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Before the Subcommittee on Capital Markets, Insurance and Government 
Sponsored Enterprises and the Subcommittee on Oversight and 
Investigations, Committee on Financial Services, House of 

United States General Accounting Office:


For Release on Delivery Expected at 10:00 a.m. EDT:

Wednesday, April 28, 2004:

Terrorism Iinsurance:

Effects of the Terrorism Risk Insurance Act of 2002:

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


GAO Highlights:

Highlights of GAO-04-720T, a testimony before the House Financial 
Services Committee, Subcommittee on Capital Markets, Insurance, and 
Government-Sponsored Enterprises and the Subcommittee on Oversight and 

Why GAO Did This Study:

After the terrorist attacks of September 11, 2001, insurance coverage 
for terrorism largely disappeared. Congress passed the Terrorism Risk 
Insurance Act (TRIA) in 2002 to help commercial property-casualty 
policyholders obtain terrorism insurance and give the insurance 
industry time to develop mechanisms to provide such insurance after the 
act expires on December 31, 2005. Under TRIA, the Department of 
Treasury (Treasury) caps insurer liability and would process claims and 
reimburse insurers for a large share of losses from terrorist acts that 
Treasury certified as meeting certain criteria. As Treasury and 
industry participants have operated under TRIA for more than a year, 
GAO was asked to describe how TRIA affected the terrorism insurance 

What GAO Found:

TRIA has enhanced the availability of terrorism insurance for 
commercial policyholders, largely fulfilling a principal objective of 
the program. In particular, TRIA has benefited commercial policyholders 
in major metropolitan areas perceived to be at greater risk for a 
terrorist attack. Prior to TRIA, we reported concern that some 
development projects had already been delayed or cancelled because of 
the unavailability of insurance and continued fears that other projects 
also would be adversely impacted. We also conveyed the widespread 
concern that general economic growth and development could be slowed by 
a lack of available terrorism insurance. Since TRIA’s enactment, 
terrorism insurance generally has been widely available, even for 
development projects in perceived high-risk areas, largely because of 
the requirement in TRIA that insurers “make available” coverage for 
terrorism on terms not differing materially from other coverage. 
Although the purpose of TRIA is to make terrorism insurance available, 
it does not directly address prices. As part of its assessment of 
TRIA’s effectiveness, Treasury is engaged in gathering data through 
surveys that should provide useful information about terrorism 
insurance prices in the marketplace.

Despite increased availability of coverage, limited industry data 
suggest that most commercial policyholders are not buying terrorism 
insurance, perhaps because they perceive their risk of losses from a 
terrorist act as being relatively low. The potential negative effects 
of low purchase rates, in combination with the probability that those 
most likely to be the targets of terrorist attacks may also be the ones 
most likely to have purchased coverage, would become evident only in 
the aftermath of a terrorist attack and could include more difficult 
economic recovery for businesses without terrorism coverage or 
potentially significant financial problems for insurers. Moreover, 
those that have purchased terrorism insurance may still be exposed to 
significant risks that have been excluded by insurance companies, such 
as nuclear, biological, or chemical contamination. Meanwhile, although 
insurers and some reinsurers have cautiously reentered the terrorism 
risk market to cover insurers’ remaining exposures, little progress has 
been observed within the private sector toward either finding a 
reliable method for pricing terrorism insurance or developing any 
viable reinsurance alternatives to TRIA once it expires.

What GAO Recommends:

GAO recommends that the Secretary of the Treasury, as part of 
Treasury’s study of the effectiveness of TRIA and after consultation 
with insurance industry participants, identify for Congress 
alternatives that may exist for expanding the availability and 
affordability of terrorism insurance after TRIA expires. These 
alternatives could assist Congress during deliberations on the 
insurance industry’s capacity to provide terrorism insurance.

[End of section]

Mr. Chairman, Madam Chairwoman, and Members of the Subcommittees:

I am pleased to be here today to discuss our report on the 
implementation of the Terrorism Risk Insurance Act of 2002 (TRIA) and 
the act's impact on the economy.[Footnote 1] The terrorist attacks of 
September 11, 2001, drastically changed the way insurers viewed the 
risk of terrorism. An industry that had considered the risk of 
terrorism so low that it did not identify or price terrorism risk 
separate from property and casualty coverage will ultimately pay 
approximately $40 billion for losses arising from September 11, 
according to industry experts. Responding to terrorism risk after 
September 11, reinsurers began excluding terrorism from coverage as 
contracts between reinsurers and insurers came up for renewal.[Footnote 
2] Without reinsurance, insurers retained greater levels of risks than 
they could responsibly carry, and their reaction was to exclude these 
risks from commercial policies as they were renewed. In short, 
believing that neither the frequency nor magnitude of terrorism losses 
could be estimated, insurance companies withdrew from the market.

In the aftermath of September 11, we reported that terrorism insurance 
was disappearing in the marketplace, particularly for large businesses 
and those perceived to be at some risk.[Footnote 3] We also reported 
significant concern that some development projects had already been 
delayed or cancelled because of the unavailability of insurance and 
fears that others would follow. Furthermore, there was widespread 
concern that general economic growth and development would be slowed by 
a lack of insurance availability and uncertainty in the marketplace. 
Because of concerns about the lack of available and affordable 
terrorism insurance, Congress passed TRIA, which took effect on 
November 26, 2002. TRIA is currently scheduled to expire at the end of 

Our report on the implementation of TRIA has two objectives. First, we 
describe the progress made by Treasury and insurance industry 
participants in implementing TRIA. We found that Treasury has made 
significant progress in implementing the provisions of TRIA, but has 
important work to complete in order to comply with all its 
responsibilities under the act. Second, we discuss the changes in the 
market for terrorism insurance coverage under TRIA. As requested, my 
testimony today focuses on the second of these two objectives. That is, 
how TRIA has affected the market for terrorism insurance and, more 
generally, the economy. Additionally, I have included appendixes to 
this statement that provide background information on TRIA and describe 
completed and ongoing engagements that GAO has undertaken for this 
Committee that relate to increasing the insurance industry's capacity 
to provide insurance for terrorism and natural catastrophe risks.

