[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
PROTECTING POLICYHOLDERS FROM TERRORISM:
PRIVATE SECTOR SOLUTIONS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE, AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON
FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
OCTOBER 24, 2001
__________
Printed for the use of the Committee on Financial Services
Serial No. 107-48
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2002
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512-1800
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice BARNEY FRANK, Massachusetts
Chair PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska MAXINE WATERS, California
RICHARD H. BAKER, Louisiana CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma KEN BENTSEN, Texas
ROBERT W. NEY, Ohio JAMES H. MALONEY, Connecticut
BOB BARR, Georgia DARLENE HOOLEY, Oregon
SUE W. KELLY, New York JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio MAX SANDLIN, Texas
CHRISTOPHER COX, California GREGORY W. MEEKS, New York
DAVE WELDON, Florida BARBARA LEE, California
JIM RYUN, Kansas FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina CHARLES A. GONZALEZ, Texas
DOUG OSE, California STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin HAROLD E. FORD, Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona RONNIE SHOWS, Mississippi
VITO FOSELLA, New York JOSEPH CROWLEY, New York
GARY G. MILLER, California WILLIAM LACY CLAY, Missiouri
ERIC CANTOR, Virginia STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
SHELLEY MOORE CAPITO, West Virginia BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio
Terry Haines, Chief Counsel and Staff Director
Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises
RICHARD H. BAKER, Louisiana, Chairman
ROBERT W. NEY, Ohio, Vice Chairman PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut GARY L. ACKERMAN, New York
CHRISTOPHER COX, California NYDIA M. VELAZQUEZ, New York
PAUL E. GILLMOR, Ohio KEN BENTSEN, Texas
RON PAUL, Texas MAX SANDLIN, Texas
SPENCER BACHUS, Alabama JAMES H. MALONEY, Connecticut
MICHAEL N. CASTLE, Delaware DARLENE HOOLEY, Oregon
EDWARD R. ROYCE, California FRANK MASCARA, Pennsylvania
FRANK D. LUCAS, Oklahoma STEPHANIE TUBBS JONES, Ohio
BOB BARR, Georgia MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, North Carolina BRAD SHERMAN, California
STEVEN C. LaTOURETTE, Ohio GREGORY W. MEEKS, New York
JOHN B. SHADEGG, Arizona JAY INSLEE, Washington
DAVE WELDON, Florida DENNIS MOORE, Kansas
JIM RYUN, Kansas CHARLES A. GONZALEZ, Texas
BOB RILEY, Alabama HAROLD E. FORD, Jr., Tennessee
VITO FOSSELLA, New York RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
GARY G. MILLER, California RONNIE SHOWS, Mississippi
DOUG OSE, California JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania STEVE ISRAEL, New York
MIKE FERGUSON, New Jersey MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
MIKE ROGERS, Michigan
C O N T E N T S
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Page
Hearing held on:
October 24, 2001............................................. 1
Appendix:
October 24, 2001............................................. 70
WITNESSES
Wednesday, October 24, 2001
Cummins, J. David, Harry J. Loman Professor of Insurance and Risk
Management, The Wharton School, University of Pennsylvania..... 48
Harrington, Scott E., Professor of Insurance and Finance, Moore
School of Business, University of South Carolina............... 46
Hillman, Richard J., Director, Financial Markets and Community
Investment, U.S. General Accounting Office..................... 58
Hubbard, R. Glenn, Chairman, Council of Economic Advisers........ 25
Iordanou, Constantinos, Senior Executive Vice President of Group
Operations and Business Development, Zurich Financial Services
Group.......................................................... 44
Keating, David L., Senior Counselor, National Taxpayers Union.... 49
Mathis, David B., Chairman and CEO, Kemper Insurance Companies... 42
Nordlinger, Marjorie S., Senior Attorney, Office of the General
Counsel, U.S. Nuclear Regulatory Commission.................... 56
O'Neill, Hon. Paul H., Secretary, U.S. Department of the
Treasury, accompanied by Sheila Bair, Assistant Secretary for
Financial Institutions......................................... 5
Sinnott, John T., Chairman and CEO, Marsh, Incorporated.......... 52
Williams, Roy A., Director of Aviation, Louis Armstrong New
Orleans
International Airport.......................................... 54
APPENDIX
Prepared statements:
Kanjorski, Hon. Paul E....................................... 71
Cummins, J. David............................................ 107
Harrington, Scott E.......................................... 102
Hillman, Richard J........................................... 137
Hubbard, R. Glenn............................................ 80
Iordanou, Constantinos....................................... 95
Keating, David L............................................. 113
Mathis, David B.............................................. 87
Nordlinger, Marjorie S....................................... 130
O'Neill, Hon. Paul H......................................... 73
Sinnott, John T.............................................. 123
Williams, Roy A.............................................. 126
Additional Material Submitted for the Record
Page
Harrington, Scott E.:
Written response to a request from Hon. Richard Baker........ 106
American Academy of Actuaries, prepared statement................ 179
American Council for Capital Formation, Associated General
Contractors of America, American Resort Development
Association, Building Owners and Managers Association
International, International Council of Shopping Centers,
Mortgage Bankers Association of America, National Apartment
Association, National Association of Industrial and Office
Properties, National Association of Real Estate Investment
Trusts, National Association of Realtors, National Multi
Housing Council, Pension Real Estate Association, The Real
Estate Board of New York, The Real Estate Roundtable, joint
prepared statement............................................. 170
American Council of Life Insurers, prepared statement............ 159
Independent Insurance Agents of America, prepared statement...... 167
PROTECTING POLICYHOLDERS FROM TERRORISM: PRIVATE SECTOR SOLUTIONS
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WEDNESDAY, OCTOBER 24, 2001,
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance
and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, DC.
The subcommittee met, pursuant to call, at 1:35 p.m., in
room HC-8, The Capitol, Hon. Richard H. Baker, [chairman of the
subcommittee], presiding.
Present: Chairman Baker; Representatives Ney, Shays, Cox,
Bachus, Royce, Lucas of Oklahoma, Shadegg, Weldon, Fossella,
Biggert, Miller, Ose, Toomey, Hart, Rogers, Kanjorski, Bentsen,
J. Maloney of Connecticut, Hooley, S. Jones of Ohio, Capuano,
Sherman, Inslee, Crowley, Israel, and Ross.
Also Present: Representatives Oxley, Roukema, LaFalce, and
C. Maloney of New York.
Chairman Baker. I offer a small apology for the environment
in which we find ourselves holding this hearing on this most
important matter. We, of course, appreciate all of the
courtesies extended by all of those interested in the matter,
and we certainly will try to facilitate providing information
from the hearing to all of the parties, for those who can't
simply get in the room. Ranking Member Kanjorski and I have
adopted a no-jacket requirement for the proceedings. Feel free
to comply at your leisure. I suspect as the day wears on, that
will become a better and better idea.
Of course the hearing today is an extraordinarily important
one, and I am very anxious that we as a subcommittee come to
some recommendation for resolution of a problem of potentially
significant systemic events to our economy. There is no doubt
that we must act, and we must act in a timely way. But we
should also act as best we can in the most professional and
responsible manner time will permit. It may be very difficult
to reach a long-term permanent solution if the remaining tenure
of this session is indeed a matter of days. If, however, we
have the luxury of time, then I am confident working together
with regulators, the industry, stakeholders, consumers and
members, we can reach an accord which will make economic sense
and sense to the American taxpayer.
To that end, I merely want to point out one historic event
that I think is constructive in these times. Going back to the
days of the Reconstruction Finance Corporation under the
Roosevelt presidency pursuant to the Great Depression in which
in the course of the activities of that organization some $50
billion worth of financial resources were made available to a
plethora of business organizations. What I found interesting
about it is the manner in which the Texas businessman
administered that program at the direction of the President.
Fifty billion dollars in the 1930s is an extraordinary program,
and at the end of the day, Jessie Jones, the administrator of
the program, recouped every cent of taxpayer dollars.
Now, I know that the discussion of repayment of credit
extensions is a very contentious matter, but as I said to some
insurance company executives, they have their shareholders, and
we have ours. They simply want our shareholders to give up our
resources with no expectation at the moment of having their
shareholders repay this courtesy.
I for one feel that is a very appropriate thing for us to
explore and to discuss and not simply because of the urgency of
this matter take action that leaves taxpayers with unlimited,
incalculable liabilities. However, there is no doubt that the
events of this year are extraordinary. Very difficult to
reconcile, and we hope never to occur again, but we simply
cannot rely on those events not reoccurring, perhaps
unfortunately even in the near term. So the subcommittee must
act.
I would refer Members to the Jessie Jones story of the
1930s with the recognition that the elements of that resolution
were the basis for the Lockheed assistance in 1971 and the
Chrysler Corporation workout in 1979, both of which resulted in
taxpayers' resources being repaid and in one case the
Government actually taking an equity position in one of the
deals and showing a small profit. I think those are very
helpful for the subcommittee to consider in the course of this
difficult matter.
With that, I would like to call on the Ranking Member
Kanjorski for an opening statement.
Mr. Kanjorski. Thank you, Mr. Chairman. Mr. Chairman, I
have prepared a full statement, but not to bore everybody in
the room, I am going to try and truncate.
I just want to state my position, and it is very simply
this. As a result of the occurrence of September 11th, I
believe we must temporarily reinsure the marketplace to
safeguard against the cascading financial crisis. In recent
weeks, several alternatives to solve the problems were merged
from one plan to establish a Government backstop for
reinsurance designed to spread the risk across the industry.
Another approach using quotas would distribute reinsurance
costs for between industry and Government, and other solutions
include allowing companies to build taxpayers reserves,
limiting liabilities from damages as we presently do for
accidents to nuclear reactors and facilitating the issuance of
catastrophic bonds.
From my perspective, any legislation to assist the
insurance industry and our economy in the short term should
adhere to four principles. First, to the extent possible, the
primary insurers must continue to bear the tangible share of
the risk for future attacks through the use of deductibles,
premiums or assessments. Equity owners must also carry some
share of the risk in order to encourage them to implement
appropriate safeguards.
Second, we must sunset the program. The reinsurance
industry is dynamic, and we should not disrupt the development
of new products.
Third, in order to protect taxpayers, we should consider
placing caps on the Government's liability and implementing
adequate oversight.
And fourth, everyone from the real estate mogul to the
average homeowner should participate in the program.
As I have said in our last hearing, we must move cautiously
and methodically in addressing this problem in order to prevent
unintended consequences. Given our forthcoming adjournment,
however, we must also move swiftly. Instead of convening
additional hearings on this problem, we should quickly assemble
a bipartisan, bicameral group to negotiate the solution with
experts and industry leaders. Time is of the essence, and I
stand ready to work with you, Mr. Chairman, and all other
interested parties on these matters in the upcoming days.
[The prepared statement of Hon. Paul Kanjorski can be found
on page 71 in the appendix.]
Chairman Baker. Thank you, Mr. Kanjorski.
Chairman Oxley.
Mr. Oxley. Thank you, Mr. Chairman, and I will make the
full statement part of the record. Without objection.
Chairman Baker. Absolutely.
Mr. Oxley. Welcome, Mr. Secretary. This is, as you can tell
from the other opening statements, a very serious issue we are
all aware of. We need to address this. This will be, along with
our money laundering bill we passed last night in the House,
probably the most important issue we are going to have to face
and we need to do it in a timely manner, and I salute the
Chairman of the subcommittee and the Ranking Member for their
leadership on this issue. We all have to pull in the same
direction.
I think we will find some differences of opinion on the
proposal that you will be outlining, along with the industry
people, but the purpose of this hearing, as I discussed with
Chairman Baker, is to get all of our cards on the table, all of
the ideas on the table and then start to whittle away until we
create something that we can all live with and that will work.
Clearly this is not just an insurance issue. This is an
issue that will affect our entire economy. A concern all of us
have, I think, is that we will get a domino effect on the
inability of companies to get insurance, the inability of
lenders to lend to those companies, and it would have enormous
negative consequences, and I notice you commented on that in
your statement. So we are all in this together, and we will
work with you and all your folks on this issue, and I yield
back.
Chairman Baker. Thank you.
Ranking Member LaFalce.
Mr. LaFalce. Thank you very much, Mr. Chairman. I ask too,
unanimous consent to put my full statement in the record.
Chairman Baker. Without objection.
Mr. LaFalce. Let me give you a couple of thoughts. First of
all, I have been through so many situations over the years
where we have been cutoff the credit or at least the credit
crunch due to severe problems, lenders liability under CERCLA,
for example, the banks wouldn't lend to the business if there
was the remotest possibility of environmental difficulty for
which they could, because of a $5,000 loan be liable for a $5
million cleanup, and I am most fearful of the economic impact
to the United States, the damages to the economy, if we have
the cessation of terrorism insurance.
Do I think the problem is real? Unfortunately, I do. I do
think it is real, and therefore I think we have to do
something.
Now, what do we do? I wish we had the luxury of careful
deliberation. We don't. If we had the luxury of careful
deliberation, I think we should come up with some scheme. It
might be something similar to the scheme that England has, with
a Federal charter and a Federal regulatory supervisory role
commensurate with the Federal risk. I think that is going to be
difficult to implement. We don't have that much expertise
within the Federal Government right now to implement that
immediately, and that is one of the reasons I think that
representatives from the insurance industry have come up with a
single State charter, but the State charter could be with an
administerial role for the State, but still, because of the
Federal assumption of risk a strong Federal regulatory
supervisory role. I think that is a possibility. It is not my
preference, but it is something. But even then, I don't know if
we have the time to do it or the present expertise in the
Federal Government to do it.
The third alternative is some stopgap, and I think that is
where the Administration is, based upon my conversations with
both Sheila and Peter Fisher. That is not my preferred option,
but it may be the only viable option now. If that is true, it
is either easier to coalesce around one Administration approach
than it is one approach after 535 individuals have come to
consensus, so I am willing to do it. But not willy nilly
either. You know, there has got to be some principles that we
follow, and at least we have to make sure that we are going to
provide insurance for all Americans and businesses who need it,
including a full range of property and casualty coverage. For
me--and I don't know if the Administration is there yet--I
think that means business interruption insurance, too.
I want you to address the issue, because I don't think we
are adequately covered if we don't have that.
Second, if the Federal Government is going to put its toe
into the water, we have got to make sure we have got all the
desirable regulatory safeguards to protect the American
taxpayer. We can't, you know, put a toe in without being
protected. OK?
We have to require the industry to share the burden of any
system that is ultimately adopted, and I think perhaps
requiring even more of a first dollar contribution than
presently contemplated by the Administration, that is
negotiable, and have the price structure that provides
compensation to the Federal Government while offering
affordable prices to the ultimate consumer and facilitate the
return of the private reinsurance market as soon as is possible
if it is ever going to be possible. I look forward to working
with you and Sheila.
Chairman Baker. Thank you, Mr. LaFalce.
I would ask if possible for all of the Members' statements
be made a part of the record so we could hear from our first
witness. Without objection, so ordered.
It is a pleasure to welcome you here, Mr. Secretary.
Chairman Oxley wanted me to make it very clear, he is not
responsible for the meeting arrangements. He would have treated
you with greater deference, I am sure, had we the luxury of
time.
Mr. Oxley. Mr. Ney.
Mr. Ney. Hey, this is the way our country was formed. Get
with it.
Chairman Baker. I hope we are as successful. With no
further delay, Mr. Secretary, we are honored to have you here
today on this most important matter. Thank you, sir.
STATEMENT OF HON. PAUL H. O'NEILL, SECRETARY, U.S. DEPARTMENT
OF THE TREASURY; ACCOMPANIED BY SHEILA BAIR, ASSISTANT
SECRETARY FOR FINANCIAL INSTITUTIONS
Secretary O'Neill. It is a pleasure to be with you and all
the subcommittee Members. And Chairman Oxley, if I may pick up
on a point you made----
Unidentified Speaker. Can you speak up a little bit for
those of us that are sitting on the end here? Thank you.
Secretary O'Neill. Let me say again, thank you very much
for the speedy and I think very valuable action on money
laundering. We are determined to do what the President said and
wage a successful war on terrorist finance, and money
laundering is a part of that issue and drug running and all the
other things that we have talked about for a long time. With
the added authority you have given and with the President's
Executive Order, we are going to make this happen. We are going
to shake down these people and their finances and do everything
we can to take them out of business and we have had great
cooperation around the world, and thank you all for that.
Now, to the issue of today, I don't know--did all of you--
whether you had a chance to look at the prepared statement or
not? And Chairman, how would you like for me to proceed? I have
a short oral--actually, it is about 10 or 12 minutes--oral
statement. If you would like me to begin with that, or I can
simply put it in the record and go to questions, whichever you
would like.
Chairman Baker. Proceed as you wish. Maybe outline the
highlights of the plan, and I think this opportunity for
Members to engage with you would be terrific.
Secretary O'Neill. Great. As I said, I appreciate the
opportunity to comment on terrorism risk insurance. We believe
that there is a real and present need for Congress to act on
this issue now. Market mechanisms to provide terrorism risk
insurance coverage have broken down in the wake of September
the 11th. Such coverage is now being dropped from property and
casualty reinsurance contracts as they come up for renewal, for
policies renewing at year-end. If Congress fails to act,
reinsurers have signaled their intention to exclude such
coverage, meaning that primary insurers may have to drop this
coverage or institute dramatic price increases.
As a result, after January 1st the vast majority of
businesses in this country are at risk for either losing their
terrorism risk insurance coverage or paying steep premiums for
dramatically curtailed coverage. If businesses cannot obtain
terrorism risk insurance, they may be unable to obtain
financing or financing may be available only at much higher
cost. This would have widespread effect to businesses of all
types, which may, for instance, be unable to expand their
facilities or build new facilities.
Our view is the problem is that insurance companies do not
take a risk, and it is a misunderstanding of the insurance
process to believe that insurance companies take risk. What
they do do is knowingly accept and mutualize risk, which is
another way of saying they do analysis of the possibility and
probability of an undesirable event happening and then they
assemble all the people in the society that they can who have
the same kind of risk and charge enough premium so that in the
event there is an occurrence of an adverse risk, they have the
wherewithal to pay off the cost that they have contracted to
pay, and at the end of the day what insurance companies do is
that mutualizing of risk function, and in order to stay in
business they must always have enough combination of premium
income and earnings from the premiums that they collect in
order to discharge all their obligations and make a market rate
of return on the capital that they have employed.
So I want to say as affirmatively as I can that the
Administration is not for ``bailing out'' the insurance
industry. What we have proposed is not bail out anybody; it
would instead provide for an ongoing mechanism to insure and to
provide for the mutualization of risk.
Because insurance companies do not know upper bound of
terrorism risk exposure, they will protect themselves by
charging enormous premiums, dramatically curtailing coverage,
or as we have already seen with terrorism risk exclusions,
simply refuse to offer the coverage. Whatever avenue they
choose, the result is the same: Increased premiums and/or
increased risk exposure for businesses that will be passed on
to the consumers in the form of higher product prices,
transportation costs, energy costs and reduced production. Put
another way, any of these choices have the potential to cause
severe economic dislocations in the near term, either through
higher insurance costs or higher financing costs.
Since September the 11th, the uncertainty surrounding
terrorism risk has disrupted the ability of insurance companies
to estimate price and insure risk. Now, as we worked on this
subject, we said our objectives are, first, in grappling with
this problem, first and foremost, we want to dampen the shock
to the economy of dramatic cost increases for insurance or
curtailed coverage. We also want to limit Federal intrusion
into private economic activity as much as possible, while still
achieving the first objective. And we want to rely on the
existing State regulatory infrastructure as much as possible.
After reviewing an array of options--and I truly believe we
have looked at the limits of the options that are available--we
developed an approach that we believe best accomplishes these
objectives. This approach reflects the current evolution of our
thinking on this issue, and let me say as clearly as I can, we
want to work with you to achieve the best possible solution.
When terrorists target symbols of our Nation's political and
military power, they are attacking the Nation as a whole. This
argues for spreading the cost across all taxpayers. Yet there
are also reasons to limit the Federal role. If property owners
do not face any liability from potential attacks, they may
underinvest in security measures and backup facilities. In
addition, the insurance industry has sufficient experience and
capacity to price some portion of the risk associated with
terrorism and have the infrastructure necessary to assess and
process claims. Under the approach we are suggesting,
individuals, businesses and other entities would continue to
obtain property and casualty insurance from insurance providers
as they did before September the 11th. The terms of the
terrorism risk coverage would be unchanged and would be the
same as that for other risk.
Any loss claims resulting from a future terrorist act would
be submitted by the policyholders to the insurance company. The
insurance company would process the claims, and then submit an
invoice to the Government for payment of its share. The
Treasury would establish a general process by which insurance
companies submit claims. The Treasury would also institute a
process for reviewing and auditing claims and for ensuring that
the private-public loss sharing arrangement is apportioned
among all insurance companies in a consistent manner.
State insurance regulators also play an important role in
monitoring the claims process and ensuring the overall
integrity of the insurance system. Through the end of next
year, 2002, the Government would absorb 80 percent of the first
$20 billion of insured losses resulting from terrorism and 90
percent of insured losses, about $20 billion. Thus, the private
sector would pay 20 percent of the first $20 billion in losses
and 10 percent of losses above that amount.
Under this approach, the Federal Government is about
absorbing a portion, but only a portion of the first dollar
losses, which we believe is important to do in the first year
of the program. The key problems faced by insurance companies
right now is pricing for terrorism risk. We favor a first
dollar loss sharing approach in the first year, because we are
concerned about premium increases over the next 12 months. We
see this as the best way to mitigate against premium increases,
but it may not be the only approach, and, again, we are
prepared and happy to work with you to shape an acceptable
outcome.
The role of the Federal Government would recede over time,
with the expectation that the private sector would further
develop its capacity each year. 2003, we would have the private
sector be responsible for 100 percent of the first $10 billion
of insured losses, 50 percent of the insured losses between $10
and $20 billion, and 10 percent of the insured losses above $20
billion. The Government would be responsible for the remainder.
