states have not (yet) accepted 
the ISO exclusion language, those five states account for more than 35 
percent of the total U.S. commercial insurance market. [Footnote 7] 

Second, even though direct insurers now have regulatory approval to 
exclude terrorism from commercial P/C insurance contracts in most 
states, such a change in coverage generally would have to wait until 
the renewal date. According to some insurance regulators with whom we 
spoke, losing reinsurance would not generally be a sufficient reason 
for canceling or changing coverage for policyholders during the policy 
period. Moreover, even when an insurance policy terminates, insurers 
generally have to give 30 to 60 days advance notice to policyholders 
before non-renewing a policy or making a significant change in 
coverage. As a result, it could be as much as a year after a direct 
insurer loses reinsurance coverage for terrorism before a similar 
exclusion could be passed on to all its policyholders. 

Finally, even at renewal, laws existing in some or most states will 
affect the extent to which insurers can completely end their exposure 
to losses resulting from terrorist events. For example, laws in nearly 
all states preclude a workers' compensation insurer from excluding 
coverage for a particular type of event. Workers' compensation must 
cover all the risks to which an employee is exposed while at work, 
irrespective of the cause. Industry sources estimate that 
approximately 10 percent of the losses resulting from the World Trade 
Center attack will be due to payments for workers' compensation claims. 

Similarly, insurance laws in approximately 30 states include what is 
called "standard fire policy" language, according to ISO officials. In 
that language, insurers are required to pay losses resulting from 
fire, irrespective of the cause. Thus, in an explosion like the World 
Trade Center attack, a terrorism exclusion would protect insurers from 
liability for losses resulting from the direct effects of the 
explosion, but not for the losses caused by the resulting fire. 
Estimates suggest that the fire, rather than the explosion itself, 
caused a substantial portion of the losses in the World Trade Center 
attacks. Industry sources have said that they expect an effort to 
change this requirement. In all of the states where the standard is 
written into state statutes, an act of the state legislature would be 
required to modify it. 

Thus, even though many reinsurers can and have moved quickly to 
exclude terrorism from reinsurance coverage, primary insurers' ability 
to exclude terrorism is more limited, at least in the short run. 
However, the rapid submission of the ISO exclusion language to state 
insurance regulators, and their generally rapid and positive response, 
clearly indicate the urgency of primary insurers' desire to be able to 
exclude terrorism from commercial P/C insurance coverage. Early 
indications suggest that many businesses, particularly those in large 
metropolitan areas, are already beginning to experience difficulty 
obtaining terrorism coverage as their insurance policies come to 
renewal. In our discussions with insurance industry participants, 
observers, and policyholders, we found that large commercial 
enterprises were among the first to feel the impact of terrorism 
exclusions. Some large property owners or developers reported that 
they are having to underinsure or "go bare" by self-insuring for 
terrorist risks because of the lack of available coverage or very 
limited coverage for the quoted prices. 

As Business Exposure to Uninsured Risks Rises, so Do the Potential 
Economic Consequences: 

While the extent of the negative economic impacts of a lack of 
terrorism coverage is not yet clear, the potential for more severe 
economic impacts is increasing as the level of uninsured risk climbs. 
Over the next year, the level of uninsured risk for terrorism-related 
incidents is expected to continue to rise as commercial policies renew 
between primary insurers and policyholders and insurers seek to 
exclude terrorism-related coverage from policies they cannot reinsure. 
Therefore, the economic burden of another terrorist attack would fall 
increasingly on policyholders as the insurance industry sheds or 
limits its risks to such exposures, raising the potential for more 
devastating economic consequences should such an event occur.[Footnote 
8] Additionally, as insurers exit the market for terrorism-related 
coverage, so too does their claims-processing capacity for 
administering recovery assistance to victims of a terrorist event. 

