The Magazine

Insurance Against Terrorism

An alternative to unlimited liability for taxpayers.

Aug 10, 2009, Vol. 14, No. 44 • By ELI LEHRER
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After hijackers destroyed the World Trade Center on 9/11, taxpayers ended up spending a lot of money to aid the injured, rebuild public infrastructure, improve security, and help the jobless. But the private firms with property and workers in lower Manhattan fell back on their private insurers. And the companies paid out: Over $35 billion flowed from their capital reserves to people harmed in the attack. No insurers went under as a result of 9/11 and all but a handful of claims were paid within a few months. In short, it was a shining hour for the insurance industry.

But if another major terrorist attack takes place, the industry won't have as much need to step up to the plate. Instead, the government will take charge. Under an obscure but potentially budget-busting program-terrorism risk insurance-the federal government has assumed nearly unlimited liability for major terrorism losses. The program, called TRIA, can claim broad support but has deep flaws and imposes billions in liabilities on taxpayers. The program, though never intended to be permanent, will be entrenched before long. Still, it's not too late to restore an affordable, private system of insurance.

Under the current program, once industry-wide private commercial and workers compensation insurance claims from a terrorist attack exceed $27.5 billion, TRIA kicks in and covers the remaining expenses up to $100 billion. (Congress would almost certainly lift the $100 billion cap if claims exceeded that amount.) In theory, the money to pay claims would come from a tax (up to 3 percent) on just about every eligible insurance policy in the country. If this tax proved insufficient, Congress would have to use other revenues.

Although TRIA was created in 2002 as a post-9/11 stopgap, insurance companies have shown almost no interest in replacing it. Often fractious industry groups representing brokers, insurers, reinsurers, and commercial insurance consumers have lined up in support of the program. And, when the Government Accountability Office studied terrorism insurance earlier this year, it found that the chances of a private terrorism insurance market developing were very slight. TRIA is currently authorized through 2014.

And that's a problem because the federal government-already stretched with bailouts and "stimulus" spending-has no business running a hugely expensive insurance program. Its record isn't encouraging. The other major federal effort at disaster insurance, the National Flood Insurance program, owes the Treasury about $19 billion, has no way to pay it back, and has actually increased the nation's susceptibility to flood by effectively subsidizing building in flood-prone areas. States like Florida that attempt to run property insurance programs have done even worse.

But that doesn't mean that doing away with federal terrorism insurance will be easy. The insurance industry has a good reason to support it. The current system for writing insurance really can't deal with terrorism adequately.

Explaining why this is so requires some background on how insurers manage risk. To write a policy, an insurer will build a group of similar risks-a pool-unlikely to experience losses at exactly the same time. An insurance company might calculate that the chances of a $100,000 house burning down during a given year were 1 in 100. It could then write policies for 100 homes in different neighborhoods worth $100,000 each and charge a yearly premium of $1,200 for each policy. Of the $1,200 collected, $1,000 would cover expected claims and the extra $200 would cover the expenses of writing the policy, provide for the purchase of reinsurance (insurance for insurance companies), build reserves, provide return on capital for company owners, and offer a margin of safety for the insurers' own uncertainty about its "1 in 100 chance" calculation.

But the actuaries who do these calculations can't make decent guesses about the likelihood of terrorist attacks. The past two decades have seen only three significant terrorist attacks on American soil. For every obvious target (like the World Trade Center), terrorists have picked a less-obvious one (such as Oklahoma City's Murrah federal building). The best information about terrorist risks, furthermore, remains a closely guarded secret within the intelligence and law enforcement communities. Before 9/11, large commercial insurers and reinsurers generally provided terrorism coverage nonetheless.