In 2004, the private sector would be responsible for 100
percent of the first $20 billion of insured losses, 50 percent
of insured losses between $20 and $40 billion, and 10 percent
of insured losses above $40 billion, and the Government would
be responsible for the remainder.
To preserve flexibility in an extraordinary attack,
combined public-private liability for losses under the program
would be capped at $100 billion. It would be left for the
Congress to determine payments above $100 billion.
The Federal Government's involvement under our
recommendation would sunset after 3 years. This approach would
also provide certain legal procedures to manage and structure
litigation arising out of mass tort terrorism incidents. This
includes consolidation of claims into a single forum, a
prohibition on punitive damages and provisions to ensure that
the defendants pay only for noneconomic damages for which they
are responsible. It is important to ensure that any liability
arising from terrorist attacks results from behavior rather
than overzealous litigation. These procedures are important in
mitigating losses arising from future terrorist attacks on our
Nation and are an absolutely essential component of the program
that we have put together.
Now, Mr. Chairman, for the reasons I have set forth, the
Administration believes that the economy is facing a temporary,
but critical market problem in the provision of terrorism risk
insurance. Leaving this problem unresolved threatens our
economic stability.
We have limits for Government's direct involvement in all
those elements of our private insurance system that continue to
operate well, and we provide the transition period to allow the
private sector to establish market mechanisms to deal with the
risk that confronts our Nation.
In conclusion, I would say one more thing that I suggested
this morning to the Senate committee. I honestly don't think we
are going to know whether what we fashion together will work,
in fact, until it is tested in the market. As well meaning as
we may be and as brilliant as we may be, only the market will
tell us whether we fashioned a solution that works. And so I
suggested this morning to the Senate committee that you all may
want to consider giving the Executive Branch some power to
adjust the terms of trade in the frame of reference, because
the policies that are at risk now are going to get canceled if
we don't act at the end of December, and usually policy renewal
takes place 45 days before the end of the contract period. So
we don't have an awful lot of time to go through an endless
process that works itself into next year, and so I think this
is a time to think about some extraordinary ways we can make
sure that what we do will work in fact, because we can't afford
not to have a workable solution that takes care of this problem
for the near term.
Mr. Chairman, I am happy to answer any questions.
[The prepared statement of Hon. Paul H. O'Neill can be
found on page 73 in the appendix.]
Chairman Baker. Thank you, Mr. Secretary.
Does somebody have a clock so we can keep our 5-minute rule
here? OK. Give me a 30-second, you know, hand signal. And as
best we can, you will advise me whatever the order for
recognition is.
With that, Mr. Secretary, let me say I very much appreciate
the description of the plan as outlined. Certainly I think in
prior meetings with the Treasury officials that I have some
concerns about elements of the plan, but I want to start with
where we agree. I do believe we have to act. I do believe that
if we cannot expect the occurrence of anything similar not to
bring about significant economic consequences. And if we do not
have an event and we approach January 1 and coverage is not
made available, construction--the economy just stops. So we
want to act very timely. To that end, I also agree we can't
know how the market will react to whatever mechanism we do
expect, and that for consideration only, perhaps the
advisability of a short-term emergency response is to get us
through the early months of the year, and I understand the
industry reluctance to that. They can't price on something that
is not real. But I would just observe that there is very little
likelihood that this Congress will reconvene next year and will
take this matter up as the highest priority and attempt to act
in a very thorough and responsible manner, that even if that is
not achievable, then I very much like the idea of discretionary
authority and responsibility being given to the Administration
to manage this event.
So if we don't get it right, there is the ability to act
without the necessity of Congressional intervention to protect
our economic viability. At the same time, one of the principal
things I think that--as you would surmise from my opening
statement, is some capacity at the appropriate window for
expected repayment. If we go through the scenario of a $100
billion event, given the constraints of the programs now
written, the United States taxpayer would ultimately pay for
more than two-thirds of the claims paid. I hate to use this,
because I overuse this so much, and Mr. Kanjorski doesn't like
me using it so much either, but I will do it anyway. It is
almost like a GSE chart. If you make money you get to keep it.
There needs to be some balancing of equities in this, and with
all due respect to the proposal, my initial first reaction to
it is it certainly is better than the industry proposal we saw,
because we do have some participation by the industry.
But I want to take you up on the statements that you
repeatedly made that we want to work through this, and a
mechanism whereby we can visit again, maybe not this week,
certainly early next, and go through the essential elements
that I think ought to be in any proposal. Administrative
concerns, again side-stepping the policy for a moment, if we
are going to have to direct providers of insurance laying claim
to the United States Treasury for reimbursement of monies paid
out as a result of an act of terrorism, the administrative
process to do that with 2300 insurance companies each paying
multiple claims, unfortunately for those concerned about
bureaucracy, you have got to have some questions about how that
is going to work. Then we are going to audit and make sure
where the money went. I have suggested that our interface with
the industry might be at a slightly different level. Wave fast
and hard, so I can see. If we engage at the commercial
reinsurance level, and it also speaks not only to minimizing
the numbers of people with whom you would have to engage, but
they are the folks really backstopping in the private market
the risk of the direct provider. They also are the ones who set
the underwriting stuff. So if you need that extra security, if
you need an extra person at the door, if there is some other
extraordinary circumstance which is identified in the market as
being necessary, let the market dictate those requirements. I
would be concerned that the more we become responsible, the
more the pressure would be on the Congress to create more
regulatory constraints and to begin to set those standards of
what is acceptable conduct.
And then lastly, by leveling at the commercial reinsurance
window, we narrow the scope of review of the eligible
participants who have access to the funds. I don't want to have
happen with the insurance industry what I would be so bold to
say I think may have happened with the airline industry, where
there were losses going into the September window that were
rolled into the claims paid pursuant to the September event. We
need to know who is getting in, that they are solvent, they
have the capacity to meet the responsibilities as best any
reasonable person could dictate, and if we do that only with
the commercial reinsurers, we again are looking at
corporations, generally international in scope, generally well
priced by the market, and we have a clear view of what their
operational condition might be, to limit again the Federal role
and bureaucratic responsibility in what will be a very
difficult time.
I can only imagine the explanation by the agent on the
street to a claimant about why they hadn't gotten the payment,
because the Federal Government hadn't acted in a timely manner.
Am I out? I am out. I am not even 30 seconds. I am out. But
let me just leave it at this. I appreciate your willingness to
come here today for this purpose. I appreciate the tone and
comments that you have made, and I just as an individual in the
room--and I am sure others will speak for themselves--really do
want to engage the office to try to come with some resolution.
Thank you very much.
Mr. Kanjorski.
Mr. Kanjorski. Mr. Chairman, thank you very much. I have a
few questions. Of course, I could name certain principles I
would like to go through in terms of when we put this policy
together, but first and foremost, on the Administration's
proposals, I don't see an incentive for the insurance industry
to want to resolve the issue until the absolute down day of
2004. I think if the Government gets involved, and I think we
should get involved, there has to be an incentive, either
premiums collected or a penalty derived by the Government to
encourage the private sector to take up the reinsurance issue.
If not, it would seem to me all companies would stand to the
bitter end, and I think one of the examples we have always had
in flood insurance is there was never an incentive to get out
and privatize it. It is going to stay with the Government as
long as I guess the leaves turn to brown.
There is a couple of questions I have. One, I think we
should insure actual loss, but not necessarily economic gain
loss. You know, we have gone through a tremendous appreciation
of assets over the last 7 or 8 years, and I think it would be
foolhardy for the taxpayers to bail out investors 100 percent,
or a mortgage holder 100 percent if there is reactivation going
on in the system to take advantage of moving up the value of
the asset to the highest degree or even above 100 percent. We
have got to have some stopgap in there to protect it.
Second, I would like to ask you what portion of this
business are we providing the Federal insurance for that is
international? How many foreign companies?
Secretary O'Neill. None.
Mr. Kanjorski. We would not cover any foreign?
Secretary O'Neill. Well, if they were a resident of the
U.S., I think they would have all the right that any one of
standing has in the U.S., but this is territorial. This is the
U.S. .
Mr. Kanjorski. Well, U.S. limited policy, but the----
Mr. Kanjorski. Right, but we still have primary insurance
for foreign companies, and this would apply to all companies
across the board. Is that correct? Is there any way we can give
a preference to the American insurers?
Secretary O'Neill. I don't think you want to distinguish
between sources of the capital where somebody's money is better
than somebody else's.
Mr. Kanjorski. So the RAC national insurance----
Secretary O'Neill. There are people we don't let into the
country for very good reasons.
Mr. Kanjorski. I am just being facetious.
Mr. LaFalce. If they are insurers, they have to be licensed
in----
Secretary O'Neill. Yes.
Mr. Kanjorski. I would rather look at a portion, some
graduation of liability. I like the fact that the first dollar
the primary insurer has to stand some risk, but I think there
should be maybe reverse graduation involved to where we get
involved and then, finally, probably some sharing of the
premiums. There has got to be something to the taxpayer that
takes the risk, simply because I am trying to distinguish in my
own mind--and I am not sure that I can anymore--of the
occurrence of September 11th, whether that is a terrorist
attack or an act of war. Clearly insurers and banks and other
investors take the risk of actual war. They are not covered for
that. So we could pretty close--I mean, using the President's
word, we could make a very strong argument that we are in an
undeclared war, and, therefore, we are picking up the next
liability for the taxpayer.
I am willing to do that because I see the economic
component, but I think that is justified. But I would just like
to see that incentive for the private sector to get involved as
early as possible. Some share--maybe the premium should be
higher than the private sector so that the private reinsurance
industry will see an opportunity to rush in and provide that
insurance as soon as possible as opposed to delaying it. We may
be interrupting the development of that market by being too
generous, and thirdly, real losses as opposed to book losses, I
think that is essential.
Secretary O'Neill. May I comment?
Chairman Baker. Please proceed.
Secretary O'Neill. I think from some of the things I have
read in the newspapers and some of the comments made, it may be
useful to talk a little bit about the concept of insurance. I
have tried to do that a little bit in my paper, but I think
maybe it is worth emphasizing some points so that we are on the
same ground together, and if--you know, simply because of the
comments an insurer makes about repayment. Under our scheme, we
are not giving--we, the people of the United States, are not
giving the insurance companies anything. We are not giving them
anything. Now, when you say repayment----
Mr. Kanjorski. We are giving them coverage support.
Secretary O'Neill. No, we are not at all. What we are doing
is we are saying to the insurance companies that if you go out
and write terrorism insurance, that after you reach a level of
20 percent of the $20 billion in the first year, that you don't
have any remaining liabilities. Now, you know, maybe what we
haven't made clear enough, and I guess we presume is clear, but
it is obvious it is not, is that they are not going to write
insurance for more than the size of their liability and the
size of the premiums that they aggregate together. So they are
not going to write us up for $100 billion. We are simply saying
we would like for the private sector to play a role, and you
are not going to do--we think they won't do it if they have
unlimited liability and no reinsurance pool, that there is not
going to be any insurance available.
OK. But if you understand how insurance companies work,
what they do is they go out and find people with similar kinds
of risk, and they do an assessment of what is the possibility
of an untoward event, and then they collect enough premiums and
invest the money so that they make income from the invested
money, and when there is an untoward event, they pay off. OK?
And this would work exactly the same way, but the liability,
that is limited, and the reason we started with a fairly low
number is because if you think about this now from the point of
view of an individual insurance company and, you know, let's
take the World Trade Center now and you be the proprietor of an
individual insurance company. You would not today go in there
and take a risk of having to pay off a $3.2 billion claim
unless you are going to get paid something like $3.2 billion,
because if it happens, it is a 100 percent event. OK?
Chairman Baker. If I can, the gentleman's time has long
since expired, and the Chairman is next. Chairman Oxley.
Mr. Oxley. Mr. Secretary, let me take you through some of
the criticisms of your proposal. The first one is that this is
an obvious industry bailout. You have addressed that to some
extent, but indeed we are asking insurers to collect 100
percent of the premiums and then the taxpayers in the first
year at least would pick up the bulk of that cost at 80
percent.
Secretary O'Neill. That is not really right. You know, it
comes across as that portrayal, and I realize now we were not
clear enough. The insurance company is not going to write $100
billion worth of face value coverage for $4 billion worth of
premiums. What this basically says is we are creating a way for
the insurance industry to create a pool that provides a first
layer of mutualization of risk with an upper limit of $4
billion in the first year, and the taxpayers are going to, in
effect, self-insure the rest. They are not getting paid
premiums for $100 billion. They are going to get paid premiums
because of the way the process works that gives them enough
money to pay off the probable cost of insuring risk. And that
is all they are going to get. They are not going to get any
gifts, because as competition works, the interaction between
the consumers, like where I was before, the head of a company,
the interaction between companies, they are saying I want the
lowest possible price, and the insurance company, you are
saying I want to write the business. It is going to bring this
price down to a level that provides at the end a $4 billion
pool to pay off the probability of an untoward event, wiping
out all of the agreed contractual coverage for the insurance
companies. It doesn't do more than that.
Mr. Oxley. And in your proposal it is a 3-year package,
basically?
Secretary O'Neill. Well, we have said we think as we go
along that the insurance industry and the reinsurance industry
will likely figure out how to deal with this issue as they were
to deal with Hurricane Andrew kinds of issues. They never have
before. And so we are saying let us look at a 3-year program
with these kinds of characteristics.
But again I want to say to you what I said before, until
we put this in the marketplace we are not going to know whether
it really works, and that is why we need to be fast on our
feet, because if this doesn't work, we need to figure out a
scheme that will actually get the job done by the first of
January.
Mr. Oxley. Traditionally insurance has been based on
obviously risk assessment. Is it fair, for example, let us say
that the target is the Empire State Building, or obviously the
World Trade Center for a terrorist attack presents a lot more
attractive target, if you will, than, say, the Marathon Oil
Building in Ohio. And indeed, currently the insurance rates
are, for a lot of reasons, different in different parts of the
country. Under your provision, and the way you explained it,
would the market ultimately then seek that?
Secretary O'Neill. Absolutely. If you think about--and I
don't want to be quoted as ``O'Neill identified,'' but you all
think of places that you know about that are obvious symbolic
targets in the United States. They are going to end up in what
I would characterize as an assigned risk pool. You all know
from your automobile insurance, you know, if you are over 25
and have three children and don't drink and smoke, then you get
a preferred rate than if you are 15 years old and you wreck
three cars and you get put in an assigned pool. We are going to
see the insurance industry go through this probabilistic
analysis and the premiums for high value symbolic targets are
going to be a lot higher than they are for a suburban home in
Maryland. The industry will work out what the appropriate
premiums are and again they will do it in a competitive
framework of, you know, State Farm says I will cover your house
for this, and Hartford says I will give you a little bit less
and throw in a blender, and that is how this process is going
to work.
Because of the scale of what we are facing and the short
amount of time that we have to deal with this, I think this is
the only reason why we ought to be at the table, because it is
right in front of us. There is a high degree of uncertainty,
and we need to make sure that we don't go over the cliff
January 1st and there is no insurance protection, because the
thing that drives us, if you are borrowing money--or even if
you are getting money from equity supporters and you don't have
insurance to cover casualty loss to your property, you are not
going to be able to get intelligent investors to give you
money.
Right? Think about it as an individual investor. Would you
give your money to someone who had the risk of losing 100
percent of all of their assets, including all of yours and no
insurance coverage? You wouldn't do it.
Mr. Kanjorski. Well, they do it all the time in war.
Secretary O'Neill. Well, you know, I think you made an
excellent point. If you go back and look at what we have done
where we have declared wars, basically the American people have
been the guarantor of casualty--of war-related events, and if
we had a declared war, I think you could make an argument that
we ought to move to that position. And I said earlier, one of
the things that we did in working this subject, because, you
know, for me--and I think for most of you--this is not an issue
that lends itself in any way to partisanship. This is how we
get it right, and so we looked at the question of maybe the
American people should simply say define terrorism and
determination of a terrorist act, we are going to use our
system of collecting revenues and distributing benefits to
people; that is to say, the general fiscal policy of the United
States, to pay for acts, for the cost of acts that are
determined to be terrorist acts and we will just take the
insurance industry out of it.
Now, as I have said here, we didn't get there because we
think the infrastructure of the insurance industry can bring
real value to dealing with the possible future terrorist events
that otherwise one would have to consider creating in the
Federal Government. That we think would be a disaster, to
create a new Federal freestanding agency that is in the
insurance business with policy writers and claims adjusters and
all the rest of that stuff.
Chairman Baker. Now you are scaring me.
Secretary O'Neill. We don't want to do that. And so we
built in this idea that by creating in effect the controlled
and limited risk and then ratcheting it up over time, that we
can have the best of all possible worlds and learn as we go
along. None of us have been here before.
Chairman Baker. If I can, Mr. LaFalce.
Mr. LaFalce. Yeah. Thanks very much. I will go quickly. We
are ready to let you take the lead. When will you get us the
legislative language by? I think there is a disposition to
adjourn Congress by Thanksgiving, maybe by Veterans' Day. Some
people will say Halloween.
Ms. Bair. There is no Administration bill.
Mr. LaFalce. Are you preparing it?
Ms. Bair. We are prepared to work with the staff.
Mr. LaFalce. Well, if you want to take the lead, you have
to take the lead. That means you have to come up with the
language quickly.
Second, what is the necessary effective date? It is one
thing to pass it in November, but when must it be effective by?
Secretary O'Neill. The sooner the better. As I said to you,
most of the notices for renewal come out on the 15th of
November, policies that expire on the 31st. So, you know, we
need it quick.
Mr. LaFalce. OK. Next, if you were to insure, Mr.
Secretary, would you advise them to give business interruption
insurance or not? I think the answer is yes, you would.
Secretary O'Neill. The reason I am hesitating, I used to
run a $30 billion company. I did make a decision in some cases
to provide business interruption insurance, but out of my 26
businesses, I made different judgments about different parts of
my business, depending what the customer relationships were and
contractual relationships.
Mr. LaFalce. My point is for an awful lot of businesses it
is not their physical infrastructure. It is their business
itself that is damaged. You know, they have no revenues coming
in. They can't pay their bank back. They are going to go belly
up with bankruptcy, and they need insurance against that.
Secretary O'Neill. We have not included it. It is a
debatable issue, and we ought to talk.
Mr. LaFalce. You are not advancing it, but right now you
are not saying you are opposed to it?
Secretary O'Neill. No.
Mr. LaFalce. All right. I think we have to act on it
quickly. I am a little afraid that the insurance industry might
be taking advantage of us, other people taking advantage of us.
You have to be wary of that, too, the same way this economic
stimulus bill, think the people are taking advantage of us. I
think you would agree with me.
Secretary O'Neill. On the latter I agree with you; on the
former I don't.
Mr. LaFalce. Well, good. In other words, you agree with me
on the economic stimulus. It is an open question on insurance,
or you don't. Fine.
Secretary O'Neill. I think as long as we have competition.
Mr. LaFalce. Then I understand you correctly, you agree
with me on the economic stimulus bill that we are being taken
advantage of.
Mr. Kanjorski. You are going to be quoted on the floor.
Secretary O'Neill. I don't want to get in trouble.
Mr. LaFalce. You did say we were being taken advantage of.
Secretary O'Neill. I didn't say by who.
Mr. LaFalce. This money----
Chairman Baker. Is the gentleman out of time?
Mr. LaFalce. I have been interrupted. I want my time. We
passed the money laundering bill today in the House. OK, fine.
It is up to you to implement it strongly, aggressively. It is a
great law. It can be meaningless unless you implement it
strongly.
Secretary O'Neill. Not to worry.
Mr. LaFalce. OK, good. Now, I am a little concerned about
your theological opposition to the concept of a Federal
charter. You know, my God, we talk about the global economy and
the need for harmonization of our banking laws, our bankruptcy
laws, our money laundering laws, and so forth. But with respect
to the insurance industry, which was one of the largest
industries in the world, my God, we can't have the United
States have a law on that. We have got to defer it to the
States. This is the 21st century, Mr. Secretary, and let us not
be afraid to step our toe into the 21st century with respect to
insurance laws. Now, I am not saying we ought to do it with
respect to terrorism insurance, because we only have a few
weeks, and I don't know that we could get there, but don't be
afraid to put your toe in. It is necessary.
Chairman Baker. Thank you, Mr. LaFalce. By my list, I have
Mr. Royce next. Is he here, Mr. Royce?
Mr. Bachus.
Mr. Bachus. Thank you. Secretary O'Neill, I commend you for
coming forward. I am as serious as you about what you are
proposing. The first is that to me this is not a backstop. We
have got the most recent proposal. Why is there not a layer of
industry exposure any time there is a claim?
Unidentified Speaker. Could you both speak a little louder,
please?
Secretary O'Neill. The reserves that are currently held by
insurance companies are held because it is their best
assessment, backed up by the securities laws about how much
money they need to put away in order to be worthy, creditworthy
by the judgment of the State insurance commissioner, that when
they have events they can pay off their customers. And so the
reserves----
Mr. Bachus. Adequate reserves.
Secretary O'Neill. I am saying they don't have extra
reserves. They have reserves to take care of the business they
have already written.
Mr. Bachus. You are saying they don't have adequate
reserves?
Secretary O'Neill. No.
Mr. Bachus. So, that is why you came--no. I am just--that
is why----
Secretary O'Neill. Well, you know, it begins with a very
basic understanding of how business works.
Mr. Bachus. Yeah. I know how insurance works.
Secretary O'Neill. And how insurance companies work. They
go out and they sell policies--.
Mr. Bachus. Now, you are lecturing us about----
Secretary O'Neill. I don't mean to be lecturing.
Mr. Bachus. You have looked at a backstop proposal and you
have rejected that. You think first dollar coverage is
necessary, right?
Secretary O'Neill. I think if we said to the insurance
companies, for example, right now that we want you to write
terrorist risk insurance and you all are responsible for the
first $50 billion.
Mr. Bachus. The second question is this, there is no
catastrophic loss of over $100 million, which is what I think
is the worst-case scenario, which I would think that you would
address that. I think that is what the reinsurance people are
concerned most about. There is absolutely nothing above $100
billion. Did you all consider that?
