The Terrorism Risk Insurance Act of 2002 (TRIA) was originally aimed at providing a three-year temporary measure to increase the availability of risk coverage, but the program has been renewed twice since and is now extended up to the end of 2014.
TRIA requires insurers to offer terrorism coverage to all their commercial clients (a legal “make available” requirement). It also provides insurers with a federal “backstop” to cover severe losses.
Contrary to what is done in other countries, the US federal government does not collect any premiums in this backstop. It provides insurers with free reinsurance for exposure that would ordinarily require a substantial amount of (costly) capital should the insurers seek protection from the private reinsurance market alone.
The main policy goal of TRIA was to ensure that commercial firms across the nation could access subsidized coverage, and as a result, more companies would purchase this coverage. The empirical evidence reveals that this strategy has worked. In the absence of any severe large-scale attack on national soil since 2001, the program has been successful at sustaining a robust terrorism insurance market here in the US.
Market data from the two largest insurance brokers,
Aon and
Marsh, on their own clients (which tend to be larger firms), indicate that take-up rates for terrorism insurance by large firms has more than doubled, from 27% in 2003 to 58% in 2007, a level that has remained stable since (it is 62% today).
Our more recent work at the Center for Risk Management and Decision Processes at the Wharton School shows that the demand for terrorism insurance from medium and large corporations in the US is strong and price-inelastic (low sensitivity to price) under current conditions. This finding has profound policy implications as Congress contemplates different design changes for TRIA. It indicates that if one would like to reduce government’s involvement in that program by increasing insurers’ deductible (before the federal backstop kicks in) and/or charging for the federal backstop, this could be done incrementally without disrupting the market much.
Some have said that to limit (or avoid any) additional financial exposure of the federal government TRIA should be allowed to expire in 2014. Under this logic, market forces would lead to even more capacity being provided to the market and more firms being insured. Losses from a terrorist attack would be covered by firms and their insurers (if they are insured).
Without TRIA, though, American taxpayers might actually end up paying as much after a large terrorist attack through federal disaster relief (which it will be impossible to deny, as taxpayers have become de facto the prime funding source in the aftermath of natural disasters and financial crises alike), if not much more as they would today if insurers lower the capacity they provide when the mandatory requirement expires. There will be an expectation for the federal government to pay for most of the uninsured economic losses.
The question thus is how do we best organize risk financing mechanisms ex ante so most of the loss does not fall on taxpayers; under its current design, this is what TRIA does. Reforms should seek to increase the private sector’s involvement without disturbing the market. As I said before, I think there is room to do just that.
In the end, it is how we best use the insurance infrastructure, in partnership with the
government, to assure effective and equitable solutions are in place that will make our economies terror-proof. This is why the debate about TRIA is not just an insurance issue—it is as much a national security and economic competitiveness issue, too.
Dr. Erwann O Michel-Kerjan is an authority on managing the risks, financial impact and public policy challenges associated with catastrophic events. He is the Managing Director of the Wharton Risk Management and Decision Processes Center, at the Wharton School of Business.
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