[Senate Hearing 109-593]
[From the U.S. Government Publishing Office]
S. Hrg. 109-593
THE DEPARTMENT OF THE TREASURY'S
REPORT TO CONGRESS REGARDING THE
TERRORISM RISK INSURANCE ACT OF 2002
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
ON
EXAMINATION OF THE DEPARTMENT OF THE TREASURY'S REPORT TO CONGRESS
ENTITLED: ASSESSMENT: THE TERRORISM RISK INSURANCE ACT OF 2002,
FOCUSING ON ASSESSING THE LIKELY CAPACITY OF THE PROPERTY AND CASUALTY
INSURANCE INDUSTRY TO OFFER INSURANCE FOR TERRORISM RISK AFTER THE
TERMINATION OF THE TERRORISM RISK INSURANCE PROGRAM
__________
JULY 14, 2005
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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senate05sh.html
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Mark Oesterle, Counsel
Mike Nielsen, Professional Staff
Martin J. Gruenberg, Democratic Senior Counsel
Stephen R. Kroll, Democratic Special Counsel
Sarah A. Kline, Democratic Counsel
Dean V. Shahinian, Democratic Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
----------
THURSDAY, JULY 14, 2005
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Dole................................................. 2
Senator Dodd................................................. 4
Senator Sarbanes............................................. 12
Senator Hagel................................................ 15
Senator Bennett.............................................. 18
Senator Martinez............................................. 21
Senator Johnson.............................................. 21
Senator Reed................................................. 22
Senator Schumer.............................................. 23
WITNESSES
John W. Snow, Secretary, U.S. Department of the Treasury......... 3
Prepared statement........................................... 24
Response to written question of:
Senator Johnson.......................................... 32
Senator Schumer.......................................... 32
Ben S. Bernanke, Chairman, Council of Economic Advisers.......... 4
Prepared statement........................................... 29
Response to written question of:
Senator Johnson.......................................... 41
Senator Schumer.......................................... 41
(iii)
THE DEPARTMENT OF THE TREASURY'S
REPORT TO CONGRESS REGARDING THE
TERRORISM RISK INSURANCE ACT OF 2002
----------
THURSDAY, JULY 14, 2005
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, D.C.
The Committee met at 10:01 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Richard C. Shelby (Chairman of
the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing will come to order.
Thank you, Secretary Snow and Chairman Bernanke, for being
here this morning. This is not the first appearance before the
Banking Committee for either of you.
The purpose of this hearing today is to review the
assessment of the Terrorism Risk Insurance Act of 2002,
recently completed by the Treasury Department, and to begin
consideration of how we should proceed in light of these
findings.
From my perspective, there has never been a question as to
the nature of the threat that terrorism presents to the United
States. I have consistently indicated that we will face the
challenge of terrorism into the foreseeable future.
In this regard, I do not believe the horrific events in
London raise any new questions about the sustained threat of
terrorism; it was already here. Rather, the most recent tragedy
serves to press home the critical issue that has confronted us
since September 11, 2001: What steps do we take to best protect
the economy in the face of the constant threat that we live
under and perhaps will live under for awhile?
In considering this matter, we should first draw from what
we have learned from the program that has been in place for the
last 3 years.
I think the lessons of TRIA are quite clear. TRIA has
provided limited short-term benefits. But, it has also impeded
the development of broader solutions for the larger problems
confronting the insurance marketplace. I believe we must look
to ways to restructure TRIA to avoid these negative
consequences.
I think the Administration has made some helpful
suggestions as to how to redesign the program to allow the
development of a functioning marketplace. I look forward to
hearing more on these ideas from the Secretary of the Treasury
and the Chairman of the Council of Economic Advisers this
morning.
Beyond today's hearing, I look forward to working with my
colleagues to design a targeted, short-term problem that
permits a transition away from a taxpayer-supported system.
In the end, I believe the best way to deal with the
challenges we face is to encourage innovation along all fronts
and to draw upon the great strengths of our market-based
economy.
Senator Dole, any opening statement?
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Thank you, Chairman Shelby, Senator Sarbanes.
Welcome, gentlemen.
As we are all painfully aware, the events of September 11,
2001, brought about changes in many aspects of American life.
And just last week, we were all shaken by the terrorist attacks
on London. Certainly, our thoughts and prayers continue to be
with the victims and their families. The events in London
remind us of how unexpected and vicious those attacks can be.
Terrorist attacks, particularly large scale events such as
those on September 11, have significant effects on the ability
of consumers and businesses to obtain insurance. Insurance
coverage provides security and certainty for Americans and is
extremely important to continued economic growth and job
creation.
In November 2002, President Bush signed into law TRIA, to
provide a Government backstop for excessive losses caused by
acts of terrorism and to establish a temporary mechanism that
the Government would use to provide assistance, should, heaven
forbid, another large-scale terrorist attack occur in the
United States. In my 8 years as President of the American Red
Cross, I have seen time and time again how a good plan of
action established in advance can make a dramatic difference
after a disaster.
The Government Accountability Office, GAO, has recently
determined that the insurance industry has made little progress
to date in providing terrorism insurance without Government
involvement. This finding is of great concern.
While the lack of any notable progress on this effort is
disappointing, it is understandable, since we continue to lack
sound methods to predict the likelihood of terrorist attacks.
Insurance companies have developed highly sophisticated models
that anticipate the likelihood of natural disasters, such as
hurricanes in North Carolina. Such models suggest that there is
a high probability that our Nation will experience a number of
hurricanes over the next 15 years. However, acts of terrorism
are man-made, and we have no way to foresee the possible
frequency or size of such events. Hence, we have no way to
price the risk involved. This uncertainty has hindered private
market solutions to this problem.
TRIA was created to provide temporary coverage for large-
scale insured losses and to ensure availability of terrorism
coverage for consumers. God forbid we ever face a truly
catastrophic nuclear or biological attack, one that has the
potential to kill countless Americans over a very wide area,
but we cannot ignore the possibility. Because this threat does
exist, we should enact a long-term mechanism to protect against
truly catastrophic losses. This should include large scale
losses to group life insurance.
Mr. Secretary, I have reviewed your statements to the House
Committee on Financial Services from yesterday, and I believe
it is clear that you and the Administration understand the
important role a Federal backstop continues to play in our
Nation's economic growth and development. I look forward to
working with you in the coming months to reform and strengthen
TRIA so that we may maintain this important Government backstop
while also encouraging innovation and creativity in the private
insurance market.
This is an issue that has profound implications for the
strength of our economy, and I stand ready, Mr. Chairman, to
work with my colleagues as the Committee considers appropriate
action.
Thank you.
Chairman Shelby. Secretary Snow, welcome again. We are
going to put your written testimony, both of yours, in the
record without objection. You sum up briefly. I do want to
remind you we have four or five stacked votes, as you know.
Secretary Snow. I know.
Chairman Shelby. And we are not going to leave now. We hope
we can begin your testimony and then come back afterwards.
Secretary Snow. Chairman, I can be very brief.
Chairman Shelby. Take your time.
STATEMENT OF JOHN W. SNOW
SECRETARY, U.S. DEPARTMENT OF THE TREASURY
Secretary Snow. Chairman Bernanke and I have agreed to
divide our time to expedite our presentation.
Let me elaborate on the findings of the study that you
asked us to undertake. Of course, the study was part of the
original TRIA, and we were asked to look into the availability
and adequacy of the insurance market in the absence of TRIA and
what had happened in the intervening period.
Our findings are really fourfold: First, the industry
capacity to provide coverage for terrorism risk has improved,
and so has the take-up rate. Second, the study concludes that
insurers are increasingly pricing terrorism risk insurance and
the price of coverage with an explicit charge has decreased. I
say this is important, because it has occurred in the face of
rising deductibles, suggesting the capacity of the market to do
more.
Third, industry surplus has increased dramatically, and
industry profitability has increased dramatically. Fourth, many
insurers reinsure a substantial part of their retained risk
under TRIA; but, and this is an important point, overall
reinsurance purchases have not increased substantially. We
think that is clearly because of the crowding out effect of
TRIA on the reinsurance business.
These findings from the surveys of insurers and
policyholders point to the success of TRIA in achieving its
short-term goals. It has effectively addressed, in our view,
the market disruptions; ensured the continued widespread
availability and affordability of property and casualty
insurance; and allowed both insurers and policyholders time to
adjust to the post-September 11 conditions.
TRIA provisions shifted an increasing share of expected
terrorism losses back to the private sector. We think the
private sector should be encouraged to assume more and more of
these responsibilities, and we think it has the capacity to do
that. Had there been no improvement in the capacity, we would
have observed, I think, a pullback of terrorism coverage in
response to the shift in the deductibles which put more of the
cost back on the business.
The expansion of terrorism risk coverage, availability, and
take-up, and the decline in the cost, even as the TRIA
deductible has increased, highlight the improvements in the
industry's ability to cover terrorism risk. If the program is
to be continued, we have various suggestions as to how it
should be done in a way to encourage innovation and create more
capacity in the private sector. I will ask Chairman Bernanke to
lay out the principles that we think should be followed.
Chairman Shelby. Mr. Chairman.
STATEMENT OF BEN S. BERNANKE
CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS
Mr. Bernanke. Thank you.
Mr. Chairman, in 2002, with the economy being very
uncertain and the insurance industry reeling from September 11,
the enactment of TRIA was a sensible measure to try to provide
some transitional aid for the industry. Today, the economy is
much stronger and on a much better footing. Insurance companies
have increased their surpluses. They have begun to be able to
price and measure risk associated with terrorism, and we feel
it is in the national interest to try to increase the share of
terrorism risk which is borne by the private sector, both
insurers and securities markets.
Therefore, we do not support continuation of TRIA in its
current form. If it is to be continued, we would like to do it
in such a way that it will encourage increased capacity in the
private sector. In particular, some measures that we would
propose for consideration would be to increase the size of the
trigger event from the current $5 million to $500 million,
restricting TRIA to large events rather than including
relatively small events in the backstop; second, to increase
private sector participation by raising dollar deductibles and
copays to increase the share of risk borne by the private
sector.
Third, we think that the program can be more effective if
we eliminate certain lines of insurance which are not so
subject to accumulation risk, for example, general liability,
while focusing on lines such as property and casualty. And
finally, we would like to consider some reasonable reforms to
litigation that would make the delivery of compensation more
efficient.
In summary, we do not support continuation of TRIA in its
current form. If it is to be continued, we would like to see it
done in such a way as to encourage greater private
participation in the market for terrorism risk insurance.
Thank you, sir.
Chairman Shelby. Senator Dodd, do you have any questions?
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Mr. Chairman, let me take advantage of the
time here, if I can.
Chairman Shelby. Sure.
Senator Dodd. And make a quick opening statement, if I
might, on this. And let me begin by thanking you immensely for
doing this.
Chairman Shelby promised those of us who have been deeply
interested in this issue that once the Treasury report was out
that he intended to move promptly to consider a proposal
regarding terrorism risk insurance. We have known each other a
long time, and his word is his bond, and once again, you have
demonstrated that by having this hearing as quickly as you
have.
I appreciate the call from Secretary Snow. It was very
generous in calling several of us here prior to the report
coming out to give us a quick brief on what would be included
in it. And I thank you for coming as well to be with us. Many
of us worked very hard, as all of you know, 3 years ago,
including the Chairman and Senator Sarbanes, to put together a
good bill, and I think one of the reports that comes out here
indicates, in fact, the bill that we adopted after a very
difficult time of getting it done actually was successful in
many ways.
So, I would like to especially thank the Secretary for his
work in this area. This study not only documents the success of
TRIA, which I think is important, but it also provides some
important suggestions, Mr. Chairman. You and I briefly talked
about that in the corridors and on the floor of the Senate that
we should be considering, as part of our work, to extending the
TRIA program.
I expect the Secretary's comments yesterday before the
House Financial Services Committee and Congressman Oxley's
comments as well, which I think are welcomed, and a lot of the
events over the last number of days, particularly the tragedy
in London, I think there is a heightened sense that this
proposal deserves more consideration than it otherwise would
have received--tragically; I wish that had not been the case
obviously.
And I do not necessarily agree with some of the suggestions
you have made, Mr. Secretary, but as we move through the
process here, I look forward to certainly working with you and
your colleagues and the Committee to see if we cannot extend
TRIA and build on the success of the program.
Let me just, if I can, appreciate the significant work, but
I would like to make a couple of points, if I could. First of
all, any notion that TRIA has in some ways helped to create the
problem is just not only misguided; but it is also dead wrong,
in my view. Let us not forget that the root of this problem is
the wanton acts of terrorism that were committed against our
country. The tragic events of September 11 caused tremendous
loss of life and severe economic damage.
This Congress worked hard to answer those attacks in a
variety of ways. And TRIA was a critical part of our national
response to a national problem. Without the passage of TRIA, we
risk significant economic dislocation, job loss, and leaving
our Nation vulnerable to future terrorist attacks. This report
accurately concludes that TRIA was effective at achieving its
main goal of ensuring affordability and availability of
terrorism insurance.
Second, the notion contained in this report that TRIA has,
in some way, crowded out the private reinsurance market is just
plain wrong. I fail to see anything in this report, empirical
or anecdotal, that supports that idea. In fact, this report
contains no information from the reinsurance industry itself,
but only from direct writers of insurance.
This omission is especially troubling, I might add, because
fundamentally, the TRIA program acts as a Federal reinsurer in
the absence of a private reinsurance market. How can a study on
the effectiveness of a Federal reinsurance program be complete
without an examination of the underlying reinsurance industry?
The truth is that direct writers of insurance, those who deal
directly with consumers, want more private reinsurance, and
they simply cannot get it.
Last year, under TRIA, the total industry-wide retention
level was around $31 billion. According to a survey conducted
by the Reinsurance Association of America, there was
approximately $4 billion to $6 billion of reinsurance currently
available in the terrorism marketplace. That is a gap of
somewhere around $25 billion, which means only a fraction of
terrorism risk is being underwritten by reinsurers.
Traditionally, depending on the risk tolerance of the
individual insurer, most direct writers underwrite between 20
to 40 percent of the policies they write, while 60 to 80
percent is ceded to reinsurers.
TRIA, in my view, has done nothing to crowd out
reinsurance; in fact, the opposite is true: There is simply not
enough reinsurance in the current marketplace, and if
reinsurers are unwilling to write greater terrorism risk with a
Federal backstop to cap their maximum exposure in place, the
expiration of TRIA will only exacerbate a lack of reinsurance.
Third, Mr. Chairman, I am concerned that this study falls
short in its analysis of alternatives in developing the concept
of capital market innovations. The report does little to
describe current or potential innovations that could occur in
the marketplace, and how the program is currently structured
either promotes or inhibits such innovations.
While I recognize that this is a bit difficult to quantify,
the fact that you conclude that the TRIA program has crowded
out innovation begs the question: What types of innovation
should or could develop in the terrorism insurance marketplace.
I certainly would welcome your response to the question later
in the hearing on that particular point.
But, Mr. Chairman, I think we need TRIA now more than ever,
and I certainly welcome a legitimate discussion of whether
modest changes are needed in the extension of TRIA. However, I
believe that letting TRIA expire is not an option. We simply
cannot afford to risk the consequences, particularly with the
overwhelming success of the current program.
