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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It's easy to see why they stopped. Based on existing data on the number of modern attacks on office buildings and the number of office buildings in the United States, actuaries forced to make the calculation might guess that the average yearly chance of a terrorist attack on a $25 million office tower located in a midsized city, is one in a million. This would indicate an "actuarial" yearly premium in the neighborhood of $25 for $25 million of coverage. But no insurance company with competent management would ever risk $25 million in capital for a premium of $25 or even $2,500. Even if an insurer decided to sell terrorism insurance at a price like that, state insurance regulators would likely block the sale as too risky to the company's other business. Insurance priced high enough to satisfy regulators and insurance company managers, on the other hand, probably wouldn't find any buyers.

Clive Tobin, the CEO of the Bermuda/London reinsurer Torus and a longtime reinsurance executive has floated another plan in comments at trade conferences: true reciprocity. Under a "true reciprocal" system, 25 firms that each own a $25 million office building would each take responsibility for paying $1 million if terrorists destroyed any group member's building. The firms would pay no yearly premiums in return for the coverage (they might pay administration fees and exchange $1 payments to make the contracts between themselves legal) and would not be regulated as insurers. Instead, they would simply pledge their full faith and credit to pay the claim if another group member experienced an attack. "What you are really looking for is an agreement," says Tobin, "to avoid an insured having to tell their board that their location has just been destroyed and they have no insurance."

The idea, as Tobin conceives it, could have some other wrinkles. For example, a company that owns a building in Manhattan might take on $50 million of risk for a Minneapolis-based company in return for the Minneapolis company taking on $10 million in Manhattan risk. Some sort of formal exchange, very likely, would have to exist to match participants' risks.

However it works out in practice, the idea has enormous potential benefits. Neither insurers nor insurance purchasers would have to divert any capital to buy expensive insurance policies against the unlikely possibility of terrorist attack but, simply by expanding the size of the groups they joined, could reduce their liabilities. Taxpayers would owe nothing. (Tobin suggests a secondary backstop that would have the government provide partial coverage against a specific company's default on its reciprocal obligations.)

And the idea isn't new. In fact, many existing mutual insurance companies like Ohio's Westfield Group and San Antonio-based USAA started writing farm and automobile insurance exactly this way and sometimes retain a few legal structures of reciprocity. The idea faded from practice as an insurance company that charges premiums in advance has a much easier time making payments on claims and can generate more profits by investing premium dollars between claims. If it doesn't suit most types of modern insurance, however, such a structure seems almost ideal for an entity providing sizeable commercial enterprises with coverage against rare terrorist attacks.

Current law, however, makes it almost impossible to set up such a structure. "The major [problem] for me is how to make sure this process can be executed in an appropriate legal and regulatory framework, but keep this at a light touch," Tobin told me. Since each state regulates insurance individually, at least some would likely demand that every party participating in a reciprocal system submit to regulation as an insurance company. And noninsurance firms would never agree to that.

Risk retention groups, a class of lightly regulated federally authorized insurance companies that focus on malpractice coverage and backing for consumer product repair insurance, have something in common with Tobin's idea but do typically charge annual premiums and face all sorts of restrictions likely inappropriate to Tobin's idea. Just as important, the apparently permanent existence of TRIA and the lack of a real potential for profit in its absence makes it unattractive for anybody (even Tobin's own company) to spend lots of resources pushing an alternative.

Making an alternative to TRIA work will probably require special legislation in Congress. Given the uncertainties, furthermore, it would be unwise to repeal TRIA before reciprocal terrorism insurance arrangements get off the ground. Piloting the idea alongside TRIA, particularly by starting in areas unlikely to experience terrorist attack, could provide an important proof of concept.