In summary, it appears that Congress's first objective in creating 
TRIA--to ensure that business activity did not materially suffer from a 
lack of available terrorism insurance--largely has been achieved. Since 
TRIA was enacted in November 2002, terrorism insurance generally has 
been available to businesses. But most commercial policyholders are not 
buying the coverage. According to insurance industry experts, purchases 
have been higher in areas considered to be at high risk of another 
terrorist attack. However, many policyholders with businesses or 
properties not located in perceived high-risk locations are not buying 
coverage because they view any price for terrorism insurance as high 
relative to their perceived risk exposure. Further, those that have 
bought terrorism insurance remain exposed to significant perils because 
insurers have broadened longstanding policy exclusions of nuclear, 
biological, and chemical (NBC) events. Congress's second objective--to 
give private industry a transitional period during which it could begin 
pricing terrorism insurance and develop ways to cover losses after TRIA 
expires--has not been achieved yet. Industry sources indicated that 
under TRIA, insurance market participants have made no progress to date 
toward the development of reliable methods for pricing terrorism risks 
and little movement toward any mechanism that would enable insurers to 
provide terrorism insurance to businesses without government 

In conducting this work, we reviewed and analyzed relevant information 
concerning state legislation and publicly available and proprietary 
industry data and studies on the terrorism insurance market. We 
interviewed officials at Treasury, the National Association of 
Insurance Commissioners (NAIC), and state insurance regulators from six 
states with high insurance sales volumes. We also interviewed 
representatives of insurance companies, reinsurance companies, brokers 
for insurance and reinsurance companies, industry associations, 
property owners and developers, and insurance filing services and 
credit rating agencies.[Footnote 4] In our discussions with these 
organizations, we endeavored to gain an understanding of their 
experience in implementing TRIA requirements, obtain their views on the 
effects of TRIA on the terrorism insurance market, and identify 
developments within the industry to address terrorism risks after TRIA 
expires. We conducted this work in Chicago, New York City, and 
Washington, D.C., from January 2003 through April 2004 in accordance 
with generally accepted government auditing standards.

Although Available, Few Are Buying Terrorism Insurance and the Industry 
Has Made Little Progress Toward Post-TRIA Coverage:

While TRIA has improved the availability of terrorism insurance, 
particularly for high-risk properties in major metropolitan areas, most 
commercial policyholders are not buying the coverage. Limited industry 
data suggest that 10 - 30 percent of commercial policyholders are 
purchasing terrorism insurance, perhaps because most policyholders 
perceive themselves at relatively low risk for a terrorist event. Some 
industry experts are concerned that those most at risk from terrorism 
are generally the ones buying terrorism insurance. In combination with 
low purchase rates, these conditions could result in uninsured losses 
for those businesses without terrorism coverage or cause financial 
problems for insurers, should a terrorist event occur. Moreover, even 
policyholders who have purchased terrorism insurance may remain 
uninsured for significant risks arising from certified terrorist 
events--that is, those meeting statutory criteria for reimbursement 
under TRIA--such as those involving NBC agents or radioactive 
contamination. Finally, although insurers and some reinsurers have 
cautiously reentered the terrorism risk market, insurance industry 
participants have made little progress toward developing a mechanism 
that could permit the commercial insurance market to resume providing 
terrorism coverage without a government backstop.

TRIA Has Improved the Availability of Terrorism Insurance, Particularly 
for Some High-Risk Policyholders:

TRIA has improved the availability of terrorism insurance, especially 
for some high-risk policyholders. According to insurance and risk 
management experts, these were the policyholders who had difficulty 
finding coverage before TRIA. TRIA requires that insurers "make 
available" coverage for terrorism on terms not differing materially 
from other coverage.[Footnote 5] Largely because of this requirement, 
terrorism insurance has been widely available, even for development 
projects in high-risk areas of the country. Although industry data on 
policyholder characteristics are limited and cannot be generalized to 
all policyholders in the United States, risk management and real estate 
representatives generally agree that after TRIA was passed, 
policyholders--including borrowers obtaining mortgages for "trophy" 
properties, owners and developers of high-risk properties in major city 
centers, and those in or near "trophy" properties--were able to 
purchase terrorism insurance.

Additionally, TRIA contributed to better credit ratings for some 
commercial mortgage-backed securities. For example, prior to TRIA's 
passage, the credit ratings of certain mortgage-backed securities, in 
which the underlying collateral consisted of a single high-risk 
commercial property, were downgraded because the property lacked or had 
inadequate terrorism insurance. The credit ratings for other types of 
mortgage-backed securities, in which the underlying assets were pools 
of many types of commercial properties, were also downgraded but not to 
the same extent because the number and variety of properties in the 
pool diversified their risk of terrorism. Because TRIA made terrorism 
insurance available for the underlying assets, thus reducing the risk 
of losses from terrorist events, it improved the overall credit ratings 
of mortgage-backed securities, particularly single-asset mortgage-
backed securities. Credit ratings affect investment decisions that 
revolve around factors such as interest rates because higher credit 
ratings result in lower costs of capital. According to an industry 
expert, investors use credit ratings as guidance when evaluating the 
risk of mortgage-backed securities for investment purposes. Higher 
credit ratings reflect lower credit risks. The typical investor 
response to lower credit risks is to accept lower returns, thereby 
reducing the cost of capital, which translates into lower interest 
rates for the borrower.