We are at war. I do not know what more clearly needs to be
stated. We have had 221 attacks against ourselves or allies
since 1983. At some point or other, we need to wake up and move
on these issues and see if we cannot establish a sound program.
So, I would like to bring to the attention of the witnesses the
strong bipartisan support for the extension of the terrorism
risk insurance. Senator Bennett and I, with 32 of our Senate
sponsors as well as a majority of the Committee, that is,
Senators Schumer, Hagel, Reed, Bunning, Bayh, Dole, Carper,
Stabenow, Corzine, and Johnson have introduced legislation to
extend this Terrorism Risk Insurance Act.
TRIA has a history of bipartisan support, and I am pleased
to say that the robust support on both sides of the aisle still
exists as we consider an extension of this program. It is my
fervent hope that we will find a solution to this problem and
do it as quickly as we possibly can, and again, Mr. Chairman, I
thank you immensely for acting as rapidly as you have by giving
us this opportunity.
Chairman Shelby. We have to go to the floor. That is where
most of our colleagues are. And we are going to be in recess,
say, for at least 45 or 50 minutes, and we will be back. I am
sure there will be a number of Senators wanting to question
you. We are in recess now.
[Recess.]
Chairman Shelby. The hearing will come back to order.
Mr. Secretary, Chairman Bernanke, I am very sorry. It is
just the nature of business in the Senate, as both of you know.
We had five votes, and they take a little while. A lot of my
colleagues are still over there, and that might be good news
for both of you.
[Laughter.]
I understand, Mr. Secretary, you have to go in just a few
minutes, and if nobody shows up, you might go sonner than that.
I do have a number of questions for the record, and I do
appreciate your indulgence.
I noted in my opening statement that the recent tragic
events in London do not teach us any new lessons, but they do
remind us of the threat of terrorism, because we know it here.
We have experienced it here. The threat of terrorism has been
an undeniable reality since September 11. But notwithstanding
the fact that most people have long recognized this, some are
now arguing that the events in London have changed the nature
of the debate.
I do not think they have changed the nature of the debate
at all. I was in London. I was there when this was going on. It
just reminds us of what we already know: That we are all
vulnerable to some degree. Chairman Bernanke, this
Administration is extremely mindful that the threat of
terrorism could remain for some time into the future.
Mr. Bernanke. Yes, sir.
Chairman Shelby. It is on record.
So in reality, the London bombings have not changed the
Administration's perspective but rather have reinforced it.
Would that be correct, Mr. Chairman?
Mr. Bernanke. That is correct.
Chairman Shelby. Is it appropriate to conclude that the
Administration was mindful of the continuing threat of
terrorism when it put together its recommendations with respect
to the TRIA program, Secretary Snow?
Secretary Snow. Yes, sir, Mr. Chairman.
Chairman Shelby. And of course, it does not leave out the
long-term economic interests of the country in any way, does
it?
Secretary Snow. Quite the contrary, Mr. Chairman. We think
it advances the long-term economic interests.
Chairman Shelby. Chairman Bernanke, in your testimony, you
raised a very important point that bears repeating, ``TRIA does
not eliminate terrorism risks but merely shifts the burden to
the taxpayer.'' With this in mind, should we not first look to
the dynamic capability always of the market economy before
exposing the taxpayers to the risk. Also, if we do pass an
extension of some type of insurance, which probably will be the
case, should it not be narrow in scope, because otherwise, the
markets will never develop the product?
Mr. Bernanke. I agree, Mr. Chairman. Under the current
rules, if there were to be a major terrorist attack, the
taxpayer would be on the hook for up to $70 billion. That is
money that would not be available for humanitarian assistance,
reconstruction, or economic rebuilding. Why not enlist the
private sector to help support the reconstruction effort? And
the reform of TRIA would increase the capacity of the private
sector, the insurance markets, the securities markets, to
provide funding in the event of such a tragedy.
Chairman Shelby. Secretary Snow, in your testimony, you
noted, ``extending TRIA in its current form is likely to
discourage the private market from development needed to deal
with the risk of terrorism.''
Secretary Snow. Absolutely.
Chairman Shelby. Would you elaborate for just a moment on
the market distortions caused by TRIA, in your judgment?
Secretary Snow. There are a number of market distortions;
basically, the fact that the Government is playing a larger
role, occupying more space in the reinsurance business, in the
insurance business than would be the case if we allowed the
market to work. If we allowed the market to work, I think we
would see a lot of adaptations and adjustments. I think we
would see a creativity and cost-effective means of covering
terrorist risks.
I think we would see aaptations on the part of
policyholders that would be beneficial in mitigating risks, and
I think we would see credit markets adjusting as well so that
the risks would be better distributed between the Government,
the taxpayers, really, who always stand behind the Government
and the private sector. The private sector can, and should do,
more in carrying these risks.
Chairman Shelby. Secretary Snow, you support--speaking for
the Administration, both of you--eliminating certain lines of
insurance from coverage under the program. Would you both
elaborate on that a little?
Secretary Snow. I can very briefly--yes, we do, lines like
auto----
Chairman Shelby. Life insurance?
Secretary Snow. Group life? Group life, yes. The reason
that we support the elimination of certain lines is that these
lines do not create the cumulation, aggregation risks that are
associated with terrorist events. We think those are lines that
can be well-covered by the market. Of course, in response to
the TRIA directive, we did a study on group life and concluded
that the market was providing ample availability of group life
insurance.
Chairman Shelby. Okay; Chairman Bernanke, one of the
interesting developments that has occurred since the enactment
of TRIA has been the emergence of insurance coverage for
domestic terrorism events, something that is not included under
TRIA. What conclusions do you draw regarding the fact that this
type of coverage is now available in the market notwithstanding
the absence of a Federal program?
Mr. Bernanke. Chairman Shelby, it is true that there is
available insurance for domestic terrorism risk, which is not
covered by TRIA, and that seems to indicate that the market
does have some ability to price and evaluate that risk and to
provide insurance for it. It may be somewhat different from the
scale or magnitude or qualitative nature of some international
risks. Nevertheless, it is encouraging in terms of what the
industry has been able to do.
Chairman Shelby. The report, Chairman Bernanke, assesses
the likely capacity of insurers to offer terrorism insurance
after termination of the program. You find that their modeling
capacity and financial capacity has greatly improved. This is
helpful, but it is only one option. Your report does not assess
the likely response of markets outside of the insurance
industry. These actions, I think, would be critical, because
insurers alone will not solve the terrorism risk problem.
Could you comment, if you have any thoughts, on where else
in the financial markets that we can expect to see innovations
for bearing terrorism risks? And do you believe that our
financial markets are sufficiently broad, liquid, and
innovative to spread this type of risk, which is important?
Mr. Bernanke. Yes, Mr. Chairman. First, I do think the
insurance industry has quite a bit of way to go to expand its
capacity to deal with these risks, and beyond the insurance
industry, in the securities markets, there are a number of
possible ways in which these risks could be shared across
society. For example, use of real estate investment trusts
would allow investors to hold portfolios of a number of
different properties that would be well-diversified by
geography and by risk. That would allow a way of diversifying
this risk. Commercial mortgage-backed securities would be
another such mechanism, as would portfolio diversification on
the part of owners of buildings that would own portions of a
number of buildings across the country. These are all ways to
spread the risk among a number of different owners, as are
potential innovations such as catastrophe bonds that would
allow the sale of part of the risks in a secondary market.
I do believe that these markets are very deep; they are
very liquid; they are very innovative; and given a chance, they
will be very helpful in providing more coverage of these risks.
Chairman Shelby. Mr. Chairman, the Treasury report also
indicates that prices for terrorism risk insurance have not
changed in a manner commensurate with the increase in insurers'
risk exposure; for example, while insurer deductibles increased
significantly, average prices only inched up, and prices in
high risk cities fell considerably. What does this tell us
about expected pricing if there were to be additional shifts in
risk in the private sector?
Mr. Bernanke. Mr. Chairman, I would be careful not to
extrapolate too far from this data, but it does suggest that as
more of the risk has been returned to the private sector,
pricing and availability have not suffered. That suggests that
the industry is building capacity and can continue to build
capacity to meet these risks.
Chairman Shelby. Senator Dodd.
Senator Dodd. Thank you, Mr. Chairman. And I apologize
again to both of you here for this interruption this morning
with our votes. What is the play, Mr. Chairman?
Chairman Shelby. The Secretary has to leave at 12:15, so I
was recognizing you right now.
Senator Dodd. Lucky guy.
Chairman Shelby. He has been here an hour or so.
Senator Dodd. I know. We apologize to you.
Let me, if I can, pick up on this in the report, Mr.
Secretary. In your report to Congress at numerous points, you
believe that a private market will develop over time for
terrorism insurance. My concern is I do not see anything, any
data in the report or any basis for that conclusion.
We have not received any testimony in this Committee, and
the Chairman has been very gracious in listening to a lot of
different people about this program and what should constitute
a good program. Nor has there been any discernible activity in
the marketplace, because certainly, there has been no guarantee
that this
program is going to exist in perpetuity. Given the history of
developing the program in the first place, the reluctance to do
much about it until this Treasury report came out. Even with
that, concerns about whether or not we would go forward, how
hard it was to get in the House; the argument, well, as long as
this program is around, no market was going to develop. It
seems to me, given the uncertainty about all of this, you would
assume that one might begin to develop, at least, out there.
The reinsurance market, the Reinsurance Association of
America, and I mentioned this in my opening comments to you,
there is only about $4 billion to $6 billion in reinsurance
available today. They state, ``there is no evidence to support
Treasury's suggestion that the expiration of TRIA will
encourage the development of a private reinsurance market and
other risk transfer mechanisms.''
Just a few months ago, the Federal Reserve Chairman, Alan
Greenspan, has said, and I am quoting him, that he has yet to
be convinced the private market alone can adequately insure
against the continuing threat of terrorism. That was in
February 17 testimony. A recent report by Standard & Poor's
rating services concludes that without terrorism risk
insurance, ``property and casualty insurers will cease to offer
this coverage or will offer it only at extremely high rates.''
TRIA is set to expire, as you all know, on December 31. And
I again quote him here: ``leaving insurers and ultimately
policyholders without protection in case of another major
terrorist attack.'' That is Standard & Poor's on February 3.
In an April 28 report, Moody's noted that insurance brokers
report that up to 75 percent of policies written since January
1 have adopted a conditional endorsement that automatically
voids terrorism coverage if TRIA is not renewed and that the
number of conditional endorsements is expected to increase as
the year progresses. These conditional endorsements appear to
be, and I am quoting here, ``these conditional endorsements
appear to be an indication that unless TRIA is renewed, premium
spikes or a sharp reduction in the availability of coverage may
result.'' That is Moody's conclusion.
With all due respect, Mr. Chairman, what makes you believe
that the market is ready? Where in the study can I find this
information that the market is going to respond to this? And
could you please tell us how you arrived at the conclusion that
the private market can and will develop such a market?
Secretary Snow. Thank you, Senator Dodd.
The study points out that we have had increasing coverage
and take-up rates, even as the market has been allowed to play
a bigger role. This is because the structure of TRIA was
designed to give the market a bigger role over time with larger
deductibles built in, going from 7 to 15 percent. And what we
have observed, and I think this is laid out in the study, is
that even as the market has taken a bigger role with those
increasing deductibles, the coverage has expanded.
We have confidence that that trend would continue as we
follow the reforms we have suggested of larger deductibles and
also larger copays. So this is a case where I think the past is
prologue.
Senator Dodd. Would you disagree with me at all about what
I said earlier that we talked about the $31 billion we are
looking at here, the $4 billion to $6 billion presently out
there, and thus, the $25 billion gap? Where is that being made
up? I do not see any evidence of that.
I agree with you. The idea was earlier, and believe in time
this will happen or at least hope it does, but I do not see any
evidence that this was emerging at all. I do not see the data
that shows that $25 billion gap is going to be closed.
Secretary Snow. As I say, Senator, we do have experience
with rising deductibles and we watched the market continue to
develop and expand, even with those rising deductibles. I think
that is pretty indicative that the market has more capacity,
and the basic conclusion of the study is that capacity has
expanded significantly. The take-up on terrorist coverage was
27 percent or so, mid-20's in 2002. It is now well over 50. The
share of insurers who were pricing insurance back in 2002 was
roughly 20 percent; today, it is about 55.
Senator Dodd. Let me just make the case that TRIA has been
working, but your numbers do not jibe here. I do not want to
keep belaboring this point, but, I mean, I think the fact you
made the point in this study, and I appreciate it, that TRIA
actually is doing a good job. It did its job providing that
product out there at reasonable prices, and that helped
stabilize that market, and our concern--I am not for a
permanent program at this point at all, as you and I have
talked about here, and you do not want that either. I gathered
in your conversation, that maybe an extension here is what we
are talking about.
But I do not want to belabor this point too much with you.
I just do not see that marketplace picking up the slack. If we
do not get this done, I do not think there is any likelihood
that you are going to have that gap that is going to be filled
here.
Secretary Snow. Yes, Senator, that is where we would
differ. We think the market has more capacity, giving it more
room to operate and giving it more incentives to operate.
Reducing the implicit subsidy for reinsurance that exists
today, which is pretty sizeable, is going to create more
opportunities for the sorts of things that Chairman Bernanke
just talked about: Mitigation on the part of policyholders,
risk sharing through financial instruments, and broader
reinsurance coverage.
Senator Dodd. I mean, what if I am right, you are wrong?
What happens to people out here? What happens out here? What
happens to people if we have an event, and we do not have the
coverage? What happens?
Secretary Snow. You are postulating the thing that we are
asserting will not happen. Coverage has expanded and will
continue to expand, and we will get a better sharing of these
risks between the taxpayers and the private sector. The private
sector, incentivized appropriately, can do more, Senator. That
is our basic proposal: And to continue the basic model that
TRIA put in place, which was a temporary program with rising
deductibles, and to include rising copays, both of which
provide more room for the market to demonstrate what it can do.
Mr. Bernanke. Senator, may I add?
Senator Dodd. Yes, certainly.
Mr. Bernanke. Just on the point of reinsurance, I think
reinsurance rates differ by type of insurance. According to the
Treasury study, commercial multiperil insurance has a 20
percent reinsurance rate, and workman's compensation has a 24
percent reinsurance rate. Twenty percent of $31 billion is $6
billion, which is about the number you cited. So it is not
clear that reinsurance is unavailable for insurance up to the
deductible.
The study also notes that small companies have been able to
utilize reinsurance at a greater rate than large companies,
which is consistent with their greater need to diversify and
also suggests that reinsurance is not being rationed. So, I
think I would agree with Secretary Snow that there is quite a
bit of capacity out there, and that once we remove the free
reinsurance being provided by the Government that market
reinsurance will take part of its place.
Senator Dodd. That is pretty speculative.
Chairman Shelby. Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Mr. Secretary and Chairman Bernanke, I do
not have the answer, but I have a very uncomfortable feeling
that the problem is not being sufficiently analyzed. The payout
if something happens is enormous, so the question becomes how
are you going to provide for that? I mean, the magnitude is
beyond other experiences, as I understand it.