Even in the absence of another terrorist event, adverse impacts due to 
the lack of adequate terrorism coverage appear to be surfacing, 
although their ultimate impact on the economy as a whole cannot yet be 
gauged. Additional cases of adverse economic impacts to individual 
firms caused by the absence or high price of coverage for terrorism-
related events are likely to become more evident as policies continue 
to be renewed over the next year. 

Another Terrorist Attack Could Have More Severe Economic Consequences: 

Many of the most severe potential negative consequences resulting from 
the lack of terrorism insurance coverage will only become evident if 
another terrorist attack occurs. The shifting of risk from reinsurers 
to primary insurers to commercial policyholders and other affected 
parties could place more risk and economic burden on businesses and 
the public at large should another terrorist attack similar to 
September 11th occur.[Footnote 9] Consequently, a lack of such 
coverage in the event of another attack could have much broader 
effects on the economy. 

Recent estimates of the losses paid by insurers as a result of the 
attacks on the World Trade Center are about $50 billion, of which 
reinsurers are expected to ultimately pay about two-thirds. If another 
terrorist event of similar magnitude were to take place, all those 
losses would still be incurred. However, depending on the timing of 
the event, the effect would be very different, because even today the 
reinsurers would be responsible for a much smaller share of the 
losses. As the event moves farther into the future and primary 
insurers successfully exclude terrorism from insurance coverage, the 
losses will increasingly be left to the affected businesses and their 
employees, lenders, suppliers, and customers. Because these entities 
lack the ability to spread such risks among themselves the way 
insurers do, another terrorist attack similar to that experienced on 
September 11th could have significant economic effects on the 
marketplace and the public at large. These effects could include 
bankruptcies, layoffs, and loan defaults. 

Another significant consequence of the insurers' exiting the market 
for terrorism coverage is the absence of a claims-processing mechanism 
that can effectively and efficiently respond to victims of an attack. 
After September 11th, insurance companies, working with public risk-
management groups, are reported to have mobilized extensive resources 
to pay many claims quickly. The administrator of the special 
government program to compensate victims in the aftermath of the 
September 11th attacks has noted the challenges of creating a 
mechanism for identifying victims and properly disbursing aid, even 
several months after the attacks. If, without insurers, the government 
should emerge as a principal source of financial recovery after 
another attack, it would first have to create the infrastructure to 
process claims and disburse financial assistance to victims, 
duplicating the mechanism already in place in the insurance industry. 
Therefore, the potential economic impacts of another incident on the 
scale of a September 11th attack could become even more devastating 
absent insurance mechanisms to quickly help businesses recover and 
restore economic activity. The current movement by insurers to 
insulate themselves from terrorism-related losses, however, means that 
their involvement in the recovery process after another terrorist 
event would also likely be substantially lessened. 

Some Examples of Adverse Impacts Are Surfacing Due to the Lack of 
Adequate Terrorism Coverage: 

Even if no other terrorist attacks occur, some adverse conditions are 
beginning to appear in the marketplace due to the lack of adequate 
terrorism coverage, though the impacts on the economy as a whole are 
still unclear. As noted earlier, commercial property owners and 
businesses are now facing higher P/C rates coupled with substantially 
reduced protection for terrorism-related risks as P/C policies renew 
over the coming year. Insurance industry observers and policyholders 
report that while limited coverage for terrorism-related losses is 
currently available at very high rates, full coverage is often not 
available at any price, forcing larger commercial policyholders to 
operate with little or no coverage for such risks. Cases of adverse 
economic impacts to individual firms caused by the absence or high 
price of coverage for terrorism-related events are likely to become 
more evident as policies continue to be renewed over the next year. 

Some examples of large projects canceling or experiencing delays have 
surfaced, with the lack of terrorism coverage being cited as a 
principal contributing factor. Overall, it is still unclear to what 
extent financing arrangements for existing or planned projects will be 
jeopardized as lenders and investors are faced with the prospect of 
absorbing additional terrorism-related risks that cannot be insured. 
These financing arrangements encompass both development and resale 
markets, where financing is contingent upon full insurance coverage 
for collateral assets backing the loan or investment. Some industry 
observers believe private markets will eventually develop and expand 
the capital available for terrorism insurance coverage, but whether or 
how quickly an adequate market can materialize is not yet evident. 