To the extent that the widespread availability of terrorism insurance 
is a result of TRIA's "make available" requirement, Treasury's decision 
on whether to extend the requirement to year three of the program is 
vitally important. While TRIA has ensured the availability of terrorism 
insurance, we have little quantitative information on the prices 
charged for this insurance. Treasury is engaged in gathering data 
through surveys that should provide useful information about terrorism 
insurance prices. TRIA requires that they make the information 
available to Congress upon request. In addition, TRIA also requires 
Treasury to assess the effectiveness of the act and evaluate the 
capacity of the industry to offer terrorism insurance after its 
expiration. This report is to be delivered to Congress no later than 
June 30, 2005.

Most Policyholders Have Not Bought Terrorism Insurance:

Although TRIA improved the availability of terrorism insurance, 
relatively few policyholders have purchased terrorism coverage. We 
testified previously that prior to September 11, 2001, policyholders 
enjoyed "free" coverage for terrorism risks because insurers believed 
that this risk was so low that they provided the coverage without 
additional premiums as part of the policyholder's general property 
insurance policy. After September 11, prices for coverage increased 
rapidly and, in some cases, insurance became very difficult to find at 
any price. Although a purpose of TRIA is to make terrorism insurance 
available and affordable, the act does not specify a price structure.

However, experts in the insurance industry generally agree that after 
the passage of TRIA, low-risk policyholders (for example, those not in 
major urban centers) received relatively low-priced offers for 
terrorism insurance compared to high-risk policyholders, and some 
policyholders received terrorism coverage without additional premium 
charges.[Footnote 6] Yet according to insurance experts, despite low 
premiums, many businesses (especially those not in "target" localities 
or industries) did not buy terrorism insurance. Some simply may not 
have perceived themselves at risk from terrorist events and considered 
terrorism insurance, even at low premiums (relative to high-risk 
areas), a bad investment.[Footnote 7] According to insurance sources, 
other policyholders may have deferred their decision to buy terrorism 
insurance until their policy renewal date.

Some industry experts have voiced concerns that low purchase rates may 
indicate adverse selection--where those at the most risk from terrorism 
are generally the only ones buying terrorism insurance. Although 
industry surveys are limited in their scope and not appropriate for 
market-wide projections, the surveys are consistent with each other in 
finding low "take-up" rates, the percentage of policyholders buying 
terrorism insurance, ranging from 10 to 30 percent. According to one 
industry survey, the highest take-up rates have occurred in the 
Northeast, where premiums were generally higher than the rest of the 

The combination of low take-up rates and high concentration of 
purchases in an area thought to be most at risk raises concerns that, 
depending on its location, a terrorist event could have additional 
negative effects.

* If a terrorist event took place in a location not thought to be a 
terrorist "target," where most businesses had chosen not to purchase 
terrorism insurance, then businesses would receive little funding from 
insurance claims for business recovery efforts, with consequent 
negative effects on owners, employers, suppliers, and customers.

* Alternatively, if the terrorist event took place in a location deemed 
to be a "target," where most businesses had purchased terrorism 
insurance, then adverse selection could result in significant financial 
problems for insurers. A small customer base of geographically 
concentrated, high-risk policyholders could leave insurers unable to 
cover potential losses facing possible insolvency. If, however, a 
higher percentage of business owners had chosen to buy the coverage, 
the increased number of policyholders would have reduced the chance 
that losses in any one geographic location would create a significant 
financial problem for an insurer.[Footnote 8]

Tighter Exclusions Leave Policyholders Exposed to Significant Perils:

Since September 11, 2001, the insurance industry has moved to tighten 
long-standing exclusions from coverage for losses resulting from NBC 
attacks and radiation contamination. As a result of these exclusions 
and the actions of a growing number of state legislatures to exclude 
losses from fire following a terrorist attack, even those policyholders 
who choose to buy terrorism insurance may be exposed to potentially 
significant losses. Although NBC coverage was generally not available 
before September 11, after that event insurers and reinsurers 
recognized the enormity of potential losses from terrorist events and 
introduced new practices and tightened treaty language to further limit 
as much of their loss exposures as possible. (We discuss some of these 
practices and exclusions in more detail in the next section.) State 
regulators and legislatures have approved these exclusions, allowing 
insurers to restrict the terms and conditions of coverage for these 
perils. Moreover, because TRIA's "make available" requirements state 
that terms for terrorism coverage be similar to those offered for other 
types of policies, insurers may choose to exclude the perils from 
terrorism coverage just as they have in other types of coverage. 
According to Treasury officials, TRIA does not preclude Treasury from 
providing reimbursement for NBC events, if insurers offered this 
coverage. However, policyholder losses from perils excluded from 
coverage, such as NBCs, would not be "insured losses" as defined by 
TRIA and would not be covered even in the event of a certified 
terrorist attack.