Secretary O'Neill. Well, what we basically said is when you
get to $100 billion, we the people of the United States will
own it all.
Mr. Bachus. You think so?
Secretary O'Neill. Absolutely. Who else is going to put up
the money? I don't know. There is no other mechanism in the
world except the good faith and credit of the people of the
United States that is going to be good for anything over $100
billion.
Mr. Bachus. All right, let me think. Third, I don't think
the insurance companies can prepare for phase-out of the
Treasury program, because there is no tax incentive. There is
no reserves against terrorist risk or other means. Why don't we
start planning for the future? This 3-year plan basically acts
as if the world is going to last another 3 years. What we ought
to be doing is planning for the future and addressing this
problem long term.
Secretary O'Neill. A couple of points. I don't think we
know enough to craft a plan that anybody can say this is the
right thing and this is what we ought to do. You know, I
haven't found anybody anywhere who thinks they completely
understand how we can fashion a perfect solution to this
problem and work.
Mr. Bachus. Let me ask you this. As I see it, it fails to
spread the risk of terrorist loss throughout the commercial
insurance industries, does not provide the market stability
necessary to encourage companies to cover terrorist risk. There
is no requirement that they cover risk to participate. They
could cherry pick. How do you respond?
Secretary O'Neill. You know, let me revert to being a
businessman. If I were where I was a year ago and I were faced
with this situation--and fortunately I was with a company that
was so good--but for most businesses they have got to pay a lot
of attention to their bankers and to their equity holders and
what their equity holders and bank holders will say to them--if
there isn't something done like this by January 1st, we are
taking our money away from you. And so what is going to happen
is businesses are going to be driven to the insurance company
to get terrorism coverage, and the price that is going to be
charged is going to be related to the risk that an insurance
company sees----
Mr. Bachus. I understand all that. You know, the final
thing, and let me just make this comment. You are not covering
life insurance or health insurance?
Secretary O'Neill. No.
Mr. Bachus. This is basically commercial policyholders.
Secretary O'Neill. Yes.
Mr. Bachus. So when you say that you are underwriting the
taxpayers, in effect you don't really mean the taxpayers; you
mean those that are commercial?
Secretary O'Neill. We are not underwriting them at all.
They are going to be out there----
Mr. Bachus. You said we were----
Secretary O'Neill. They are either going to have to self-
insure, be forced into the hands of the insurance companies who
will write the risk insurance.
Mr. Bachus. But, if those people were backing up, not
exactly the taxpayers, but the policyholders as opposed to
taxpayers----
Secretary O'Neill. We are working a way to try to reduce
the economic shock that is related to either no coverage or
very, very high premiums as many companies wouldn't be able to
afford, and some would therefore not have access to financial
markets because nobody would give them any money.
Chairman Baker. The gentleman's time has expired.
Mr. Bachus. I am just concerned about people's life
insurance policies.
Chairman Baker. Mr. Inslee, are you here?
Mr. Inslee. Thank you, Mr. Secretary, for coming. I am
going to take issue with what I think I heard you say, that
this is not a benefit to the industry as a whole. I think I
heard you say that or something to that effect.
Secretary O'Neill. That is exactly right.
Mr. Inslee. And I have got to take issue with that, because
it seems to me that if we do this, we are telling the industry
that you can go out to prospective customers and tell them that
if you buy my policy, you will also have in effect access to,
you know, $90 billion plus of Federal money if things go south,
and vis-a-vis other uses of that customer's money to protect
themselves against risk, either by risk reduction work or other
investments or the like. This, quote, distorts the market by
helping the insurance industry vis-a-vis other expenditures
that that investor could make.
Now, tell me where I am missing something in that analysis.
This does benefit the city, because it makes their product more
attractive vis-a-vis, say, risk loss investments.
Secretary O'Neill. Well, think about the problem as a
disaggregated problem. We here in Washington tend to talk about
the insurance industry like it is one big monolithic thing.
This is all going to be done one transaction at a time. So if
you have a corner grocery store, you know, you are not thinking
about, oh, the Government is going to provide $16 billion worth
of additional coverage. Your issue with your insurance agent is
how much the premium is to insure you against complete
catastrophic loss in a terrorist incident. And when he tells
you that the premium is more than the value of your business,
you are going to say, I am going to get on the phone and start
calling through the insurance list in the yellow pages and you
are going to get people in there swarming around, nickling,
diming, trying to figure out how they can reduce your premium
so they can write your business. That is the way competition
works. That is the way insurance works, and so, you know, all
this lofty stuff about $20 billion and $80 billion, it is just
an aggregation of millions of individual transactions.
So, you know, nobody is going to get done a favor here.
Competition, given some time, is going to grind these rates
down to an assessment of the probabilistic cost of a terrorist
event.
Mr. Inslee. Yeah, I agree with you as this is not going to
benefit one insurance carrier vis-a-vis another insurance
carrier. I accept your point in this regard, but it does
benefit the whole industry, vis-a-vis other investment or other
expenses by the insured. For instance, if I got a thousand
dollars, whether I buy a bomb screening detection device to
keep bombs out of my business or whether I put it in insurance
premium, this lowers the price of the premium vis-a-vis that
other investment.
Secretary O'Neill. But the insurance company will help you
make that decision.
Mr. Inslee. I understand, but the investor, the customer
makes that decision, and this is a clear benefit to the
industry, because it makes their investment more valuable in
relationship.
Secretary O'Neill. No. If there is a thousand dollar value
associated with a detection device, the insurance company will
either charge you the thousand dollars you didn't invest or you
will put the money into the detection device.
Mr. Inslee. Well, I see we are at loggerheads on that
issue. Let me try another one.
If you did accept the proposition, if you did, that this
was of some benefit to the insurance industry and that the
taxpayer ought to have some upside potential in this
investment, how would you structure it? If you did want to do
something like that, to, in effect, whether it is an equity or
it is some benefit to the general fund, how would you structure
the other experiences?
Secretary O'Neill. Well, I know this is very difficult and
I don't mean to sound like lecturing, but let me tell you with
25 years worth of experience running big companies and knowing
a lot about this stuff, the way competition works, you know,
you can find aberrations, but the insurance industry over time
has to earn the cost of capital, and the competition is tough
enough that it is very difficult to earn the cost of capital.
There are a lot of companies out there, including in the
insurance industry, are not even close to earning the cost of
capital. So if you want the general taxpayer to get something
out of what you think is a benefit, then you are going to have
to give the insurance industry enough room so that they can
make additional net profit so they can pay you--you, the
Congress--something, because competition is going to grind them
down to the necessary rate of return on the capital that they
employ. They are not going to make economic rent out of this
proposal. Competition doesn't create economic rent.
Mr. Inslee. My time has expired. I remain unconvinced, but
I appreciate the brilliance.
Chairman Baker. Mrs. Biggert.
Mrs. Biggert. Mr. Secretary, as the market is sorting
itself out, there are certain areas that are thought of as high
risk. One of those would be, let us say, public schools or
maybe municipalities or amusement parks. Does your proposal
cover those?
Secretary O'Neill. We are assuming as to the current
practice, it would continue. The Federal Government, basically
we are a self-insurer. We do not insure anything. We by habit,
if not by explicit decision, have decided to use the future
cash flow from our taxes to pay for these kind of events.
Local government has made different kinds of decisions.
Some of them buy insurance. Some of them actually budget for a
rainy day fund. We just basically assume that public bodies
will continue to do whatever they are doing. We have not made a
special provision or assumption about a change in policy
direction.
Mrs. Biggert. I think a lot of those local governments are
self-insured now. Whether they can afford that risk, if you
take those high risks out of those, will we still have
problems?
Secretary O'Neill. I think so. I think we can find lots of
examples like the World Trade Towers where catastrophic loss
would be multi-billion dollars. Again, I don't want to tell you
any names, but I see the threat list every day. A lot of those
places are on the threat list.
Mrs. Biggert. If they are not self-insured, we are right
back where we started.
Secretary O'Neill. I am not talking about public, I am
talking about private buildings like the World Trade Towers.
There are a substantial number of places in this country that
have multi-billion dollar replacement costs. I think Mr.
Kanjorski made the point about historical value. We should have
no conversations like that, because the difference between
historical and replacement value in some places is significant,
and I don't think you would like to be stuck with just the
historical value protection.
Mrs. Biggert. So, if there is high risk and no coverage, is
there a provision to require it, or is it just commercial
insurance?
Secretary O'Neill. We are working on the private sector
side. I had a role in Pittsburgh in Allegheny County when I was
there, and given what has happened, I probably would be
advising the mayor that we have to take a look at whether we
can buy some terrorism coverage for bridges.
Mrs. Biggert. Utilities?
Secretary O'Neill. Public property. People must be
rethinking those things on the State and local level, but we
have not designed a new kind of Federal intervention or
coverage.
Mrs. Biggert. Do you think that would be a possibility?
Secretary O'Neill. I am not sure that we need to do that. I
think the market will sort those pieces out without our
intervention.
Mrs. Biggert. Thank you.
Chairman Baker. Mr. Capuano.
Mr. Capuano. Mr. Chairman, thank you.
Mr. Secretary, this is a thoughtful approach toward a
difficult issue. I love the fact that you said no one really
knows how to deal with this. I appreciate that.
For the record, I would also like to get your answer
relative to if this does not work, I assume you would have no
objection to revisiting this next year or 2 or 3 years from
now?
Secretary O'Neill. As I said earlier, you all may want to
consider writing a very unusual provision in whatever you may
do, and give the Executive Branch the ability to modify terms
and conditions on a very short turnaround basis, because if
what you all write gets done, it will be the 10th or 15th of
November. If it does not work, we need to make the changes
right away.
Mr. Capuano. I am glad to hear that. One of my concerns is
as you submit this, and I know it would be very difficult, but
I would like to see some pricing estimates. The reason I ask
this is because my concern is that terrorism is clearly a
societal problem. Insurance is, in theory, in the greatest
philosophical theory, all of us chipping in a few dollars so
that nobody in particular takes a hit. In the private market
system, that gets a little muddled. That is fine.
In this particular case when the Government gets out
entirely in a couple of years, and let us assume that we do not
change it between now and then, my concern is if there is a
market impact of the cost of that insurance, that market impact
will negatively impact downtown areas in general. That is a
general statement.
The reason I say that is because, let us be serious, the
best terrorist targets are downtown. In Boston, it would be the
Hancock Tower, the Prudential Tower. That is not a secret. We
all know that. It is unlikely that terrorists are going to
target a one-story office complex along Route 128 in
Massachusetts.
What kind of impact on the market of leasing, because most
of our buildings in Boston are owned by real estate investment
trusts? They are not owned by the Alcoas of the world. They are
owned by real estate investment trusts that own the buildings.
They are the ones that have to buy the insurance, not the
companies in the building. The companies in the building will
be paying it through lease agreements. You pay a premium for
being downtown, and you make a decision, and so forth, and so
forth, how much more of an impact is that going to have.
That is very important, because it doubles the cost of
downtown space. You are clearly having an impact on a different
market that is unintentional. Again, I don't know enough about
pricing insurance to know whether or not this is real or not,
but I would like to see something on it.
Secretary O'Neill. I think your question is an excellent
one. It is useful to return to the principles of insurance.
Over time the way premiums are determined is on the basis of
experience. If you are an insurance company and you are
covering 10 million automobiles and they have crashes at a
certain rate, that determines what the premiums are in order to
stay afloat and pay the claims and earn your cost of capital.
What we all ought to pray for is we never have another
experience, and that means there will be no economic cost.
There will be premiums for awhile, but the longer we can go
without another experience, the lower the premiums can be
because there is no cost. God forbid we have experience so we
can begin to create premiums on the basis of terrible events
happening on a regular basis.
So I think again, we do not know. There are so many things
associated with these events that are just new thoughts that we
never had to think about before. This is a broader question
even than the question of insurance. If we are going to have to
continue to, for example, have a separate facility to open mail
because of the anthrax scare, it creates all cost and no value
to our society.
Those kind of deadweights on our society are like the
deadweight of having to have insurance coverage that hopefully
we never really need to use. We do not know the answer to your
question.
Mr. Capuano. I respect that. I think it needs to be thought
about, not the least of which are the indirect items such as
downtown parking facilities.
We just had a thousand pounds of fertilizer stolen in
Massachusetts. We do not know what is going to happen to it, if
it is going to be used by somebody that wants to do something
horrendous, they are going to go to a downtown parking
structure under a building. That means all the parking
structures are gone, and that increases rents.
I am a little concerned about the free market having a
completely terrible negative impact on the cost of rental
property, particularly in downtown markets where people can
least afford to have people move out of.
Chairman Baker. The gentleman's time has expired.
Mr. Shays.
Mr. Shays. Mr. Secretary, I would have thought, unless I am
not reading your proposal right, that you would want premiums
to go up so you start to build a reserve, and that cost could
be passed on, but you want a reasonable increase, something
that is not outrageous. I was thinking that the cost of
premiums would go up, and you would buildup a special reserve,
and that over time this reserve would become so large that the
liability disappears; that is, if there are no further
terrorist activities. My reading is that you really do not
buildup long-term reserves.
Secretary O'Neill. I don't believe it is desirable for the
Federal Government to create an insurance system. I think we
have a way in our country of spreading the cost of things that
impact society, and it is through a combination of our tax
system and our spending system, and it ends up with a
distribution effect on the general population.
I think for the part of the terrorism cost that we are
going to accept, unless somebody has a better idea, the
interaction of all those things that we do is perfectly fine
with me, and we have a basis for spreading the cost for that
part that we are going to put on the American people, for the
insurance companies. What they will do, they will set premiums
that they believe will give them the wherewithal to service
terrorist events and earn a 12 or 15 percent return on their
capital.
Mr. Shays. Are you saying they will build the reserve?
Secretary O'Neill. They have reserves now against business
that they have already written. If they add new business, they
will add new reserves. Their premiums will include enough
earnings to building up a reserve so if an untoward event
happens, they have the money to pay it off.
Mr. Shays. My understanding is that you do the back end and
not the front end. The Government says catastrophic, you are
the first payer. Yet you are not doing it that way.
Secretary O'Neill. I tell you why. It is a very important
question of how much the traffic can bear under uncertain
conditions and a lack of experience.
Think about this as an individual business person. You can
afford to pay a certain level of insurance costs. Let us say
you have been paying a certain level of insurance cost, and now
this event comes along and your insurance company says in order
to give you terrorist coverage which you need in order to get
financing from your bank, I am going to raise your premiums on
$1 million a year to $10 million a year. As a business person,
if you are go to stay in business, you do not have a whole lot
of choice.
The way we have crafted our proposal is in a way that we
think will permit the premiums to be written on each of those
business people and not put them out of business.
Mr. Shays. Do you believe premiums are going to go up
significantly?
Secretary O'Neill. Premiums will go up.
Mr. Shays. Even if we back them? Significantly?
Secretary O'Neill. Yes. Premiums are going to go up,
although it depends what you mean by ``significant.'' if you
want to make the insurance company just paper processors and
guarantee them a 25 or 30 percent rate of return on their
capital, they would be happy to take that.
This is an attempt to get the administrative structure and
the value part of the insurance in front of us before the loss.
Mr. Shays. Thank you.
Chairman Baker. Mr. Crowley.
Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman.
Mr. Secretary, first of all, I concur with the Chairman. I
think we would be better off, and I appreciate what you have
done and what you have looked at. I don't completely agree with
your proposal. None of us know what the perfect proposal is. I
think we would be better off having a little shorter sunset,
and I would also be a little reticent of extending too much
flexibility to the Executive Branch, with all due respect,
because at the end of the day, whether our name is on the bond
or not, the Congress underwrites, if not fiduciary
responsibility, the political responsibility for the taxpayer's
liability.
I hope you all would take that into consideration, whether
we try and do something that just gets us over the hump, and I
realize that Congress is not always good about meeting its own
deadlines, but we are going to have to focus on this.
Second of all, I am curious of how you determine your
shared loss schedule? How did you decide the ratios that you
set in 2002, 2003, and 2004?
Third, I am not convinced that you have made the case that
from a cost-benefit standpoint to the taxpayers, that having a
shared loss program with the first dollar coverage on the part
of the taxpayers is all that much better on a dollar-per-dollar
basis, or even on a market basis quite frankly, than a pooled
model similar to deposit insurance.
I am curious whether or not the fear there, and it is not
necessarily a cost-benefit analysis issue, it is a concern of
the creation of another bureaucracy, and I am not sure that we
can look at the deposit insurance and say that is such a bad
system.
Finally, I would think the way your proposal is structured,
and it might be true with pooled structure, is how we score it
for budget purposes. I would think that under your proposal we
might have to score it dollar for dollar and at some point we
are going to have to keep an accounting of the money spent and
back into what our long-term solution is.
Secretary O'Neill. The last issue is that it would be
scored like the money that is now spent for disaster
assistance.
The pooling idea has some complications in terms of, if you
are going to have a pool, yes, it suggests you are going to
write policies. If you are going to write policies, somebody in
the Federal Government is going to decide what the premium
schedule is. And then we are going to charge premiums to people
and money will come in, and what will we do with it. If we do
with it what we do with almost all of the other money, we
invest it in Government bonds where we do not really do
anything. We have this paper game.
Mr. Bentsen. And I grant you that, in your testimony you
bring that up. But even in the shared loss, we are going to
have to go through some underwriting analysis.
Secretary O'Neill. We are going to write checks.
Mr. Bentsen. My question, Mr. Secretary, from the
taxpayers' standpoint, have you all determined where the
taxpayer is really better off?
Secretary O'Neill. I think the taxpayer is better off not
having the fiction of a pool and all of the appearance of being
in the insurance business when we really do not want to be in
the insurance business.
If you think about setting up a pool, the implication of
that is basically that we are going to withdraw capital from
society on no particular basis and we are going to hold it
aside. That is an added cost to society, that we take capital
and in effect neutralize it.
Mr. Bentsen. In fairness, Mr. Secretary, if we incur a
liability, we are taking capital from society.
Secretary O'Neill. But we take it when we need it and not
in anticipation.
Mr. Bentsen. If your staff can look at those issues. I
agree that we could not do a pooled issue right away. I don't
know that we can do any of this right away other than get us
over the December hump. If you can get back to me on the
question of how you determine your shared loss schedule, what
the analysis was, I would appreciate that.
Chairman Baker. Thank you, Mr. Bentsen.
Mr. Ney.
Mr. Ney. Mr. Chairman, I want to focus on the issue on a
broader, generic basis concerning McCarren-Ferguson and our
current system and how we regulate insurance. Do you have any
idea how the proposal would affect how we regulate insurance
with respect to McCarren-Ferguson.
Secretary O'Neill. Perhaps Ms. Bair could address that.
Ms. Bair. We would want to rely on the current regulatory
structure. I think there are a couple of scenarios and issues.
Mr. Ney. My second question, the plan hopefully addresses
the underlying problem of the pricing and various taxes. In
other words, if we had an attack 6 years from now, would we be
right back to where we started? Is there any consideration
about what the tax incentive side of this does for businesses?
Secretary O'Neill. Is your question how you would entertain
the needs of tax incentives, and who would they go to?
Mr. Ney. Without changing our tax laws on the insurance
side reserves for terrorism, has that been discussed?
Secretary O'Neill. Yes, we have discussed it. It has a
certain amount of appeal, because it sounds like we are
inducing insurance companies to do the right thing. We are
lowering the cost of capital for insurance companies. I don't
know why we would want to do that.
Mr. Ney. Assuming we want to phaseout the Government
backstop, if that is an issue?
Secretary O'Neill. We are assuming as there is more
experience, the insurance companies will figure out a way to
neutralize the risk of terrorist attacks in the way that they
have done for hurricanes and tornadoes. There have been
accusations that there is somehow an interest in bailing out
the insurance companies or helping the insurance companies. A
tax incentive would lower the cost of capital for insurance
companies, which would be a prima facia case for a bailout for
the insurance industry.
Mr. Ney. I just wondered when we talk about incentives, to
eventually phaseout the Government's portion.
Secretary O'Neill. We are saying that we will back out, and
the industry will fill the hole.
Mr. Ney. I just wonder in 6 years, where are we at? I am
not saying that I would have an idea to have a proposal that
tax incentives are the way to go, I am just saying that the
Government is going to be removing the backstop. Are there
other incentives?
Secretary O'Neill. I don't believe so.
Mr. Ney. Thank you.
Chairman Baker. I am advised that the Secretary has a need
to depart. If I could make this request of Ms. Bair in your
absence to continue. We are most appreciative of your generous
time. We do thank you, Mr. Secretary.
If I might suggest to the Members, we appreciate Ms. Bair's
willingness to stay. We would ask that Mr. Hubbard come
forward.
STATEMENT OF R. GLENN HUBBARD, CHAIRMAN, COUNCIL OF ECONOMIC
ADVISORS
Mr. Hubbard. Thank you, Mr. Chairman.
I know that Secretary O'Neill has said a lot about the
proposal, so I do not want to go into a great detail, but I
want to spend a few minutes with your permission, Mr. Chairman,
to talk a little bit about the economic rationale and why we
proposed what we did, because I picked up a little of that in
the discussion, the questions that you were asking the
Secretary.
As an economist, the way that I think about the pure
economic events of September 11, in addition to the terrible
human tragedy, is that in one shot it gave a very powerful
supply shock to the economy and a demand shock.
The supply shock is that it raised the cost of almost
everything that we do. The first thing that we looked at with
the Congress is commercial aviation. We are talking about
insurance costs today, but the transacting cost of doing
business went up a lot. That ultimately is going to show up in
lower output and all the bad things we are worried about.
The second issue that does not concern us today is what is
the effect on household and business confidence. I think it is
important at the outset to reiterate something that Paul said,
this is not about the insurance industry.
The purpose of your holding these hearings, which I think
is very helpful, is to think about the property and casualty
insurance market and the cost of insurance. There is no reason
to suspect that this industry is not competitive, so that the
issue here is about costs of insurance and not about the
industry.