Our contacts with various industry and regulatory sources indicate 
that some financial problems are surfacing due to the lack of 
terrorism coverage, though it is still too early to gauge how 
widespread these problems will become. Though we could not 
independently validate each of the assertions provided, we found 
consistency among the sources in the reasons contributing to delays or 
cancellation of projects. These reasons can be attributed to 
uncertainty and an unwillingness among lenders and investors to accept 
risks that cannot yet be reasonably estimated and that insurance 
companies are unable to price. 

Property Owners and Developers: 

Two of the most common adverse impacts being cited by commercial 
sources, particularly owners and developers, are the conditions of 
having to go bare or only partially insure assets against terrorism 
due to the inability to obtain meaningful terrorism coverage. Even 
when limited coverage is available, uncertainties about the frequency 
and cost of future events cause insurers to set premiums very high. 
This condition appears to be particularly acute for properties located 
in central business districts of major metropolitan areas. 

Specifically, several property owners that we spoke to with properties 
across the United States reported not being able to purchase the 
amount of terrorism coverage they need because the capacity they 
require is not available in the current market. As a result, these 
owners are largely bare for terrorism risks and liable for any 
uninsured damages that would result from a terrorist attack on their 

For instance, a major North American commercial real estate firm that 
owns trophy[Footnote 10] properties and office buildings in the 
central business districts of several major U.S. cities reported that 
it cannot find enough terrorism insurance to cover the value of its 
properties. This firm previously had a blanket property insurance 
policy providing $1 billion of total coverage-—including terrorism—-
that expired in October of 2001. Since that time, the firm has been 
able to find only one insurer who would offer it a quote for stand-
alone terrorism insurance for a maximum $25 million of coverage. The 
firm stated that minimal damage to its buildings could surpass $25 
million in claims and that this limit was inadequate. 

In another example, a New York insurance brokerage firm reported that 
it tried to obtain terrorism coverage for a client's portfolio of non-
trophy office buildings in New York City. The incumbent insurer agreed 
to provide $100 million of insurance coverage on the portfolio that 
included terrorism, at double the cost of the previous year's $500 
million policy. The broker could not find more terrorism coverage for 
these properties. Industry consultants also reported that their 
clients were experiencing difficulty finding sufficient liability 
insurance for terrorism risk. 

An owner and operator of a midwestern city's principal airport and 
several smaller area airports reportedly experienced a 280 percent 
increase in its aviation liability premium for 2002. The new policy 
does not include war risk. The insurer offered $50 million in war risk 
and terrorism coverage back to the airport owner in a stand-alone 
policy for a premium of $1 million. The owner needs $500 million in 
coverage to satisfy its obligation to customers. 

Lenders and Borrowers: 

Property owners' search for terrorism coverage has been driven not 
only by the fear of personal liability for terrorist attacks to their 
properties, but also by the fact that lenders are requiring this 
coverage on the collateral backing existing mortgage loans. Therefore, 
the shifting of risk back to the policyholders is also creating 
adverse business conditions for lenders and investors. Lenders 
typically require borrowers to carry all-risk insurance coverage to 
protect the value of loan collateral. 

Lenders and investors are now voicing their concern over their 
increasing exposure to terrorism-related risks as collateral assets on 
mortgages become uninsured for such risks. Post-September 11th, many 
lenders began notifying borrowers with properties considered at risk 
for terrorism of the requirement to carry insurance for the risk of 
terrorism. If borrowers cannot obtain the requisite terrorism 
coverage, lenders may find them in violation of their loan covenants. 
Lenders and investors are now being faced with the dilemma of either 
allowing their risk exposure to increase or acting to terminate 
existing loan agreements because terrorism coverage is not available 
to satisfy insurance requirements on the agreement. Overall, it is not 
yet clear how financial institutions will react to borrowers that 
cannot satisfy insurance requirements on existing loans. 