In an increasing number of states, policyholders may not be able to 
recover losses from fire following a terrorist event if the coverage in 
those states is not purchased as part of the offered terrorism 
coverage. We have previously reported that approximately 30 states had 
laws requiring coverage for "fire-following" an event--known as the 
standard fire policy (SFP)--irrespective of the fire's cause. 
Therefore, in SFP states fire following a terrorist event is covered 
whether there is insurance coverage for terrorism or not. After the 
terrorist attacks of September 11, 2001, some legislatures in SFP 
states amended their laws to allow the exclusion of fire following a 
terrorist event from coverage. As of March 1, 2004, 7 of the 30 SFP 
states had amended their laws to allow for the exclusion of acts of 
terrorism from statutory coverage requirements.[Footnote 9] However as 
discussed previously, the "make available" provision requires coverage 
terms offered for terrorist events to be similar to coverage for other 
events. Treasury officials explained that in all non-SFP states, and 
the 7 states with modified SFPs, insurers must include in their offer 
of terrorism insurance coverage for fire following a certified 
terrorist event because coverage for fire is part of the property 
coverage for all other risks. Thus, policyholders who have accepted the 
offer would be covered for fire following a terrorist event, even 
though their state allows exclusion of the coverage. However, 
policyholders who have rejected their offer of coverage for terrorism 
insurance would not be covered for fire following a terrorist event. 
According to insurance experts, losses from fire damage can be a 
relatively large proportion of the total property loss. As a result, 
excluding terrorist events from SFP requirements could result in 
potentially large losses that cannot be recovered if the policyholder 
did not purchase terrorism coverage. For example, following the 1994 
Northridge earthquake in California, total insured losses for the 
earthquake were $15 billion--$12.5 billion of which were for fire 
damage. According to an insurance expert, policyholders were able to 
recover losses from fire damage because California is an SFP state, 
even though most policies had excluded coverage for earthquakes.

Reinsurers Have Cautiously Returned to the Market, but Many Insurers 
Have Not Bought Reinsurance:

Under TRIA, reinsurers are offering a limited amount of coverage for 
terrorist events for insurers' remaining exposures, but insurers have 
not been buying much of this reinsurance. According to insurance 
industry sources, TRIA's ceiling on potential losses has enabled 
reinsurers to return cautiously to the market. That is, reinsurers 
generally are not offering coverage for terrorism risk beyond the 
limits of the insurer deductibles and the 10 percent share that 
insurers would pay under TRIA. In spite of reinsurers' willingness to 
offer this coverage, company representatives have said that many 
insurers have not purchased reinsurance. Insurance experts suggested 
that the low demand for the reinsurance might reflect, in part, 
commercial policyholders' generally low take-up rates for terrorism 
insurance. Moreover, insurance experts also have suggested that 
insurers may believe that the price of reinsurance is too high relative 
to the premiums they are earning from policyholders for terrorism 

The relatively high prices charged for the limited amounts of terrorism 
reinsurance available are probably the result of interrelated factors. 
First, even before September 11 both insurance and reinsurance markets 
were beginning to harden; that is, prices were beginning to increase 
after several years of lower prices. Reinsurance losses resulting from 
September 11 also depressed reinsurance capacity and accelerated the 
rise in prices.[Footnote 10] The resulting hard market for property-
casualty insurance affected the price of most lines of insurance and 
reinsurance. A notable example has been the market for medical 
malpractice insurance.[Footnote 11] The hard market is only now showing 
signs of coming to an end, with a resulting stabilization of prices for 
most lines of insurance. In addition to the effects of the hard market, 
reinsurer awareness of the adverse selection that may be occurring in 
the commercial insurance market could be another factor contributing to 
higher reinsurance prices. Adverse selection usually represents a 
larger-than-expected exposure to loss. Reinsurers are likely to react 
by increasing prices for the terrorism coverage that they do sell.

In spite of the reentry of reinsurers into the terrorism market, 
insurance experts said that without TRIA caps on potential losses, both 
insurers and reinsurers likely still would be unwilling to sell 
terrorism coverage because they have not found a reliable way to price 
their exposure to terrorist losses. According to industry 
representatives, neither insurers nor reinsurers can estimate potential 
losses from terrorism or determine prices for terrorism insurance 
without a pricing model that can estimate both the frequency and the 
severity of terrorist events. Reinsurance experts said that current 
models of risks for terrorist events do not have enough historical data 
to dependably estimate the frequency or severity of terrorist events, 
and therefore cannot be relied upon for pricing terrorism insurance. 
According to the experts, the models can predict a likely range of 
insured losses resulting from the damage if specific event parameters 
such as type and size of weapon and location are specified. However, 
the models are unable to predict the probability of such an attack.

Even as they are charging high prices, reinsurers are covering less. In 
response to the losses of September 11, industry sources have said that 
reinsurers have changed some practices to limit their exposures to acts 
of terrorism. For example, reinsurers have begun monitoring their 
exposures by geographic area, requiring more detailed information from 
insurers, introducing annual aggregate and event limits, excluding 
large insurable values, and requiring stricter measures to safeguard 
assets and lives where risks are high.[Footnote 12] And as discussed 
previously, almost immediately after September 11 reinsurers began 
broadening NBC exclusions beyond scenarios involving industrial 
accidents, such as nuclear plant accidents and chemical spills, to 
encompass intentional destruction from terrorists. For example, post-
September 11 exclusions for nuclear risks include losses from 
radioactive contamination to property and radiation sickness from dirty 

As of March 1, 2004, industry sources indicated that there has been 
little development or movement among insurers or reinsurers toward 
developing a private-sector mechanism that could provide capacity, 
without government involvement, to absorb losses from terrorist events. 
Industry officials have said that their level of willingness to 
participate more fully in the terrorism insurance market in the future 
will be determined, in part, by whether any more events occur. Industry 
sources could not predict if reinsurers would return to the terrorism 
insurance market after TRIA expires, even after several years and the 
absence of further major terrorist attacks in the United States. They 
explained that reinsurers are still recovering from the enormous losses 
of September 11 and still cannot price terrorism coverage. In the long 
term and without another major terrorist attack, insurance and 
reinsurance companies might eventually return. However, should another 
major terrorist attack take place, reinsurers told us that they would 
not return to this market--with or without TRIA.


