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Published: 2008-03-26

An Overview of the Terrorism Risk Insurance Act of 2002



Introduction

On November 26, 2002, President Bush signed into law the Terrorism Risk Insurance Act of 2002 (the "Act"). The Act, which takes immediate effect, serves as a financial backstop, enabling commercial insurers to provide affordable terrorism coverage to policyholders. It is expected to benefit businesses that were unable to obtain terrorism coverage after September 11, 2001. The following is a summary of the Act's key features.

The Act renders all existing policy terrorism exclusions null and void, and requires all property and casualty insurers to offer policyholders terrorism insurance for two years (which, at the Treasury Secretary's discretion, may be extended an additional year). The terrorism coverage offered must not "materially differ from the terms, amounts, and other coverage limitations applicable to losses arising from events other than acts of terrorism." When offered, the terrorism coverage premium and the existence of the federal backstop must be clearly and conspicuously disclosed to policyholders. Act, §§103 & 105.

The Act does not provide coverage pricing guidelines. States, however, can invalidate any rates determined to be excessive, inadequate or unfairly discriminatory. Act, § 106. Policyholders can decline the offered terrorism coverage. For an insurer to reinstate any terrorism exclusions, however, the insured must sign an authorization or decline to pay (within 30 days) the terrorism coverage premium. Act, § 105.

The Act establishes a program within the Treasury Department, under which the Federal government shares the risk of loss from future foreign terrorist attacks. If an act, certified to be a foreign act of terrorism,[2] causes losses in excess of $5 million, participating insurers pay a certain amount in claims – a deductible – before Federal assistance becomes available. For losses above the deductible, the government covers 90%, while the insurer contributes 10%. Losses covered by the program are capped at $100 billion, and the program permits the government to recoup the amounts paid by virtue of a surcharge on all policyholders. The Act does not apply to last year's terrorist attacks (which generated approximately $40 billion in insured claims), and it terminates on December 31, 2005. Act, § 103.

Participating Insurers

All insurers who provide property or casualty insurance are required to participate in the program. Act, § 103(a). The Act broadly defines "Insurer" as (but not limited to) licensed insurers; non-licensed insurers; surplus line carriers listed on the Quarterly Listing of Alien Insurers of the NAIC; insurers approved to offer commercial or casualty insurance by a federal agency that regulates maritime, energy or aviation activity; a state residual market insurance entity or a state workers' compensation fund; any insurer that meets reasonable criteria set forth by the Treasury Secretary; and any other insurer that receives premiums for commercial property or casualty insurance coverage. Act, § 102. If the Treasury Secretary determines it appropriate before any triggering foreign terrorist event, the Act also can be applied to captive insurers and other self-insurance arrangements. Act, § 103(f).

Covered Losses

The Act applies only to foreign acts of terrorism, resulting in covered property damage within the United States (and to damage outside the United States if to an air carrier or flag vessel or on the premises of a United States mission). The Act also applies only to acts perpetrated on behalf of a foreign person or interest as part of an effort to coerce United States citizens or influence the United States' policies. Terrorism committed during war generally is not covered by the Act. Act, §§ 102 & 103.

The Act does not eliminate all potential terrorism exclusions to coverage. Exclusions for losses to property outside the United States are expected to remain in force, as are exclusions for losses arising from civil commotion, domestic terrorism, vandalism and riots. See Act, §§ 102 & 103.

Deductibles

Before federal assistance is available, participating insurers must pay a deductible. During the "Transition Period" (i.e., from November 26, 2002 to December 31, 2002), the deductible is one percent of the value of the insurer's directly earned premiums during the year preceding the Act's enactment. During 2003, the deductible is seven percent of the insurer's directly earned premiums for the preceding year; it rises to ten percent during 2004. In 2005 (if the program is extended), the deductible is fifteen percent of the insurer's directly earned premiums during the preceding year. Act, § 102.

Coverage Limits

The program covers aggregate insured losses up to the annual limit of $100 billion. Insurers that meet the deductible (presently) are not liable for losses in excess of the cap. If the cap is exceeded, Congress must decide who will pay and in what amounts. Act, § 103(e).

Retentions and Recoupments

If the government pays losses under the program, the Treasury Secretary can recoup the difference between:

The lesser of the "Insurance Marketplace Aggregate Retention Amount" (which varies each program year) or the aggregate amount of all insured losses for that program year

and

the aggregate amount of all losses not covered by the program that program year (i.e., the insurance industry's deductibles and their ten-percent share of losses above their deductibles).

Recoupment is not mandatory if uncompensated losses exceed the Insurance Marketplace Aggregate Retention Amount. Until December 31, 2003, the Insurance Marketplace Aggregate Retention Amount is $10 billion. During 2004, it is $12.5 billion; during 2005, it is $15 billion.

Commercial property and casualty insurers will collect (by policyholder surcharge) the mandatory and discretionary recoupments and remit them to the federal government. Surcharges cannot exceed three percent of any policy's annual premium. The Treasury Secretary, however, has discretion to make certain adjustments to the surcharge and its timing. Act, § 103(e).

State Law

The Act does not impact state insurance law except (1) to establish the definition of terrorism, and (2) to make terrorism coverage (and the forms and rates for it) effective without prior state approval or waiting period (until December 31, 2003). States, however, can invalidate any rates set as excessive, inadequate or unfairly discriminatory. Act, § 106.

The Act provides a federal cause of action -- generally governed by the substantive law of the state where the act of terrorism occurred -- as the exclusive remedy for claims arising out of or resulting from a terrorism act. The Judicial Panel on Multidistrict Litigation shall assign all claims to a single federal district court (or multiple district courts, if necessary), which has exclusive jurisdiction over them. Act, § 107.

Other Provisions

The Act applies only during the effective period of the program. It does not limit the liability of any government, organization or person who participated, conspired, aids and abets or commits an act of terrorism. It does not modify policyholders' and insurers' contractual rights, such as the right to arbitration. It also does not abrogate any provision of the Air Transportation Safety and System Stabilization Act. The Act excludes punitive damages from the calculation of insured losses.

Conclusion

The Act was designed (among other things) to ensure reasonable and predictably-priced terrorism coverage. By providing a temporary federal backstop, the government seeks to encourage insurers to offer affordable coverage for the unprecedented financial risks posed by foreign acts of terrorism. Whether the Act will fulfill its purpose is unclear. The Act simply requires participating insurers to make terrorism coverage available that "does not differ materially from the terms, amounts and other coverage limitations applicable to losses arising from events other than acts of terrorism." See Act, § 103(c). How insurers will interpret their obligations, and how the Treasury Department will enforce the Act, remain to be seen. With previous terrorism coverage exclusions now rendered null and void, insurers may be hard pressed to quickly provide premium quotes regardless of whether they reflect individual policyholder experience. In so doing, the existence of a temporary federal backstop may not serve to reduce the substantial premiums currently associated with terrorism coverage. Policyholders must remain mindful of all policy terms, conditions and exclusions, as well as developments in implementation of the Act to meaningfully assess their insurance programs and future needs as they relate to terrorism coverage.




[1] The views expressed are not necessarily those of McCarter & English, LLP. The information provided should not be relied upon as legal advice or as a legal opinion as to any specific set of facts or circumstances. The contents are intended only for general information purposes and the reader is urged to consult counsel concerning their situation and any specific legal questions.

[2] The act of terrorism must be certified as such by the Treasury Department in concurrence with the Secretary of State and the Attorney General.