One way of thinking about the consequences of not acting or
not acting in a timely way is to ask what we might lose. We
have already been through the aviation issues and insurance.
Here the problem is much more widespread. There are at least
three ways of thinking about this. One, think about the new
projects. I am trying to build a new skyscraper or general
commercial real estate property. My ability to do that depends
on the availability of insurance and its cost. Second, and more
important, is existing assets. My ability to sell a building I
own, a power plant, any facility, depends on the availability
and cost of insurance. Those costs are capitalized into the
value of that asset.
If one thinks about the size of potential costs here, the
P&C premia are about 3 percent of domestic income, about $155
billion a year.
The Administration was concerned about some principles, and
I want to go over those. I picked up the flavor of some of the
questions to the Secretary.
In my own ordering, since I was not here for his remarks, I
don't know if it is his ordering. One is intervention should
encourage, not discourage, the private industry's ability to
expand capacity. That is what this is all about. That is
principle number one.
The second principle is that any intervention should be
explicitly temporary. We are in the view in the Administration,
and I gather many of you are from the questions that I heard,
that the industry is capable of stepping up to the plate for a
very large share of this and is capable of learning how to
price. We have seen this in other areas. We will come back to
that. We need to make sure that we have a receding Government
intervention.
Third, we need to give the private sector incentives to
limit losses should terrorist events occur, which means less
than full cost takeover by the Federal Government.
A fourth that I will come to at the end is that we need to
reduce one source of uncertainty that we really can deal with,
which is uncertainty about liabilities that arise from
litigation surrounding terrorist events.
Again, I would underscore that none of these principles has
anything to do with a bailout of the insurance industry. In
today's Wall Street Journal on the editorial page, an editorial
that I otherwise liked, I did not like the beginning because
there was an indication of ``eating cabbage.'' There was an
indication, coming to the table like we are today, that was
``eating cabbage'' in the editor of the Wall Street Journal's
judgment. They talked again about bailing out the insurance
industry, and that is not what we are talking about.
We want to work with you on the specifics. This is an
outline of our ideas. We think that our approach is consistent
with the principles from the economics of the problem.
First, we think that it encourages private sector capacity
building and respects the industry's ability to price, market
and service products. I am quite suspicious of alternatives
that involve direct Government setting of premiums. I don't
think that is something that Government officials, with all due
respect to my Treasury colleagues, want to be doing.
Also in that respect I think there are plenty of people who
say that the insurance industry cannot learn to do this. As
somebody who in my academic life has worked in insurance a long
time, I can remember 10 or 15 years ago naysayers saying we
will never figure out how to really do disaster insurance. We
will never figure out how to get beyond basic insurance and
reinsurance, and experience has proven that wrong. I realize
that this is a different set of risks, but I have every faith
in the industry as being better able to figure out the way to
go.
The second piece of what the Administration wants to do
that I think is important is addressing the issue of capacity.
I know that came up in some of the questions that the Secretary
got. The big issue here is back end capacity. Several Members
asked that question. I want to come back to that. That is the
key insurance question that the Government ought to be at the
table for.
The third is the fact that the industry is sharing in
losses, and indeed in our proposal sharing a greater burden
over time up to a cap, and provides, frankly speaking, a profit
motive to learn the price. Somebody asked why we had this
particular model, I believe it was Mr. Bentsen. The exact
numbers one can quibble with. The idea was to give slivers of
risk that the private sector would have an incentive to go out
and learn. If we take 100 percent of that for some short period
of time, we do not give that incentive. That was our economic
rationale for doing that.
A final point I would make with regard to these principles
is that the potential losses that we are looking at in this
event, hopefully not in any future events, certainly in this
event, depend not only on the security environment, which is
something that we are coming to grips with and has a lot of
uncertainty, but also in the legal setting.
The physical costs of Hurricane Andrew at the beginning of
1992 were pegged at $6 billion. They grew over time to more
than $20 billion, not because the physical damage was any
bigger that it was in 1992, but because of the cost in
litigation.
In order for the private market to do what we want it to
do, which is to take over the lion's share of this, we believe
and put in the approach that I believe the Secretary outlined
for you, a set of legal procedure issues that we felt would
facilitate greater private market participation. Those were
consolidating claims in a single Federal jurisdiction. That is
the sign to promote consistency and avoid redundancy, limit
some punitive damages other than obviously for actual
perpetrators and abettors, and proportional liability for
noneconomic harms.
This is not an attempt to marry tort reform agendas with
insurance agendas. We want the private market to come in and
work here. In addition to the uncertainty we are facing about
terrorism itself, we have to be able to address uncertainty
issues in the litigation area.
Let me say a little bit about roads not taken. Why not the
monopoly pool? There I think a couple of reasons. One, we were
very worried about monopoly power. To be frank, that just means
higher premiums for businesses and ultimately consumers. We did
not think that was wise. It also had the flavor of a very long-
term Government presence, which is not something we wanted to
suggest to you.
Somebody asked about charging premiums, why are we not
charging premiums for taxpayers being on the hook. We decided
on this sliding scale sharing mechanism as an alternative,
because we did not want the Government in the business of
setting arbitrary premiums. We will learn more about pricing
only as the private sector figures this out, not us in
Government.
Questions came up about health, life and business
interruption. Let me take those up. The health issues are
issues that should be discussed, but not in our view in the
context of the P&C legislation. Likewise on life.
Business interruption is, just to be really frank with you
as to why we did not put this in, is subject to very, in
econspeak, moral hazard problems. For small businesses, the
FEMA and the SBA emergency disaster programs do provide some
stepping in on business insurance. We, of course, obviously are
willing to work with you on what is in and out. In terms of
exposure for the taxpayer, as an economist I would offer you
advice: You do not want to put health, life and business
interruptions in.
The other road not taken was full Government socialization.
There again we felt the industry would not have any incentive
to learn how to price, and the exit from that we viewed at
least as being pretty dicey. That is a quick tour. I am sure
that the Secretary told you all about our wonderful proposal.
[The prepared statement of R. Glenn Hubbard can be found on
page 80 in the appendix.]
Chairman Baker. Thank you.
We are going to pick up in the line of questioning from the
Members who indicated an interest in asking questions of the
Secretary. Next is Mrs. Hooley.
Mr. Israel.
Mr. Ross.
Mr. Maloney of Connecticut.
Mr. Maloney. I have a couple of questions. The first one
goes to the issue of experience and the idea that companies are
going to learn how to price this risk. It strikes me that 3
years is a very short time to anticipate that to happen. I
think it is a short time from a couple of different
perspectives. The good news is what the Secretary was alluding
to, perhaps there will not be another event; and if there is
not, there is no experience from which to price.
Second, it is a very short timeframe from the perspective
of the world we live in. I think it is clear from what I
understand of the origins of these attacks, these are the
results of historical processes which have been at work for 20-
50 years. Bin Laden says 80. My first question is why 3 years?
Isn't that far too short, even accepting the model, you say the
road taken, even accepting the model for what you advocate,
isn't 3 years much, much too short?
Mr. Hubbard. This is a double-edged sword. What we wanted
was a quickly receding Government presence. So we compromised
with the 3-year number. We felt there was enough time for the
industry to begin getting experience on pricing. Part of that
would come from--since the industry is shouldering slivers of
risk, they will try to lay off that risk on the capital
markets, and modeling efforts will be used to fill in price,
and the natural disaster area will come to bear as well.
So is 3 years a magic number? No. But that was our
thinking. We wanted something longer than a very short run, but
not so long as to intimate a long-term Government presence.
Mr. Maloney. So there is no economic analysis behind the 3
years? It is a judgment call? It is sort of a best guess, is
what we are being told?
Mr. Hubbard. I can give you a fancy answer or a plain
answer. The plain answer is this is new terrain. What we can
learn by indirect example from the natural disaster area is
relatively rapid learning, modeling capabilities to set up a
securitization. We are in new terrain. I cannot tell you that
period is exact here, but we were comfortable enough after
talking with people in the industry and people expert in the
disaster area that was a reasonable place to start. If you said
4 years, we would not scream.
Mr. Maloney. Let me ask a similar question in regard to the
cutoff point of the $100 billion. First of all, if I understand
the proposal correctly, at the $100 billion there is no
mechanism for payment, there is simply at that point the
Treasury will sort of seek the advice of the Congress, and
maybe the Congress will do something and maybe it will not.
Maybe it will invest in some public improvements or maybe it
will not. In terms of the market and the ability of the market
to look at it, the $100 billion is the end of the line of any
kind of insurance that can be then priced?
Mr. Hubbard. I don't think so. I think on the back end,
$100 billion was just a sign that we need to go back to the
Congress. The obvious political answer is for a disaster that
large, we probably are looking at Federal Government
intervention. One model we might consider is a Price-Anderson
type model.
Our view was $100 billion is a sufficiently big event.
Mr. Maloney. The follow-on discussion is that that is what
the insurance industry is concerned about? At some level the
insurance industry, as I understand it, is not as concerned
about a $5 billion event or a $10 billion event? There is a
sense if that were the level of events, if that were the size
and scope of the events, there might not be a need for any bill
at all, and that their real concern is when you begin to get to
the upper end? That is where the real concern is? The point is
if you are asking the market to price something, you have built
a cliff, and I am a lawyer and not an economist, but you have
built a cliff in this bill that you have some coverage up to
$100 billion, and then there is nothing?
Mr. Hubbard. No, not that it is nothing.
Mr. Maloney. What is it? As I read the bill, it basically
says at $100 billion, go talk to the Congress?
Mr. Hubbard. Our intent was to try to come up with
alternative solutions. As you folks and the Treasury folks work
on this, you may specify what that is. I think that from an
economic perspective, you want the industry bearing some role,
even if it is tiny. Our intent was not to walk away, you are
exactly right.
Chairman Baker. Mr. Weldon.
Dr. Weldon. I understand your criticisms of creating a pool
which would put the Government in the business of pricing. It
would take a lot of capital and just kind of lock it up. I am
not sure that is the exact way to describe it, but the way you
have laid this proposal out, at the end of 1 year, and the
Secretary just testified if there is any first dollar exposure
the insurance companies are not going to write it, but if you
asked for first dollar exposure in the second year, do you
really think in 1 year the insurance companies, and unless we
have more experience, how are they going to be able to write
premiums to effectively value that level of exposure in just 12
months?
Mr. Hubbard. I don't know what the Secretary said, I was
not here. But if you look at year 1 and year 2 in the proposal,
our thinking was not just that insurance companies could not do
anything in year 1. They can. It is a question of cost.
For example, if we did nothing, we do not believe that
every project in America would go negative. I don't think that
will happen at all. Part of our concern was trying to stabilize
that supply shock so that there is a small cost to the business
sector in the first year. Then the deductible starts in the
second year.
If you decided to have a deductible in year 1, it does not
mean that none of this works. It simply means a higher cost and
makes it harder for us.
Dr. Weldon. I want to follow up on something that Mr. Ney
asked about in trying to address this through the Tax Code.
One of the ways I think we can possibly do that if you had
an officially declared disaster, the way that the insurance
companies pay the tax system and collect on the premiums, they
settle on the claims and what is left is taxed. If you had a
provision in the law that allowed for, once a terrorist act was
declared, that the costs of those claims would then be taken
off the corporate tax responsibility, would that not be an
easier way to encourage the industry to step up to the plate
and start pricing?
Mr. Hubbard. I don't think so. I agree with the Secretary's
remarks that you do not want to start complicating the Tax
Code. If there is a desire to revisit the taxation of
insurance, that should be a general question that gets taken up
by Congress. We felt that it was more transparent to do it the
way we did. We think that the incentive for the industry to go
out and build capacity is because of the risk that it is now
having to bear.
Chairman Baker. Mrs. Maloney.
Mrs. Maloney. I want to thank as a New Yorker the
Administration working swiftly on this.
Given your statement that we are in new terrain and the
comments of many of my colleagues, why not a shorter period?
Why not say for a year or just getting over the November crisis
and then coming back and studying it more. Many of my
colleagues are saying that we acted too swiftly on the airline
proposals, that we should have thought it through a little
better. Why not a shorter frame like a year or even shorter,
just getting through November and giving us more time to look
at it?
Second, the bill appears to be written in a way that would
give a big incentive to interpret occurrences as terrorist
occurences. Politics is everywhere. Earlier the Secretary was
saying the Administration should have more leeway. There would
be tremendous pressure if there is a crisis in one State to
declare something a terrorist act because it would reflect a
great deal of money. So how are we going to define it in a way
that it does not become something that can be so flexible and
that really has more taxpayer exposure?
Third, why 80 percent of the first $20 billion? Why not 50
percent? 50 percent for the taxpayers and 50 percent for the
private industry? How did we get to the 80 percent?
Lastly, could you share with us some of your thoughts on
what happened in England? Apparently they have had this pool
insurance policy. Has it been a big liability on taxpayers? Has
it worked? What has the experience in Britain been on insuring
for terrorism?
Mr. Hubbard. First, I am a fellow New Yorker.
Mrs. Maloney. Great. So you are feeling our pain.
Mr. Hubbard. I am feeling your pain.
First, on the question of why not just a year, I think our
feeling was in order to give some certainty to the process in
commercial lending and the construction of new projects,
particularly of concern in Manhattan, that we believe some
period longer than a year was necessary. We suggested three.
This is not a religious position that it be three, but I think
our position was that it be longer than a year.
On your issue of interpretation of occurrences of
terrorism, it is important to have a rigorous definition of a
terrorist act.
Second, a cabinet board or Presidentially directed board,
probably consisting of the Attorney General, the Treasury
Secretary, perhaps some others at the President's discretion,
to make these----
Mrs. Maloney. As a Member of the legislative body that has
to produce the money, that would put us in a very difficult
position, because the President can be put under political
pressure to determine that this is a terrorist activity, and
then we have to raise taxes to pay for it.
Mr. Hubbard. That is why you want a tight definition of a
terrorist act.
Mrs. Maloney. I would want to have it shared with the
legislative, not just be an Executive Branch decision.
Mr. Hubbard. That is something to be worked out in the
process. It is not obvious that the same political economy
problem does not arise in Congress.
The third question was the 80/20 versus 50/50. This is not
about industry, it is about cost. We picked a position which
would have cushioned the cost for business insurance purchases
in year 1. You could certainly do it 50/50. That would be a
smaller cushion. That is why we made the decision.
The U.K. pool Re model is a different policy choice. It was
a decision actually to have the Government more involved on a
long-term basis.
Mrs. Maloney. But has it worked? What has been the
experience? Has it cost more for consumers? Has it been a
successful experience?
Mr. Hubbard. The British made a conscious decision to be
long term.
Ms. Bair. The capitalization at the end of 2000 was 1.3
billion pounds. It was set up to deal with car bombs. We are
envisioning significantly greater events.
They do financial insolvency regulation. They have a
monopoly pricing structure, so they have to have financial
integrity regulation. It is quite an apparatus.
Chairman Baker. I am sorry, Sheila Bair was never properly
introduced. Sheila Bair is the Assistant Secretary for
Financial Institutions.
Mr. Rogers.
Mr. Miller.
Mr. Lucas.
Mr. Toomey.
Ms. Hart.
Ms. Hart. I just have a couple of questions. Is there
anything that you see in here that would encourage private
insurers to get back into the market, and I am not saying
skyscrapers, say nuclear power plants?
Mr. Hubbard. This proposal is related only for terrorism
risk insurance, unless you wanted to rethink generally. The
simple answer is nuclear power plants are covered under a
separate provision of Government intervention.
The insurance companies see now an opportunity to deal with
business, and the fact that the Government is on the back end
of it, the hope is that they will.
Ms. Hart. I didn't get a clear enough answer to Mrs.
Maloney's question about the 80/20.
Mr. Hubbard. The issue is what is the cost that is going to
be borne in premiums. Our judgment is in the short run we
wanted to err on the side of being cautious about premium
increases for business. That is the 80/20. You could well
decide to do 50/50 and stick within the same model. Indeed, you
move toward that in later years in our proposal. If you do
that, it would be higher cost increases in the short run. That
is the tradeoff.
Ms. Hart. Is it based on input from the industry?
Mr. Hubbard. We talked with industry and mainly with
commercial real estate holders and with large companies about
the share of insurance premia in income. You could do 50/50. It
would be a larger cost increase.
Ms. Hart. My question is when you made the determination
how much the Government would cover, was it based largely on
what would make it affordable to the consumer as well as
obviously what private insurers would cover?
Mr. Hubbard. There were two parts. One, if you think about
the outyears, the back end was primarily to focus on
catastrophic issues; and in the short run, we deliberately
erred on cost increases. That was our first and foremost issue.
Chairman Baker. Mrs. Jones.
Mrs. Jones of Ohio. Thank you, Mr. Chairman.
Mr. Hubbard, you keep saying it is not about the industry,
it is about what?
Mr. Hubbard. It is about people who buy insurance.
Mrs. Jones. But people who buy insurance create the
industry?
Mr. Hubbard. What I mean about it not being about the
industry, there is a use, even in the Wall Street Journal
editorial pages, which normally I praise, of saying this is a
bailout of the industry. That is simply not true. This is a
competitive marketplace. What you decide to do is being
reflected in premiums that policyholders pay.
Mrs. Jones. But the basis of us doing this is saying that
the people who use the industry will not be able to afford the
industry.
Mr. Hubbard. It is about the customers of this industry.
Insurance companies are just a pass through, as the Secretary
explained. They are just a financial intermediary. This is
about risk sharing in the economy and the cost of that risk
sharing.
Mrs. Jones. But there is some benefit of being a part of
the industry and having an insurance company? That is why
people invest in insurance companies because they are a good
benefit?
Mr. Hubbard. Absolutely.
Mrs. Jones. I am trying to make the point that it is about
the industry, otherwise we would not be sitting at the table
having this discussion about insurance.
My next question goes to you are saying this intervention
should encourage private industry to increase capacity.
Elaborate on that for me.
Mr. Hubbard. In other words, by creating an incentive to
price this; and after all the insurance companies are bearing
part of this risk and you have to figure out how to price it,
they will have to add capacity for those new lines of business.
And they should, prudent business practice, try to lay off some
of that risk, both through reinsurance and later to securitize
it.
Mrs. Jones. How do we ensure that the buyers of this
insurance, that they will not be priced out of the market when
their dollars are undergirding this industry by doing what we
do?
Mr. Hubbard. Competition. If the taxpayers are on the hook
for a fraction of this, that should float through to premiums.
If Sheila's insurance company tries to charge too much, I will
come in and undercut her. That process keeps insurance prices
down.
Mr. Kanjorski. If the gentlewoman would yield.
Mrs. Jones. Go ahead.
Mr. Kanjorski. That all depends on the size of the policy.
For a homeowner, there is not going to be competition. If Mrs.
Jones' insurance company triples her insurance policy, All-
State is not going to try to take that policy. That only
happens in large industry?
Mr. Hubbard. The process of competition works in mysterious
ways, and if you think about something known as long distance
telecommunications and aggressive competition on almost a
customer-by-customer basis, where there are profit
opportunities, people will come.
Mrs. Jones. I have got two more questions, so I am going to
ask you to keep your answers short for me. Compare what you are
talking about right now with floodplain insurance. Remember
when we couldn't cover--people weren't covered for floods and
we began to talk about a 100-year flood, and so forth, and so
forth, and so forth, tell me--compare that, if you could.
Mr. Hubbard. Well, the disaster insurance doesn't have the
same kind of sharing mechanism that we are talking about. It is
a subject for another day, would actually be the reform of
natural disaster insurance generally.
Mrs. Jones. Well, forget that question. Tell me--compare
what you are talking about--apply the concept you are talking
about to what we did for the airline industry and no caps on
victims, on the victims of September 11th.
Mr. Hubbard. You mean the whole airline package?
Mrs. Jones. Yes.
Mr. Hubbard. Basically I think what we are doing for
aviation--and I say aviation, not airline industry, for the
same reason I did before--was you were trying to----
Mrs. Jones. A semantical. Right?
Mr. Hubbard. Not under competition, it is about customers
and travelers. The reason for a Government intervention in
aviation, we can always argue about the----
Mrs. Jones. Short.
Mr. Hubbard. ----Is to help travelers, and today we think
about another industry where business costs are very, very
high. Well, part of your response earlier was something about
private market participation and putting caps on people's
ability to collect claims and so forth and so on. What are you
factoring in for the people, the victims in this instance, if
you are putting caps on their claims in the insurance industry?
And I may not be able to get an answer. Maybe you can give me
an answer later on. Am I out of time, or can I get the answer
to my question?
Chairman Baker. The time has expired, but if the gentleman
wants to respond.
Mr. Hubbard. This proposal, or this hopefully soon-to-be
proposal, doesn't envision separate victims' funds. That is a
separate thing. Is your question about the litigation involving
victims or----
Mrs. Jones. No. In one of your answers, you said the reason
we created this proposal was we took into consideration private
market participation. We put in caps on people's abilities to
make--and you listed six or seven other things that I wasn't--
--
Mr. Hubbard. Yes. Punitive damages was important. To avoid
certain litigation costs, you would want to cap non-economic
damages and punitive damages.
Mrs. Jones. But we didn't do that in the airline industry.
Ms. Bair. You eliminated----
Mrs. Jones. But there were no caps.
Ms. Bair. We are talking about a $100 billion aggregate cap
on payments that the Treasury Department and industry combined
would make before we would have--there is the moral obligation,
but before we would have to go to Congress. This is an
aggregate cap on liability under this program. It is not a cap
on tort liability. We believe to manage the litigation process
in the event of a major event, there need to be some reforms
along the lines of what was in the airline bill, which mainly
were claims consolidation and elimination of punitive damages.
So, two separate issues. And we were talking about aggregate
capping on this.
Mrs. Jones. I didn't understand that to be what you were
saying.
Mr. Hubbard. Yes. The $100 billion is an aggregate cap.
Mrs. Jones. Thank you, Mr. Chairman.
Chairman Baker. Mr. Ose.
Mr. Ose. Ms. Bair, my question comes to you. I served for a
number of years in Florida. The large property casualty
issues--also borrow money to build things, and I understand the
dilemma we are in. The thing we all struggled with before was
providing certainty for the actuarial models. Does Treasury
have a definition of a terrorist act that you would suggest we
consider?
