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The Terrorism Risk Insurance Act Of 2002:
What It Means For Insurers And Policyholders

By Robert M. Elconin, Lindquist & Vennum P.L.L.P.

On November 26, 2002, President Bush signed into law the Terrorism Risk Insurance Act of 2002 (“TRIA”), creating a $100 billion public-private program to cover losses caused by terrorism. The legislation has important implications for commercial insurers and their policyholders.

The purpose of the new law is to ensure the availability of insurance coverage for acts of terrorism and supplement industry capacity for catastrophic exposures created by terrorism. The program is temporary. It expires at the end of 2004 unless extended one year by order of the Treasury Secretary. Its most immediate impact is to nullify all terrorism exclusions in commercial lines policies until policyholders are notified of the new program, advised of the cost of terrorism coverage, and given the option to accept or decline coverage.

Under TRIA, the federal government reimburses insurers for losses caused by terrorism, paying 90% of covered terrorism losses exceeding a deductible paid by insurance companies. The deductible is prescribed by statute and phases in over several years based on an insurance company’s earned premiums in the prior calendar year (1% of premiums for any claims in 2002, 7% for 2003, 10% for 2004, and 15% if the program is extended into 2005). The maximum amount covered by the program—including both government and insurance industry costs—is $100 billion in any single year.

Participation in the program is mandatory for all insurers covering commercial lines property and casualty insurance, including excess insurance, workers’ compensation and surety. Excluded from the legislation are crop and livestock insurance, private mortgage insurance, title insurance, financial guaranty insurance, medical malpractice, life and health insurance, federal flood insurance and reinsurance. State residual market mechanisms (such as so-called FAIR plans and Joint Underwriting Associations), and state workers compensation programs are to be covered in accordance with rules established by the Secretary of the Treasury. Self-insurance arrangements, risk retention groups, and captive insurers may also be covered to the extent deemed appropriate by the Treasury Secretary in consultation with state insurance regulators.

Coverage of claims is triggered when the Secretary of the Treasury, in concurrence with the Secretary of State and the Attorney General, certifies an event to be an “act of terrorism.” Terrorism is defined to include violent acts resulting in damages within the United States, or outside the United States in the case of an airplane, ship, or at the premises of a United States mission, committed by persons acting on behalf of any foreign person or foreign interest as an effort to coerce the civilian population or to influence the policies or conduct of the United States government. A key element of terrorism appears to be the involvement of a foreign interest, thus excluding acts of domestic terrorism, such as the Oklahoma bombing. Also excluded from the definition of terrorism are acts committed in the course of war and losses under $5 million.

Under the Act, insurers are required to provide “clear and conspicuous” disclosure to policyholders of the premium charged for terrorism insurance. For policies currently in force, this disclosure must be provided within 90 days of the law’s enactment; for policies issued or renewing after the 90-day time period, the disclosure must be provided on a separate line item in the policy. Existing terrorism exclusions are voided to the extent they would deny coverage for acts of terrorism as defined by the Act, unless the policyholder affirmatively declines terrorism coverage within 30 days of receiving the insurer’s notice, or the policyholder fails to pay any additional premium required by the insurer.

Another important but complicated feature of TRIA is a recoupment mechanism that enables the federal government to recover part or all of the payments made to insurers. The Act requires the insurance industry to absorb the first layer of loss caused by terrorist acts, known in the insurance industry as a retention. The retention is set at $10 billion in 2003, $12.5 billion in 2004, and $15 billion in 2005 if the program is extended into the third year. For example, if there were covered losses of $20 billion in 2003 and the insurance industry as a whole paid $4 billion as a result of deductibles and co-payments, the federal government would recoup $6 billion (the retention amount of $10 billion less the $4 billion already paid). The recoupment provisions are important to policyholders as well as insurers, because the legislation authorizes insurers to surcharge policyholders up to 3% of premiums in order to recover recoupment amounts.

The Act also creates an exclusive federal cause of action for claims resulting from acts of terrorism. Under these provisions, in the event of an act of terrorism, claimants would be prohibited from pursuing claims in state court and would instead be required to pursue any damages in federal court. However, state law would substantively govern such actions. While the Act does not prevent claims for punitive damages, it would prohibit compensation of punitive damages out of insurance proceeds.

The Secretary of the Treasury is vested with authority to promulgate formal regulations, study certain issues (including whether group life insurance should be covered by the program), and exercise certain powers such as extending the program’s termination date from 2004 to 2005 and increasing insurance industry retention levels.

The Terrorism Risk Insurance Act is a complex piece of legislation that leaves many questions in its wake. What happens if losses exceed $100 billion? How would an act of war against certain countries (like Iraq) impact the program? How much will insurers charge for this additional protection? It can be expected that the insurance industry, state insurance regulators, and United States Treasury Department will be sorting through these various issues over the coming months.

ABOUT THE AUTHOR

Robert M. Elconin is a partner in the Twin Cities law firm of Lindquist & Vennum P.L.L.P., practicing in insurance and financial services. He may be reached at 612-371-3930 or relconin@lindquist.com.

riskVue | The webzine for risk management professionals
January 2003