Wall Street Journal

REVIEW & OUTLOOK

Risky Terror Business
June 27, 2005

The Terrorism Risk Insurance Act, one of Congress's more hasty responses to September 11, is set to expire at the end of this year. It deserves a decent burial, though with government programs that's easier said than done.

TRIA, as the law is known, made the federal government the reinsurer of last resort. That is, the government (read: taxpayers) agreed to bear much of the costs of large claims resulting from future attacks. In return for this government backing, insurers are required to offer terrorism coverage to their commercial policy holders.

Not surprisingly, insurance companies think this is a swell deal, and industry groups like the American Insurance Association are lobbying hard to extend the program. Typically, insurers pay a premium to reinsurers for coverage against earthquakes, hurricanes and other catastrophes that can result in large losses. But under TRIA, the insurers get free terrorism reinsurance. The federal government receives no premium for providing coverage, yet agrees to cover losses amounting to $100 billion annually.

In the weeks following 9/11, carriers did threaten to exit the terror insurance market, which was one rationale for government intervention. But it's hard to know for certain how insurers, developers and commercial real estate lenders would have ultimately responded in the absence of TRIA. We do know that, even before the law's enactment in 2002, the industry was adjusting apace to the post-9/11 world. Insurers and reinsurers were raising capital, and terrorism coverage costs were falling fast. Premiums fell significantly in 2003 and 2004, and they continue to fall today while take-up rates climb.

In any case, TRIA's sunset provisions are there for a reason, and it's clear that the law has outlived whatever usefulness it might have served. Financial health in the property/casualty insurance industry is determined by the ratio of net premiums written to surplus, or retained earnings. And by that measure, the industry owned by the likes of Warren Buffett has been hugely profitable of late.

Robert Hunter of the Consumer Federation of America was an initial supporter of TRIA. But at a forum on terrorism insurance last month he noted that since 2001 there has been an increase of $93 billion in retained earnings. "The commercial segment of the industry has seen retained earnings grow by $49 billion over what they had before the attacks," said Mr. Hunter, "enough to fund more than two terrorist incidents of a September 11th magnitude."

Congress is awaiting a Treasury Department study -- due June 30 -- on the law's effectiveness. And we hope it recommends ending the program, all the more because the course of least political resistance in Congress will be to extend the subsidy. In part, that's because of the way the government handles its books. In the private sector, insurance is evaluated in a way that shows year-to-year costs based on the expected value of the coverage.

By contrast, this government insurance pretends that terrorism coverage can be provided at no cost, except in years when something big happens. Hence, as a federal budgetary matter, TRIA looks like a "free" program, even though its true cost has been estimated at more than a billion dollars per year. And any program that provides benefits to substantial industry bodies, sounds like it's essential to the nation's "economic security," and appears to have no budget costs will have current politicians figuring they can pass the burden onto future taxpayers.

Still, Congress might consider that letting TRIA live distorts the marketplace. How are we ever going to develop a private reinsurance market for terrorism if government provides the service for free? At the very least, the government could be charging for reinsurance protection, which would provide some incentives for the private market to develop because it wouldn't be competing against a free good.

In the end, terrorism may turn out to be an uninsurable risk. It's clearly not a standard actuarial issue where you can look at thousands of events or scientific data to determine potential costs. But until this federal backstop is removed or modified, and the private sector is put to the test, we'll simply never know.