Ms. Bair. We have been giving it a lot of thought and, yes,
we are ready to sit down as soon as you would like and share
our thoughts on that.
Mr. Ose. I think that would be very helpful to us. The
other question I have is whether the proposal that we have
talked about today, is this the President's proposal or is this
the Treasury Department's proposal? Is this just an option to
consider? What is it we are looking at here?
Mr. Hubbard. This is from the President. This is not
something the Treasury--that is why we are--this is a White
House-adopted, signed off on--this is the Administration's
approach.
Mr. Ose. I do want to compliment you. The biggest problem
we always had was, first, the certainty; then the pricing; and
then the processing of claims. And to the extent that this
proposal would insulate the Federal Government from getting
involved in the processing of claims, a remarkable step for
clarity and for the purpose to bring something to the
conclusion that goes beyond the understanding of people in this
room.
I do want to encourage you to get us a definition of what
the Terrorist Act is. That is the starting point, it would seem
to me. What is the Terrorist Act?
Thank you, Mr. Chairman.
Chairman Baker. Thank you, Mr. Ose. I have no further
Democrat Members, I think, to be recognized. I would continue
on our side. Mr. Fossella? Mr. Shays?
I just want to conclude by saying how much I appreciate
your willingness to participate today.
Mr. Bachus. We are going to continue to call him for
questioning, yes?
Chairman Baker. Well, we have another panel.
Mr. Bachus. I haven't had an opportunity to question him.
Chairman Baker. Oh, OK. Well, I went down the list and I
didn't let the senior Members ask questions of this panel. One
of the concerns that I had in reading an earlier version--and I
don't know where the definition is now, not having read it of
late. With regard to Mr. Ose's concerns and the definitive
circumstance under which an act of terrorism would occur and
then looking at the definition, the reading of it at the time
was that it was very broad, and I hate the word ``nebulous,''
but it wasn't necessarily very specific; and you could do
careful reading of the provision, and I can see where there
would be the question of $40, $50, $60 billion at stake, where
there might be some legal perspective that would want to take
that matter to court for some final determination. I rather
suggested that since the nature of these events are
extraordinary and unique and unfortunately will remain, I
think, in that category no matter what our preparations; that
the elements of each event are so unique that that should be a
determination by somebody, not a statutory definition, for the
principal reason of minimizing the potential for litigation.
Where we delegate--and the concern I think I heard
expressed earlier today, if it were not the President, if it
were a board, or we find some team on which this terrible
decision would have to be placed. As opposed to a statutory
definition, because I have not yet seen--and there may be an
artful crafting yet to be done that would eliminate all
probabilities--but my observation is that these events are each
unique in themselves, and you are not ever going to have a
definition of what has already occurred that would make
absolute clarity possible.
Mr. Hubbard. That is an excellent point. In the whole
process of trying to write out a definition, multiple sets of
bracketed language, we are struggling with it ourselves. I
think the idea of the board is a good one and one that we are
pursuing. I think we do want to have some designated board that
would make this decision. How much guidance you give that board
through the definitions is something that would be worked out.
Chairman Baker. Certainly. Well, if the President or a
President's representatives are required to make a declaration
of the natural disaster for purposes of FEMA relief, it
certainly seems like it should be appropriate in this regard.
Second, with regard to minimizing the bureaucracies, if the
proposal still stands where the 2,300 insurance principles will
make the claims for reinsurance reimbursement from the Federal
Government--and the Secretary's characterization is we just
write checks--even if that were the case, to process several
thousand claims with 2,300 providers, merely looking at the
forms is going to require I think an ample number of people
that we don't now employ to do that work.
Second, to then audit, as he expressed, the efficacy of the
claim and the fact that the person receiving it sustained the
damages for which the claim was made is an enormous task. I can
well imagine the Federal bureaucracy required to establish that
role. Hence, my suggestion that the interface might more
appropriately be the commercial reinsurance industry as opposed
to the Federal Government's relationship directly to the
insurance private delivery system; because the reinsurance
market is where the underwriting criteria are established,
where the security guards could be required, the doors be
replaced, whatever it is that the markets determine are the
most advisable to deter additional acts of terrorism, let the
market work, and in that event we are not paying money out
until after an actual claim has been paid.
We could then address some of the Members' concerns who
have spoken earlier about first dollar coverage or haircuts on
both end of the pipe, early and late, and at that juncture then
consider the repayment process. And at the end of the day,
under the current proposal, the Administration will share in
the cost of those events, and we are going to do that by using
taxpayer dollars.
Now, whether that is a subsidy or a bailout, that is not
appropriate. What I am hoping is that we can come to an
understanding we are using taxpayer money for a public purpose,
but that the taxpayer should not bear the brunt of this for
this reason: If we do the liquidity in the market so the
economy remains stable and we do it for the economic system,
but when they return to profitable and economic conditions are
stable, I would hate to think there would be a year in which we
would write a check for several million dollars for an industry
that at year end reports several million dollars profit. We
would not be looked on as very capable stewards of the
taxpayers' resources, for this is to facilitate our economic
system, not to enable the system to gain the books and make a
profit. And I have great concerns about that, the way the
structure of the current proposal is put together.
Mr. Hubbard. Well, because the proposal is so short term,
the Federal Government receives, and then if it has a presence
at all, if the Congress wishes, it would be on the back end.
And so I don't think you would be in that position. The
question you raise would be more for the very short term.
Chairman Baker. Well, I would never suggest this, but if I
were in the insurance industry and had great PR people, then I
would begin today after the passage of the act, begin building
a public necessity for permit--engage in a rather significant
communications program to say that unless the Congress
continues this at even better levels, you are not going to get
your coverage. We are going to have to face that one day or
another, and I would rather not put into place a system which I
think creates unlimited liability without an ability to recoup,
in some manner or mechanism, even to the extent of just giving
it to the Secretary of the Treasury and say when you think it
is right, go get a check. And if it is not right and if it will
cause economic turmoil, don't do it. But not give authority to
write checks rather without limit, not fully understanding who
the check is going to. And look at the interface with
commercial reinsurers to minimize that bureaucratic structure.
Now I am out of time.
Mr. Kanjorski. They talked about the need for a fair
impartial equity board, and by definition, that would rule out
the Supreme Court.
Mr. Hubbard. No comment.
Mr. Kanjorski. No. I am a little bit disturbed in terms
of--we seem to be talking about the events of September 11th in
New York, and not talking about the recent anthrax problem. And
if you look at it, I know I have one constituent in my district
who runs a huge mail order house. They officially are out of
business as a result of the threat through the mail and the
potential closing down of the post office. And if that were to
happen, we would have to make sure that we are not insuring all
businesses across the country because they can't get their
transactions. So we have to be fairly restrictive as to how we
write this policy.
I know my friend from New York, Mr. LaFalce, mentioned
business cessation, but there is no way that we could recover
that kind of losses. A catastrophic event, even of a minimal
nature, would rule that out.
I am disturbed that we are not thinking about other type
events. This is not just something that is going to be
concentrated in one area, but very easily could end up being a
nuclear stockpile, a waste facility that probably in one event
out of 104 nuclear plants, are likely to cause hundreds of
billions of dollars of damage. I think that should be included,
because, you know, we can't go to the limitations of policies
on nuclear plants--I think is $7 billion--and then we have 102*
an $300 billion dollars and a million people killed or radiated
and we have no coverage.
But one of the things that really disturbed me about our
failure to think this through to a large extent--and I don't
want to push on you and then the Administration--is that the
airline bill, the compensation act I think is atrocious. It is
indefensible, because it wasn't thought out, it wasn't properly
presented. We had 15 minutes, I believe, to read the bill
beforehand. I almost had a heart attack as a former tort lawyer
as to the potential liability. As I told Sheila, someday in the
not too distant future, the Treasury is going to be writing out
$1- and $2- and $3-billion checks to single estates in the
United States Treasury. I don't think that was ever the intent
of Congress, and yet the Administration hasn't come forward
with a terrorist victims' compensation act. We have already had
four or five deaths, and these people were in the service of
this Government. They were the direct result of terrorist
activity, and because they don't have contingent liability to
have to go to banks, they are not going to get airline
protection unless we do something about it.
And we have got a great time to do it right now. With this
bill--I agree we are not bailing out the insurance company, but
we sure as hell are encouraging business and providing a
reduced cost of business. If we are going to do that, we ought
to make sure that we compensate some of these people that are
directly or indirectly affected in their life and person from
the tragedies that are occurring and will occur in the future.
I think it is absolutely incumbent upon the Administration to
face that.
I also encourage the Administration to revisit the
compensation act. I just believe we have to have limitations on
this thing. To pay a bond trader that died in that building $3
billion when we are not compensating the people that died in
Oklahoma City as a result of the terrorist act, that we won't
be compensating these postal people that are dying all over the
country, that is ludicrous and unacceptable, and we have to get
out of a mind-set of just thinking about money for bricks and
mortar. There are more people that could be hurt, and will be
hurt, in terrorist activities in this country that deserve the
total feeling of the taxpayers in the entire country to provide
some compensation, not to make them wealthy, but to make them
as near whole so that they can exist with their loss as
possible. So I think we really have to study that. And in
reality, we will be saving the taxpayers money when we do go
back and find out how we can put a cap on this exposure.
Mr. Ose. Will the gentleman yield?
Mr. Kanjorski. Yes.
Mr. Ose. When Paul talks about this, one of the questions
that comes to my mind is with what happened on September 11th,
one, two, or three terrorist acts, and I think that is right in
the middle of your questioning, and we don't know what the
answer to that is, and if it is 1, you know, the limitations on
the policy are X; but if it is 2, it is twice a big as pi; or
if it is 3, it is 3 times as big.
Chairman Baker. 3.6 at risk if it is one event. 7.2 if it
is two events.
Mr. Kanjorski. Right now we are really trying to insure
bricks and mortar and not people. After all, if the General
Motors plant gets wiped out, it may be a $10-, $20-billion
disaster. I would hate like hell to see a check for $20 billion
going to General Motors when there are 2,000 families that lost
their breath--and if we can send people in harm's way over to
Afghanistan and only have a liability of $250,000 with them, we
have to provide the soldiers on the homefront with some
liability. And we shouldn't have unlimited liability or
compensation for people that have to die in New York.
And I feel very sorry for them, but we are not to make them
totally whole. That was never the intention, should never be
the intention of the United States Government, because it is
just incredibly--that liability, $30 to $70 billion, that is an
awful lot of money. It should be used in other anticipatory
events. And I guess with that I will----
Chairman Baker. Your time has expired.
We are going to have to step out for a vote on the floor. I
believe Mr. Bachus indicated to ask his question. On the
conclusions of Mr. Bachus' questions, he will have to come up
to the floor for the next vote. The bad news is for the next
panel, I am told, that the votes that are now pending will keep
us 20 minutes. And then we will reconvene for our final group.
It has been suggested that we just delay the third panel and
conclude that tomorrow, but I haven't had a chance to talk to
Mr. Kanjorski about it. If you are here, I suspect many of you
would like to go ahead. With that, I recognize Mr. Bachus in
the chair, and we will return in a moment.
Mr. Bachus. [Presiding.] Mr. Hubbard--and I think some of
these questions have just been asked--there has been a
significant blurring of the line between acts of terrorism
and--between acts of terrorism and acts of war, and I don't
know that anything in this will clear it up. Will a future
attack by Usama bin Laden's network be covered by the
Administration's proposal?
Mr. Hubbard. Well, formally what we have been looking at is
the war being mutually declared, more a formal declaration of
war as opposed to a terrorist act. I agree with you, including
the President's own rhetoric, maybe the impression of a blurred
line between war and terrorism is certainly an open question.
Mr. Bachus. Another attack by this network or another
terrorist network. And if we don't clarify what this
Government--I mean, if it doesn't cover acts of war, then----
Mr. Hubbard. At least under the current definitions,
another bin Laden attack and the present lack of a declared war
would qualify as a terrorist act.
Mr. Bachus. How about by the Taliban?
Ms. Bair. No, we have decided that our current thinking is
to have a bright line with a U.S.-declared war and----
Mr. Bachus. The other thing, and I am not sure I disagree,
but public policy questions have got to be what this Congress
is going to do about health and life insurance coverage. If it
is written to exclude terrorist acts, it is going to affect an
awful lot of people, particularly when we are stepping in and
procuring commercial law, not health law.
Mr. Hubbard. We felt that at the moment, we wanted to focus
narrowly on P&C laws, one of which is workmans' compensation,
so there is some health related. What isn't is other health
insurance. My impression of the HIA folks is that at least at
the moment, to not exercise--they are----
Mr. Bachus. That is something that we probably ought to at
some point take up.
Ms. Bair. There doesn't appear to be an obstruction of the
market for life and health right now.
Mr. Bachus. You are talking about the short term, and you
want to get into the short term and do something, and the long
term that the market ought to take care of. Let us assume
that--should there be tax incentives for the private sector to
build reserves against terrorist groups? That is not in here.
Mr. Hubbard. No. That's right. We felt that we should just
go more directly with the sharing scheme in the short run. I
don't think it is a wise idea to distort the Tax Code. I think
we can more explicitly----
Mr. Bachus. Well, you know, what you do is a 3-year deal,
but at the same time, when people finance property, they
finance 10 years, 20 years, and 30 years.
Mr. Hubbard. That is true, but nobody guarantees you
insurance over 10, 20 or 30--all insurance has features or rate
change features. I think the idea was to give the industry
time.
Mr. Bachus. If they are going to finance property and--will
a 3-year plan actually cause them to bill that--to finance that
property, when, you know, they are going to be financing it
over 10 years or 15 years or 20 years? And what I am thinking,
you know, have a 1-year plan, but come with some Government
backstop is a better proposal than what you have here, and then
you are not getting the Government as involved in the second
and third--creating some backstop.
Mr. Hubbard. Well, our hope is that 3 years would be enough
time that the industry would have developed better pricing
methodologies going forward. If you do just the year, our
concern was that you are having an almost freezing in place for
a year while people wonder what the Congress will do.
Mr. Bachus. Another terrorist attack, another terrorist
attack, this 3 years is going to turn into 6 years and it is
going to continue to be pushed back. I am just saying that--
backstop as part of a long-term solution.
Mr. Hubbard. You should defensively do a backstop for a
long-term solution. The question is the short term.
Mr. Bachus. Should an insurance company's eligibility for
the program be conditioned on providing terrorist risk
insurance in all its P&C policies? You are not doing that in
here.
Mr. Hubbard. Well, it is an open question, actually,
whether this is mandatory or not.
Mr. Bachus. You mean legislation? We are not sure about
looking at the legislation?
Mr. Hubbard. No. I think it is an open question in this
process whether you want to make it mandatory or not. One
school of thought would be that----
Mr. Bachus. Require P&C insurance to provide----
Mr. Hubbard. Well, that would be a step that you could
take.
Mr. Bachus. Is the Administration open to that?
Mr. Hubbard. We are looking at all these options.
Mr. Bachus. You haven't rejected that option.
Mr. Hubbard. No.
Mr. Bachus. Particularly if the Government is going to be
involved in a matter of public policy, if we are going to get
involved in it, we want to make insurance affordable and
available. And if we don't, and if we allow P&C companies to
only select certain risk and--more high risk--to me it doesn't
get--utilities, things of that nature.
Mr. Hubbard. I agree. The tension was the Federal versus
State aspects of the insurance industry in the U.S., but I
agree with you in principle that that is a concern.
Mr. Bachus. And I am just saying if the Government is going
to get involved, the Government ought to say, you know, you
offer it and you make it available.
Ms. Bair. I would just say I think we thoroughly discussed
that, and you might want to pose that question to them. I think
there are a couple of questions. One is do you want to require
that all P&C insurers provide the coverage, or do you just want
to say it has to be a standard part of the P&C policy?
Mr. Bachus. Well, you could. So your eligibility to
participate in this program----
Ms. Bair. Well, you still have an adverse----
Mr. Bachus. You don't have to provide that coverage, but if
you don't provide that coverage, you don't participate in this
program, because the program's design is to make that coverage
available. And why allow someone who has no intention of
providing that coverage to participate in the program; or has
existing coverage, perhaps for the next year that is already
written, but, you know, they have no intention of rewriting it?
Ms. Bair. I think the 20/80 approach in the first year
reduces the incentive for insurers to cherry-pick.
Mr. Bachus. Well, a better incentive would be just a
requirement that they participate in the program. And I would
rather do that than constitutionally tell them they have to
provide it. I think if they participate in the program, they
have to.
Ms. Bair. Yes.
Mr. Bachus. You know, the British plan, their
contribution--well, let me just say this. What about an ex-post
subsidy? You know, for our cause, would you consider that?
Mr. Hubbard. Priced how?
Mr. Bachus. I don't know. Just give maybe the Secretary
some discretionary authority to charge assessments based on
some of the--to recoup any losses associated with administering
the program.
Mr. Hubbard. But then you are not encouraging the private
industries' ability to price. I think our----
Mr. Bachus. No, I agree.
Mr. Hubbard. Our prejudice is the private industry could--
--
Mr. Bachus. Yes. Thank you both for your testimony. I would
now like to bring our third panel up.
We have a distinguished panel, and I always feel sorry for
the third panel of any day, but particularly today, I know some
of you came from out of town, in these wonderful quarters we
are having for this hearing. But all that aside, we truly
appreciate your being here, and I am subbing for Chairman Baker
until he returns. But we wanted to give you folks an
opportunity to testify and for the panel to ask questions.
Let me begin just to introduce the panel: Mr. David Mathis,
Chairman and CEO of the Kemper Insurance Companies; Mr.
Constantinos Iordanou--I always mess up this--Iordanou, Senior
Executive Vice President of Group Operations and Business
Development for the Zurich Financial Services Group; Scott
Harrington, Professor of Insurance and Finance, Moore School of
Business, University of South Carolina; Mr. J. David Cummins,
Harry J. Loman Professor of Insurance and Risk Management at
the Wharton School at the University of Pennsylvania; Mr. David
Keating of the National Taxpayers Union; Mr. John T. Sinnott,
Chairman and CEO of Marsh, Inc; Mr. Roy A. Williams, Director
of Aviation from the Lewis Armstrong New Orleans International
Airport; Mr. Richard J. Hillman, the Director of Financial
Markets and Community Investment, U.S. General Accounting
Office; and Ms. Marjorie S. Nordlinger, Senior Attorney, Office
of the General Counsel, Nuclear Regulatory Commission.
Thank you all for your patience under these very difficult
circumstances.
We will begin with the gentleman from Chicago, Mr. Mathis.
STATEMENT OF DAVID B. MATHIS, CHAIRMAN AND CEO, KEMPER
INSURANCE COMPANIES
Mr. Mathis. Thank you. Thank you all for allowing us to
attend. Having listened to some of the presentations today and
having seen some of the other presentations earlier, I am going
to cut short some of the comments that I would make in order to
allow more time for questions and answers at the end. I do want
to point out that Kemper is a large property and casualty
insurance company, based in Chicago, with offices throughout
the United States and in many foreign countries. Our largest
line of business is workers' compensation coverage, but we also
are a prominent writer of commercial coverages for a variety of
businesses, from Main Street operations to mid-sized firms and
to Fortune 500 companies.
I would point out also that as a structure, we are a mutual
insurance company owned by our policyholders as opposed to
being owned by the stockholders.
Skipping forward, I would mention that Kemper, like other
property and casualty insurers, has been steadfastly committed
to meeting our promises to policyholders as a result of the
September 11 event. Our pretax losses are estimated at $360
million gross and $60 to $80 million net of reinsurance. I
mentioned the two figures, because as we go forward I think it
is interesting to keep in mind that absent reinsurance in this
type of event, we would be looking at a $440 million loss as
opposed to an $80 million loss. So the function of reinsurance
has been important and continues to be important for the
industry. While that is a significant sum, we will continue to
meet our obligations to policyholders with no difficulties, and
that includes the payment from our reinsurers as we go forward.
For the industry as a whole, we are looking at losses from $30-
to $60-billion, although the final number will not be known for
some time.
Although no natural disaster or, for that matter, man-made
catastrophe even comes close, for the sake of reference, I
would note that Hurricane Andrew, which devastated south
Florida, caused approximately $19 billion in insured losses,
perhaps half compared to the September 11th losses. Put another
way, the September 11 losses will exceed the entire property
and casualty insurance net income for the past 3 years, 1999,
2000 and 2001. In just one day, industry profits for 3 years
were wiped out, depleting investment income.
Recognizing that the American people and our economy will
recover and move onward, we also are looking ahead. And
although the property and casualty insurance industry can deal
with the incredible loss of September 11th, we are very
concerned about what will happen if additional large-scale
terrorist acts in the future occur. It is critical that you as
public policymakers share our recognition that terrorism
currently presents four challenges to the insurance marketplace
which we cannot meet. It is crucial that everyone recognize
that we are dealing with a peril that is at this stage not
quantifiable and therefore not insurable within the finite
resources of the insurance industry. Quite simply, the
financial capacity of the industry is limited, and
unfortunately, the potential harm that terrorists may inflict
is unpredictable in frequency and unlimited in severity. Given
this mismatch, insurers and reinsurers cannot assess, measure
or spread the risk of terrorism. As a result, terrorism has
become uninsurable in the private market. This insurance market
crisis, and, by its extension, pending economic crisis is why
we are all here today.
As you probably are aware, more than two-thirds of the
annual reinsurance agreements--and we have all talked about
that--by which primary insurance companies purchase their own
insurance to adequately spread risk are renewed as of January
1, and reinsurers have already notified primary carriers that
the reinsurance contracts coming up for renewal will provide no
coverage for terrorism. And although the primary insurance
sector in the industry is adversely affected by such decisions,
we recognize that this may well be the reinsurers' only way to
protect against insolvency themselves.