In one case, a firm that develops large-scale buildings and that owns 
over a hundred non-trophy office and residential buildings both in the 
suburbs and central business districts of cities in several East Coast 
states reported that it cannot find enough terrorism coverage to cover 
the replacement value of its holdings and satisfy the lenders' 
insurance requirements. The firm currently has mortgage loans on each 
of its properties with over 30 different lenders ranging from local 
savings banks to investment banks, pension funds, and the securities 
market. All of the firms' lenders notified the firm that insurance 
policies on the properties must include the risk of terrorism. As the 
firm's current umbrella policy expires in March 2002, the firm began 
looking for the requisite insurance coverage to maintain compliance 
with the lenders' terms. For fiscal year 2001-2002, the firm had 
purchased a blanket property insurance policy covering $300 million 
per property per occurrence for a premium of $1 million. The firm 
reported that the same amount of coverage was available for 2002-2003 
for $5 million, but it excluded terrorism. The firm found only one 
insurer who would offer a quote for a stand-alone terrorism insurance 
policy. This quote specified a maximum coverage of $75 million for a 
premium of 1.5 percent, or $1,125,000. As $75 million is not enough to 
cover the replacement value of any of the buildings it owns, the firm 
stated that it would be in technical default of its loan covenants 
when its current insurance policy expired. 

In another case, the owners of a major midwestern mall reported that 
when their all-risk insurance policy on the property expired at the 
end of 2001, they purchased a terrorism-excluded insurance policy 
because they could not find one that would cover the risk of 
terrorism. The mall's mortgage lender objected to the policy's 
terrorism exclusion and argued that it violated the "all-risk" 
insurance requirement stipulated in the loan documents. Consequently, 
the lender notified the owners that it had purchased a stand-alone 
$100 million terrorism insurance policy to protect the mall from this 
risk. Furthermore, the lender demanded repayment by the mall of the 
$750,000 premium. The mall owners protested the lender's action, 
arguing that they could not be required to purchase insurance that was 
not available to them or other owners of similar properties. The 
owners successfully sought a temporary restraining order from the 
courts to prevent the lender from forcing repayment of the insurance 

Similarly, another lender described the adverse business relationships 
created as the bank responded to the technical default of mortgages 
when full terrorism insurance was not in force. From the bank's 
perspective, it is being asked to absorb risk that it had not 
previously priced into the mortgages and is therefore putting pressure 
on its mortgage holders to obtain terrorism coverage. At the same 
time, the bank recognizes that the unavailability or increased cost of 
terrorism coverage will also negatively impact the mortgage holder's 
ability to service the loans. Consequently, the bank's likely course 
of action will be to review each loan on a case-by-case basis. 

New Lending and Investment Activities: 

While owners with existing mortgages are not sure what actions lenders 
will take if sufficient terrorism coverage is not available, firms 
interested in buying and selling properties reported that the lack of 
adequate terrorism coverage has delayed or prevented certain projects. 
Several developers, financiers, and insurance industry observers noted 
a number of examples where lenders or investors were reluctant to 
commit resources to projects that could not be insured against 
terrorist acts. A common financing requirement places the 
responsibility on borrowers to fully insure the assets used as 
collateral in lending arrangements. In these instances, lenders and 
investors were unwilling to supply financing because the buyer or 
seller could not obtain adequate terrorism coverage on the property. 

For instance, a general contracting firm in New York City reported 
that its bank will not provide financing for a proposed construction 
project unless it obtains all-risk insurance that includes terrorism 
coverage. The planned project is a 30-story apartment building in a 
high-risk area in New York City. The firm reported it has not been 
able to find an insurer that will sell it terrorism coverage at any 
price. Without this coverage, the firm cannot obtain the financing 
needed to hire construction workers and begin construction. The firm 
stated it typically hires 500 construction workers for projects such 
as this one. 

