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INSURING AGAINST TERRORISM March 2002

The tragic events of September 11^th caused the insurance market (which had already been hardening) to deteriorate significantly. The cost for property insurance has increased (in many cases) by multiples… and adding insult to injury, coverage for the peril of Terrorism is either limited to a fraction of insured value or is now excluded entirely.

Insurance companies, unable to estimate the cost of future terrorist losses are withdrawing from the market. Insurers point out that experience with major terrorist events has been so limited, and potential losses so huge, that it is virtually impossible to apply any type of sound actuarial method to price terrorism coverage.

This withdrawal happened very quickly among reinsurers, who suffered enormous losses from September 11th. Reinsurance is vital to the insurance industry as it provides a way to insure large risks without exposing a single direct insurer to the possibility that its entire surplus could vanish from a single event. Because reinsurers are not subject to regulation, they have had no difficulty excluding Terrorism in their treaties with direct commercial insurers.

Direct commercial Property Insurers on the other hand, have been slower to react due to regulatory constraints imposed by State Insurance Authorities. As a result, they are not writing business in States requiring them to provide Terrorism coverage. In some instances, they will write coverage with a “sister” company, not admitted in the State and not subject to State regulation. Other times, they may offer a small sub-limit of Terrorism coverage.

Losing Terrorism coverage creates other problems as well. Large business and property owners may be in technical default of their loans and mortgages. Many loan documents require the borrower to cover the property utilizing a standard “all risk” property policy. While the term “all risk” was never all encompassing (certain perils such as Flood and Earthquake were almost always excluded) it did not exclude the peril of Terrorism.

This issue has already been disputed and will be settled in court. Simon Property Group, an Indianapolis-based real estate investment trust that owns the nation’s largest shopping center, Mall of America, has been challenged by GMAC Commercial Mortgage Corp. over whether its loan agreement requires terrorism coverage.

Few insurance companies are willing to offer “stand-alone” Terrorism coverage. The “opportunists” selling Terrorism coverage are currently charging between 7% - 9% of insurable value. To put in it perspective, most property insurance premiums range in the thousands of 1% of insurable value.