Now, the likelihood may be small, but nevertheless, it is
likely to be heavily concentrated. I am struck by the fact that
the British, who are pretty good at analyzing things and
figuring them out, they have had experience in dealing with
terrorism over several decades. They have established a
permanent public-private partnership for dealing with the
question of insurance against terrorist attacks, Pool Re, an
industry-supported reinsurance pool with a backstop by the
Government.
Now, the London Financial Times reported on July 8 that,
``a large portion of the insurance claims rising from the
explosions that ripped through London is likely to fall on Pool
Re, the government-backed mutual reinsurer for UK terrorism
risks.'' Now, the Israelis, who have also had, of course, long
experience in dealing with terrorism, also have a system where
they provide a permanent government coverage.
I do not see these pickups coming. The Treasury report
concludes that the immediate effect of the removal of the TRIA
subsidy is likely to be less terrorism insurance written by
insurers, higher prices, and lower policyholder take-up. Well,
you may say that will be over a temporary period, and then, the
market will step in and accomplish this. I am not quite clear
how that is going to happen.
The President of the Reinsurance Association of America
recently stated, ``reinsurers continue to view terrorism as a
risk that is uninsurable unless there are limits to protect
against catastrophic exposure.'' And that seems to me to put
the issue pretty well, because the exposure is huge.
Now, if you are going to set premiums to cover the
exposure, they are going to accumulate a lot of money that they
may never be called upon to use, because you may never have the
incident. On the other hand, if you have the incident, they are
really going to get socked and socked hard, as the British are
now demonstrating.
It seems to me that the Government backup gets the rest of
the market in a proper balance so that people are paying for
some coverage, which deals with the beginnings of this thing,
but they do not have to pay for the coverage of the
catastrophic amounts. Otherwise, you are going to levy a
charge. It may never be used.
Of course, you can say that is the case in all insurance,
but the levels are a lot more reasonable than what is occurring
here. How do we get around that problem? How is the private
market going to pick up this very heavy risk, catastrophic
potentially?
Mr. Bernanke. Senator, if I could----
Secretary Snow. Yes, go ahead, Ben. Maybe I should, because
I am going to have to just leave in one minute.
Senator the world is a lot different----
Senator Sarbanes. Well, I do not want to drive you out with
my question.
[Laughter.]
Secretary Snow. No, no, unfortunately, the conditions that
drive me out preceded your arrival.
Chairman Greenspan has been cited. He is talking about a
really mega-event, beyond, we would stipulate, beyond the
capacity at the private market. TRIA contemplates that there
are some events so large that Congress and the Administration
would have to come back and look at it. Everyone would agree
with that. We would all agree that there are events of some
scale and size and risk that are large relative to the capacity
of any individual insurance company.
Senator Sarbanes. Now, do I take that to mean that you
think there should be a bill, a further extension of some sort?
Secretary Snow. I think there should be reform. I think
that the reforms that we outlined are the right way to go. They
would give us the ability to see the private market work
better. They would encourage mitigation. They would encourage
financial market developments. We would narrow the lines of
coverage; and, we would give the market more of an opportunity.
Earlier, I said, Senator Sarbanes, that we have watched the
market, even in the face of higher deductibles, expand and take
on more of the responsibility. This is a matter of getting the
risk sharing between the private sector and the Government into
a better posture.
Senator Sarbanes. But I take it you are asking the Congress
to enact legislation; is that correct?
Secretary Snow. Well, I am really saying that we should
reform the current TRIA system if you extend it.
Senator Sarbanes. Do you want it extended?
Secretary Snow. I want the reforms.
Senator Dodd. You cannot get reforms without extending it.
[Laughter.]
Secretary Snow. Well, then, if you extend it, if you extend
it, it should be reformed.
Senator Sarbanes. What is your view of not doing anything?
Secretary Snow. I think the system should be reformed. I
think that is the prudential thing to do.
Chairman Shelby. If I can, I think that what we are doing
is the right thing, listening to the report, listening to your
views, and we will certainly listen to your recommendations.
But I personally believe that we do need a program here, and we
need to have it narrow in scope, and we need to be careful in
what we do, because if we do not, we will never develop the
private markets.
Senator Dodd. Mr. Chairman, can I ask, just before the
Secretary leaves, because I am curious about this $500 million
number here.
Secretary Snow. Right.
Senator Dodd. The problem is, again, going from $5 million
to $500 million is a pretty large leap.
Secretary Snow. Right.
Senator Dodd. And rather than argue about the number
itself, I would just be curious on how you arrived at that
number.
Secretary Snow. We arrived at that, Senator Dodd, through
the Treasury experts consulting with industry experts, brokers,
and industry participants. We looked at it as well, and we can
give you the references to these people that we talked to. We
looked at their current and existing limits on existing events,
and we looked at the evidence of the last 3 years, as the
market itself has evolved and developed in the face, as I say,
of higher deductibles.
So it is judgmental; if you are asking me is it a judgment;
yes, it is a judgment, but I think it is a well-informed and
thoughtful judgment.
Senator Dodd. Well, I would be, you know, I wonder what the
effect would be on small insurers, because it is not all just
big companies we are talking about. It would be a pretty heavy
hit.
Secretary Snow. Who also tend to insure smaller scale
events, take on smaller scale risks.
Senator Dodd. I would be very interested in the data that
helped you arrive at that.
Secretary Snow. We will submit that, and I apologize very
much Mr. Chairman, Senator Sarbanes, Senator Dodd, for the
prior commitment, Senator Hagel, and I would be delighted--
Chairman Shelby. Mr. Secretary, you got time for a question
if he has one from Senator Hagel?
Secretary Snow. I always have time for Senator Hagel.
[Laughter.]
STATEMENT OF SENATOR CHUCK HAGEL
Senator Hagel. Mr. Secretary, thank you.
Senator Sarbanes. That is the right answer.
[Laughter.]
Senator Hagel. He experienced some Cornhusker hospitality
last week, and I understand they treated you well out there and
that you were a big hit.
Secretary Snow. Thank you, Senator.
Senator Hagel. But you did not bring any linebackers or
quarterbacks with you, I heard.
I am sorry I am late here, Mr. Secretary, but I understand
in referencing the Treasury report, which came out, what, a
week or 2 weeks ago, that Treasury report noted the lack of
reinsurance coverage on group life and for group life
companies, and it is my understanding, I watched a little bit
of this on television here before I came, that you had
responded to the Chairman saying that you, Treasury, do not
recommend that we include covering group life in TRIA, and I do
not know whether that has been covered.
Chairman Shelby. Go ahead.
Senator Hagel. And I apologize for taking you back through
that, but if you could explain that essentially; what do we do
here if we cannot find that reinsurance element, and what is
your suggestion if we do not cover it under TRIA?
Secretary Snow. Senator, under the original TRIA, Treasury
was asked to do a study and determine what course of action was
prudent with respect to group life. We were asked to look at
two criteria: One was the availability of general insurance for
group life, and two was reinsurance. We found, and we said that
we should not cover group life unless it was a conjunction, it
met both tests.
We found that there was general availability of group life,
but that there was not general availability of reinsurance;
and, since the test was the twofold test, we did not include
group life. Then, going to the broader issue of the
recommendation, we do not think group life presents the
accumulation risk that terrorist risk insurance was intended to
cover, so we do not recommend covering it. We think the
marketplace can work well in that area if we move the
Government out and thereby reduce the implicit subsidy and
encourage a larger role for reinsurance. That is our basic
view. I know you do not agree with it.
Senator Hagel. I do not, but more to the point, we are
going to have to address it and deal with the realities here of
the market, and I am inclined, as I am sure some of my
colleagues and others, to find a resolution and have to and
work with you on this as well and, as you know, Senator Dodd
and others have led the effort here, and I will continue to
work with them, and I know you have to go, so thank you for
allowing me a question. I appreciate it.
Secretary Snow. Thank you.
We have given you our study, and we have given you the
recommendations that we think follow from the study, and we
look forward to working with the Committee and the Congress as
you continue to consider this important issue.
Senator Sarbanes. Mr. Chairman, as Secretary Snow departs,
let me note Senator Schumer was not able to be with us, because
he has some amendments on the floor that he is dealing with. He
is obviously keenly interested in this subject, and he has a
series of questions he wants to submit for the record.
Chairman Shelby. Without objection, they will be made part
of the record.
Senator Sarbanes. I want to bring that to the Secretary's
attention, because I know some of them are directed to the
Treasury.
Secretary Snow. Exactly, Senator Sarbanes, and Senator
Schumer and I have talked about that, and I fully contemplate
further conversations with him as I do with Senator Dodd,
Senator Hagel, the Chairman, and you.
Thank you very much.
Chairman Shelby. Thank you, Mr. Secretary.
Senator Sarbanes. Mr. Bernanke, could I ask you a couple of
questions before you go?
Mr. Bernanke. Yes.
Senator Sarbanes. Nice to see you here, and congratulations
on your confirmation.
Mr. Bernanke. Thank you, sir.
Senator Sarbanes. Is this the first time you have appeared
as Chairman of the CEA.
Mr. Bernanke. It is.
Senator Sarbanes. Good.
Chairman Shelby. But not the first time he has been before
us, been with us.
Senator Sarbanes. No.
You noted in your testimony that the 60 percent of the
policies included terrorism coverage in 2002 and conclude from
that that it was generally available. I am interested in, first
of all, whether you know the 60 percent of policies included
coverage that was comparable in terms of limits and exclusions.
Mr. Bernanke. No, sir, I am quoting the number from the
Treasury study, and I merely made the point that insurance
coverage did not dry up entirely. I do believe that TRIA was
useful and did enhance the insurance market.
Senator Sarbanes. Do you know the geographic location and
risk profiles of the properties covered, the 60 percent by
those policies?
Mr. Bernanke. I do not. The Treasury study does, however,
suggest that premiums between cities, large cities and other
cities and premiums between so-called ``high risk properties''
and ``less risk properties'' did not diverge unduly over this
period, suggesting some capacity to cover even higher risk
areas.
Senator Sarbanes. They may have taken the path of not
providing the coverage rather than escalating the premiums,
which they made the kind of judgment about the risk.
I guess the point I am trying to get at, and I am not
suggesting a counteranswer, because I just do not know; I mean,
it is not meant to draw a conclusion, but if the policies were
in relatively low risk areas in effect, it would be difficult
to draw the conclusion that terrorism insurance was generally
available, would it not?
Mr. Bernanke. Again, I would differentiate between 2002 and
then the subsequent years. In 2002, there was a good bit of
insurance being written, but I am not claiming it was the
optimal amount or the desired amount. TRIA did help to
strengthen the market. I think TRIA was a good bill.
As we looked over the next few years, though, we saw that
generally, availability and pricing improved, and I believe the
Treasury study showed that that was both the case in high risk
as well as less high risk areas, despite the fact that the
exposure to the private industry essentially doubled as
deductibles went from 7 percent to 15 percent. So, I take that
as evidence that the industry, over time has been building
capacity, ability to price these risks, and ability to insure
these risks.
Senator Sarbanes. Why do you think the British and the
Israelis do it the way they do?
Mr. Bernanke. Senator Sarbanes, different countries use
different methods. The OECD report suggests that only 5 of
their 30 members have similar approaches. I would think that in
the case of the London bombings, as tragic as they were, that
preliminary estimates of the damages are on the order of 1 to 2
percent of a major hurricane, and therefore, it seems to me
something that could have been handled strictly in a private
market, and the British have decided to provide this backup;
that is the approach they have chosen.
Senator Sarbanes. So you do not see the catastrophic size
as way out of bounds; is that correct?
Mr. Bernanke. Senator, your point that you actually raised
earlier, I think, is right on point, which is that I believe
the insurance markets can handle substantial risks but not
unlimited risks, and in particular, TRIA as currently written
is capped at $100 billion, and presumably, a shock above $100
billion would require the Congress to reconsider the entire
situation and make priorities about where its available funding
would go.
What we are talking about here is creating more exposure to
the private sector below this $100 billion risk. That number is
a very high number, but it is not radically different from
risks that are borne in other kinds of contexts.
Senator Sarbanes. Do you think we need to pass legislation
on this issue?
Mr. Bernanke. On TRIA? I would like to see substantial,
increased exposure to the private sector of terrorism risks. I
would be happy with any legislation that accomplished that
objective.
Senator Sarbanes. Let me pursue the question for a minute,
because sometimes, the easiest thing in the Congress is no
action, you know? What is your view of a scenario in which the
Congress failed to take action on this issue and the program
simply expired?
Mr. Bernanke. I think an expiration would probably require
some transition period before it was finally expired to give
the markets ability to adjust. I think the more likely
outcome----
Senator Sarbanes. That means you think we need legislation.
Mr. Bernanke. I am comfortable with legislation that
increases the exposure of the private sector to these risks.
Senator Sarbanes. Thank you, Mr. Chairman.
Chairman Shelby. Senator Hagel, do you have any questions
for the Chairman?
Senator Hagel. No questions.
Chairman Shelby. Mr. Chairman, we appreciate first your
indulgence in waiting, and we will continue to work with you on
this issue that we think is very important.
I think it would be unacceptable for us to not do anything,
and we are going to try to come with a bill, a meaningful bill,
a responsible bill and hope that with time that the private
market will assume more and more of the risks.
Senator Sarbanes. Is the Council of Economic Advisers still
banished, exiled, or still outside the Executive Office
Building?
Mr. Bernanke. I have a personal office that is in the
Executive Office Building, which is very useful, and we use
that to----
Senator Sarbanes. But you are separated from all your
staff.
Mr. Bernanke. But my staff, unfortunately, are a block
away. We make the best of that.
Senator Sarbanes. Are they scheduled to come back in? Is it
because refurbishing is going on?
Mr. Bernanke. It is entirely because of refurbishing and
reconstruction, and I do not think that is about to be
completed. I think there is still some time.
Senator Sarbanes. We are trying to be helpful to you on
that issue.
Mr. Bernanke. Senator, I would be happy to accept any help
you are willing to offer on that front.
Chairman Shelby. Mr. Chairman, how is the transition going
from the Federal Reserve, a Member of Board of Governors, as
you were, very active, to the Chairman of the President's
Council of Economic Advisers?
Mr. Bernanke. The new job is very exciting and gives me a
wide range of opportunities to look at different issues like
this one, and I want to thank you again for your speedy
confirmation.
Chairman Shelby. Senator Bennett, you are just in time.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Yes; thank you, Mr. Chairman. I apologize
for being late. The votes disrupted all of our mornings. But I
am still grateful for the opportunity.
I will not go into any particular details. I am sure they
have been discussed at great length, and I will read the record
with great interest. But let me just get your reaction to one
thought that has occurred to me, and I have discussed it with
Secretary Snow privately.
If we do not have a formal TRIA program, and there is
another September 11, that is, a major disaster that is in the
$40 billion category, remembering what happened after September
11 around here, the Congress went to great lengths to assure
everybody that they would be made whole. The speed with which
the $40 billion for New York and Virginia went through here was
really astonishing.
I believe that same thing would happen, I say, if there
were an event, somebody flew an airplane or found a rogue
cruise missile or whatever disaster you might think of in San
Francisco to the TransAmerica Building, the California Senators
would be here saying you have to help us, and every one of us
would say yes, we will help you.