Congress had two major objectives in establishing TRIA. The first was 
to ensure that business activity did not suffer from the lack of 
insurance by requiring insurers to continue to provide protection from 
the financial consequences of another terrorist attack. Since TRIA was 
enacted in November 2002, terrorism insurance generally has been widely 
available even for development projects in high-risk areas of the 
country, in large part because of TRIA's "make available" requirement. 
Although most businesses are not buying coverage, there is little 
evidence that development has suffered to a great extent--even in 
lower-risk areas of the county, where purchases of coverage may be 
lowest. Further, although quantifiable evidence is lacking on whether 
the availability of terrorism coverage under TRIA has contributed to 
the economy, the current revival of economic activity suggests that the 
decision of most commercial policyholders to decline terrorism coverage 
has not resulted in widespread, negative economic effects. As a result, 
the first objective of TRIA appears largely to have been achieved.

Congress's second objective was to give the insurance industry a 
transitional period during which it could begin pricing terrorism risks 
and developing ways to provide such insurance after TRIA expires. The 
insurance industry has not yet achieved this goal. We observed after 
September 11 the crucial importance of reinsurers for the survival of 
the terrorism insurance market and reported that reinsurers' inability 
to price terrorism risks was a major factor in their departure from the 
market. Additionally, most industry experts are tentative about 
predictions of the level of reinsurer and insurer participation in the 
terrorism insurance market after TRIA expires. Unfortunately, insurers 
and reinsurers still have not found a reliable method for pricing 
terrorism insurance, and although TRIA has provided reinsurers the 
opportunity to reenter the market to a limited extent, industry 
participants have not developed a mechanism to replace TRIA. As a 
result, reinsurer and consequently, insurer, participation in the 
terrorism insurance market likely will decline significantly after TRIA 

Not only has no private-sector mechanism emerged for supplying 
terrorism insurance after TRIA expires, but to date there also has been 
little discussion of possible alternatives for ensuring the 
availability and affordability of terrorism coverage after TRIA 
expires. Congress may benefit from an informed assessment of possible 
alternatives--including both wholly private alternatives and 
alternatives that could involve some government participation or 
action. Such an assessment could be a part of Treasury's TRIA-mandated 
study to "assess…the likely capacity of the property and casualty 
insurance industry to offer insurance for terrorism risk after 
termination of the Program.":

Recommendation for Executive Action:

As part of the response to the TRIA-mandated study that requires 
Treasury to assess the effectiveness of TRIA and evaluate the capacity 
of the industry to offer terrorism insurance after TRIA expires, we 
recommend that the Secretary of the Treasury, after consulting with the 
insurance industry and other interested parties, identify for Congress 
an array of alternatives that may exist for expanding the availability 
and affordability of terrorism insurance after TRIA expires. These 
alternatives could assist Congress during its deliberations on how best 
to ensure the availability and affordability of terrorism insurance 
after December 2005.

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

Contacts and Acknowledgements:

For further information regarding this testimony please contact Richard 
J. Hillman or Davi M. D'Agostino, Directors, or Lawrence D. Cluff or 
Wesley M. Phillips, Assistant Directors, Financial Markets and 
Community Investment, (202) 512-8678. Individuals making key 
contributions to this testimony include Sonja Bensen, Rachel DeMarcus, 
Tom Givens III, Jill Johnson, Barry Kirby, Caitlyn Lam, Tarek 
Mahmassani, Angela Pun, and Barbara Roesmann.

[End of section]

Appendix I: TRIA Background:

Under TRIA, Treasury is responsible for reimbursing insurers for a 
portion of terrorism losses under certain conditions. Payments are 
triggered when (1) the Secretary of the Treasury certifies that 
terrorists acting on behalf of foreign interests have carried out an 
act of terrorism and (2) aggregate insured losses for commercial 
property and casualty damages exceed $5,000,000 for a single 
event.[Footnote 13] TRIA specifies that an insurer is responsible (that 
is, will not be reimbursed) for the first dollars of its insured 
losses--its deductible amount. TRIA sets the deductible amount for each 
insurer equal to a percentage of its direct earned premiums for the 
previous year.[Footnote 14] Beyond the deductible, insurers also are 
responsible for paying a percentage of insured losses. Specifically, 
TRIA structures pay-out provisions so that the federal government 
shares the payment of insured losses with insurers at a 9:1 ratio--the 
federal government pays 90 percent of insured losses and insurers pay 
10 percent--until aggregate insured losses from all insurers reach $100 
billion in a calendar year (see fig. 1). Thus, under TRIA's formula for 
sharing losses, insurers are reimbursed for portions of the claims they 
have paid to policyholders. Furthermore, TRIA then releases insurers 
who have paid their deductibles from any further liability for losses 
that exceed aggregate insured losses of $100 billion in any one year. 
Congress is charged with determining how losses in excess of $100 
billion will be paid.

Figure 1: Prerequisites for and Limits of Coverage Under TRIA:

[See PDF for image]

[A] The percentage of direct earned premiums increases each year: 7 
percent in 2003, 10 percent in 2004, and 15 percent in 2005.