Similarly, a firm stated that it could not obtain mortgage financing 
on an office building it owns on the East Coast because the firm could 
not purchase enough terrorism insurance to cover the replacement value 
of the property. Only one insurer offered a quote—for a premium of 
$800,000, at a level far below what the lender is requiring. Before 
September 11th, the insurance for this building, including terrorism 
coverage, was $60,000 for $80 million of coverage. The firm stated the 
mortgage lender refused to lend the money, despite the fact that the 
building had a guaranteed multimillion-dollar cash flow for the next 
20 years. Without this loan and others like it, the firm's future 
growth potential is severely limited. 

In another case, an insurance broker stated that a client who was 
interested in purchasing a major property found terrorism coverage 
available in the needed amount to satisfy the lender, but the coverage 
was too expensive to make the deal economically viable. This buyer 
needed $300 million in terrorism insurance to cover the replacement 
value of the asset and satisfy the lender' s insurance requirements. 
According to the broker, the buyer received a quote of $6 million for 
a $300 million standalone terrorism insurance policy. Although the 
buyer was able to find coverage, he was unable to purchase it, as the 
building in question generates only $75 million annually in rent. The 
buyer had budgeted $750,000 for all of the building's insurance needs. 
Given all the other expenses associated with the building's operation, 
maintenance, and loan service, the buyer believed that he could not 
afford terrorism insurance at that price. However, without that 
insurance, the buyer could not obtain financing for the deal and it 
was not completed. 

Again, a mortgage broker reported that a client interested in the 
purchase of a trophy property in New York City could not obtain the 
$200 million necessary to finance its purchase. The broker stated that 
arrangements for financing with one lender were almost complete before 
the events of September 11th. After the terrorist attacks, the 
lender's credit committee reportedly decided it would not approve the 
loan unless the client could get enough terrorism coverage to cover 
the replacement value of the property. The prospective buyer could not 
find coverage or another bank that would lend the money without it. 

In some cases investors have been unwilling to buy securities when the 
availability of terrorism coverage on assets backing the securities is 
uncertain. One example included a large insurance company with a loan 
of approximately $250 million on an office building in New York. An 
investment firm reported that this loan was scheduled for 
securitization as a way for the company to reduce exposure. Potential 
investors in the loan reportedly said they would not buy shares of the 
loan without terrorism coverage. The investment firm stated that since 
the insurance company cannot reduce its exposure in this type of loan, 
it is unlikely to provide capital for similar projects in the future 
unless terrorism coverage becomes available. In a second example, a 
capital management firm stated that it led the marketing effort for a 
domestic commercial mortgage-backed securities deal in the United 
States at the end of 2001. Investment firms in the United States and 
Europe chose not to purchase these securities primarily out of concern 
that terrorism insurance would not be available in the future. 

The examples cited above do not allow definitive conclusions about the 
ultimate economic effects of the ongoing risk shift from reinsurers to 
insurers and on to property owners and businesses. However, they do 
indicate greater uncertainty, which may affect both financial 
decisions and real economic activity. 

The Potential Negative Consequences of Not Having Terrorism Insurance 
Are Cause for Concern: 

Our government leaders continue to warn of imminent and credible 
terrorist threats. Should one of these threats become a reality in a 
world where insurers are no longer the first line of protection for 
businesses, the economic consequences could be very different from 
those following September 11th. As businesses both large and small are 
faced with uninsured losses that threaten their ability to survive, 
Congress could be faced with a time-critical decision to intervene or 
not. A decision not to act could have debilitating financial 
consequences for businesses, together with their employees, lenders, 
suppliers, and customers. At the same time, a decision by Congress to 
act could be difficult to implement quickly—and extremely expensive. 