I remember one Senator saying at the Senators' meeting we
had after September 11 consider me the third Senator from New
York. I will fight as hard as you do for these appropriations.
Senator Sarbanes. I hope they got it down and recorded it.
[Laughter.]
Senator Bennett. Well, yes.
Now, my concern is, for those who say, well, let us not
have the Federal Government involved in this; this is something
the market should do because we do not want to put the
taxpayers on the hook, that experience says to me the taxpayers
are going to be on the hook, emotionally if not financially,
but emotion will turn to finance really quick, as it did after
September 11.
Now, I am not begrudging the $40 billion, but I can tell
you that the emotion around here was so strong that if somebody
had said $50 billion, no, it has to be $60 billion, there would
not have been very many who would have stood up and said, well,
I am going to look at the pocketbook rather than the problem in
New York, and $60 billion is too much. I do not know whether
$40 billion was the right number or not, but $40 billion is
what we did.
All right; I am rambling, but let me get to the point. I
think, paradoxically, that extension of this program with a
specific number in it that will cause the industry itself to
come in and backfill, if you will, up to that number actually
would be better for the taxpayers than if there were no formal
action, because then, we could say, well, the legislation is in
place; there is a taxpayer involvement; but there is a $30
billion, a $40 billion, or a $50 billion, if you will,
deductible from the taxpayers, that the market has now, in an
orderly fashion, filled in.
If we do not put that deductible in place, the market will
not fill in anything, and the taxpayers will be on the hook for
the whole amount. React to that observation. Am I right or
wrong? I mean, I think am right on the emotion, but am I right
on what the market might do?
Mr. Bernanke. Senator, I think I broadly agree with you. I
think what we want to do is get the private sector more
involved to provide more insurance and other types of
mechanisms for sharing risk and compensating losses so that
should an attack happen, the private sector will provide
substantial funding for reconstruction and for compensation,
leaving the Government without these huge obligations through
TRIA but with the money available to do whatever is necessary
on a prioritized basis for humanitarian assistance, for
reconstruction, and for getting the economy back on its feet.
So, I think the purpose of TRIA is not to say we are
throwing the country to the wolves; the point is to get both
the private sector's insurance capacity and the Government's
reserve for emergencies of all kinds--both of those things--
available should an attack occur.
I believe I agree with the philosophy you are saying, and I
think a big part of that, again, is to stop suppressing the
private market and allow the private market to come back in to
this process in a much bigger way than it is now.
Senator Bennett. So if we set a Federal number at a
reasonably high level, then, the private market says okay, we
can fill up to that number. If we leave the high level off, the
private market says we do not know quite where to go, and the
taxpayers, I think, in the event of a real disaster would end
up paying more than they would if we extend TRIA in a logical
fashion.
Mr. Bernanke. We have a $100 billion limit now on TRIA.
Above that level, the Congress is going to simply reconsider
the entire situation. We have a number of mechanisms already
for dealing with emergencies such as FEMA, for example.
Senator Bennett. Right.
Mr. Bernanke. So what I would suggest is not that we try to
preprogram how we respond to a shock of that size, but rather
that we simply--by putting more of the cost onto the private
sector--leave more capacity for the Government to respond ex
post, after the fact, in the most effective way, given the
circumstances.
Senator Bennett. Okay; well, I am for extension of TRIA. I
appreciate the Administration's indicating their support for
extension, and we will argue over the details.
Thank you.
Chairman Shelby. Senator Sarbanes.
Senator Sarbanes. I have nothing further.
Chairman Shelby. Mr. Chairman, we appreciate your
appearance here, and again, we apologize for the delay.
Mr. Bernanke. Not a problem, sir.
Chairman Shelby. We will see you again. Thank you, sir.
The hearing is adjourned.
[Whereupon, at 12:41 p.m., the hearing was adjourned.]
[Prepared statements and response to written questions
supplied for the record:]
PREPARED STATEMENT OF SENATOR MEL MARTINEZ
Thank you, Mr. Chairman, for holding this important hearing. You
and your staff have conducted a very comprehensive examination of this
issue. I also commend the work of the Treasury Department in preparing
its report for the Congress. I am going to keep my opening remarks
brief so that we can hear from our witnesses.
As we have observed in recent years, Federal and State governments
have a responsibility to respond to catastrophic events. Whatever the
type of assistance provided, the goal is the same--to return to
normalcy and protect ourselves going
forward by learning from what happened. On Monday, I spent the day in
Florida traveling to several emergency operation centers across the
panhandle visiting with constituents impacted by Hurricane Dennis. In
Florida, we never know what the next hurricane could bring, but
Floridians do everything they can to get back to life as usual as
quickly as possible and to learn from the hurricane for future storms.
To assist Floridians, Governor Bush declared a state of emergency for
the counties hardest hit to initiate relief efforts.
On a much larger scale, Congress responded to the terrorist attacks
on September 11 by passing a temporary program to help the private
property and casualty insurance companies rebound after the
unprecedented premiums they paid out in the last months of 2001. As
Secretary of HUD, I participated in the efforts to assist lower
Manhattan and its businesses recover and rebuild. What happened that
day was unimaginable and after the immediate outpour of Government
assistance, the Congress had to develop a way to protect the insurance
industry against future events.
Over the last 3 years, the majority of property-casualty insurance
policyholders took up terrorism insurance--because TRIA made it
available and affordable--and the insurance industry has now reached a
point where its surplus has returned to pre-September 11 levels--making
them financially strong enough and better able to bear unexpected
losses.
The Treasury report made clear that while TRIA has been effective
in fulfilling what it was originally intended to do, the future
existence of a TRIA program discourages the private markets from
developing a long-term solution.
We exist in a world that will always have risk. Hurricanes, stock
market investments and potential terrorist attacks all carry risk. It
is our responsibility to determine how we hedge against those risks and
who bears the financial risk that would accompany another terrorist
attack.
I understand that terrorism poses a unique risk potential. We must
find a way to allow the marketplace to develop while at the same time
be mindful of the potential for catastrophic losses of such magnitude
that may require Government intervention.
Thank you. I look forward to the testimony.
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PREPARED STATEMENT OF SENATOR TIM JOHNSON
Chairman Shelby, Ranking Member Sarbanes, thank you for holding
this important hearing today on terrorism risk insurance.
It has been almost 4 years since the September 11 attacks that
prompted the passage of the Terrorism Risk Insurance Act. And while we
have been fortunate here in the United States that no events have
triggered the use of this Federal backstop, the bombings in London last
week, the Madrid train bombing last year, and the nightclub bombing in
Bali in 2002, each serve as painful reminders of the reality of the
ongoing war on terror, and the fact that attacks can happen anywhere at
anytime.
Prior to September 11, the risk of terrorism was not a factor when
insurers wrote policies. However, in the post September 11 environment,
the availability of affordable insurance for terrorism risks has become
a necessity.
The war on terror involves protecting our homeland and protecting
our citizens. Recent polls show that Americans believe that more
attacks on the United States are very likely. In light of the current
environment, it would be both unrealistic and premature to conclude
that a Federal backstop is no longer necessary. Moreover, with less
than 6 months before its expiration, it is irresponsible for the
Administration to determine that extending TRIA is not warranted absent
significant changes, and to suggest that it is appropriate to shift the
burden of insuring against the risk of terrorist attacks solely to the
private insurance market.
At this juncture, I believe we continue to need a program like what
we have established with TRIA. This week, I joined with Senators Dodd
and Bennett, and nine other Members of this Committee in cosponsoring
S. 467 which extends the program, and would enable the Presidential
Working Group on Financial Markets to make long-term recommendations
for Congress to consider.
S. 467 would also direct Treasury to include group life products in
the program. As I have reiterated over the past several years, it is
critical that we create conditions that permit the private insurance
markets to continue to offer group life insurance coverage to employees
at high risk of attack. Moreover, the lack of affordable reinsurance
for group life products calls into question the Administration's
position that TRIA is crowding out innovation that would otherwise
enable the industry to offer insurance for terrorism risk without a
governmental backstop. Reinsurance has essentially evaporated for the
group life sector, which Treasury specifically chose not to include in
the terrorism risk insurance program, and thus was not hindered in its
pursuit of market innovations. We should be working to create a
marketplace where reinsurance can reemerge for group life products,
rather than jeopardize the TRIA-facilitated appearance of reinsurance
for products, like workers compensation, which are comparable to group
life.
That said, I certainly appreciate that innovations within the
insurance industry may be part of the long-term solution, and we
certainly should facilitate that as we go forward. I think the time has
come for Congress to review the current regulatory landscape of the
insurance industry to ensure that it does not unnecessarily restrict
innovation, and I am pleased that Senator Dodd's legislation is
consistent with that objective--extending TRIA for a period of time
sufficient for Congress to begin looking at modernizing the regulatory
scheme for insurance while it also reviews longer term solutions to the
challenge of insuring against acts of terror.
Because of the random and unpredictable nature of terrorism, I am
not yet convinced that the private sector can adequately or accurately
assess terrorism risk in the absence of a Federal backstop. Estimating
the likelihood of attacks or the extent of loss is difficult, if not
impossible. Now is not the time for the Administration or Congress to
leave the private insurers to go it alone.
I look forward to hearing from today's witnesses.
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PREPARED STATEMENT OF SENATOR JACK REED
Terrorism Risk Insurance is one of the most important economic and
national security issues we face. Terrorism is still a very real threat
in this country. The bombings last week in London serve as a reminder
that enemies remain who are committed to threatening our security and
our way of life. September 11 was not only an attack on the American
people, but it was also an attempt to undermine our economy. Terrorist
will undoubtedly try again.
We live with the threat of terrorism for the foreseeable future and
Congress has a critical role in insuring that our economy is protected
from the potential dislocations from a terrorist attack.
I am proud to be a sponsor of the Dodd-Bennett bill because I
believe that we must extend the Terrorism Risk Insurance Act and
protect our economy from the threat of terrorism.
Everyone agrees that the TRIA program has worked. TRIA helped
stabilize the insurance markets after September 11 and has strengthened
them since then. The question facing us today is how to proceed for the
future and what form the TRIA program should take going forward. I
think there are several facts that are critical to this debate.
Terrorism is a major and continuing threat that we cannot ignore.
Protecting our national security is first and foremost the
responsibility of the Federal Government. Other nations have looked at
this problem and have chosen to provide a government backstop program.
Unlike some other types of insurance coverage, regardless of how
prudent a policyholder is or how much he acts to protect against a
terrorist attack, the policy holders ability to protect themselves is
limited.
While we all prefer to allow markets to function without Government
intervention when possible, this is a classic market failure. Unlike
the actuarial data for floods, earthquakes, hurricanes, and life
expectancy, no one can quantify the likelihood of a terrorist attack
because it is less predictable and there is no historical data to allow
for an accurate assessment. If we cannot predict the likelihood and
policyholders have a minimal role in protecting themselves, how can we
create a market to insure against it? And perhaps most importantly, we
cannot risk the potential economic dislocation of getting this wrong.
At a recent testimony, Chairman Greenspan said that there are
certain instances in which markets do not work and there is no
compelling evidence that the market can be made to work.
In a June 2005 Special Comment, Moody's stated ``Almost
universally, private market reinsurance is not being utilized to cover
terrorism risk below companies' TRIA deductibles. Consistent with our
2003 survey, Moody's would still characterize the proportion of
terrorism risk being shifted from primary insurers to private markets
as low.''
I believe there are some modifications that can and should be made
to this program within the framework of the original program. However,
we should not throw out the baby with the bath water. I am no more
convinced that the private markets are any better equipped today to
effectively insure against terrorism without a Federal backstop than
they were after September 11.
We should reauthorize TRIA and examine the appropriate Federal role
for the future. We have an obligation to the American people to protect
our economy. I believe there probably will need to be a continuing
Federal role because the markets will not be able to adequately insure
against the risks of terrorism in a fair or affordable manner.
Mr. Chairman, I want to raise one more note of caution. We should
reauthorize TRIA in a bipartisan and expeditious fashion without
extraneous and controversial issues. As we learned in 2002, tort reform
provisions will only impede the legislative process and threaten the
extension of this important program. I have supported a number of legal
reform measures, but we should keep this legislation clean and not
weigh it down with unnecessary and contentious tort reform provisions.
I look forward to hearing the testimony of the witness.
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PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER
Do you know that under the Treasury new trigger proposal many of
our world's most recent terror attacks would not be covered? London
would not be covered. Madrid would not be covered. I take issue with
the fact that you only collected data until February 2005 several weeks
short of the end of the first business quarter.
The bottom line is that I am absolutely open to a serious
consideration of minor tweaks to improve the TRIA program. But, I am
not willing to accept any drastic changes that are based on incomplete
data, information driven by ideologues, or information that simply
lacks empirical evidence. I mean you said it yourself, the program has
been effective, it has been a success.
Mr. Chairman, as we move forward I want us to remember why this
program was established in the first place. It was established to
create a public/private partnership between business and Government
that would provide a safety net to allow us to bounce back from a
terrorist attack with little market disruption and minimal impact on
our overall economy. That need has not changed. We know what happens
when there is no terrorism insurance, because it happened in 2002. In
that year, the President himself said that the lack of terrorism
insurance cost our economy tens of billions of dollars and 300,000
construction jobs.
We, in government, have a responsibility to get this done to
protect our Nation's businesses and workers.
We have a responsibility to find a long-term solution because
terrorism is a long-term problem.
Until our Government can declare that we are no longer at risk of a
terror attack, no longer in need of the Department of Homeland
Security--we will continue to be in need of TRIA.
But most of all we have a responsibility to create policies to
protect our policyholders--they are our businesses and property owners.
We should not be in the business of placing the financial burden of
fighting the war on terrorism on our private citizens.
If you look at the history of war in this country that has never
been the case.
During World War II we provided a program called the War Risk
Insurance program that provided insurance for property damage here
in the United States caused by German or Japanese attacks.
During the Vietnam War we provided an insurance program to
cover commercial airplanes that flew into and out of Vietnam.
And, today we have a first dollar loss insurance program for
the airline industry to cover losses caused by terrorism in the
United States, which is expected to be reauthorized at the end of
August.
London showed us that the reauthorization of TRIA should be one of
this country's highest priorities.
Yesterday, during the House Financial Services Hearing, Secretary
Snow seemed even more supportive of moving a TRIA in the coming weeks.
Maybe in light of the recent attacks we all see there is a greater need
for the reauthorization of TRIA sooner than later.
So Mr. Chairman one of the things I would like to take away from
this hearing today is a commitment and a timeline to get this done in
the next few weeks. Every day this does not happen--our businesses,
workers and economy are at risk.
Thank you.
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PREPARED STATEMENT OF JOHN W. SNOW
Secretary, U.S. Department of the Treasury
July 14, 2005
Thank you, Chairman Shelby, Ranking Member Sarbanes, and other
Members of the Committee. I appreciate the opportunity to discuss the
Treasury Department report on the Terrorism Risk Insurance Act (TRIA).
As you know, President Bush signed TRIA into law in November 2002
to help safeguard America's economy following the terrorist attacks of
September 11, 2001. The September 11 losses led the insurance industry
to reduce its exposure to future losses largely by excluding coverage
of terrorism risk in many policies. The pullbacks in terrorism coverage
and the quotations of rapidly increasing premiums raised concerns that
this period of adjustment to the reality of global terrorism risk in
the insurance market could have a negative effect on the economy.