[End of figure]

TRIA also contains provisions and a formula requiring Treasury to 
recoup part of the federal share if the aggregate sum of all insurers' 
deductibles and 10 percent share is less than the amount prescribed in 
the act--the "insurance marketplace aggregate retention amount." TRIA 
also gives the Secretary of the Treasury discretion to recoup more of 
the federal payment if deemed appropriate.[Footnote 15] Commercial 
property-casualty policyholders would pay for the recoupment through a 
surcharge on premiums for all the property-casualty policies in force 
after Treasury established the surcharge amount; the insurers would 
collect the surcharge. TRIA limits the surcharge to a maximum of 3 
percent of annual premiums, to be assessed for as many years as 
necessary to recoup the mandatory amount. TRIA also gives the Secretary 
of the Treasury discretion to reduce the annual surcharge in 
consideration of various factors such as the economic impact on urban 
centers. However, if Treasury makes such adjustments, it has to extend 
the surcharges for additional years to collect the remainder of the 

Treasury is funding the Terrorism Risk Insurance Program (TRIP) office 
operations--through which it administers TRIA provisions and would pay 
claims--with "no-year money" under a TRIA provision that gives Treasury 
authority to utilize funds necessary to set up and run the 
program.[Footnote 16] The TRIP office had a budget of $8.97 million for 
fiscal year 2003 (of which TRIP spent $4 million), $9 million for 
fiscal year 2004, and a projected budget of $10.56 million for fiscal 
year 2005--a total of $28.53 million over 3 years. The funding levels 
incorporate the estimated costs of running a claims-processing 
operation in the aftermath of a terrorist event: $5 million in fiscal 
years 2003 and 2004 and $6.5 million in fiscal year 2005, representing 
about 55 - 60 percent of the budget for each fiscal year. If no 
certified terrorist event occurred, the claims-processing function 
would be maintained at a standby level, reducing the projected costs to 
$1.2 million annually, or about 23 percent of the office's budget in 
each fiscal year. Any funds ultimately used to pay the federal share 
after a certified terrorist event would be in addition to these 
budgeted amounts.

[End of section]

Appendix II: Summary of Completed and Ongoing GAO Work Related to 
Insurance for Terrorism and Natural Catastrophe Risks:

Terrorist attacks and natural catastrophes---such as hurricanes and 
earthquakes---pose unique challenges to insurers. Forecasting the 
timing and severity of such events is difficult and the large losses 
associated with catastrophes can threaten insurer safety and soundness. 
Insurers also frequently respond to catastrophic events by cutting back 
coverage significantly or substantially increasing premiums for 
policyholders. Over the years, several approaches have been suggested 
to expand the capacity of the insurance industry to cover catastrophic 
events. These approaches include securitization of catastrophe risk, 
changing tax and accounting treatment of catastrophe risk, and 
permitting risk-retention groups to cover property as well as liability 
exposures. At the request of the Chairman of the House Financial 
Services Committee and others, we have completed reports that address 
some of these issues or have work ongoing in these areas. Our work may 
assist the Committee in its oversight of the insurance industry and 
consideration of the industry's ability to both insure against and 
respond to catastrophic events.

Securitization of Catastrophe Risk:

Given the enormous financial losses associated with catastrophic events 
and questions about insurers' ability to cover such losses, interest 
has been generated in transferring some of these risks to the capital 
markets, which had total value of about $29 trillion as of the first 
quarter of 2003. Since the mid-1990s, some insurance companies, 
reinsurance companies, and capital market participants have developed 
various financial instruments, the most prevalent of which are 
catastrophe bonds. [Footnote 17] These bonds offer a relatively high 
rate of return to investors that are willing to accept some of the 
substantial risks associated with catastrophes.

In two previous reports, we assessed the development of the catastrophe 
bond market.[Footnote 18] We found that some insurance companies view 
catastrophe bonds as an important component of their overall strategy 
for managing natural catastrophe financial risks. In addition, 
representatives from some institutional investors we contacted 
expressed positive views about catastrophe bonds because they offer 
attractive yields compared to traditional investments and help 
diversify investment risks. However, other insurers and investors are 
not willing to issue or purchase catastrophe bonds because they are 
more costly than traditional reinsurance, too risky, or illiquid. We 
also reported that developing catastrophe bonds to cover terrorism 
risks in the United States is considered challenging for many reasons, 
including the difficulties associated with developing computer models 
to predict the frequency and severity of terrorist attacks. 
Sophisticated models have been developed to predict the frequency and 
severity of natural catastrophes--particularly hurricanes--that have 
facilitated the development of catastrophe bonds covering such risks.

Tax and Accounting Treatment of Catastrophe Risk:

We are currently conducting follow-up work on potential tax and 
accounting issues raised in our previous reports that might affect the 
use of catastrophe bonds. As we reported in September 2002, most 
catastrophe bonds are issued offshore--for example, in Bermuda--rather 
than in the United States due to favorable tax considerations. Some 
insurance industry groups have argued for changes in U.S. tax laws to 
encourage insurers to issue catastrophe bonds onshore to lessen 
transaction costs and afford regulators greater scrutiny over these 
activities. As part of our ongoing work, we are reviewing the tax 
treatment of catastrophe risk coverage in selected European countries. 
Furthermore, in 2003 we reported that the Financial Accounting 
Standards Board had issued guidance that may require insurers or 
investors to list catastrophe bond assets and liabilities on their 
balance sheets. We reported that this guidance had the potential to 
limit the appeal of issuing catastrophe bonds but that insurers and 
financial market participants were not certain of the impact of this 
guidance. We are continuing to investigate developments on these tax 
and accounting issues and will discuss them in an upcoming report.