Primary carriers, however, do not have the same flexibility
as reinsurers with respect to their own products, because we
are subject to tighter regulatory oversight. Any terrorism
exclusion we might choose to introduce must be approved by
individual State regulators. If approved, our customers could
find them bearing 100 percent of the risk associated with
terrorism, and certainly the repercussions of this are clear.
However, if exclusions are not approved, primary insurers would
be left to shoulder 100 percent of future terrorist losses,
which we cannot do.
Allow me to give you an example of and to illustrate the
higher retention of risk imposed on the industry. One of the
Members of the subcommittee mentioned that we were not involved
in dealing with lives here. We specialize in workers'
compensation sector business, which significantly deals with
lives. And let us say that an insurer provides workers'
compensation coverage for a manufacturing facility with 6,000
employees. The plant in my example would not be located near an
earthquake fault or any other place where a natural disaster
caused a workforce loss of life. If, God forbid, that plant
would be targeted by an extreme terrorist act which takes the
lives of all the employees, the workers' compensation claim,
depending on the State where the plant is located, could run
between $2.5 billion to $3 billion and could fall on that
individual insurer without reinsurance.
Chairman Baker. I hate to interrupt you, but for the sake
of the proceeding, on the panel I would ask that everybody try
to prepare your remarks, revise them to, like, a 5-minute
limit. We will incorporate the full statement into the record,
and to give you a minute to collect your thoughts, if you could
begin to summarize for us, because we will have other Members
coming back, and it is going to be a lengthy evening for us if
everybody wants to ask everybody questions.
Mr. Mathis. I will do it without notes. Let me just say
that a basic part of our discussion has been associated with
trying to find a means where the industry would spread risk and
could get a backup to replace the reinsurance mechanism. In our
instance, I think the major issue that should be kept in mind
really relates to four points. One is that the larger the
amount of risk that the industry is forced to retain, without
an adequate ability to spread that risk, will create a
dislocation by individual companies. And that was the reason
that the industry put forward a proposal to spread the risk and
provide a Federal Government backstop.
Second, the industry needs to be in a position where it can
pass rate increases on, in terms of any kind of charges for
whatever net retention or, for that matter, whatever charge the
Government may impose for its backup in terms of reinsurance.
So any Federal legislation should provide some State regulatory
preemption to allow that rate regulation to go through.
Third, the industry would need to be consistent in its
wording for terrorism, not only with the Federal Government,
but also with each insurance policy, and as a pass-through to
the reinsurance industry as well. If you have a different
definition of terrorism, which is excluded in the reinsurance
industry, the industry would have no recourse but to underwrite
against the biggest potential loss or net losses to the
company.
And finally, the industry would need to have some measure
of giving credit for any kind of reinsurance. So, bottom line,
the industry needs to find a way to spread risk. We do not
think that all of the proposals that are presented allow us to
do that.
[The prepared statement of David B. Mathis can be found on
page 87 in the appendix.]
Chairman Baker. Thank you very much.
Please excuse me, is it Iordanou?
Mr. Iordanou. Yes. It is a Greek name.
STATEMENT OF CONSTANTINOS IORDANOU, SENIOR EXECUTIVE VICE
PRESIDENT, GROUP OPERATIONS AND BUSINESS DEVELOPMENT, ZURICH
FINANCIAL SERVICES GROUP
Mr. Iordanou. Chairman Baker, Chairman Oxley, it is a
pleasure to be here. Zurich is a multinational insurer of
significant size. We operate in 60 countries with $20 billion
in equity capital. We have significant operations in the U.S.
The event of September 11th will cost consumers anywhere
between $700 and $900 million in losses. This is net of
reinsurance. If we would have counted our direct loss absent of
any reinsurance protection, that would have been significantly
higher, probably approaching $2 billion. Clearly, these are
substantial amounts, but, however, Zurich in its strength with
its global capital base can absorb these losses without any
long-term financial implications for us, assuming there is no
subsequent event of a size and assuming that we continue to
have the ability to protect our balance sheet reinsurance
purchases.
I will tell you today that we have notifications from all
of our reinsurers that as of January 1, coverage for terrorist
acts will be excluded from our reinsurance. So what does that
mean? Unfortunately, for us it means that at a time when our
customers need this coverage the most, not all the customers,
but our largest and our smaller customers are being told by us
that they cannot renew their insurance coverage absent some way
of excluding terrorist risk. The larger ones have been told so
because they represent very high-dollar risks to a single
location and the smaller ones are being told so because the
potential of risk in a particular territory creates the same
issue.
This is a new economic reality, which is sad, but very
real, and we need to deal with it. We now have such drastic
steps----
Chairman Baker. We are sorry. We are just trying to figure
out strategy on the votes we have, just so we can dispel this.
We are going to wait and run up to the--so we will go 5
minutes.
Mr. Iordanou. Without the drastic steps that Zurich is
taking to protect its balance sheet, but at the expense of our
customers, we can't continue to assume these kinds of risks.
The private sector, in my view, is the way to respond to
the situation and could potentially fill the void with some
normal risk management tools. However, the cost to the Zurich
for such tools will be prohibitive, and they will fail to
provide sufficient capacity to address the multiexposures that
the U.S. economy faces today.
Any Government solution should measure and should focus on
bringing sufficient stability back to the insurance market so
that companies like Zurich will feel comfortable including
coverage for terrorist exposures to its risk portfolio.
I would remind the subcommittee that the essence of
insurance is to efficiently apply capital to risk, so the
standard way in which we determine whatever that goal has been
met will be to whatever the degree and concentration of capital
exposed to future terrorist acts is manageable. Too much
exposure will force insurance to continue excluding terrorists
from their coverages. However, we also appreciate that too much
taxpayer exposure results are unacceptable. The solution, in
our view, will need to balance the market's need for maximum
stability with the Government's need for minimum exposure to
these types of risk and involvement in the free marketplace.
I, for one, am confident that such a balance exists and
would urge all participants to move this debate to focus on the
common themes embedded in the options offered to date instead
of the shared shortcomings we see in those options.
For example, the industry's original proposal utilized a
pooling concept utilized a pooling structure, an approach that
has longstanding use within the industry and has served other
nations well in their quest to address the economic realities
of terrorist risks. We understand while the concerns have been
expressed, and that the debate has moved beyond this proposal,
but the underlying concept of facilitating the spreading of
this new type of risk is an important one that should not be
abandoned. Ultimately the success or failure of this effort
will be judged in the marketplace on a risk-by-risk basis, not
by some broad industry aggregate, so there might be some
component that serves as a proxy, even in the medium term, to
the traditional reinsurance mechanism.
The White House has quoted a different approach that
utilizes a pro rata risk sharing concept. It is a short-term
stop-gap measure that increases the private sector retention in
the second or third year, probably to the levels that are
beyond the industry's capability to handle. Plus, there are a
number of operational questions that would need to be answered
before judging the effectiveness of this approach. However, the
proposal effectively spreads both the risk and aggregate
exposures that the industry is facing and signals a very
important recognition on the part of the Administration that
the Government does have a role to play in managing what are
fundamentally political risks in our view.
Both proposals, then, reflect the underlying concept of
shared private and public sector responsibility, and with
modifications--some major, some minor--could serve as the basis
of a meaningful resolution to this problem.
In closing, I would suggest that anyone who views a
thorough backstop as a bailout may be underestimating the
discipline of the private marketplace. The actions Zurich and
other insurers have taken to minimize their exposure to
terrorism are firmly in line with economic reality. Our capital
is finite, but the risk is infinite. Thus, if there is any
``bailing'' out occurring, it is the natural tendency and
expected flight of capital away from terrorism risk. This
should not be surprising, since it is how markets operate in
general, and it reflects an immediate manifestation of how the
capital markets are responding to the ``new normalcy'' of post-
September 11th American life.
Thank you for allowing me the time to present to you
Zurich's perspective, and I would be happy to answer questions.
[The prepared statement of Constantinos Iordanou can be
found on page 95 in the appendix.]
Chairman Baker. Thank you very much.
What time do we have remaining? If we would, Mr.
Harrington, we will recognize you, Professor of Insurance and
Finance, University of South Carolina. Welcome.
STATEMENT OF SCOTT E. HARRINGTON, PROFESSOR OF INSURANCE AND
FINANCE, MOORE SCHOOL OF BUSINESS, UNIVERSITY OF SOUTH CAROLINA
Mr. Harrington. Chairman Baker, Mr. Oxley. I spent my
career studying insurance, and I really appreciate the
opportunity to be here to have this opportunity to testify.
We don't know how bad things are going to get this winter
when these contracts are ultimately--we don't just know yet.
Some Federal intervention may be very desirable to prevent a
potential crisis. But we need to consider very carefully--
insurance involves the fundamental tension between risk sharing
and incentives--you have heard a little bit about this today.
We widely appreciate the incentives of risk sharing. The moral
hazard effects are likely less appreciated. It tends to dull
incentives to manage risk. At this time, private markets do a
tolerably good job of dealing with moral hazard.
Government insurance programs or Government-backed
insurance mechanisms--they are also not likely to provide good
incentives for efficient claims management. They are not going
to provide the right incentives for risk management in the
private sector.
Subsidized Federal reinsurance or direct Federal
reimbursement of a large proportion of terrorist losses could
make citizens more vulnerable to harm. And, again, it could
make citizens more vulnerable to harm. If insurance against
terrorist acts is made available at heavily-subsidized rates,
some--perhaps many--businesses could take far fewer precautions
to protect life and property. If you help too much, there is a
good chance that more property will be destroyed and more
people will, in fact, die.
The Administration's proposal has some advantages. It might
keep the Federal Government out of pricing insurance; but then,
it might not, because if you start thinking about mandating the
offer of such coverage, I think you are going to pretty quickly
have to think about limiting price. It could be awkward.
I think the Administration's proposal would provide some
limited subsidy to the insurance industry. It would provide
some significant subsidies to large commercial property owners.
I think the major problem is the first dollar coverage at an 80
percent basis. Professor Hubbard said that they wanted to err
on the side of caution. They erred on the side of too much
precautionary risk spreading. That proposal would seriously
undermine the integrity of risk assessment, claims adjustment,
and management. And the proposal does relatively little to
encourage capacity. In fact, I think it does very little to
encourage capacity.
I encourage you to consider two things. One is some form of
tax incentives for insurance companies to build the massive
amounts of capital it takes to write this stuff. We are not
talking about distorting the Tax Code. The Tax Code distorts
these markets immensely. It is a punitive tax on the private
sector. If we are going to try and help these markets
accumulate capital, then we need to remove some of that
punitive taxation.
I think you could encourage supply substantially with some
form of temporary system of ex-post assessments. Let me just
step through that very quickly. You might have a system where,
with $5- or $10-billion in terrorist losses in a year, God
forbid, that insurance companies, all property casualty
insurance companies, will be assessed to finance a material
proportion of the losses above that threshold. The insurance
companies could limit their risk. We could allow them to borrow
from the Treasury if the assessments in any given year exceeded
some amount like 2 percent of the premiums. They could pay back
the amount that they borrowed with future assessments under
that type of proposal, if necessary, at a higher threshold. The
Government could then become a direct sharer in the risk
bearing.
In conclusion, I think the tax incentive approach and the
possibility of ex-post assessment of the insurance industry
would help mitigate the threat of a crisis and mitigate these
inherent problems without substantial undermining of private
sector risk assessment, claims settlement, and risk management,
and I really think that the result could be less loss of
property and less loss of life. Thank you.
[The prepared statement of Scott Harrington can be found on
page 102 in the appendix.]
Chairman Baker. Thank you very much.
I think we are going to call our next witness and proceed
before we depart for the vote. So Mr. David Cummins, Professor
of Insurance and Risk Management at the Wharton School.
STATEMENT OF J. DAVID CUMMINS, HARRY J. LOMAN PROFESSOR OF
INSURANCE AND RISK MANAGEMENT, THE WHARTON SCHOOL, UNIVERSITY
OF PENNSYLVANIA
Mr. Cummins. I would like to thank the Chairman and
subcommittee Members for allowing me to be here today. I have
outlined some principles that I think any Federal program
should satisfy, and to say at the outset that they are more
consistent with the Administration plan than they are with the
private insurance industry plan. I am basically very much
opposed to the private industry plan. I think the
Administration plan has a number of features to recommend it,
but there are a number of features or problems that would have
to be fixed before it would be enacted and be really an
effective program.
I think, first of all, the program should have the clearly
stated objectives of helping the policyholders, insurers, and
the economy to weather the current crisis by encouraging
private insurers to return to the market as soon as possible.
Second, the Federal program should avoid the creation of
any new institutions or new bureaucracies, such as the homeland
security insurance company proposed by the industry.
Third, the Federal contracts have to be sold at a positive
price. Providing free coverage would set off all the wrong
incentives in terms of claims settlement and charging premiums
in the direct market. So you have to come up with a price. I
would recommend hiring an actuarial firm to apply the
principles of actuarial science to come up with the best
possible price under the uncertainties that we know are present
in the program.
Fourth--and this is a commendable part of the
Administration's proposal--that any Federal coverage should
have a cost sharing provision, where the Government should
never cover 100 percent of any layers. So it should at least be
20 percent covered by the industry, or maybe even more than
that, except possibly at the very highest layers.
Fifth, Federal coverage should start after a reasonably
large deductible. There should be no first dollar coverage,
even during the first year. The industry could easily bear $5-
to $10-billion. That is not the layer that they are really
concerned about, and it sets the wrong incentives to provide
Federal first dollar coverage.
Sixth, the Federal obligation should be capped. There is no
magic number, but $100 billion is probably reasonable; perhaps
something somewhat less than that would also be a possibility.
And this basically gives the Congress the option to come back
in at the $100 billion layer and either agree to continue or
extend the program or decide to do something else. You don't
want to put an unlimited program in place.
Seven, the program should be limited to property coverage--
--
Chairman Baker. Just stop for a moment. We will put Mr.
Bachus in the chair. We will be right back.
Mr. Cummins. The coverage should be limited to property
coverage and other coverage to terrorism where the loss amounts
are relatively easy to identify. For example, the program
should not provide coverage for difficult-to-verify claims such
as business interruption insurance. This is to prevent abuse of
the Federal program and to provide incentives for policyholders
to get back in business as quickly as possible following a
loss. There may be the need for other policy remedies,
especially for small businesses facing business interruption
crises, but it shouldn't be a part of the insurance program.
Consideration should be given to incorporating ``finite
reinsurance'' provisions in any Federal plan. Essentially
finite reinsurance transfers less risk to the reinsurer than
traditional indemnity reinsurance that is basically intended to
smooth out the insurers' losses over time. The reinsurer
essentially advances money to the insurance company when losses
are high, with the obligation of the insurer to repay most of
the money when losses are relatively low. This might be
especially appropriate in a Federal plan at the lower layers of
coverage.
And then finally, the Government should explore ways in
which it could encourage the development of private markets for
catastrophic risk without providing Federal backing, such as
lowering regulatory barriers to securitize the insurance risk,
and perhaps acting as a facilitator of securitization by
providing data that could be used by private firms in
developing better loss indices to enable the provision of
securitized financial instruments which are much more efficient
than insurance in insuring this type of risk.
So I guess just a couple comments on the Administration
proposal. Several things I see wrong with it. First is
providing first dollar coverage during the initial year is not
a good idea. The industry should bear the first $10 billion of
coverage.
Second, without going into each year and each layer, case
by case, the proposal is generally too generous, and it is
split between the Government share and the industry share.
Third, the finite reinsurance option should be seriously
considered for lower layers of coverage, with the indemnity
reinsurance going to the higher layers.
And then, fourth, the program should exclude certain types
of difficult-to-verify claims, such as business interruption
insurance.
And then also it is important to charge a premium for the
coverage. Thank you.
[The prepared statement of J. David Cummins can be found on
page 107 in the appendix.]
Mr. Bachus. [Presiding.] And their proposal does exclude
businesses. Right?
Mr. Cummins. It excludes punitive damages.
Mr. Bachus. My understanding is the last draft took out
that. Well, I think it is going to, if it hasn't, as a result
of the testimony today.
Mr. Keating.
STATEMENT OF DAVID L. KEATING, SENIOR COUNSELOR, NATIONAL
TAXPAYERS UNION
Mr. Keating. Mr. Chairman, thank you for the invitation to
speak before the subcommittee today. We represent 335,000
members, and we are strongly opposed to the insurance industry
proposal and the Administration proposal, at least as it has
been offered. I would like to associate our views with what I
have heard both from Professor Harrington and Professor
Cummins. All of the concerns that they have raised, all the
points that they both made I think were excellent, and the
subcommittee should keep them foremost in your mind as you go
to draft any legislation.
We wholeheartedly agree that both these proposals stand the
risk not only pf putting taxpayers in danger of unnecessary
losses of human life and property, and I didn't hear much--and
much to my disappointment--from the Treasury Secretary or Mr.
Hubbard about that, and I think that most people agree human
life is the key thing that we should be watching here. And we
need to have incentives for the people in the industry to watch
their clients to see that they are putting forth the proper
security measures, escape mechanisms and such, and if we just
give away Federal reinsurance, we are not going to see that
kind of activity taking place and clearly we need to have that
kind of activity. People need to reassess how they are running
their businesses.
It is essential that we limit the Government's total
liabilities in any action or legislation, that you make firm
limits or policy, clearly define terrorism, and limit the
Government's exposure to certain types of losses. We are very
concerned about business interruption coverage. Otherwise we
could see the Government paying companies not to go back to
work for years.
We see the same problems with unemployment insurance. I
mean, people don't have the same incentive to go get a new job
if the Government is underwriting their business revenues even
though you are not in business. Things are very vague and can
be stretched out. We can't go there.
We also have to make sure insurers pay enough of the claims
out of their own pocket. Otherwise they are going to make their
long-term clients happy with Federal Government taxpayer
dollars. Easiest thing in the world to make someone happy with
someone else's money.
Now, I also want to express my surprise and shock about the
Treasury Secretary, of all people, and the Chairman of the
Council of Economic Advisers, their understanding of tax laws
regarding insurance. To me it is astonishing that they think
that somehow allowing reserving on a tax-free basis for the
expected losses from catastrophes is somehow a distortion of
the tax laws. They have got it exactly backward. The tax laws
are what are distorting sound insurance principles here. If we
knew with precision what the future would bring, we could set
aside the money now, the exact correct amount, so that when the
disaster happens, the money would be there. If you guide it by
years, you know it is the cost of doing business; yet the way
the tax laws are written, that cost of doing business is
counted as a profit and taxed. It is crazy.
So I think they have got it exactly backward, and Members
that had asked about that, perhaps you are using the wrong
language. Maybe they heard the question wrong. It is not so
much we need a tax incentive. Should we stop the tax penalty
for sound reserving catastrophes? That is the way I would ask
the question and perhaps you would get a different answer next
time.
Rather than discuss point by point what we have in front of
us from the industry to the station, I would like to outline
some principles for legislation. One.
One is, I think this is obvious, any Federal capacity
should offer the maximum amount of economic benefit, not only
to the Nation, but injured parties, at the lowest cost to the
taxpayers.
Two, legislation must not erode incentives for wise
underwriting and insurance company management of risk, proper
security escape contingency plans I spoke of earlier. We cannot
have a blank Federal reinsurance check and reduce incentives
for increased security.
Three, if Federal reinsurance capacity is offered, then
there should be payment for the use of capital and the
assumption of risk, for many of the reasons I spoke of earlier.
Four, Federal coverage should certainly not insure against
all industry terrorism losses. Coverage in the first dollar of
losses is unnecessary and unwise, because it would erode
incentives and increase security.
Fifth, Federal insurance capacity should be temporary to
maximize the use of market mechanism, first for reentry of
prior reinsurance at higher levels at the earliest possible
date.
Six, legislation must contain strong incentives to pay only
valid claims. We believe the Federal Government's copayment
claims should never exceed 80 percent. As spoken of earlier, it
is too easy to make other people happy with someone else's
money, in this case the Federal Government's.
Seven, and this is a point I haven't heard yet today, maybe
it is so obvious that no one has spoken of it, but I am not
sure so I will say it. The Federal Government's exposure should
be capped primarily to preserve America's national security
options. Let us face it, we are in a war. We don't want to have
a Federal Government entitlement program to underwrite every
dollar of every damage that might happen. We are not facing the
bombing of London like they did during World War II, but if
something terrible should happen here, we can't have a Federal
entitlement program to cover every dollar of loss for war or
terrorist attacks.
So I am not even sure where the definition is, but the
primary purpose of the Government is to defend our Nation. So
we cannot have an unlimited liability, and that is one positive
trait in this Administration proposal. We will have to balance
off what we can do for our Nation's people, their property
losses, the lives that are lost, but we also have to balance
the key reason for Government, to defend the country. So that
is the real reason why it needs to be capped.
Another principle that the Administration has talked about
and we agree with, we need some sort of panel to quickly pay
and settle claims to incur losses in a fair and inexpensive
way. We don't want to spend taxpayer money paying the trial
lawyer a lot of money, stretching out litigation years and
years. If the private markets were to get back and cover this
kind of loss, they need to know what the loss is. We can't
stretch it out over the 5 or 10 years, figure out what the
eventual losses are, and we don't need to waste money paying a
lot of lawyers to do this.
So those I think are the key principles. I think by--
listening to those principles and applying them to the
proposals before you I think will help steer the subcommittee
and the Congress in the proper direction, and we are willing to
work with you, Mr. Chairman, other people in the industry,
other interested parties to help work out a solution here.
Thank you very much for the invitation.
[The prepared statement of David L. Keating can be found on
page 113 in the appendix.]
Chairman Baker. Thank you.
Mr. John Sinnott. You are Chairman and CEO of Marsh,
Incorporated.
STATEMENT OF JOHN T. SINNOTT, CHAIRMAN AND CEO, MARSH, INC.
Mr. Sinnott. Thank you, Mr. Chairman, for allowing me to be
here. I should probably explain what Marsh, Inc., is, because
we represent, perhaps a slightly different constituency than
others. We are the world's largest risk adviser and insurance
broker. We have about 35,000 employees around the world, and we
are located in about a hundred countries. Our clients comprise
all segments of the commercial world. Private clients also. And
we also act as advisors and reinsurance brokers to insurance
companies. So I think that we have a pretty good view of what
is happening today in this marketplace and what we expect will
happen for our clients if something doesn't happen here very
quickly.