In response, TRIA was passed. It was meant to address any market
disruptions and ensure the continued widespread availability and
affordability of property and casualty insurance for terrorism risk,
and to allow a transitional period for the private markets to
stabilize, resume pricing of such insurance, and build capacity to
absorb any future losses, while preserving State insurance regulation
and consumer protections.
TRIA required the Treasury Department to assess the effectiveness
of the Terrorism Risk Insurance Program. It also required Treasury to
assess the likely capacity of the property and casualty insurance
industry to offer insurance for terrorism risk after termination of the
Program.
The report finds that TRIA has been effective in meeting its goals
of supporting the industry during a transitional period and stabilizing
the private insurance market. Consistent with TRIA's design to
encourage the development of the private market, the Administration
opposes extension of the program in its current form. Extending TRIA in
its current form is likely to discourage the private market development
needed to deal with the risk of terrorism. The Administration has
outlined principles that any extension should recognize and we look
forward to discussions with the Congress on them. Before I review the
main findings of the report, however, I would like to discuss the
approach that the Treasury Department took in the course of evaluating
TRIA.
Treasury Approach to TRIA Evaluation
Treasury contracted with an outside survey research firm to conduct
two independent, nationally representative surveys. One survey sampled
insurers in the commercial property and casualty line, which is
eligible for the Federal reinsurance provided under the program. The
other survey sampled policyholders, businesses, and other organizations
that purchased commercial property and casualty insurance in TRIA-
eligible lines. Respondents were asked to provide information on an
annual basis from 2002 (prior to passage of TRIA), to the first 2
months of 2005. The data therefore give a unique, comprehensive
overview of the availability and affordability of terrorism risk
insurance coverage in the private market.
From insurers, the surveys collected information on the amount of
terrorism coverage written, the cost of terrorism coverage, terms and
conditions on terrorism coverage, and the purchase of reinsurance. From
policyholders, we collected information on take-up and cost of
terrorism coverage, the characteristics of firms and other
organizations that purchase terrorism coverage, special terms and
conditions associated with that coverage, reasons why the mandatory
coverage offer was declined, and loss-mitigation efforts.
To safeguard the confidentiality of the business information
requested in these surveys, Treasury took great care to ensure that the
data were assembled at arm's length from the Government. All
identifying information was removed or masked prior to analysis by
Treasury staff and officials.
I have been insistent throughout this process, consistent with
Congress' direction to us in TRIA, that we draw upon as many sources of
information and input as possible. Treasury has in fact consulted with
a broad range of experts representing the insurance industry, the
National Association of Insurance Commissioners (NAIC), policyholders,
and taxpayer groups in developing the survey instruments. Preliminary
survey instruments were reviewed by insurance industry representatives,
NAIC representatives and others experts, including the American
Insurance Association (AIA), and the Alliance of American Insurers
(AAI) after consultation with its members. Members of the Coalition to
Insure Against Terrorism (CIAT) also met with Treasury staff to review
the policyholder survey.
We are very pleased with the extensive collaborative process that
Treasury undertook to conduct this assessment, and believe that it
reflects fully the extensive input of the industry and other groups.
The completed survey results, and information derived from these other
sources forms the basis of the report to Congress.
Structure of TRIA
TRIA established a temporary Federal program of shared public and
private compensation for insured commercial property and casualty
losses resulting from foreign acts of terrorism. TRIA represents a form
of publicly provided and subsidized terrorism risk reinsurance, which
essentially transfers risks associated with terrorism losses from the
private to the public sector (taxpayers).
Under TRIA, companies that provide commercial property and casualty
insurance are required to offer (make available) terrorism coverage on
the same terms and conditions as offered in their non-TRIA coverage. To
be eligible for TRIA reinsurance, an act of terrorism must be certified
by the Secretary of the Treasury, with the concurrence of the Secretary
of State and the Attorney General, and must have resulted in aggregate
property and casualty losses of $5 million or more. TRIA defines an act
of terrorism as (1) a violent act or act that is dangerous to human
life, property, or infrastructure, that (2) has resulted in damage
within the United States or outside of the United States in the case of
an air carrier or vessel (as defined by TRIA) or on the premises of a
U.S. mission, and (3) has been committed by an individual or
individuals acting on behalf of any foreign person or interest, (4) as
part of an effort to coerce the U.S. civilian population or influence
the policy or affect the conduct of the U.S. Government by coercion.
The Federal Government would have to cover 90 percent of insured
losses beyond an insurer deductible, up to $100 billion per year. In
the first full program year (2003) the deductible was 7 percent of 2002
premiums, in 2004 the deductible was 10 percent of 2003 premiums, and
in 2005 the deductible is 15 percent of 2004 premiums. The purpose of
the graduated deductible amounts was to encourage development of
private market capacity over time. Insurers are also liable for 10
percent of losses above the deductible threshold.
In the event that the Federal Government provides compensation for
insured losses for an act of terrorism under the program, TRIA requires
recoupment of at least a portion of the Federal compensation through
policyholder premium surcharges. Recoupment is mandatory in cases where
the aggregate industry insured terrorism losses (deductibles and
copays) are below a specified aggregate retention amount. The annual
aggregate retention amount was $10 billion for 2003, $12.5 billion for
2004, and is $15 billion for 2005. The Government is required to
collect the difference between these recoupment amounts and the
aggregate industry insured terrorism losses through an industry-wide
surcharge, not to exceed 3 percent of the premium paid on a policy. If
the aggregate industry insured terrorism losses exceed the aggregate
retention amount, the Federal Government may require recoupment at the
discretion of the Secretary of the Treasury, but the statute does not
require recoupment.
To encourage the development of private market capacity over time,
provisions in TRIA have gradually shifted more of the risk to the
private sector.
Impact of TRIA on Insurance Markets
The Treasury Department report finds that the program provided
support in a transitional period, during which the capacity of the
insurance industry to write terrorism risk insurance has improved.
I will elaborate on four main findings in the report:
Industry capacity to provide coverage for terrorism risk has
improved, as has take-up of such coverage.
Insurers are increasingly pricing terrorism risk insurance,
and the price of coverage with an explicit charge has decreased.
Industry surplus has improved.
Many insurers reinsure a substantial portion of their retained
risk under TRIA, but overall reinsurance purchases have not
increased substantially.
Availability and Take-up of Terrorism Coverage
Results from both the survey of insurers and the survey of
policyholders show that the availability and the take-up (purchase) of
terrorism insurance increased while TRIA has been in effect.
Insurers now provide terrorism coverage on a greater share of
commercial property and casualty insurance policies than in 2002 (the
year before TRIA). While 60 percent of policies written in 2002
included terrorism insurance coverage, fully two-thirds of such
policies included such coverage in 2004. Terrorism insurance was also
more widely available in the market, as the share of insurers providing
any terrorism coverage rose from 73 percent to 91 percent over the
period.
Policyholders as well are now more likely to purchase terrorism
risk insurance than in 2002. The data show a doubling in the take-up
rate of terrorism risk coverage: From 27 percent of policyholders in
2002 to 54 percent of policyholders by 2004. The finding that just
under half of policyholders do not take-up such coverage does not
necessarily reflect a problem in the market. The decision to purchase
terrorism insurance reflects a tradeoff between the benefits and cost
of the coverage. Firms that perceive a low risk of terrorism attacks or
that have some form of self insurance (for example, through diversified
portfolios) may simply not place a high value on terrorism insurance.
It is useful to note that TRIA did not mandate the purchase of
terrorism insurance, but rather that such coverage be made available.
Pricing and Cost
Both insurer and policyholder surveys show that insurers
increasingly began pricing terrorism risk insurance during the time
TRIA was in effect. More than 75 percent of insurers providing coverage
for terrorism risk in 2002 did not charge for it, but only 40 percent
in 2004 provided coverage for free. These numbers are very similar to
those reported by policyholders.
The average cost of terrorism insurance (measured as the share of
total premiums paid for terrorism coverage) generally rose during this
period. Overall, insurers reported costs ranging from 0.9 percent of
premiums in 2002 to 1.8 percent by 2004. Among insurers who charged for
terrorism insurance, the share of premiums charged for terrorism
coverage first declined from 3.7 to 2.4 percent of premiums between
2002 and 2003, but then increased to 3.1 percent of premiums by 2004.
The average costs reported by policyholders increased from 1.2
percent of premium in 2002 to 1.6 percent in 2003, and further to 1.7
percent of premium by 2004. Among policyholders who reported paying for
terrorism coverage, cost declined steadily over the period: From 4.0
percent of premium in 2002 to 2.8 percent in 2003 and further to 2.7
percent of premium in 2004.
Policyholders located in high-risk cities faced overall declining
costs for terrorism risk coverage that varied from 2.8 percent of
premiums in 2002, 3 percent in 2003 and 1.9 percent in 2004.
Industry Surplus and Reinsurance
Industry surplus, a key source of insurer capacity, has returned to
pre-September 11 levels. Insurers are financially stronger and more
able to bear unexpected losses than they were prior to the enactment of
TRIA. Reinsurance, another important component of an insurer's capacity
to absorb losses, has not increased substantially, however. Seventy
percent of insurers reported purchasing reinsurance for terrorism risk
in 2003, but only 65 percent in 2004 reported purchasing reinsurance in
2004. Preliminary data from the first months of 2005 are encouraging
and suggest a rebound to 75 percent. Smaller and medium-sized insurers
generally reported greater use of reinsurance for terrorism risk
exposure (TRIA deductibles and copayments) between 2003 and 2005.
During this same period, however, larger insurers reported less use of
reinsurance for terrorism risk exposure.
Summary
The findings from the surveys of insurers and policyholders point
to the success of TRIA in achieving its short-term goals. TRIA
effectively ``addressed market disruptions and ensur[ed] the continued
widespread availability and affordability of property and casualty
insurance for terrorism risk.'' While we do not ascribe a direct causal
effect to TRIA, we note that insurer financial strength has improved
substantially over this period. More generally, TRIA allowed both
insurers and policyholders time to adjust to the post-September 11 view
of terrorism risk.
TRIA provisions shifted an increasing share of expected terrorism
losses back to the private sector, as the deductible was increased from
7 percent of premiums in 2002 to 15 percent of premiums in 2004. Had
there been no improvement in capacity, we should observe a pullback of
terrorism coverage in response to this shift in cost. The expansion of
terrorism risk coverage availability and take-up, and the decline in
cost even as the TRIA deductible has increased therefore highlights the
improvement in the industry's ability to cover terrorism risk
Industry Capacity to Cover Terrorism Risk After TRIA
Congress also directed Treasury to assess the likely capacity of
the property and casualty insurance industry to offer insurance for
terrorism risk after expiration of the program. TRIA provided a Federal
backstop for terrorism losses that effectively subsidized terrorism
risk insurance. It is reasonable to expect that the removal of the
subsidy will result in adjustments in coverage and pricing. In the
Treasury report, we present a framework to evaluate the impact of a
TRIA sunset in more detail, and provide evidence from our surveys and
from insurance industry statistics, data, and discussions with industry
and other experts. Two important determinants of insurers' ability to
effectively write coverage for terrorism in the near-term are the
ability to model terrorism risk and the industry's financial capacity--
including both surplus and access to reinsurance--to cover terrorism
losses.
Modeling Terrorism Losses
To provide and price insurance efficiently, insurers should be able
to quantify their exposure to losses from terrorism risk. The primary
tool available for quantifying loss exposure is modeling terrorism
risk. Our assessment of developments in risk modeling over the past few
years is positive, but we note that challenges do remain.
Modeling terrorism risk has two critical components: The ability to
identify and quantify the severity of an event in terms of insurers'
losses, and the probability of the loss occurring. Our study concludes
that insurers' ability to identify and quantify the severity of an
event in terms of insurers' losses has improved greatly. In particular,
insurers are much better able to assess their exposures or
accumulations of risk for a given terrorist event on an overall and
individual customer basis. The industry--particularly the primary
insurance industry--has made great progress in tracking aggregate
exposure by location to estimate exposure to losses from physical
damage and considerable progress in tracking aggregates of employees
down to the level of individual locations to estimate exposure to
workers' compensation losses. Modelers have created and implemented
sophisticated probabilistic loss estimates that are said to take
account of terrorists' shifting goals and strategies. Insurers writing
coverage for high risk exposures are able to use multiple methods of
assessing terrorism risk. This is important because it allows insurers
to more effectively underwrite coverage. We acknowledge that the
industry faces some difficulty in assessing the probability of the loss
from terrorism. The uncertainty surrounding their predictions reduces
the usefulness of these models.
Financial Capacity
An insurer's capacity to write coverage is limited to the maximum
coverage it could provide, while retaining its ability to meet current
and future obligations to its base of policyholders. An important
determinant of insurers' capacity to cover terrorism losses is
financial strength, which incorporates both balance sheet strength and
operating performance. The financial health of the insurance industry,
especially surplus, has improved greatly in the past 3 years. Among
insurer groups providing coverage in TRIA-eligible property and
casualty lines, surplus was higher in the third quarter of 2004 than it
was in the third quarters of 2001, 2002, and 2003. Between the 3rd
quarter of 2001 and the 3rd quarter of 2004, surplus increased from
$256 billion to $341 billion. Measures of the industry's capacity to
cover terrorism risk, including the ratio of net premiums to surplus,
the return on surplus, and the capital adequacy ratio (accounts for
underwriting, investment and credit risk) have all improved since the
losses following the September 11 attacks.
By purchasing reinsurance, insurers can write additional coverage
without increasing their financial holdings. Our survey results show
that reinsurance is available, and purchased, for a sizable portion of
the retained risk under TRIA. Seventy percent of insurers purchased
reinsurance for TRIA-eligible risks in 2003. The results also indicate,
however, that over the time period covered by our study, purchases of
reinsurance have not increased substantially.
Insurance Market Outcomes
The expiration of TRIA will change the business environment in
which insurers operate and will therefore change their behavior.
Insurers will likely consider factors such as the possibility of
insolvency from terrorism losses given the levels of surplus available
and the effect on credit ratings. Experience with natural catastrophe
risk underwriting and assignment of agency ratings suggests that in
order to avoid ratings downgrades, insurers may significantly alter
their approach to terrorism risk insurance after TRIA's expiration.
Among the changes insurers may institute are increasing the use of
private reinsurance, building surplus by tapping into capital markets,
and raising premiums or placing exclusions on some policies.
Our surveys included direct responses on the availability of
coverage after the expiration of TRIA. Responding to questions about
policies written in early 2005 that continue into 2006, nearly 50
percent of insurers reported that they are not writing coverage for
terrorism risks in 2006 (after the scheduled expiration of TRIA) that
is similar to the coverage they write under TRIA. One-quarter of
policyholders with terrorism risk coverage indicated that their
coverage excludes terrorism coverage after the expiration of TRIA.
TRIA's expiration will conclude the transitional assistance first
provided to the
insurance markets in the uncertain economic environment of 2002. While
the immediate effect of the removal of the TRIA subsidy is likely to be
less terrorism insurance and, higher prices, we expect that over time
the private market will develop additional terrorism insurance
capacity. We anticipate that the initial response of premiums in the
market will spur the buildup of surplus as insurers tap into capital
markets; and the development of additional private reinsurance and
other risk shifting mechanisms.