Even if, as we all fervently hope, another terrorist attack does not 
occur, there are indications that the lack of adequate terrorism 
insurance is beginning to affect firms in some sectors of the national 
economy. The ultimate scope of these effects is uncertain at this 
time, but they could become potentially significant in an economy 
recovering from a recession. Deciding whether Congress should act to 
help businesses obtain insurance against losses caused by terrorism is 
properly a matter of public policy. The consequences of continued 
inaction, however, may be real and are potentially large. 

Madam Chairman, this concludes my statement. I would be happy to 
respond to any questions that you or other members of the Subcommittee 
may have. 

Contacts and Acknowledgments: 

For further information regarding this testimony, please contact 
Richard J. Hillman, Director, or Lawrence D. Cluff, Assistant 
Director, Financial Markets and Community Investment Issues, (202) 512-
8678. Individuals making key contributions to this testimony include 
James Black, Rachael DeMarcus, Thomas Givens Ill, Ronald Ito, Stefanie 
Jonkman, Monty Kincaid, Barry Kirby, and Angela Pun. 

[End of section] 

Appendix I: Information on the Insurance Services Office (ISO) 
Exclusions for Terrorism and War Risk: 

The Insurance Services Office (ISO) develops standardized policy 
contract language - forms and endorsements - for use by property-
casualty (P/C) insurers. Last October, ISO developed terrorism 
exclusion language and filed the language with each state's insurance 
department for use by its insurer-customers. ISO also offered the use 
of these endorsements for free to insurers that were not its clients. 
Insurers operating in states that have approved ISO's endorsements can 
choose to incorporate them into their insurance policies; insurers 
operating in states that have rejected or have not yet approved ISO's 
endorsements typically cannot. 

Generally, ISO's endorsements describe, among other things, events 
that are considered "terrorism" and "war," define various thresholds 
that trigger the exclusion of insurance coverage, and describe events 
that would trigger the exclusion of all insurance coverage. For 
terrorism events, ISO wrote endorsements that could be used for 
different lines of insurance to explain when claims are not covered by 
an insurance policy. These endorsements contain essentially the same 
language. Concerning commercial property insurance lines, two 
endorsements were written--one for states that have statutory 
requirements for fire coverage and one for states without such a 
requirement. Another endorsement was written for commercial general 
liability policies. 

As of February 22, 2002, forty-five states, the District of Columbia 
and Puerto Rico have adopted ISO's terrorism exclusions, while five 
states have either rejected the exclusions or are still evaluating 
them, according to NAIC officials. To gain further insight at the 
state regulatory level, GAO interviewed NAIC and several state 

According to NAIC officials, ISO initially developed very broad 
exclusionary language and filed it with insurance regulators across 
the country. State insurance regulators raised concerns about the 
overly broad exclusionary language and recommended that ISO develop 
more consumer-friendly language that did not endanger insurer 
solvency. Late last year, when NAIC assessed that Congress would not 
be passing a federal solution, NAIC facilitated communications between 
ISO and state insurance regulators to narrow the impact of the 
exclusionary language. ISO has amended that language. 

NAIC and many state regulators that GAO interviewed said that their 
primary motive for adopting the ISO endorsements was to protect 
insurer solvency. NAIC officials also told GAO that they have worked 
with ISO in developing a level of coverage that individual insurers 
could bear. NAIC agreed with insurers that without reinsurance, 
insurers' solvency could be at risk if they were required to provide 
insurance for terrorism. However, regulators told us that they were 
uncomfortable with ISO's original proposal to exclude all terrorism, 
from the first dollar of losses, because of the potential to exclude 
acts that may not be the result of terrorism. NAIC officials stated 
that the $25 million threshold was acceptable because it reflected the 
maximum losses that a single company could absorb. They told GAO that 
losses of $25 million born by a single insurer would threaten the 
solvency of 886 insurers representing approximately 44% of the P/C 
insurance companies writing commercial lines of insurance in the 
United States. 