Some believe removing accounting and tax barriers that prevent U.S. 
insurance companies from establishing tax-deductible reserves to cover 
the financial risks associated with potential natural catastrophes and 
terrorist attacks would supplement private-sector capacity. Under 
current U.S. accounting standards and tax law, insurers must build any 
reserves for events that have not yet occurred from after-tax income 
(retained earnings). As a result, insurers do not usually establish 
reserves in anticipation of catastrophic events, such as hurricanes. 
Therefore, insurers attempt to limit their exposure to catastrophic 
risks through the underwriting process, the purchase of reinsurance, or 
issuance of catastrophe bonds, among other alternatives.

There is considerable disagreement about the appropriateness and 
effectiveness of tax-deductible reserving. Advocates believe that 
allowing insurers to establish such reserves would provide increased 
capacity at lower cost. On the other hand, critics of tax-deductible 
reserving have argued that, in addition to lowering federal tax 
receipts, there is no assurance that insurers would actually increase 
their catastrophe insurance capacity, but rather either shield existing 
capital from taxes or substitute tax-deductible reserves for 

At the Chairman's request, we are currently reviewing the tax treatment 
of catastrophe risk reserves in selected European countries---France, 
Spain, Germany, Switzerland, and Italy. We continue to review these 
practices and will comment on them in a forthcoming report. In addition 
to discussing reserving practices, we are gathering information on 
general approaches to insuring against catastrophic risks in these 

Implementation of the Liability Risk Retention Act:

Congress enacted the Liability Risk Retention Act of 1986 (Act) to 
facilitate the formation of risk-retention groups (RRGs) and risk-
purchasing groups (RPGs), insurance entities initially established to 
increase the availability and affordability of liability insurance 
during the 1980s.[Footnote 19] As authorized by the Act, these groups 
may only provide commercial liability insurance. An RRG is simply a 
group of businesses with similar risks that join to create an insurance 
company to self-insure their risks. An RPG, on the other hand, is a 
group formed to purchase insurance as a single entity from a 
traditional insurer. The majority of our ongoing work focuses on RRGs 
because, as insurers, they have the potential to provide new insurance 
capacity. A wide variety of groups, such as professional groups 
(doctors, attorneys), institutions (universities, hospitals), and 
businesses (trucking firms, homebuilders) have created RRGs. As of mid-
April 2004, about 150 RRGs were operational and approximately 72 were 
formed in the last year and half.[Footnote 20] In contrast to most 
other insurers, an RRG can sell insurance in as many states as it 
chooses but is to be regulated by only one state--the state in which it 
is chartered. [Footnote 21]

Our ongoing work focuses on assessing the extent to which RRGs have met 
the Act's intent that they increase the availability and affordability 
of liability insurance. We will also assess how the unique regulatory 
structure of RRGs--where only one state serves as regulator--has 
promoted the establishment of RRGs and if this structure has resulted 
in uneven or ineffective regulation. The recent failure of four RRGs 
has resulted in some regulators questioning the efficacy of having a 
single-state regulator and the standards used by some states to charter 
and regulate RRGs. If we identify any problems as part of our work, we 
will evaluate what legislative or regulatory changes might be needed. 
These changes, if needed, could be important whether or not, as some 
advocates have suggested, the Act is expanded to include commercial 
property insurance. Finally, in the event the Act were expanded to 
include property insurance, we also are exploring the potential of RRGs 
to provide additional capacity for terrorism insurance.

[End of section]

Appendix III: Prior GAO Reports and Testimonies Related to Insurance for 
Terrorism and Natural Catastrophe Risks:

U.S. General Accounting Office, Terrorism Insurance: Implementation of 
the Terrorism Risk Insurance Act of 2002, GAO-04-307 (Washington, D.C.: 
Apr. 23, 2004).

U.S. General Accounting Office, Catastrophe Insurance Risks: Status of 
Efforts to Securitize Natural Catastrophe and Terrorism Risk, GAO-03-
1033 (Washington, D.C.: Sep. 24, 2003).

U.S. General Accounting Office, Catastrophe Insurance Risks: The Role 
of Risk-Linked Securities, GAO-03-195T (Washington, D.C.: Oct. 8, 

U.S. General Accounting Office, Catastrophe Insurance Risks: The Role 
of Risk-Linked Securities and Factors Affecting Their Use, GAO-02-941 
(Washington, D.C.: Sep. 24, 2002).

U.S. General Accounting Office, Terrorism Insurance: Rising Uninsured 
Exposure to Attacks Heightens Potential Economic Vulnerabilities, GAO-
02-472T (Washington, D.C.: Feb. 27, 2002).

U. S. General Accounting Office, Terrorism Insurance: Alternative 
Programs for Protecting Insurance Consumers, GAO-02-199T (Washington, 
D.C.: Oct. 24, 2001).

U.S. General Accounting Office, Terrorism Insurance: Alternative 
Programs for Protecting Insurance Consumers, GAO-02-175T (Washington, 
D.C.: Oct. 24, 2001).

U.S. General Accounting Office, Insurers' Ability to Pay Catastrophe 
Claims, GAO/GGD-00-57R (Washington, D.C.: Feb. 8, 2000).


[1] U.S. General Accounting Office, Terrorism Insurance: Implementation 
of the Terrorism Risk Insurance Act of 2002, GAO-04-307 (Washington, 
D.C.: Apr. 23, 2004).