Macroeconomic Effects
We do not believe that the elimination of the Federal terrorism
risk reinsurance subsidy is likely to have a discernable macroeconomic
effect. In late 2001 and 2002, there was concern that there could be
macroeconomic effects associated with the transition between a world in
which terrorism coverage was provided for a negligible price and one
where terrorism risk was considered a nonnegligible risk. The economic
climate during the discussion of TRIA and its enactment was highly
uncertain. Industrial production had peaked in mid-2000, and by
September 2001 had already fallen more than 5 percent. The terrorist
attacks of September 11 created macroeconomic uncertainties that most
analysts believed would translate into a further sharp downturn in
economic activity that would last at least two additional quarters.
Nonresidential building activity tumbled about 33 percent at an annual
rate in the fourth quarter of 2001, and continued to experience
declines well in excess of 15 percent in the subsequent three quarters.
It was difficult at the time to assess whether the substantial declines
in nonresidential building were due to the chilling effect of terrorist
activity, terrorism insurance issues or the result of a cumulative
unwinding of activity more typical of a recession and even the excesses
of the late 1990's.
Helped by tax cuts and monetary stimulus, the economy has since
improved substantially. GDP growth rose from just 2.3 percent in 2002
to 3.9 percent in 2004 (fourth quarter over fourth quarter). The
unemployment rate, which was 6 percent in December 2002, fell to 5.1
percent in May 2005. However, despite the rising economy and the
enactment of TRIA, nonresidential building has rebounded only slightly.
Nonresidential building is currently 4.2 percent higher than the trough
reached in the first quarter of 2003, but remains substantially below
the previous peak. From our current perspective it appears that neither
the potential lack of terror risk insurance nor a general economic
downturn were responsible for weakness in nonresidential building
activity.
Overall Assessment and Policy Recommendations
The risk of terrorism changed fundamentally and permanently after
the events of September 11, 2001. In the words of the President:
Our country is safer than it was on September 11, 2001, yet, we
are still not safe. . . . We are a Nation in danger. We are
doing everything we can in our power to confront the danger. We
are making good progress in protecting our people and bringing
our enemies to account. But one thing is for certain: We will
keep our focus and we will keep our resolve and we will do our
duty to best secure our country.
It is our view that continuation of the program in its current form
is likely to hinder the further development of the insurance market by
crowding out innovation and capacity building. Consistent with TRIA's
original purpose as a temporary program scheduled to end on December
31, 2005, and the need to encourage further development of the private
market, the Administration cannot support a straight extension of TRIA.
Any reform of TRIA should be consistent with several principles. It
is the Administration's view that extension of the program should
recognize the temporary
nature of the program, the rapid expansion of private market
development (particularly for insurers and reinsurers to grow
capacity), and the need to significantly
reduce taxpayer exposure. The Administration would accept an extension
only if it includes a significant increase to $500 million of the event
size that triggers coverage, increases the dollar deductibles and
percentage copayments, and eliminates from the program certain lines of
insurance, such as commercial auto, general liability, and other
smaller lines, that are far less subject to aggregation risks and
should be left to the private market.
It is also important to keep in mind that the program would cover
damages awarded in litigation against policyholders following a
terrorist attack. Current litigation rules would allow unscrupulous
trial lawyers to profit from a terrorist attack and would expose the
American taxpayer to excessive and inappropriate costs. The
Administration supports reasonable reforms to ensure that injured
plaintiffs can recover against negligent defendants, but that no person
is able to exploit the litigation system.
The events of the past week in London have been an unwelcome
reminder that the risk of terrorism is real and that the war on
terrorism is one that will be waged over a long period of time on many
fronts. Some believe the fact that terrorism risk is real suggests the
need for a permanent and obtrusive Federal role in the market for
terrorism risk insurance. I agree that the risk of terrorism is likely
to remain a part of our lives for some time to come, but that is
precisely why the Federal Government needs to encourage the development
of the most creative and cost effective means of covering terrorism
risks. The Administration looks forward to working with the Congress to
achieve this end.
----------
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman, Council of Economic Advisers
July 14, 2005
Thank you, Chairman Shelby, Ranking Member Sarbanes, and Members of
the Committee, for this opportunity to discuss the Treasury
Department's report on the Terrorism Risk Insurance Act of 2002 (TRIA).
The Economic Climate in 2001 and 2002 was Uncertain
The terrorist attacks of September 11, 2001, which devastated
thousands of lives and wreaked billions of dollars in losses, also came
at a time of considerable macroeconomic uncertainty. By that time, our
economy had already slid into recession. Payroll employment peaked in
March 2001 and declined through the remainder of 2001 and 2002.
Industrial production stalled in the second half of 2000 and had
already fallen by more than 5 percent by September 2001. At the time of
the attacks, stock prices had been falling for a year and a half. The
terrorist attacks heightened concerns about the near-term strength of a
number of sectors of the economy, including aviation, travel and
tourism, the financial industry, and nonresidential construction.
Nearly one million jobs were lost in the first 90 days after September
11.
As of late 2001, the prospect that terrorism risk insurance might
be unavailable raised particular concerns. Prior to September 11,
insurers underwriting property and casualty policies generally treated
terrorism as a negligible risk. The industry had not developed models
of the likelihood or severity of potential terrorist events and
consequently did not have the capacity to price those risks. Moreover,
the large payouts associated with September 11 and low returns to
insurers' portfolios reduced the financial capacity of the insurance
industry. Some observers pointed out that, if terrorism risk insurance
were unavailable or prohibitively expensive, the capitalized value of
existing commercial structures might decline, possibly creating
significant financial problems for lenders and building owners. The
willingness of builders to undertake new commercial construction, or
their ability to obtain financing for that construction, might also be
reduced, putting construction jobs and economic growth in jeopardy.
These concerns contributed to the prevailing climate of uncertainty
about the economy in 2002.
In retrospect, survey results in the Treasury's report suggest that
the market for terrorism risk insurance did not dry up in 2002, to the
extent feared. The insurer survey indicates that more than 70 percent
of insurers writing in commercial property and casualty (P&C) lines
wrote terrorism risk insurance in 2002, and that 60 percent of
commercial P&C policies written in 2002 carried terrorism cover. The
policyholder survey offers a somewhat different picture, but likewise
indicates that terrorism risk insurance was available in 2002.
Nevertheless, given the considerable uncertainties of the time, it was
prudent for Congress to enact TRIA and for the President to sign it
into law in November 2002. TRIA provided a temporary Federal backstop
in terrorism risk insurance and allowed the insurance industry a
transition period to adjust to post-September 11 realities.
Insurers Have Increased Their Capacity to Deal with Terrorism Risk
The tragic events in London last week underscore the ongoing risks
posed by terrorism. In the period immediately after September 11, the
ability of the insurance industry to handle terrorism risks was in
considerable doubt. However, the evidence presented in the Treasury
report suggests that, in the nearly 4 years since the attacks, private
insurers have developed increased capacity to deal with such risks.
Insurer capital, known as policyholder surplus, has rebounded and
now exceeds pre-September 11 levels. This surplus approached $341
billion in the third quarter of 2004, a 33 percent increase over the
third quarter of 2001. The industry booked this increase of $85 billion
over 3 years despite absorbing heavy hurricane losses last fall.
The industry has developed new analytical tools, including
sophisticated models of loss exposure that allow insurers to limit and
manage their accumulation risk from a terrorist attack. Better
measurement of accumulation risk facilitates the spreading of the risk
of loss from a terrorist attack across a broader set of insurers. The
industry has also made progress in modeling the likelihood of terrorist
attacks, although this is an area where considerable challenges remain.
The insurance industry's capacity to bear terrorism risk is not
unlimited, of course. Some have raised concerns about the industry's
ability to handle what might be termed a mega-event, resulting in
insured losses of more than $100 billion. However, it is important to
keep in mind that TRIA, as currently structured, provides reinsurance
only up to $100 billion and does not specify how losses above $100
billion would be handled. TRIA states only that Congress would
determine the source and procedure by which any payments in excess of
$100 billion would be made. Likewise, should TRIA be allowed to expire
and a mega-event were to occur, presumably Congress and the
administration would evaluate the overall situation and determine how
to respond to such losses.
TRIA's Effect on Pricing and Availability: Evidence from the
Treasury Study
We cannot observe the counterfactual of what would have happened to
the pricing and availability of terrorism risk insurance had TRIA not
been enacted. But the Treasury study's survey results allow a
comparison of pricing and availability immediately before and after
TRIA's enactment, as well as changes to pricing and availability in the
second year of TRIA's operation, as higher deductibles were phased in
and the Federal provision of reinsurance was scaled back.
The survey results indicate that, after the passage of TRIA, the
proportion of P&C policies carrying terrorism cover at a nonzero
premium increased. This pattern tended to raise average premiums for
terrorism risk insurance after the introduction of TRIA. On the other
hand, policies that had nonzero premiums in 2002 exhibited a pattern of
declining cost share for terrorism risk insurance (as a proportion of
total P&C premiums) between 2002 and 2003. The net effect was a slight
increase in the cost share of terrorism risk insurance across all
policies after the introduction of TRIA, contrary to some expectations.
Between 2003 and 2004, TRIA's insurer deductible for Federal
reinsurance increased from 7 to 10 percent of direct earned P&C
premiums, shifting some exposure to terrorism losses from the Federal
Government back to insurers. Yet, despite this increased exposure, the
cost share of terrorism risk insurance across all policies rose only
slightly, from 1.6 percent of P&C premiums in 2003 to 1.7 percent in
2004. It would be inappropriate to read too much into these results
about the likely effects of allowing TRIA to expire. However, at least
for the period during which TRIA has been in force, the surveys do not
support the view that the cost share of terrorism risk insurance is
highly sensitive to changes in the industry's risk exposure.
Regarding the availability of insurance, the insurer survey
indicates that the proportion of commercial P&C policies carrying
terrorism risk insurance grew by 7
percentage points between 2002 and 2003, and the policyholder survey
found that takeup rates for P&C policyholders rose during that period
as well. These results suggest that TRIA improved the availability of
insurance during 2003. However, the proportion of commercial P&C
policies carrying terrorism risk insurance remained stable through
2004, while take-up rates increased, despite the fact that TRIA's
increasing deductible raised insurers' exposure to terrorism risks.
Again, it is important not to extrapolate these results too far.
However, at least after 2003, availability of insurance does not appear
to have been closely linked to the industry's overall exposure to
terrorism risk.
These insurer and policyholder survey results are consistent with
the view that TRIA succeeded in providing a transition period for
insurers. The data also appear consistent with the view that insurers
have been able to cope with increased exposure to terrorism risks as
the Federal provision of reinsurance has diminished.
The Economy Has Strengthened
The economy is more robust now than when TRIA was enacted. GDP
growth has increased from 2.3 percent in 2002 to 3.9 percent in 2004
(fourth quarter over fourth quarter). The unemployment rate, which was
6.0 percent in December 2002, has fallen to 5.0 percent as of June
2005. Overall construction jobs (residential and nonresidential) are at
a record high 7.2 million. Financial markets are also functioning well
now, with more credit available at lower long-term rates. The economic
uncertainties that partly motivated TRIA's adoption have receded and
the economy is fundamentally stronger and more robust.
Conclusions
TRIA has succeeded in its limited role of providing a transition
period for the insurance industry to adjust to the new realities after
September 11, through a temporary Federal backstop. Continuation of the
program in its current form is likely to hinder the further development
of the insurance market by crowding out innovation and capacity
building.
Consistent with its original purpose as a temporary program
scheduled to end on December 31, 2005, and the need to encourage
further development of the private market, the Administration opposes
extension of TRIA in its current form.
Any extension of the program should recognize several key
principles: The temporary nature of the program, the need to rapidly
expand the development of private markets and capacity, as well as the
need to substantially reduce taxpayer
exposure. The last point bears emphasizing: TRIA does not eliminate
terrorism risk but merely shifts the burden to taxpayers. It should be
noted that, should a large terrorism event occur, the Treasury would
face many competing priorities, and the responsibility to provide large
insurance payments under TRIA could put a heavy strain on the
Government's finances.
If TRIA is to be retained, it should be reformed in such a way as
to increase the role of private insurers and significantly diminish the
public responsibility for terrorism risks. The Administration would
accept an extension only if it includes a significant increase to $500
million of the event size that triggers coverage, increases the dollar
deductibles and percentage copayments, and eliminates certain lines of
insurance from the program, such as commercial auto, general liability,
and other lines that are much less subject to accumulation risks. The
Administration also supports reasonable reforms to ensure that injured
plaintiffs can recover against
negligent defendants, but that also guarantee that no person is able to
exploit the litigation system, exposing the American taxpayer to
excessive and inappropriate costs. We look forward to discussing this
very important issue further with Congress.
RESPONSE TO A WRITTEN QUESTION OF SENATOR JOHNSON
FROM JOHN W. SNOW
Q.1. According to Secretary Snow's testimony, one of the
recommendations the Treasury report makes is to eliminate from
TRlA certain lines of insurance that are far less subject to
``aggregation risks'' and should be left to the private market.
Based on this, how does Treasury define the term ``aggregation
risk''? Furthermore, which lines of insurance does Treasury
deem to be qualified under the definition?
A.1. In general, aggregation or accumulation risk refers to the
concentration of an insurance company's portfolio of risks,
comprised of relatively small exposures on an individual basis,
but which represents an enormous exposure when taken as a
whole. This is because each individual exposure is located or
``aggregated'' in such a way that all are exposed to the risk
of a single terrorist attack or simultaneous set of attacks.
Two examples of geographic aggregation that would result in a
high concentration of risk are providing workers' compensation
insurance to the majority of employers in a skyscraper, or
insuring several buildings in the same urban block. It appears
that lines of insurance that are not subject to accumulation
risk could be handled by the private sector without the
assistance of the Government backstop provided by TRlA. Thus,
one of the key features we suggested for any temporary
extension of the TRIA program is the elimination from the
program of lines of insurance that are far less subject to
accumulation risk, such as commercial automobile and general
liability.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER
FROM JOHN W. SNOW
Q.1. When the ``TRlA'' law was passed in 2002, we did not know
half of what we know now about the enemy and its resolve. We
all acknowledge that the war on terror will be with us for a
very long time.
So if it is a long-term war and this is what the
Administration and the intelligence community tells us often,
why don't we need a long-term solution to the terrorism
insurance problem? A long-term solution that will provide our
economy with the stability to keep growing and protect our
citizens and their businesses from catastrophic loss when
another major terrorist event occurs.
Do you agree that the insurance industry took a long time
to come back from the combined effects of terrorism and natural
disasters?
If so, why do you think they can now handle these disasters
on their own? Furthermore, do you believe it is responsible to
speculate when our economy will take huge hits from any future
attacks?
A.1. As reflected in its statutory purposes, TRIA was intended
to be a temporary, short-term Federal program to address market
disruptions following the September 11 terrorist attacks; to
ensure the continued availability and affordability of
terrorism risk insurance; and, to allow a transitional period
for the private insurance markets to stabilize, resume pricing
of such insurance, and build capacity to absorb any future
losses. The Treasury study found positive signs of private
market development since the September 11 attacks. Even as the
TRIA deductible has risen over time (increasing the private
market's participation), terrorism risk insurance take-up has
continued to increase, insurers have written coverage on a
similar or greater number of policies, and pricing has fallen
where insurers have charged for the coverage.