I should also point out that I represent not just Marsh,
Inc., but I also represent the member firms of the Council of
Insurance Agents and Brokers which is the national trade
association. So I am speaking for both constituents. I will cut
through some of the comments that I had planned to make. There
are two problems here. One is the size of this event, which is
more than twice the size of the next largest catastrophic
event. If you add the other five largest events that took place
in the last 10 years, you have only about aggregated what the
estimated loss coming out of this particular event is.
The second problem is the uncertainty of the current
environment. That is what is different since September 11th and
why we are talking about this issue now. The nature of this
risk has radically changed because of certainly a perception of
what we have heard from Washington which is the probability
that there will be another event. So trying to compare the way
we approach this pre-September 11th and today you will never
come up with the right answer.
What is the result of these two problems? Since September
11th, we have undertaken many renewals on behalf of our
clients, and most reinsurance is still in place, although we
are seeing terrorist exclusions on the policies more so than
not. And the other thing that I can say, as we look forward to
January 1st, our reinsurance unit cannot identify a reinsurance
company that is not going to exclude terrorism come January 1.
So the issue of this is not an issue of supporting the
industry, but the fact that American business will not have
protection for a catastrophic potential loss come January 1st.
I would disagree with the comments about business
interruption. Business interruption is a normal sort of risk
that business clients transfer to others. It will comprise a
significant part of the September 11th event. And why one would
exclude, when the commercial market is going to be picking up
and adjusting these claims, and they have had to adjust these
claims, if it is straight fire they will have to adjust it, if
it is a fire caused by terrorism, they would have the same
adjustment issue. The markets will not provide coverage for a
terrorist event for business interruption if it is not covered
for property damage in the first place. Markets almost never
cover business interruption in isolation to property damage.
So I was not aware that there was a disconnect here on
business interruption. But that just puts it back. There will
be no coverage for this come January 1 with businesses if that
is the case. Seems to me as far as the timing, it is fairly
straightforward. If the current environment doesn't change,
this risk is going to be 100 percent uninsurable in the
commercial market.
What the Government is trying to do obviously is change
that environment and cure this problem so we get back to some
normalcy the way we were before September 11th. I am not saying
it is going to be exactly the same, but at some point that has
got to be our hope. I don't know whether that is in 2 years, 3
years or 6 years. I think it is something that one has to look
at. And as soon as normalcy starts to come back, you will see
the commercial market come back to this arena. That is why the
Administration's plan does allow for that. And I think that
will happen as long as we find some way to cure the
environment.
I will just finish with one other comment. In 1993, we had
the first terrorist attack on the World Trade Center. We had
offices in that building at that time. Fortunately, we had no
loss of life. That is most important. Second, the amount of the
insurance claim that we had resulting from that loss was less
than $5 million. So as a result of that particular incident,
you didn't hear anything about the commercial insurance market
saying it needed help that you are hearing now.
On September 11th, my firm lost almost 300 people in the
World Trade Center. Obviously, that is the biggest loss that we
have ever sustained. And it is something that my colleagues
carry around in the halls and will for a long time. But
secondarily, we will also have an insurance claim to present
not of a few million, but in the hundreds of millions of
dollars. And we just have an office occupancy.
Mr. Bachus. Hundreds of millions?
Mr. Sinnott. Hundreds of millions of dollars. That is the
difference. That is what has happened. I don't see any way for
us to get terrorism coverage--and we are starting on our
renewals right now with our clients--if some mechanism isn't
coming up for sharing the risk, even on a temporary basis
between the Government and the private industry, we have got a
train wreck coming January 1 in the property area.
Somebody mentioned the aspect of life insurance. I don't
believe that withdrawal of coverage in the life insurance field
is an issue, although I would defer maybe to Constantinos and
Dave who are in that business.
[The prepared statement of John T. Sinnott can be found on
page 123 in the appendix.]
Chairman Baker. We are told it is not now. Or if you look
at it from that perspective, the life industry pays 5,000
claims a day. So even this incident will not be significant for
them. Because you take the U.S. population, 275 million people,
if you say the average----
Mr. Iordanou. 7,000. And most of them that have that
understanding, so that industry covers it. It is not an unusual
and extraordinary event for them. Yes, it is dramatic based on
the way it happened, but not a big event for the life insurance
business.
Chairman Baker. Thank you, sir.
Mr. Bachus. Just to clarify, again, we don't have the text
of any legislation. It is in appropriations.
Chairman Baker. All we have is a recommendation.
Mr. Bachus. The approach says that business interruption is
not a big deal.
Chairman Baker. I would like to recognize Mr. Roy Williams,
director of aviation, Louis Armstrong New Orleans International
Airport, with which I am greatly familiar. Welcome.
STATEMENT OF ROY A. WILLIAMS, DIRECTOR OF AVIATION, LEWIS
ARMSTRONG NEW ORLEANS INTERNATIONAL AIRPORT
Mr. Williams. Thank you, Mr. Chairman. Mr. Bachus, Members
of the subcommittee. And I am sure you are only familiar with
it because you fly over it after you have left out of Baton
Rouge Airport. But I am very happy to be here today, although I
do feel I am a bit like a fish out of water with this panel
that you have assembled here with you. Perhaps the airport
experience that we are experiencing today gives some credence
to the discussion of what may happen to other industries in the
coming months.
Let me begin with a little background. Armstrong
International has 16 passenger carriers and five air cargo
carriers, and we just celebrated serving more than 10 million
passengers in one 12-month period, an all-time record for the
airport. That ranks us as 39th in the United States. There is
nothing particularly unique in the airport in terms of
insurance risks. It doesn't have any reservation centers, it is
not a hub for a passenger cargo carrier. So I think we are sort
of a normal example of an airport.
Prior to the events of September 11th, airports usually had
substantial levels of war and terrorism risk included as part
of their general airport liability coverage. In our case, $300
million and sometimes up to $1 billion at large hub airports.
To date, since September 11th, only 2 insurers have come back
into the market with a product that is very expensive and has a
very limited and inadequate liability cap of $50 million. At
least one of the available policies contains massive exclusions
such as not covering screening, baggage and security functions.
In addition, these policies include a 7-day cancellation
clause.
So turning specifically to Armstrong International, for the
12 months which ended September 30th, 2001, our policies
covered essentially all risks, including war and terrorism, up
to $300 million. Our annual premium was $321,000.
We had already begun a search for a new policy before
September 11th, and in fact, after September 20th we did have
an offer of a policy. But the new policy excluded war and
terrorism completely. It excluded certain officer and director
coverage, and was at a price of $520,000 per year for the same
$300 million coverage.
A short while later, we received an offer of $50 million in
terrorism coverage for a $450,000 premium. Thankfully, we
received a second offer for the same level of coverage, $50
million for a premium of just over $300,000. And we have bound
those coverages. So right now we are now at about $900,000 in
insurance costs for much less coverage than we had before at
$321,000.
Now, just this week, we received an additional option to
consider, and that is an offer of an additional $100 million in
war and terrorism coverage which would increase our total
protection to $150 million, half of what we had before. The
premium on that additional coverage is $573,000 a year. So put
simply, if we accept that coverage, we would have half of our
prior war and terrorism coverage, essentially all of our other
coverage as we had before for a total annual premium of nearly
5 times what the airport paid last year. About $1.4 million
versus $321,000.
And the important point in this is who pays for this? In
terms of our agreement with the airlines, we pass costs such as
this directly to the air carriers in their rents and landing
fees. That $1.1 million insurance premium increase that we are
facing represents a 3 percent increase in the total air carrier
costs to operate at Armstrong. This would raise our landing fee
by about 15 cents per thousand pounds. Put another way, it is
22 cents per passenger. Again, this is simply not the same
coverage we had before.
We really don't recommend that we sustain these risks of
insuring ourselves against the risk of terrorism by simply
assessing exorbitant costs. We instead recommend the
subcommittee consider solutions to spread these risks as
broadly as possible, taking into account the fact that the
risks associated with an act of terrorism far exceed the
economic capacity of any individual airport to sustain or pay.
For example, one solution might be to extend the current
Federal War Risk Insurance Program exclusively to airports. The
program now does cover airlines and covers their vendors and
agents.
Looking forward, New Orleans is doing well. We are down
only 14 percent from our regular scheduled flights. We appear
to be operating at close to 75 percent of our normal traffic.
We think these numbers will continue to improve. But we cannot
fulfill our obligation to Louisiana unless national air volumes
return to normal. We believe that what will get those
passengers flying again is to restore confidence in the
security of our planes and our airports and provide stability
in the marketplace. The insecurity regarding the availability
of insurance and the calculation of risks associated with
actions of terror creates a background of instability, has
wreaked havoc with the traveling public and the insurance
industry. Restoring the insurance at reasonable rates should
underpin any legislative effort to restore this confidence.
[The prepared statement of Roy A. Williams can be found on
page 126 in the appendix.]
Chairman Baker. Thank you, Mr. Williams.
Next, Ms. Marjorie Nordlinger, Senior Attorney, Office of
General Counsel, Nuclear Regulatory Commission. Welcome.
STATEMENT OF MARJORIE S. NORDLINGER, SENIOR ATTORNEY, OFFICE OF
THE GENERAL COUNSEL, U.S. NUCLEAR REGULATORY COMMISSION
Ms. Nordlinger. I am pleased to be here today to provide
information about the unique nontraditional Price-Anderson
system referred to so many times today. It has evolved from
Congress's initial 1957 enactment of the Price-Anderson Act. I
will focus on the development of the functions of the
indemnification of public liability compensation. The
testimony, of course, relates to the nuclear power reactors
regulated by the Nuclear Regulatory Commission. I am not
speaking on behalf of DOE's parallel functions.
The Act addressed an unusual insurance situation which was
blocking Congress's aim for the development of the peaceful
uses of atomic energy. That situation was one where it was
impossible to rule out the potential for an accident. There was
little or no experience of the kind Secretary O'Neill
described. And the possible costs of damages were uncertain.
And thus neither industry nor private insurers could absorb the
risk. Congress had two paramount goals in resolving this
predicament. One was to make available adequate funds to
satisfy public liability claims in a catastrophic nuclear
accident, and the other was to permit private sector use of
nuclear energy by removing the threat of potentially enormous
liability in the event of such an accident.
The solution combined indemnification with the limit on
liability. The solution applied to all reactors as a further
condition of licensing. And the licensing process itself
provided substantial assurance that each reactor would be
designed, built and operated to satisfy high safety standards.
Originally, Price-Anderson prescribed that each power reactor
licensee had to procure available financial protection, which
as a practical matter, meant the purchase of $60 million of
commercial insurance, the maximum then available. I might add
here that the commercial insurance was itself pooled coverage
and that was the only way they could get some companies to
stand behind the commitment for funding.
That first layer was then followed by indemnification by
the United States itself to cover up to $500 million in
liability over the amount covered by commercial insurance. And
the United States never, on the commercial side, exceeded a
$500 million indemnification role.
Aggregate liability for any single accident is, by statute,
limited to the sum of the commercial insurance available and
the Government indemnity. As you all perhaps know, the
Government has never had to pay any indemnity for a nuclear
accident on the commercial side, nuclear power plan. The
aggregate liability included the liability of any one who was
found liable for any reactor accident with the exception of an
accident resulting from an act of war.
This broad coverage is known as omnibus coverage. The
omnibus nature of the coverage was designed to serve many
purposes. It was to ensure the availability of funds to
compensate for personal injury or damage to property of members
of the public, no matter who caused the accident. It was there
to permit suppliers and professionals to participate in the
industry without fear of liability far out of proportion to any
profit they might expect to gain, and it was to make possible
efficiencies in the process of presenting, settling and
satisfying claims.
Mechanisms to accomplish these goals were incorporated in
insurance contracts and in required agreements of
indemnification between the licensee and the United States. The
end result benefited the public by channeling all legal claims
to the reactor licensee or operator.
While the Price-Anderson Act provided that liability was
limited, the reports of both Houses on passage noted that if
actual damages were to exceed the available funds in commercial
insurance coverage and Government indemnity, ``the way was left
open for Federal contributions after further congressional
consideration.'' This concept present at the outset was later
expressly included in the Price-Anderson Act amendment, and is
often referred to as a ``third layer of protection.''
Congress amends the Price-Anderson Act from time to time,
always mindful of the delicate balance of obligations between
operators at nuclear facilities and the United States
Government as indemnitor and as representative of the people.
The most significant amendments to date were those that
effectively remove the United States from its obligation to
indemnify commercial power reactors and place the burden on the
nuclear power industry. This was accomplished without any
substantial alteration of the other elements that characterized
the Price-Anderson theme, most particularly, without affecting
omnibus coverage and liability limited to the availability of
funding. And it was enacted with increased protection for the
public.
The first step in this direction occurred in 1975 when
Congress mandated that each commercial power reactor contribute
$5 million to a retrospective payment premium pool. This
retrospective premium was due if, and only if, there were to be
damages for a nuclear accident that exceeded the maximum
commercial insurance available. The limit of liability was then
$560 million. Government indemnification was phased out in 1982
when the potential pool and available insurance reached that
sum.
In 1988, Congress increased the potential obligation of
each and every reactor in the event of a single accident at any
reactor to $63 million. The liability insurance available to
comprise the first layer is now $200 million. When that
insurance is exhausted, each U.S. reactor licensee must pay
into the pool up to $83.9 million as adjusted for inflation, if
needed, to cover damages in excess of the sum covered by the
commercial insurance. The $83.9 million is payable in annual
installments not to exceed $10 million.
Today, the first layer of commercial insurance and the
second layer from the reactor pool together would make
available over $9 billion to cover any person or property harm
to the public caused by an accident. An early amendment
expanded the waivers so that in serious accidents, denominated
extraordinary nuclear occurrences by the NRC, the defendants
must also waive other defenses. The waivers in sum provide a
result in the nature of strict liability where the harmed
public need prove only that the accident caused their injury,
proof of fault is eliminated.
The statute excludes coverage of property damage at the
reactor site, and there are also provisions covering, among
other things, settlements, establishment of a single Federal
forum, case management, distribution of funds, criteria for
allowing legal costs, and the preparation of reports to
Congress in the event there is an expectation liabilities will
exceed the available sums.
Thank you, Mr. Chairman. I welcome your comments and
questions.
[The prepared statement of Marjorie S. Nordlinger can be
found on page 130 in the appendix.]
Chairman Baker. Thank you.
Our final panelist this afternoon, Mr. Richard Hillman,
Director of Financial Markets and Community Investment with
GAO. Welcome, sir.
STATEMENT OF RICHARD J. HILLMAN, DIRECTOR, FINANCIAL MARKETS
AND COMMUNITY INVESTMENT, U.S. GENERAL ACCOUNTING OFFICE
Mr. Hillman. In the interest of time, I will be very brief.
At your request, our testimony today outlined features of
selected insurance programs covering terrorists and other
catastrophic events ranking from programs completely controlled
and managed by the Federal Government or other governments to
programs with little or no explicit Government involvement.
Sandwiched in between was a wide range of programs that the
public and private sector shared risks together and in varying
and different ways.
The second point of my testimony provided information on
alternative mechanisms for funding insureds also including both
pre-and post-funding mechanisms and the use of industry pools
to share risk.
Finally, our last point provided some of our own thoughts
about how the Congress ought to be approaching next steps. Most
importantly we are hopeful that what we are seeing before us is
a temporary market failure. And in that vein, we are hopeful
that the program that would be designed would not displace the
private market. Rather, it should create an environment in
which the private market can displace the Government program.
In summary, we have provided a great deal of information on
Federal and international programs to your staffs. And we stand
ready to provide any additional information on these programs
should you so desire.
[The prepared statement of Richard J. Hillman can be found
on page 137 in the appendix.]
Chairman Baker. Thank you very much. We appreciate your
attendance and your brevity.
Let me suggest, Mr. Chairman, that since it is just the
three of us and likely to be the only three of us that rather
than just proceed with 5 minutes apiece, that we take advantage
of a group discussion which would be a little more beneficial,
I think and just dispense with the normal 5-minute rule and
just jump in when you like.
We know that we have to do something. We are not sure what
that something is. But providing liquidity to the markets at
some point with some limit--because like the shareholders of
insurance companies who don't and will not tolerate unlimited
exposure, neither will our shareholders. So the meeting, I
think, needs to be around perhaps a two-step approach,
something immediate and short term that would buy us time to do
the long-term resolution that might be more appropriate. Is
that something--just that protocol from an industry
perspective, say we are going to do X and then come back next
spring and address the remaining issues, let's assume the
short-term program is a 12- or 15-month short-term solution, is
that enough comfort for the reinsurance markets to function,
given that we are going to come back with a longer term
resolution when we have the appropriate time to construct it?
Is that acceptable?
Mr. Mathis. Can I take the first crack at that? I think
that several issues are associated with that. One, the
reinsurance market isn't going to function. It is my hope and
belief that they may function if there is a viable limit out
there in the market. But there isn't any associated with that.
Mr. Oxley. That wouldn't be right away.
Mr. Mathis. No, it would be a matter of time associated
with that. Second, that was the reason why there was an
industry mechanism associated with a pool to try to spread the
risk in that area, which could work in the retention area. The
problem associated with big net retentions against the
industry, and I understand that, in Government, is that it
doesn't deal with the individual risk exposure. So therefore,
individual companies still have to underwrite against the
collective loss that they feel that they might have on an
individual risk exposure. And I would predict that, even though
a top level measurement on the top part of the Government would
certainly bring some measure of comfort and stability back into
the marketplace, it wouldn't solve it all unless there was some
solution to that mechanism.
And third, if the Government comes up with something that
is associated with a short term timeframe stopgap that isn't
consistent over a period of time, you have to recognize that we
write policies that have a 1-year policy limit. So if you have
that, you have a net retention that is going to move next year
to a much higher number, then you have to write the business
understanding that that is what your net retention is.
Chairman Baker. But that is a problem with even the 3-year
program. Because there are projects that are going to take
longer.
Mr. Mathis. The industry or the current Administration
proposal talks about a plan that is 80/20 to begin with and
moves to 50/50 in the second year then to higher retention. I
think that that is a problem for the industry to not have
something that is consistent all the way across to look at and
try to quantify and measure because, you know, one month after
January 1st, you are writing into the next year.
Mr. Sinnott. I think if you did it on a risk attachment
basis, which is the normal way of doing things, since it will
be the commercial insurance policy there that will adjust the
claim, the Government will have to agree that the cause was
terrorism, but if it is on a risk-attaching basis, it is during
that policy year, it follows that policy. And if that
acceptance happens to extend out over a period of years, it
still goes back to that period. That is the way the insurance
mechanism works. As long as it follows that, I don't see a
problem.
Mr. Iordanou. If there was no sunset provision. But you are
postponing the issue, because at the end of the day you have to
revisit it.
Chairman Baker. We are understanding what we are doing is
not final. We need more time to examine, study and understand.
What I fear is we act precipitously in the next 3 weeks not
fully understanding what we are doing, and find out that we
have represented to the industry a 3- or 4- or 5-year program
that is fatally flawed. That, to me, is a great disservice as
opposed to a short term, publicly acknowledged, this is to get
us by January 1, guys, and by March or April of next year, we
will have an ample opportunity to thoroughly vet it. I wanted
to know if there was a visceral no to that. But it may be with
certain conditions.
Mr. Iordanou. Let me jump in on a couple of our issues.
Mr. Oxley. Let me back up. What is the biggest down
argument against what Chairman Baker was talking about? What is
the worst-case scenario if we were to do that? Is it that there
is no longer the political will to fix the problem entirely?
Mr. Sinnott. Really, the issue comes down to what is the
sharing between the private industry and this mechanism. As
long as that is basically agreed.
Chairman Baker. For purposes of discussion, let's just take
the President's first year of his plan and just say year one,
here is the deal.
Mr. Sinnott. If the industry and the insurers can live with
that, and if the brokers and others, Dave, can go out now that
it is only a 20 percent issue rather than 100 percent
withdrawal from the market, I think there is an opportunity to
start the market moving along to maybe provide some protection
for that 20 percent.
Mr. Oxley. The subcommittee will have some evidence by then
as to what is happening in the marketplace?
Mr. Sinnott. I think getting through January 1 is a big
issue.
Mr. Iordanou. You are talking----
Mr. Oxley. The policy being renewed for another year?
Mr. Sinnott. Yes.
Mr. Iordanou. Or maybe more. On the risk attachment basis,
if any of you own a 3-year policy for a project a construction
project, that it will take 26 months or 27 months, if the risk
attachment is there, then the coverage will follow throughout
that period.
Mr. Sinnott. It is the only logical way to do it. The 20
percent that the private industry has, that is the way the
commercial market will look at the claim. It is on a risk
attaching basis, even if it is a construction project that runs
out. There is nothing unique about that. That is the way the
mechanism works.
Mr. Iordanou. There is another issue here that I think is
grossly misunderstood about how the mechanisms in the industry
work. Even I was surprised to hear the comments by my
colleagues from academia that were opposed to the first dollar
sharing of risk. I will agree that $5- or $10- or $15 billion
in the aggregate is a size of risk that the industry can handle
collectively. But the way contracts are issued, unless you
create within that mechanism an invented sharing, it is not
going to work in the marketplace; because at the end of the
day, who does provide the insurance for the factory that has
the 10,000 employees or assembly plant that might be the next
attack?
Now, even though the industry loss might be $5 billion, not
significant, it is only covered by one insurer, and that
insurer is out of business. Because if it was Kemper or if it
was Zurich in North America, with $4 billion committed to North
America, we would be out of business. And that is the part that
is being misunderstood in the debate today. That we have not
only an issue with aggregation of small risk, but we have an
issue in the way the mechanism works today in the private
market by instructing the insurance component that allows
spreading of risk to operate efficiently.
And focusing on $5-, $10-, $15-billion in the aggregate, it
is significant, but not catastrophic, but it could be
catastrophic to a single insurer.