[2] Reinsurance is a mechanism that insurance companies routinely use 
to spread risk associated with insurance policies. Simply put, it is 
insurance for insurance companies. Reinsurance is a normal business 
practice that satisfies a number of needs in the insurance marketplace, 
including the need to expand capacity and obtain protection against 
potential catastrophes.

[3] U.S. General Accounting Office, Terrorism Insurance: Alternative 
Programs for Protecting Insurance Consumers, GAO-02-175T (Washington, 
D.C.: Oct. 24, 2001), and Terrorism Insurance: Rising Uninsured 
Exposure to Attacks Heightens Potential Economic Vulnerabilities, 
GAO-02-472T (Washington, D.C.: Feb. 27, 2002).

[4] Filing services perform many services for insurance companies, 
including submitting to state insurance regulators the documents 
required to sell a line of insurance. 

[5] TRIA defines "make available" to mean that the coverage must be 
offered for insured losses arising from terrorist events and that 
coverage not differ materially from the terms, amounts, and limitations 
applicable to coverage for losses arising from other types of events. 
However, TRIA gives Treasury the option of determining whether the 
"make available" requirement should be extended through 2005, the third 
year of the act, and gives the agency until September 1, 2004, to do 

[6] According to industry experts, the insurers that provided "free" 
terrorism insurance likely did so for policies already in place at the 
time TRIA was enacted and may have deferred operational changes and 
difficult pricing decisions because they lacked the resources to do so.

[7] Howard Kunreuther, Erwann Michel-Kerjan, and Beverly Porter, 
Assessing, Managing and Financing Extreme Events: Dealing with 
Terrorism (National Bureau of Economic Research: December 2003), 13.

[8] Casualty Actuarial Society, Foundations of Casualty Actuarial 
Science, 4th ed. (United Book Press, Inc.: 2001), 51, 86.

[9] According to the National Association of Mutual Insurance 
Companies, Louisiana, Michigan, Minnesota, Nebraska, New Hampshire, 
Oklahoma, and Virginia have amended their standard fire policies to 
allow for exclusion of terrorism from statutory fire coverage. State 
legislators in Massachusetts have introduced a similar bill. 

[10] Capacity is the amount of reinsurance or insurance that is 
available for a defined risk.

[11] U.S. General Accounting Office, Medical Malpractice Insurance: 
Multiple Factors Have Contributed to Increased Premium Rates, 
GAO-03-702 (Washington, D.C.: June 27, 2003). 

[12] Christian Brauner and Georges Galey, "Terrorism Risks in Property 
Insurance and Their Insurability after 11 September 2001," (Swiss 
Reinsurance Company: 2003), 25. 

[13] Aggregate insured losses are the sum of insured property and 
casualty losses from all commercial policyholders that result from a 
certified act of terrorism.

[14] Section 102(4) of TRIA defines direct earned premiums as "a direct 
earned premium for property and casualty insurance issued by any 
insurer for insurance against losses …" Treasury provided further 
clarification that direct earned premiums are "earned as reported to 
the NAIC in the Annual Statement in column 2 of Exhibit of Premiums and 
Losses (commonly known as Statutory Page 14)" and cover all risks, not 
only for risks from terrorism. The percentage of the direct earned 
premium allowed as an insurer deductible varies over the program years: 
7 percent in 2003, 10 percent in 2004, and 15 percent in 2005.

[15] According to Treasury officials, the formula for the mandatory 
portion of the recoupment is intended to ensure that the insurance 
industry is financially responsible for a prescribed level of the first 
dollars of losses. The prescribed loss levels are as follows: $10 
billion in 2003, $12.5 billion in 2004, and $15 billion in 2005. 
Therefore, if the sum of insurers' aggregate payments for deductibles 
and the 10 percent share--the amounts paid by industry--is less than 
the level prescribed for that year, then a recoupment would be required 
to collect the difference. On the other hand, if the amounts paid by 
industry exceed the prescribed level, then a recoupment would not be 

[16] "No-year money" is budget authority that remains available for 
obligation until expended, usually until the objectives for which the 
authority was made available are attained.

[17] Catastrophe bonds are an example of risk-linked securities. This 
statement focuses on catastrophe bonds that are privately placed 
securities sold to institutional investors under Securities and 
Exchange Commission Rule 144A. In general, a qualified institutional 
investor under Rule 144A owns and invests on a discretionary basis at 
least $100 million in securities of issuers that are not affiliated 
with the investor.

[18] See U.S. General Accounting Office, Catastrophe Insurance Risks: 
Status of Efforts to Securitize Natural Catastrophe and Terrorism Risk, 
GAO-03-1033 (Washington, D.C.: Sep. 24, 2003) and Catastrophe Insurance 
Risks: The Role of Risk-Linked Securities and Factors Affecting Their 
Use, GAO-02-941 (Washington, D.C.: Sep. 24, 2002).

[19] The Product Liability Risk Retention Act of 1981 established these 
groups but limited them to providing product liability insurance. In 
1986, in response to another shortage of liability insurance, Congress 
amended the Act and allowed these groups to offer most types of 
commercial liability insurance.

[20] Data estimates were provided by the Managing Editor, Risk 
Retention Reporter. 

[21] The McCarran-Ferguson Act of 1945 left regulation and taxation of 
the insurance market to the states. (15 U.S.C. 1011) As a result, 
states have primary responsibility for regulating the insurers 
operating in their states and each state has its own insurance