In the Treasury report, we conclude that the TRIA has been
effective in achieving its objectives. Insurers are much better
able to assess their exposures and are increasingly pricing
terrorism risk insurance. Insurer surplus, a major source of
insurer capacity to write coverage, has improved from pre-
September 11 levels. The insurance industry's recovery from
September 11 and its resiliency show that the private market
functions well over time and returns stronger and capable of
handling catastrophes--both natural and man-made.
The risk of terrorism is likely to remain a part of our
lives for some time to come, and that is precisely why the
Federal Government needs to encourage the development of the
most creative and cost effective means of covering terrorism
risks. Over the long-term, the most efficient, lowest cost, and
most innovative methods of providing terrorism risk insurance
will come from the private sector. It is time for the Federal
Government to step back and allow more opportunities for
private sector development. I have faith in the power of
markets to provide the resources and flexibility needed in a
way that will be more efficient and lower cost than any
permanent government provision of insurance.
Q.2. Mr. Secretary and Mr. Chairman, during World War II we
provided a program called the War Risk Insurance program that
provided insurance for property damage here in the United
States caused by German or Japanese attacks. During the Vietnam
War we provided an insurance program to cover commercial
airplanes that flew into and out of Vietnam. And, today we have
a first dollar loss insurance program for the airline industry
to cover losses caused by terrorism in the United States.
My question is two-fold.
First, is there a difference between war and terrorism?
What is it? Why does the Administration seem to be saying that
the private insurance market can provide insurance against
terrorism but not against war? If we are in a ``War against
Terror'' why do not we provide the same type of economic
protections that we have historically provided when we are at
war.
Second, what is the Administration's position on the first
dolIar loss program for airlines? And, what is the difference
between such a program for airlines and a reinsurance program
for buildings and people that those airlines fly into? Clearly
the reinsurance program is less costly than a first dolIar loss
program.
During your review did you study any mechanisms like this
to deal with the economic risks posed by this ongoing war on
terrorism?
A.2. As passed by Congress, TRIA does not provide a backstop
the insurance industry for losses caused by acts of war, except
in the case of workers' compensation insurance.
The insurance industry itself treats war risk and terrorism
risk differently. War risk has been subject to long-standing
exclusions for losses caused by war, warlike action by a
military force, insurrection or similar unrest, while terrorism
risk had not been excluded prior to September 11. Terrorism
risk was insurable despite decades of international terrorist
attacks, and remained insurable even after the 1993 bombing of
the World Trade Center and the 1995 bombing of the Alfred P.
Murrah Federal building in Oklahoma City. What the insurance
industry was not prepared for was a catastrophic terrorist
attack of the magnitude of September 11. Yet our report showed
an expansion of terrorism risk availability and purchase, even
as the deductible increased, which highlights the improvements
in the industry's ability to cover terrorism. Even without the
TRIA backstop, insurers are providing coverage for terrorist
acts that would not be eligible for TRIA program coverage. Our
report showed that about 40 percent of insurers reported
writing polices covering noncertified terrorism risk. The
private market itself is the best indicator as to why the two
risks are treated differently.
TRIA required Treasury to assess the effectiveness of TRIA
and the likely capacity of the property and casualty insurance
industry to offer insurance for terrorism risk after
termination of the program. The Treasury report finds, in
accordance with its purpose, the program provided support in a
post-September 11 transitional period, during which the
capacity of the insurance industry to write terrorism risk
insurance has improved. It is our view that continuation of the
program in its current form is likely to hinder the further
development of the terrorism insurance market by crowding out
innovation and capacity building. Our report did not evaluate
the extent of private market provision of war risk insurance.
In connection with its work in this area, Treasury
evaluated other past and present Federal insurance programs,
such as the terrorism coverage provided through the Federal
Aviation Administration's war risk insurance program. Though
structured differently, the provision of terrorism coverage
through the FAA program is temporary (currently expiring at the
end of this year). The FAA program is not inconsistent with our
overall view that in the long-term the most efficient, lowest
cost, and most innovative methods of providing terrorism risk
insurance--even for air carriers--will come from the private
sector. As Transportation Secretary Norman Mineta reported to
Congress in March 2003, war and terrorism risk insurance is
generally available from private insurers for U.S. airlines and
other segments of the aviation industry, though at
significantly higher costs than prior to the September 11
attacks.
The Administration will continue to monitor the improvement
in the cost of available private war and terrorism coverage and
the likely economic effect upon air carriers and other parts of
the aviation industry before making any decisions concerning
the continuation of terrorism coverage through that program.
Q.3. Mr. Secretary, one of the things that concerned me the
most about the Treasury report is that there is virtually no
focus on the policy consequences for policyholders.
To me the most important people in this debate are the
consumers of terrorism insurance. They are largely responsible
for growing the U.S. economy. They do so by running businesses,
owning property, employing workers.
Businesses are even committed to doing so in my hometown of
New York City--even though it is a high-risk area that has
proven to be a most desirable target to terrorists.
Yet, Treasury seems to want to throw these people back on
the mercy of a purely private marketplace that, before TRIA was
enacted, wouldn't write terrorism insurance to any of them. The
Treasury report seems to be putting their faith in a private
market specifically the reinsurance industry--that shows no
sign of being able to fill the coverage gap as this
Administration decides to pull away.
It seems that you express this belief, based on no
empirical data. You say with a great deal of confidence that
the reinsurers will come back even though this conclusion is
inconsistent with a statement by the Reinsurance Association of
America that ``the expiration of TRIA is no likely to stimulate
much additional capacity.''
Are you both aware of the fact that reinsurers continue to
view terrorism as a risk that is uninsurable. And, that there
is only $4 to $6 billion of reinsurance in the current market,
well short of the aggregate industry retention level.
What evidence does Treasury rely upon to conclude that
private reinsurance would be more available if the retention
level is raised, especially if the reinsurance market has not
come back under the current TRIA level?
Are you willing to bet that the economy will not be
negatively affected with the changes you are proposing?
A.3. One of the statutory purposes of TRIA is to protect
policyholders by addressing market disruptions and ensuring the
continued widespread availability and affordability of
insurance for
terrorism risk while preserving State insurance regulation and
consumer protections. In evaluating the TRIA program, Treasury
paid particular attention to the impact on policyholders. We
found that the purchasing (or ``take-up'') of terrorism risk
insurance increased significantly among policyholders between
2002 and 2004. We found the cost of terrorism risk insurance,
as reported by policyholders, declined over the period, both
nationally and for policyholders located in high-risk cities.
We were pleased to find that
insurers resumed pricing terrorism risk insurance, even for
policyholders located in high-risk cities, as insurers built
capacity to absorb any future losses.
As we note in the Treasury report, these changes correlated
with TRIA but were not necessarily a result of TRIA. Other
factors, such as the general insurance underwriting cycle
likely had some effect on these insurance market outcomes
during this period.
In the Treasury report, we concluded that TRIA was
effective for the purposes it was designed to achieve. But this
does not imply continuation of the program, even for
policyholders in high-risk cities. As has been demonstrated
before with natural catastrophes, once insurers have rebuilt
capacity and come to understand a new risk, private markets
resume coverage. The sunset of TRlA should encourage further
development of the private markets.
It is reasonable to expect that the removal of the subsidy
provided by the program will result in adjustments in coverage
and pricing. We expect that innovators in the private markets,
spurred by the likely initial response of increased premiums,
will continue to develop additional terrorism risk insurance
capacity.
As noted in the Treasury report, we found a modest net
increase in use of reinsurance over the period, particularly
among smaller and medium-sized insurers, as insurer retentions
increased. We would not expect to see evidence that private
reinsurers were providing coverage for insurers' TRIA-eligible
losses during the time that TRIA is in effect. By providing, in
effect, subsidized reinsurance, TRIA has crowded out private
reinsurance markets.
Q.4. How did Treasury determine the amount of the recommended
trigger?
In your June 30 letter to Congress, you state that the
Administration would accept an extension of TRIA only if it
includes an increase of the event size that triggers coverage
from $5 million to $500 million. This is a big increase--how
did you arrive at the $500 million number? As you may know,
many terror attacks would not be covered under this new
trigger.
The London Bombing would more than likely not be
covered.
The Madrid Bombings would not be covered.
The bombing of Pan Am flight 103 would not be covered.
The Rand study showed that most terrorist are willing to do
smaller attacks like the bombings I just spoke of. They are not
usually as dramatic as September 11.
Is the proposed $500 million trigger appropriate in these
cases, especially when the goal should be to build a public-
private partnership?
A.4. It is our view that any reform of TRIA should be
consistent with several principles, including the rapid
expansion of private market development, and the need to
significantly reduce taxpayer exposure. Raising the minimum
event trigger is recommended because the private market now has
the capacity to provide coverage for losses in this range. If
Congress docs not act to remove the Federal Government from
intruding into this range, we will further hinder the
development of the private markets.
The conclusion with regard to the size of the minimum event
trigger reflects our consultations with the insurance industry
and our own research into recent market conditions. We
considered the levels of coverage generally available for
individual exposures. Individual exposures are important
because they are a ``limiting case.'' If individual exposures
can be covered to this amount, then any event of this size can
be covered.
Reinsurance Available at this Level
Private reinsurance capacity for this relatively low level
of loss is readily available. As Treasury reported, survey data
indicates that in 2004 some 70 percent of insurers writing
property coverage purchased reinsurance for a portion of their
TRIA deductibles and copayments.\1\ Today, it is reported \2\
that about $300 million of commercial reinsurance capacity is
available for individual insurer
programs, including chemical, biological, radiological, or
nuclear (CBRN), on an aggregate basis, and up to $600 million,
excluding CBRN, on an occurrence basis, and more than $1
billion is available for a single reinsurance program in which
the terrorism exposure is limited in a single State. The market
for stand-alone reinsurance coverage has become cheaper as more
capacity and
competition has entered.
---------------------------------------------------------------------------
\1\ U.S. Department of the Treasury, ``Assessment: The Terrorism
Risk Insurance Act of 2002,'' Report to Congress, June 30, 2005, pages
111-112.
\2\ The information reported in this paragraph is drawn from the
following sources; Benfield Group Limited, ``Outrageous Fortune:
Reinsurance Market and Renewals Review,'' Benfield Industry Analysis
and Research, January 2005, pages 38-39. Marsh, ``Marketwatch:
Terrorism Insurance 2005,'' Marsh Research Report, 2005, pages 24-25.
---------------------------------------------------------------------------
Many Insurers Unaffected
Terrorism risk insurance coverage from insurers with
deductibles above $500 million today--the 13 largest insurers
representing about half the market in TRIA-eligible lines--is
likely to be unchanged by the increase in size of the minimum
event because they are providing this level of terrorism risk
insurance today without TRIA compensation.\3\
---------------------------------------------------------------------------
\3\ Although the increased event minimum means that fewer losses
will count toward their TRIA deductible, this would affect these large
insurers only in the case where they experience significant losses from
several such attacks during the year, or moderate losses from each of a
great number of attacks.
---------------------------------------------------------------------------
Other Insurers Already Providing this Level of Coverage
Without Backstop
We expect that any primary coverage gaps in terrorism risk
insurance could be provided by the stand-alone markets, which
are typically used to cover gaps in all-risk coverage for
example, noncertified acts of terrorism such as terrorism
attacks on policyholders' locations abroad that do not
otherwise fit within TRIA's definition of ``act of terrorism.''
The stand-alone terrorism risk insurance markets routinely
offer property terrorism insurance for international terrorism
risk that is not eligible for TRIA compensation. Overall
capacity has been relatively stable since January 2004. Most
recent Treasury consultations with brokers show the maximum
coverage amounts available for any risk in the stand-alone
market for individual exposures is over $1 billion.
Q.5. Mr. Secretary, the Treasury report spends a lot of time
comparing the availability of terrorism insurance in the pre-
September 11 world with the one that has existed for the first
2 years that TRIA has been in effect. That strikes me as a
false and misleading comparison.
Terrorism insurance was pretty much offered for free pre-
September 11, so of course everyone had it. Everyone who wants
terrorism insurance now has it because the Federal program
requires insurers to make it available.
But the reason why TRIA became law was because we
experienced, post-September 11, a whole year (2002) when--
according to the President--terrorism insurance increasingly
was impossible to get, $15 billion in construction projects
were cancelled or idled and 300,000 jobs were lost.
So, isn't the real point that terrorism insurance would not
be widely available without the Federal program? And isn't that
one big reason why we need it?
A.5. The data in the Treasury report, in fact, cover 2002
through 2005, and therefore reflect adjustments in the market
following September 11. The data for the report was collected
in three annual series or ``waves'' of surveys: The first
covered the policy years 2002 and 2003; the second wave covered
2004 and the third survey wave covered the first two month of
2005. The survey data reflect adjustments in the market to the
September 11 attacks. All conclusions in the report refer to
the data from these three waves of surveys.
Survey data from 2002--which captured what was happening in
the marketplace prior to the enactment of TRIA--indicates about
73 percent of commercial property and casualty insurers
provided some terrorism coverage in TRIA-eligible commercial
property and casualty lines, not including workers'
compensation (terrorism is not permitted to be excluded by
State law so 100 percent of workers' compensation insurers
provide coverage). The policyholder survey indicated that
roughly 27 percent of policyholders reported some terrorism
coverage. The average cost of terrorism coverage reported by
policyholders was about 1 percent of the premium for the entire
policy.
In its study, Treasury found that the availability and
affordability of terrorism risk insurance has increased during
the time that TRIA has been in place. It is our view that, we
have reached the point at which it is now time for the Federal
Government to allow further private market development in this
area.
Q.6. As you both know, many reports have been conducted on the
need for terrorism insurance. The Rand Corporation issued a
report expressing the urgent need to continue TRIA. The
Organization for Economic Cooperation and Development (OECD)--a
UN-specialized agency--recently made its own report on
terrorism insurance stating ``private markets are not yet able
to fully cover the extremely large losses that could result
from terrorist acts in the future.''
It also states that ``despite improvements in market
conditions, the losses associated with very large scale
terrorist attacks may, under current conditions, remain beyond
the capability of the private insurance and reinsurance
industry to price and to absorb alone. The future evolution of
the terrorism threat, and the ensuing capacity and willingness
of the private market to cover resulting losses, is
uncertain.''
Most of the OECD's 30 member countries--except the United
States--currently have some type of long-term Federal terrorism
risk insurance program.
Do you have a response to the OECD report's conclusions?
Why does the Treasury Department think that private markets
in the United States are better prepared than other nations to
handle this incalculable risk, particularly when some of the
some of the other member countries like the United Kingdom and
Spain have more experience dealing with this terror attacks?
A.6. The OECD Report does not conflict with Treasury's report
on TRIA. We see a number of areas of agreement between the two
reports--for example we agree with their conclusion that
terrorism risk modeling faces some challenges and that
financial markets so far have not been a source of capacity. We
certainly agree with their conclusion that countries should
rely on private sector solutions as far as possible and avoid
crowding out private sector initiative.