Chairman Baker. What has bothered me in the interface
between the Government and the industry in the proposal is the
direct providers of the policy to the insured property as
opposed to the commercial reinsurance industry. Everybody that
I have heard express concern about exposure goes to dense
projects where you have high value, high numbers of people in
small areas, not necessarily to cattle operations in Wyoming.
And in order to not create more of a hazard, we need for
insureds to take appropriate self-protecting actions.
Since the commercial reinsurance guys set the underwriting
standards, doesn't it make some business sense for us to enter
into our agreement for the backstop with the commercial
reinsurers, and then have them set the new security measures or
standards in a private market context, but ensure that they do
provide coverage for terrorism?
Mr. Bachus. I think actually what has been also discussed
is the State-chartered reinsurance. They would then--in turn
the Government would come in and----
Mr. Mathis. The pool.
Mr. Iordanou. Independent of how you do it, Chairman Baker,
there is no opposition if it is insurance or reinsurance. The
principle is the ability to share risk. But that is how you
allow the free mechanism, you know, the freedom to go out and
write these very large limit policies for the airport or for
the water supply company or for the train station or for the
stadium. Because at the end of the day, they know that if an
event happens, you know that risk will be spread.
Chairman Baker. The insurance company has to lay it off to
the reinsurer. The reinsurer is going to lay it off to the
Federal Government. All I am saying is from an operations
standpoint, when your customer makes the claim and you have to
fill out the form the Federal Government prescribes and send it
to the Secretary of the Treasury for him to issue a check, I
suspect for 2,300 companies and thousands of claims, you are
going to have a long wait.
I would rather, as much as it is practicable, have you
engage, turn it around as a business matter and ask a
reinsurance company for their appropriate contribution and have
the reinsurers dealing with the Department of the Treasury. It
seems to me to be a more efficient mechanism.
Mr. Sinnott. I hope no one is envisioning that we had a
frequency problem. It is a severity issue. If you had a
frequency problem, you are 100 percent right. But we are
talking severity, which means very few; hopefully no events,
but at the worst severity of events. They will be severe in
nature. And that can be managed this way. That is the other
reason why we advise our clients to take deductibles. Don't do
first dollar. But in this case, with the few events--or
hopefully none--but the few events that could occur, it is not
really first dollar. The industry is going to be in there,
because if you get an event, it is likely to be a major event.
So the whole idea of first dollar doesn't ring with me on this.
I don't view this as really first dollar, because we are
talking catastrophic risk.
Mr. Bachus. What about a special State-chartered
reinsurance company?
Mr. Cummings. I am really against setting up that. I think
the market works more efficiently in terms of reinsurance
contracts. I think that's what we see in commercial markets. It
is fairly like financial.
Mr. Bachus. You wouldn't have to. They could see----
Mr. Mathis. The industry proposal. Not that it could pick
and choose individual risk.
Mr. Bachus. It is an option you can cede risk to. The
reinsurance company, the Government would then participate.
Mr. Harrington. Then you have the Government in pricing.
You should avoid the Government in pricing. If you go down that
route----
Mr. Bachus. Don't you do that on other----
Mr. Mathis. Supporting a funding of the first $10 billion
of losses that has built up over a period of time.
Mr. Bachus. You actually said that you thought there ought
to be a first dollar.
Mr. Iordanou. You oppose that.
Mr. Harrington. I have assumed that given what I know about
the sophistication of reinsurers, if there was a $5- or $10-
billion attachment point, there are a lot of smart people in
this business that would start thinking about how they could
design property treaties so they could price it in recognition
that there was a relatively low probability that there will be
an amount greater than that amount. Maybe I have grossly
overestimated sophistication in the reinsurance markets. But
the latest contracts are set up, it has got to attach an 80/20
basis in the first dollar.
Mr. Iordanou. There is no way to spread the risk on a
catastrophic event. The concept of an industry aggregate of $5
or $10 billion and then something that attaches on the next
system, it creates an environment that singular insurers will
be exposing up to 100 percent of their capital to an acceptable
risk. For that reason, you are defeating the purpose of trying
to create liquidity.
Mr. Harrington. I thought you could deal--you and your
reinsurance friends could get together and negotiate this.
Mr. Iordanou. It needs to be part of this proposal. If that
happens and there is some encouragement either with tax, which
I think is a great idea, the reason we are exploring more
coverage to foreign markets today in the United States is
because we have a bias against the mechanism of setting the
reserves for events that we know that will happen once every 10
years, once every 25 years, once every 50 years. Today it is
tax efficient for me as a buyer to send my dollars for
reinsurance to Bermuda and get a deduction as a business
expense, it is a cost of doing business, versus putting it in a
tax-free pool.
Chairman Baker. Let's go right to that point. We had the
discussion earlier. If you were to create a tax-free pool for
terrorism reserves only--and that is a reserve which does not
exist--therefore I would argue has no budget implications, but
that is a thin argument, what would that do for you in your
perspective in enabling you to insure against terrorist risk?
Mr. Iordanou. Over time--not immediately, over time as that
builds up, it will create more and more capacity in an ability
for companies----
Chairman Baker. Are you talking 2 or 3 years?
Mr. Iordanou. It depends on the size of how much would
allow it to--because you got to have some--there is not going
to be an open-ended ability to set terrorist reserves, you
know, for risk. There has got to be some parameters; otherwise
you will eliminate paying any taxes, continue putting up
reserves and earmarking them.
Chairman Baker. But from an industry perspective, that is a
major element in the long-term private market resolution of
this problem.
Mr. Iordanou. I agree.
Chairman Baker. Doesn't help us January 1.
Mr. Keating. If we don't think about the long term, we are
not going to get there. We will wind up having more of this.
Mr. Sinnott. I think that is right. As I say, we do not
have much time to figure out what we are going to do for
January 1.
Chairman Baker. Let's jump on that, if I may. If we take
the President's first year proposal, what additions or
modifications would this group suggest to make it a workable
plan for, say, 15 months?
Mr. Keating. Could I say something? I really don't think it
makes sense that the Treasury do first dollar, because the
assumption here is that anything that happens is going to be a
catastrophic event. Just because they were so clever the first
time around doesn't mean every event is going to be a huge
event. I don't see the need for the Treasury to step in on
everything that might be considered a terrorist act. So first
dollar coverage to me makes absolutely no sense.
Mr. Oxley. There ought to be a deductible.
Mr. Sinnott. You are complicating it, because now you are
trying to aggregate the industry together. You are getting into
a very complex mechanism. If you keep it simple, it is a co-
insurance, policy by policy by policy. Now, that is, you could
view that as interim. But otherwise, you figure out an event
occurs and you have many insurance companies; how do you
allocate it? Who gets the benefit? It becomes more complicated.
Mr. Iordanou. Worse than that, you get two insurance
companies, both of them out of business.
Mr. Sinnott. So you have to keep it simple starting out,
although these points, looking at taxes, are clearly good; you
know, the near-term/long-term things that can be done. The
other thing that as I said before, I mean I don't know why the
mechanism would not include business interruption. It will
create another disconnect between the 0 percent that the
commercial market is offering and the 80 percent, if that is
the number that the Federal program provides. Because these are
programs that are together. Most businesses buy property damage
and business interruption.
Mr. Iordanou. Let me give you the statistics. The business
interruption component of loss arising out of covered perils is
50 percent of the loss. So for every dollar of indemnity we
give to a customer, 50 cents goes to rebuild the factory and 50
cents goes to reimburse them for business interruption.
Mr. Keating. But not everybody buys business interruption.
Mr. Iordanou. There is no commercial enterprise that I know
that has no business interruption coverage.
Mr. Sinnott. Wait a second. Let me tell you. We have
experience on this. We do the Fortune 500. I can tell you that
there is only a handful, relatively speaking, of the very
largest companies that don't buy business interruption. . You
are talking about Fortune 500.
Mr. Harrington. There are lots of things that are on
business interruption.
Mr. Iordanou. The business interruption provided by the
insurance industry is business interruption arising out of
covered perils, so you have to have an incident.
Mr. Sinnott. Of your actual lost loss.
Mr. Oxley. Mr. Hillman has been studying this at GAO. What
is your cut on these different proposals?
Mr. Hillman. I find some of the remarks that these
gentlemen are making to be very useful. One of the points that
I think may be worth considering is rather than coming up with
a $5 billion, a $10 billion, a $15 billion retention for the
industry as a whole, because that provides a lot of
complicating factors, one thing you may wish to consider is
establishing a per-claim limit. And perhaps I will have Mr.
Cluff provide that.
Mr. Cluff. Either per claim or per insurer.
Chairman Baker. For the record, give your name.
Mr. Cluff. Lawrence Cluff with the U.S. General Accounting
Office. But either way, you avoid the problem of trying to
aggregate to some $5 billion, $10 billion, you avoid the
pricing problem, and you also avoid the Treasury having to
write a check for every little thing that happens. If you have
a retention on a per-claim or a per-insurer basis, that solves
a lot of those problems.
Chairman Baker. Any reaction?
Mr. Mathis. Well the 80/20 is a retention per claim.
Mr. Sinnott. That does eliminate the problem that I was
saying. It is specific.
Mr. Keating. That is fine with me; but going on each claim,
each first dollar doesn't make any sense.
Mr. Cluff. I concur.
Mr. Iordanou. There is no first dollar coverage to begin
with in the business. First dollar coverage is for your
homeowners. When you get into the commercial business, a lot of
our clients will retain maybe $100,000, $500,000, $1 million,
some of them $5 to $10 million over the first dollar coverage.
They buy beyond that. So in those parameters, I think
everything is workable. I don't think it is a bad idea. I think
it needs to be on the table. As a company we will not be
opposed to it.
Mr. Sinnott. It just gets back to what the retention
tolerance is of the industry. Fine. They take the first X
amount, then they know that they are also going to have 80
percent. It is a matter of figuring out what the retention
tolerance of the private industry is, and the willingness of
the Government; and hopefully those two things on a temporary
basis will match, so that we get beyond this particular real
problem that we have and have more time.
And the brokers can help in this. There are already small
bits of capacity that are being developed. The problem is it is
just too big a gap that we are looking at, and we are looking
at 100 percent withdrawal. If this was just 10 percent, it
would be different, like when some markets decided to get out
of the business when we went through this 16 years ago. We were
able to deal with it without asking the Government to step in,
and we were able to get policyholder investment, and we got it
done, and the market returned to normal.
I think the same thing can happen here, though there is one
difference. We didn't have an environmental issue 15 years ago
that had to be changed, that we had to find a solution for. In
our case, I can tell you that our midtown office, which is
where our headquarters is, security is on the top of our list
of priorities. I think the comments about this being a free
ride for businesses is innacurate.
Mr. Bachus. What about the comment, I thought you said,
that would increase the risk when the Government steps in?
Mr. Iordanou. We totally disagree.
Mr. Sinnott. The insurance was there before. We are talking
about the withdrawal of insurance. Let's continue to provide
insurance which is a social instrument, continuing to provide
it on a temporary basis, get the Government in there, get it
out as quickly as possible and do it on a basis that allows
competition, the particular competition that we like to see on
behalf of our clients, which is each of the markets doing its
own thing.
Chairman Baker. Let me jump in.
Mr. Harrington. Temporary, that is fine. But over the long
term, it will be a good idea to have some relocation of certain
businesses, to spread the risk out to reduce the risk of a big
event in a particular place. In the long term, if we intervene
we are going to discourage those type of responses.
Mr. Sinnott. We are looking at it ourselves because we have
5,500 people in New York City in one big building. I mean,
forget about whether or not we have insurance. We are looking
at lives here, whether or not there is business disruption.
Regardless of the insurance response, we had business
disruption. If we have our risks better spread, we will have
less business disruption and we lessen the risk to our
colleagues. So all of those things are ongoing right now.
Chairman Baker. Our position is not to----
Mr. Bachus. Can we get into some of the finer points?
Chairman Baker. Let me jump one more thing before you do
that. As to the element of why there is the pushback on the
structure either to the industry or the Administration proposal
from some unidentified Members of Congress, you are going
through this self-assessment of how do we protect our people,
how do we ensure our business exists? But the resolution of
that is to ask people with the checkbook or the money, without
the people who are going to write that check knowing anything,
with the industry, the solvency of the companies to whom we are
extending the credit, the limit of our exposure if, God forbid,
this thing does turn out to be frequent and large. What we are
tying to say, we understand the importance of acting timely and
responsibly, but we have to take risk aversion steps ourselves.
So that is what we are looking for here. If we can do that
with something temporary and come back and not have industry
claiming that Congress has not met its obligations because it
has not met final resolution, and do that next year, we can
have more of these and really get down to the fine points that
Mr. Bachus and others would choose to pursue.
Only to that end in looking at the Administration proposal,
pro and con, all the ideas possible are about how we tweak the
first-year methodology to potentially be a short-term remedy to
give us the long-term critical analysis. None of you gentlemen
would invest large sums of money without relying on a great
deal of examination by the best staff you could find to give
you all the pros and cons. That is where at least I am speaking
for myself. I don't feel I am competent to make this decision
this afternoon. I may not be competent to make it next year,
according to some people. But I think I want to give myself the
best shot. So that is where I am.
Mr. Bachus. Adverse risk selection. I ask this question:
Should an insurance company eligibility for the program be
conditioned on providing terrorist risk insurance in all its P
and C policies?
Mr. Mathis. To a large degree, it already is.
Mr. Sinnott. The large commercial markets file and use,
where you don't have to get State agreement.
Mr. Bachus. But what I am saying, again, should one of the
policies of this Congress be that we would require them to
offer it?
Mr. Mathis. Well, I have two questions which are associated
with that. Are you going to agree that there is a rate
preemption and that people can charge whatever rates they
choose in the marketplace? The other is that you clearly
wouldn't expect that every company would want to underwrite
every risk.
Mr. Iordanou. In order to eliminate the moral hazard, it
has to put the pressure on the management of that company to
deal with the kind of risk that would be criticized today in
this area that maybe the industry is not paying much attention
to.
And the second point is that, in our view, risk management
for terrorism risk, the only authority who can do the best risk
management is the U.S. military and the CIA and the FBI and the
Federal Government. At the end of the day--that is why we have
this event today. In 1993, in 1993 we knew we had a terrorist
attack. In 1993 we knew it was the same set of buildings. In
1998 the industry suffered about a little over $1 billion in
claims. And we were down in Washington looking, because actual
mechanisms of the industry dealt with it.
Today, just for the record on the perspective that we are
talking about, the property casualty business has a revenue of
$155 billion. When you look at the equity capital of the
industry supporting the $155 billion, it is anywhere from $80
to $100 billion. In one event, almost 50 percent of that
capital has appeared. So now you face executives that say they
are providing that liquidity in the marketplace. They say if
they have two such events in the next year, you will have no
property casualty business. The entire business will vanish.
Chairman Baker. That is only the case if we have a
significant untoward event in the near term. If we are able to
get a few years' grace, the industry can survive. And perhaps
with tax incentives for reserves, whatever the necessary steps,
we can get there. The short-term question is--I think the
principal question we have got to resolve today, in the next
few days, what do we do about January 1? What does it look like
and what are the elements for the taxpayer to make marketplace
sense?
Mr. Bachus. Let me ask another. Should the Secretary be
given discretion to preempt State regulation?
Mr. Mathis. In certain areas. Not total.
Mr. Bachus. It will have to happen.
Mr. Sinnott. As he says, it will happen in certain cases
once you get beyond a certain point where rates are not
tariffed. You know, rates are freely negotiated, policy
conditions are negotiated. There is not much issue there as far
as scope of coverage.
Mr. Mathis. Let us take workers' compensation.
Mr. Sinnott. Well, that is statutory.
Mr. Mathis. And it is State regulated in every State, and
there is no ability to deal with----
Mr. Sinnott. I was thinking workers' comp. Or what is a
terrorist about? If we go to 50 States, we will be in
litigation for the next 50 years.
Chairman Baker. Some of the things I have read, we are
going to be in litigation for the next 50 years.
Mr. Bachus. That is something to give thought to.
Mr. Mathis. I want to talk totally about a large--we write
a lot of middle-America business. That is in urban areas.
Mr. Bachus. OK. Now, this thing includes private passenger
automobile coverage. We are talking about 7,000 people die
every day. We insure every automobile every day. Should the
Government program insure private passenger--isn't there going
to be a lot of claims?
Mr. Iordanou. Let me give you a scenario and you draw your
own conclusion. Most personalized carriers write personal
automobile and also write homeowners policies.
Mr. Bachus. Homeowners?
Mr. Iordanou. Well, if I am in your home and I drink
contaminated water, I can have a claim against you, in essence,
against your homeowner's, and I can paint a scenario that maybe
a water company, their wells get contaminated, and now you have
a significant number of homes that have contaminated water
through an agent. And we have significant number of----
Mr. Bachus. I am just concerned about the volume. If we
cover private passenger automobile coverage, the Government
proposed it, that is a big volume of claims.
Mr. Iordanou. I can envision private passenger automobile
to have a large number of claims.
Mr. Bachus. It is in here. Right? What you don't want, you
don't want a process in the automobile claim where there is
some----
Mr. Sinnott. Right.
Mr. Mathis. I would say to you, we are in the commercial
line. But I don't want to speak for----
Mr. Bachus. It is in here right now.
Chairman Baker. And I thought we had generally agreement
that--because my comments earlier, I was reflecting on
commercial reinsurance principally as an interface and
commercial lines only being subject to----
Mr. Bachus. Well, right now it is commercial property and
commercial liability and commercial automobile, workers'
compensation, private passenger automobile, homeowners. It does
include business interruption, and that is my next question.
You know, you are saying that that is----
Mr. Sinnott. Sure it is.
Mr. Bachus. It is possible to design a two-tier--what I did
here is it is more subjective in figuring out----
Mr. Sinnott. Yeah. It is a difficult business interruption
adjustment.
Mr. Bachus. We just have a different--you know, where we
insure 90 percent, you know, and----
Mr. Sinnott. We could, but----
Mr. Bachus. Could we do 80, 75 percent----
Mr. Sinnott. But the adjustment issue is not as
straightforward, I grant you, but the World Trade Center claims
are going to be adjusted eventually. There are going to be some
disputes as respects property damage and also business
interruption. There will be a sum total. So the fact that it is
more difficult to adjust.
Mr. Bachus. You mean to compute what the loss----
Mr. Sinnott. Yeah. To calculate what the loss is. I don't
see why that would make different treatment from the sharing.
Mr. Bachus. It is----
Mr. Iordanou. No. It is----
Mr. Bachus. Certainly you are talking about a proposal by
the Administration to take care of 50 percent of the profit.
Mr. Sinnott. I wasn't aware of that. Was that a recent
takeout?
Chairman Baker. There are several memoranda characterizing
the Administration's proposal. So we don't really have a----
Mr. Sinnott. I heard the Secretary, and that was the first
I had heard about it.
Mr. Bachus. It is in here right now, and what I am saying,
it certainly won't take care of the problems of increased
premiums, which I agree is not an insurance problem. It is an
economic problem. If we are going to have a recovery----
Mr. Iordanou. You----
Mr. Bachus. We are already in a recessionary situation.
Mr. Sinnott. I can almost guarantee that the primary
insurance carriers will not cover terrorism on their own for
business interruption.
Mr. Bachus. It may be what is done, is that it is an 80/20.
Either way.
Mr. Iordanou. So there have got to be those mechanisms. But
I can tell you the liquidity of the market, working capital and
capital for fixed assets will disappear. Why will a bank lend
to a restaurant owner if he can't pay the mortgage back because
of a business interruption versus a fire?
Chairman Baker. Sure.
Mr. Bachus. These are little things. You know, you get a
package and----
Mr. Keating. We have got to be very careful to have the
things to protect----
Chairman Baker. Well, let me suggest this as a starting
point for us, because we have got to do something pretty
quickly. Among the respective interests represented here, send
us a couple pages apiece on the essential elements you think
make short-term sense. Let us not try to fix the world long
term. Let us try and get us past January 1, with the
understanding that if we can reach an agreement, it would be
our obligation to come back to stakeholders next year and do it
the right way, but if you really--in my casual observation,
where our potential risk is, there aren't many remaining
elements that offer all the downside that occurred September
11th, and the likelihood of something of that magnitude
occurring in the near term, no one knows.
But it would be very difficult, I think, given all the
extraordinary measures that have been engaged in, and we
certainly can expect, I think, more events, but, you know,
hopefully no loss of lives and very little dollar. If we have
that luxury and we can do this in a less difficult environment.
February, March, I think we can craft a package, hearing
everyone's perspective that makes some long-term economic
sense, without only debating unnecessarily tax dollars beyond
foreseeable vision. And to that end, unless you have got
something further, Spencer, I just----
Mr. Bachus. Well, we have had mail interruptions here. Does
that--if you had a company that had mail interruptions because
of an anthrax scare at a local post office, can they make a
claim under business----
Mr. Sinnott. There has got to be----
Mr. Bachus. Or the business has to be shut?
Mr. Sinnott. It has got to be damaged from a peril.
Mr. Bachus. Mail interruption does----
Mr. Sinnott. Sure.
Mr. Iordanou. It was the same issue with the Y2K, that
there was no business interruption, you know, and there was
mitigation around that.
Mr. Sinnott. Remember that we will have, I mentioned, our
insured losses. We will have uninsured losses that will be very
significant. So insurance----
Mr. Iordanou. Professionals that you have----
Mr. Sinnott. Insurance only covers generally a relatively
small part of what the total loss is.
Mr. Bachus. And Mr. Williams, there has been a proposal
from this airline security to the airports, and you all write
some of that. Be aware that in that bill, the proposal, the
standby coverage, extended----
Mr. Williams. Yes.
Mr. Bachus. We don't know. I am just telling you. They can
start fighting and you can start fighting about that.
Chairman Baker. Let me express my appreciation to all of
you for your long-standing tolerance today. It was a difficult
day and we made it and it was helpful to us in getting a better
understanding. Thank you very much.
[Whereupon, at 5:55 p.m., the hearing was adjourned.]
A P P E N D I X
October 24, 2001
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