Some state regulators have not yet adopted ISO's terrorism exclusion 
endorsements for various reasons. These states include California, 
Florida, Georgia, New York and Texas. GAO interviewed these state 
regulators to obtain their views and concerns. In general, their 
concerns were related to the definition of terrorism, the loss 
thresholds for which coverage would apply, and the impact that such 
exclusions would have on small businesses in their states. 

One state regulator maintained that ISO's definition of terrorism is 
overly broad, and could exclude insurance coverage of relatively minor 
incidents such as vandalism. ISO officials told us that the $25 
million threshold, in effect, addresses lower levels of events that 
may come from domestic terrorism or vandalism. Another state regulator 
said the $25 million threshold is too low and that a minor incident in 
a central business district would trigger the total loss of coverage. 
One regulator found the exclusion language reasonable, but was 
concerned about the exposure small businesses would bear because they 
are least able to afford terrorism insurance. 

ISO endorsements contain several key elements. One key aspect of the 
endorsements is its definition of terrorism. ISO's definition of a 
terrorist act provides that: 

Terrorism means activities against persons, organizations or property 
of any nature: 

1. That involve the following or preparation for the following: 

* Use or threat of force or violence; or: 

* Commission or threat of a dangerous act; or: 

* Commission or threat of an act that interferes with or disrupts an 
electronic, communication, information, or mechanical system; and; 

2. When one or both of the following applies: 

* The effect is to intimidate or coerce a government or the civilian 
population or any segment thereof, or to disrupt any segment of the 
economy; or: 

* It appears that the intent is to intimidate or coerce a government, 
or to further political, ideological, religious, social or economic 
objectives or to express (or express opposition to) a philosophy or 

Although ISO's endorsements are commonly referred to as terrorism 
exclusions, they also contain language to define acts of war and to 
exclude war from coverage. While the endorsements' definition and 
application of the war exclusion did not change the war risk exclusion 
already used for commercial property lines, its application of the war 
exclusion was greatly extended for commercial general liability lines. 
ISO officials explained that historically, the war exclusion was 
limited to contractual liability in commercial general liability 
insurance lines, but now it will be applied much more broadly, similar 
to its application in commercial property lines. 

A second key element of the ISO terrorism exclusion endorsements 
relates to the thresholds at which losses are excluded from coverage. 
The endorsements for both the commercial property and commercial 
general liability lines contain a $25 million loss threshold. Along 
with this threshold, the terrorism exclusion threshold for commercial 
general liability lines will also be met if an event causes death or 
serious injury to fifty or more people. Specifically, if a terrorism 
event causes aggregate damages of $25 million or less, insurance will 
cover insured property losses to policyholders.[Footnote 11] However, 
if aggregate damages exceed $25 million, insurers will not be liable 
for any resulting losses, not even the first $25 million. In some 
urban centers the value of many individual buildings, even those not 
considered to be trophy properties, exceed $25 million. 

The $25 million threshold has a geographic component, an insured 
damage and business interruption losses definition, and a timeframe 
definition. The geographic component specifies the geographic location 
of the damages that would aggregate towards the $25 million threshold. 
For commercial property lines of insurance, insured damages to all 
types of property located in the United States and its territories and 
possessions, Canada, and Puerto Rico would be included. For commercial 
general liability lines of insurance, ISO officials said damages 
anywhere worldwide would be included. The exclusion also states that 
"...all insured damages...and business interruption losses" would be 
added towards the $25 million threshold. ISO officials explained that 
"all insured damages" means damaged property that is covered by 
personal and commercial property insurance plus damage that would be 
covered by any insurance but for the application of any terrorism 
exclusions. "Business interruption losses" would be limited to 
properties that were damaged by a terrorism event. The exclusion 
further states that multiple events that occur within seventy-two 
hours and that appear to be carried out "in concert" are considered to 
be one incident. ISO officials explained that "in concert" means 
terrorism events that appear to be working together. 