We evaluated the permanent state-run programs in other
countries, such as in the United Kingdom and Spain, but we
believe that in the long-term the most efficient, lowest cost,
and most innovative methods of providing terrorism risk
insurance will come from the private sector. The power of the
markets will provide the resources and flexibility needed in a
way that will be most efficient.
While there may be some short-term adjustments to a reduced
government role, it is our view that over the long-term the
industry will continue to build capacity and that the private
market can and will work. Treasury's Report pointed to a number
of positive developments: The increased pricing of terrorism
risk insurance; greater availability of reinsurance; and
improving market conditions even as insurer retentions under
TRIA have increased through the life of the program.
Q.7. Mr. Secretary, I want to ask you about your report's
findings on how policyholders have been taking terrorism
insurance--the so-called ``take-up rates'' issue. The report
says that take-up rates only improved ``somewhat'' from 2002-
2005 (Executive Summary), or that rates have been ``increasing
steadily.'' However, the report's hard statistics show that 27
percent of surveyed policyholders reported taking terrorism in
2002, increasing to 39 percent in 2003, and finally increasing
to 54 percent in 2004.
A doubling of the take-up rate in just 2 years' time is a
phenomenal rate of growth that shows how successful the TRIA
program has been for policyholders. Why does the Treasury
report downplay this great success?
A.7. Treasury was pleased to find that policyholders have been
able to obtain larger amounts of coverage for their risks
during the period. The Treasury report highlights this in the
Executive Summary, which states, ``Between 2002 and 2003, after
the enactment of TRIA, take-up of terrorism risk insurance
increased from 27
percent of policyholders to 39.5 percent. In 2004 54 percent of
policyholders reported having terrorism risk insurance
coverage.'' Further, in my prepared written testimony I
reiterated that, ``data show a doubling in the take-up rate of
terrorism risk coverage: From 27 percent of policyholders in
2002 to 54 percent of policyholders by 2004.''
The rise in take-up rates should not be attributed solely
to TRIA. If market development factors were not at work, one
might expect that the increase in insurer retention would have
a negative effect on take-up rates but that is not what we
observed. The increase in take-up rate occurred as the TRIA
deductible increased from 7 percent in 2003 to 10 percent in
2004, to 15 percent by 2005. The key market development that
might drive take-up of such insurance is the increasing
awareness and understanding of terrorism risks.
Q.8. Doesn't sound national security include a strategy for
economic security?
Your report concludes that, if we allow TRIA to expire,
there will be a significant shortage of terrorism coverage and
coverage that is available will be more expensive. All issues
of price aside, is not it a national security issue if our
commercial buildings and public spaces such as stadiums are
left uninsured? In other words, does not having a safety net in
place help to deter terrorists who are out to ``hit us where it
hurts'' economically in this case?
A.8. Our fundamental position is that TRIA should not be
extended in its current form. TRIA was expressly intended to be
temporary. What we have said is that the existing TRIA program,
unless reformed, will hinder further development of the private
market. This is why the Administration opposes a straight
extension of the program in its current form.
Extending TRIA in its current form is likely to discourage
the private market development needed to deal with the risk of
terrorism. The most efficient, lowest cost, and most innovative
methods of providing terrorism risk insurance will come from
the
private sector. Encouraging our private markets is the best way
to make the country more economically secure.
Q.9. Treasury's report expresses confidence that private
insurers now can take care of all the needs of policyholders.
How is this true in the case of chemical, nuclear, biological,
or radiological (CBRN) terrorism--including detonation of a
``dirty bomb''? The market does not even cover this under the
TRIA regime. What makes you think that CBRN will be covered by
the private marketplace when it is not even covered with TRIA
in place?
A.9. As Treasury has stated throughout the temporary Program,
TRIA does cover certified terrorist acts involving chemical,
biological, radiological, or nuclear (CBRN) weapons if the
coverage is provided in the primary or excess property and
casualty insurance
policy issued by the insurer. To that extent, the CBRN coverage
decision has been left to the market.
As reflected in the Treasury report, we found that CBRN
risk has been covered to some degree. The insurer survey found
that, on average, 35 percent of insurers reported including
CBRN risks in some of their policies in 2003 and 2004 (and all
of their workers' compensation policies as State law requires
it be covered.) There has been a distinct shift in the size of
insurers writing the coverage, however; while the number of
smal1er insurers providing this coverage declined, the number
of larger insurers providing it increased. From 2003 to 2004,
there was an increase of 12 percent in the number of insurers
with assets of $1 to $10 bil1ion who reported writing some
coverage, and about 17 percent in the number of insurers with
assets of over $10 billion who wrote some coverage, compared
with a decrease of roughly 6 percent in the number of insurers
with assets of under $1 billion who wrote some coverage.
Yet, though the coverage was available, our study revealed
that only a very small percentage of policyholders purchased
CBRN terrorism risk coverage--less than 3 percent, other than
workers' compensation policies (that are not permitted to have
exclusions.)
Ofthe 97 percent of policyholders that did not purchase
CBRN coverage, our study revealed that they did not do so
mostly because they believed that they were not at risk.
Another reason was that some (15 percent) felt that the
premiums were too high. Only about 5 to 8 percent of the
nonpurchasers reported that they could not find adequate CBRN
terrorism coverage.
RESPONSE TO A WRITTEN QUESTION OF SENATOR JOHNSON
FROM BEN S. BERNANKE
Q.1. According to Secretary Snow's testimony, one of the
recommendations the Treasury report makes is to eliminate from
TRIA certain lines of insurance that are far less subject to
``aggregation risks'' and should be left to the private market.
Based on this, how does Treasury define the term ``aggregation
risk?'' Furthermore, which lines of insurance does Treasury
deem to be qualified under the definition?
A.1. In general, aggregation or accumulation risk refers to the
concentration of an insurance company's portfolio of risks,
comprised of relatively small exposures on an individual basis,
but which represents an enormous exposure when taken as a
whole. This is because each individual exposure is located or
``aggregated'' in such a way that all are exposed to the risk
of a single terrorist attack or simultaneous set of attacks.
Two examples of geographic aggregation that would result in a
high concentration of risk are providing workers' compensation
insurance to the majority of employers in a skyscraper, or
insuring several buildings in the same urban block. It appears
that lines of insurance that are not subject to accumulation
risk could be handled by the private sector without the
assistance of the Government backstop provided by TRIA. Thus,
one of the key features we suggested for any temporary
extension of the TRIA program is the elimination from the
program of lines of insurance that are far less subject to
accumulation risk, such as commercial automobile and general
liability.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER
FROM BEN S. BERNANKE
Q.1. When the ``TRIA'' law was passed in 2002, we did not know
half of what we know now about the enemy and its resolve. We
all acknowledge that the war on terror will be with us for a
very long time.
So if it is a long-term war and this is what the
Administration and the intelligence community tells us often,
why do not we need a long-term solution to the terrorism
insurance problem? A long-term solution that will provide our
economy with the stability to keep growing and protect our
citizens and their businesses from catastrophic loss when
another major terrorist event occurs.
Do you agree that the insurance industry took a long time
to come back from the combined effects of terrorism and natural
disasters?
If so, why do you think they can now handle these disasters
on their own? Furthermore, do you believe it is responsible to
speculate when our economy will take huge hits from any future
attacks?
A.1. As reflected in its statutory purposes, TRIA was intended
to be a temporary, short-term Federal program to address market
disruptions following the September 11 terrorist attacks; to
ensure the continued availability and affordability of
terrorism risk insurance; and, to allow a transitional period
for the private insurance markets to stabilize, resume pricing
of such insurance, and build capacity to absorb any future
losses. The Treasury study found positive signs of private
market development since the September 11 attacks. Even as the
TRIA deductible has risen over time (increasing the private
market's participation), terrorism risk insurance take-up has
continued to increase, insurers have written coverage on a
similar or greater number of policies, and pricing has fallen
where insurers have charged for the coverage.
In the Treasury report, we conclude that TRIA has been
effective in achieving its objectives. Insurers are much better
able to
assess their exposures and are increasingly pricing terrorism
risk insurance. Insurer surplus, a major source of insurer
capacity to write coverage, has improved from pre-September 11
levels. The insurance industry's recovery from September 11 and
its resiliency show that the private market functions well over
time and returns stronger and capable of handling
catastrophes--both natural and man-made.
The risk of terrorism is likely to remain a part of our
lives for some time to come, and that is precisely why the
Federal Government needs to encourage the development of the
most creative and cost effective means of covering terrorism
risks. Over the long-term, the most efficient, lowest cost, and
most innovative methods of providing terrorism risk insurance
will come from the private sector. It is time for the Federal
Government to step back and allow more opportunities for
private sector development. I have faith in the power of
markets to provide the resources and flexibility needed in a
way that will be more efficient and lower cost than any
permanent government provision of insurance.
Q.2. Mr. Secretary and Mr. Chairman, during World War II we
provided a program called the War Risk Insurance program that
provided insurance for property damage here in the United
States caused by German or Japanese attacks. During the Vietnam
War we provided an insurance program to cover commercial
airplanes that flew into and out of Vietnam. And, today we have
a first dollar loss insurance program for the airline industry
to cover losses caused by terrorism in the United States.
My question is two-fold.
First, is there a difference between war and terrorism?
What is it? Why does the Administration seem to be saying that
the private insurance market can provide insurance against
terrorism but not against war? If we are in a ``War against
Terror'' why do not we provide the same type of economic
protections that we have historically provided when we are at
war.
Second, what is the Administration's position on the first
dollar loss program for airlines? And, what is the difference
between such a program for airlines and a reinsurance program
for buildings and people that those airlines fly into? Clearly
the reinsurance program is less costly than a first dollar loss
program.
During your review did you study any mechanisms like this
to deal with the economic risks posed by this ongoing war on
terrorism?
A.2. As passed by Congress, TRIA does not provide a backstop to
the insurance industry for losses caused by acts of war, except
in the case of workers' compensation insurance.
The insurance industry itself treats war risk and terrorism
risk differently. War risk has been subject to long-standing
exclusions for losses caused by war, warlike action by a
military force, insurrection, or similar unrest, while
terrorism risk had not been excluded prior to September 11.
Terrorism risk was insurable
despite decades of international terrorist attacks, and
remained insurable even after the 1993 bombing of the World
Trade Center and the 1995 bombing of the Alfred P. Murrah
Federal building in Oklahoma City. What the insurance industry
was not prepared for was a catastrophic terrorist attack of the
magnitude of September 11. Yet Treasury's report showed an
expansion of terrorism risk availability and purchase, even as
the deductible increased, which highlights the improvements in
the industry's ability to cover terrorism. Even without the
TRIA backstop, insurers are providing coverage for terrorist
acts that would not be eligible for TRIA program coverage.
Treasury's report showed that about 40 percent of insurers
reported writing polices covering noncertified terrorism risk.
The private market itself is the best indicator as to why the
two risks are treated differently.
TRIA required Treasury to assess the effectiveness of TRIA
and the likely capacity of the property and casualty insurance
industry to offer insurance for terrorism risk after
termination of the program. The Treasury report finds that, in
accordance with its
purpose, the program provided support in a post-September 11
transitional period, during which the capacity of the insurance
industry to write terrorism risk insurance has improved. It is
our view that continuation of the program in its current form
is likely to hinder the further development of the terrorism
insurance market by crowding out innovation and capacity
building. Our report did not evaluate the extent of private
market provision of war risk insurance.
In connection with its work in this area, Treasury
evaluated other past and present Federal insurance programs,
such as the terrorism coverage provided through the Federal
Aviation Administration's war risk insurance program. Though
structured differently, the provision of terrorism coverage
through the FAA
program is temporary (currently expiring at the end of this
year). The FAA program is not inconsistent with our overall
view that in the long-term the most efficient, lowest cost, and
most innovative methods of providing terrorism risk insurance--
even for air carriers--will come from the private sector. As
Transportation Secretary Norman Mineta reported to Congress in
March 2003, war and terrorism risk insurance is generally
available from private insurers for U.S. airlines and other
segments of the aviation industry, though at significantly
higher costs than prior to the September 11 attacks.
The Administration will continue to monitor the improvement
in the cost of available private war and terrorism coverage and
the likely economic effect upon air carriers and other parts of
the aviation industry before making any decisions concerning
the continuation of terrorism coverage through that program.
Q.3. As you both know, many reports have been conducted on the
need for terrorism insurance. The Rand Corporation issued a
report expressing the urgent need to continue TRIA. The
Organization for Economic Cooperation and Development (OECD)--a
UN-specialized agency--recently made its own report on
terrorism insurance stating that ``private markets are not yet
able to fully cover the extremely large losses that could
result from terrorist acts in the future.''
It also states that ``Despite improvements in market
conditions, the losses associated with very large scale
terrorist attacks may, under current conditions, remain beyond
the capability of the private insurance and reinsurance
industry to price and to absorb alone. The future evolution of
the terrorism threat, and the ensuing capacity and willingness
of the private market to cover resulting losses, is
uncertain.''
Most of the GECD's 30 member countries--except the United
States--currently have some type of long-term Federal terrorism
risk insurance program.
Do you have a response to the GECD report's conclusions?
Why does the Treasury Department think that private markets
in the United States are better prepared than other nations to
handle this incalculable risk, particularly when some of the
some of the other member countries like the United Kingdom and
Spain have more experience dealing with this terror attacks?
A.3. The GECD Report does not conflict with Treasury's Report
on TRIA. We see a number of areas of agreement between the two
reports--for example we agree with their conclusion that
terrorism risk modeling faces some challenges and that
financial markets so far have not been a source of capacity. We
certainly agree with their conclusion that countries should
rely on private sector solutions as far as possible and avoid
crowding out private sector initiative.
The Administration evaluated the permanent state-run
programs in other countries, such as in the United Kingdom and
Spain, but we believe that in the long-term the most efficient,
lowest cost, and most innovative methods of providing terrorism
risk insurance will come from the private sector. The power of
the markets will provide the resources and flexibility needed
in a way that will be most efficient.
While there may be some short-term adjustments to a reduced
government role, it is our view that over the long-term the
industry will continue to build capacity and that the private
market can and will work. Treasury's report pointed to a number
of positive developments: The increased pricing of terrorism
risk insurance; greater availability of reinsurance; and
improving market conditions even as insurer retentions under
TRIA have increased through the life of the program.
Q.4. Mr. Chairman, do you believe that terrorist attacks are
attacks on our Government in most instances? That when they
attack the World Trade Center, they are attacking a symbol of
America and not the securities firms or other businesses that
inhabit those buildings?
A.4. Terrorist attacks are attacks on our Government, our
businesses, and our citizens. However, terrorist goals do not
factor into the economic justification of TRIA. The economic
justification for Government to subsidize terrorism risk
insurance should be motivated by the existence of a positive
public benefit that is not taken into account by private
parties. In the case of terrorism risk insurance, there was a
case to be made after September 11 that heightened fears
triggered a temporary disruption of terrorism insurance
services. However, the recent increase in terrorism insurance
take-up rates suggests that this motivation for TRIA no longer
exists, at least not to the degree it did in the period
immediately following the attacks. Moreover, as long as the
private market is willing to provide terrorism insurance, the
accurate pricing of such insurance by private counterparties
will help businesses react efficiently to this very real risk.