ISO exclusions provide an alternative fifty-person threshold for 
commercial general liability policies. If a terrorist event causes 
death or serious physical injury to fifty persons or more, insurance 
will not cover any losses to the policyholder, not even for the first 
fifty persons killed or seriously injured, and not even if aggregate 
damages are $25 million or less. 

The thresholds do not apply to events of war, and use of nuclear, 
biological, and chemical agents of terrorism, any of which can trigger 
the exclusion of all commercial property and general liability 
coverage to the policyholder. For an exclusion of coverage, the ISO 
endorsements look at the intent of a terrorism event involving 
biological or chemical agents. If the intent of the terrorism is to 
release biological or chemical agents, insurance will not cover any 
losses to the policyholders. However, if biological or chemical agents 
were released in the course of any other incident, the $25 million 
threshold would apply, and the fifty-person threshold would apply for 
commercial general liability policies. 

In an interview with the GAO, the National Association of Insurance 
Commissioners (NAIC) stressed that the ISO exclusionary language was 
meant as an interim solution to bring some level of certainty to the 
insurance marketplace while awaiting enactment of federal legislation. 
Accordingly, NAIC recommendation includes a sunset clause. 
Specifically, the sunset clause provides that the approval be 
withdrawn fifteen days after the President signs into law a federal 
backstop to address insurance losses attributed to acts of terrorism, 
consistent with state law. 

End of section] 


[1] Prices were already increasing for commercial coverage prior to 
September 11th. Industry participants have told us that the increases 
were a part of the underwriting cycle normal in this insurance market. 
Industry losses from the terrorist attack almost certainly exacerbated 
the rise in prices, as any major catastrophe would have. While there 
may be some examples of excessive price increases in the market, as 
long as insurance continues to be available, it is likely that 
competitive pressures will ultimately remedy that problem. 

[2] Whether 70 percent of all reinsurance policies did in fact expire 
at that time, as was suggested, is difficult to determine. However, 
the consensus of industry sources is that the majority of reinsurance 
contracts did expire then and that reinsurance contract renewal cycles 
tend to be concentrated at the beginning of January and the beginning 
of July. 

[3] Called "policy form" by state regulators. 

[4] Many states do not require regulatory approval for "large" risks. 
The resulting contracts are sometimes called "manuscript" or "script" 
policies and are considered to be contracts between sophisticated 

[5] The blanket approval does not compel insurers to exclude terrorism 
from every contract, but it assures them of regulatory approval when 
they choose to exclude such losses. 

[6] A description of the ISO terrorism exclusion can be found in 
appendix 1. 

[7] There is no reliable information, however, on the share of the 
commercial P/C insurance market in those states that is actually 
affected by the rejection of the exclusion. Each of these states 
already exempts "large, sophisticated buyers" from the regulations 
governing the terms of insurance contracts. These buyers could, and 
many may already have, renewed insurance contracts without terrorism 

[8] Of course, direct insurers are still bearing some of the risk and 
may not be able to shift all the risk to policyholders in the near 
term. If an event were to occur soon, this exposure could result in 
insolvency and failure for some otherwise healthy insurance companies, 
potentially affecting the availability of other kinds of insurance. 

[9] In this statement, we assume that another terrorist event would be 
property-damage intensive, similar to the World Trade Center attacks. 
Of course, a successful terrorist attack, such as a biochemical or 
nuclear incident, would pose significantly different challenges to the 
insurance industry and the economy, although the ISO language contains 
a total exclusion for nuclear, biological, or chemical attacks. 

[10] For purposes of this report, "trophy" properties are those 
properties that are sometimes regarded as icons of American business, 
culture or history, or that could be considered as representative of 
American culture or values. Because of their symbolic status, insurers 
consider them to be at high risk for a terrorist attack. 

[11] Property damages and interruption losses at the damaged property. 

End of section]