This is the accessible text file for GAO report number GAO-04-307 
entitled 'Terrorism Insurance: Implementation of the Terrorism Risk 
Insurance Act of 2002' which was released on April 28, 2004.

This text file was formatted by the U.S. General Accounting Office 
(GAO) to be accessible to users with visual impairments, as part of a 
longer term project to improve GAO products' accessibility. Every 
attempt has been made to maintain the structural and data integrity of 
the original printed product. Accessibility features, such as text 
descriptions of tables, consecutively numbered footnotes placed at the 
end of the file, and the text of agency comment letters, are provided 
but may not exactly duplicate the presentation or format of the printed 
version. The portable document format (PDF) file is an exact electronic 
replica of the printed version. We welcome your feedback. Please E-mail 
your comments regarding the contents or accessibility features of this 
document to Webmaster@gao.gov.

This is a work of the U.S. government and is not subject to copyright 
protection in the United States. It may be reproduced and distributed 
in its entirety without further permission from GAO. Because this work 
may contain copyrighted images or other material, permission from the 
copyright holder may be necessary if you wish to reproduce this 
material separately.

Report to the Chairman, Committee on Financial Services, House of 
Representatives:

April 2004:

TERRORISM INSURANCE:

Implementation of the Terrorism Risk Insurance Act of 2002:

GAO-04-307:

GAO Highlights:

Highlights of GAO-04-307, a report to the Chairman, Committee on 
Financial Services, House of Representatives 

Why GAO Did This Study:

After the terrorist attacks of September 11, 2001, insurance coverage 
for terrorism largely disappeared. Congress passed the Terrorism Risk 
Insurance Act (TRIA) in 2002 to help commercial property-casualty 
policyholders obtain terrorism insurance and give the insurance 
industry time to develop mechanisms to provide such insurance after the 
act expires on December 31, 2005. Under TRIA, the Department of 
Treasury caps insurer liability and would process claims and reimburse 
insurers for a large share of losses from terrorist acts that Treasury 
certified as meeting certain criteria. As Treasury and industry 
participants have operated under TRIA for more than a year, GAO was 
asked to describe (1) their progress in implementing the act and (2) 
changes in the terrorism insurance market under TRIA.

What GAO Found:

Treasury and industry participants have made significant progress in 
implementing TRIA during its first year, but Treasury has important 
work to complete in order to comply with its responsibilities under the 
act. For example, Treasury has issued regulations to define program 
requirements, created and fully staffed the Terrorism Risk Insurance 
Program office, and begun data collection efforts in support of 
mandated studies. Insurers also have adjusted their operations and 
policies to comply with TRIA. However, insurers have expressed concerns 
that Treasury has not yet decided whether to extend through 2005 the 
requirement that insurers offer terrorism coverage on terms that do not 
differ materially from other coverage. Although the act gives Treasury 
until September 1, 2004, to decide this issue, a more timely decision 
is needed to avoid hindering underwriting and pricing decisions for 
policies that are issued or renewed through 2005. In addition, Treasury 
has not fully established a claims processing and payment structure. 
Insurers are concerned that a delayed payment of claims by Treasury, 
whether because of the length of time taken to certify that an act of 
terrorism met the requirements for federal reimbursement or from 
inadequate claims processing capability, might seriously impact insurer 
cash flows or, in certain circumstances, insurer solvency. 

It appears that Congress’s first objective in creating TRIA—to ensure 
that business activity did not materially suffer from a lack of 
available terrorism insurance—has been largely achieved. Since TRIA was 
enacted in November 2002, terrorism insurance has been generally 
available to businesses. But most commercial policyholders are not 
buying the coverage. According to insurance industry experts, purchases 
have been higher in areas considered to be at high risk of another 
terrorist attack. However, many policyholders with businesses or 
properties not located in perceived high-risk locations are not buying 
coverage because they view any price for terrorism insurance as high 
relative to their perceived risk exposure. Further, those who have 
bought terrorism insurance remain exposed to significant perils. 
Insurers have broadened long-standing policy exclusions of nuclear, 
biological, and chemical events. Congress’s second objective—to give 
private industry a transitional period during which it could begin 
pricing terrorism insurance and develop ways to cover losses after TRIA 
expired—has not yet been achieved. Industry sources indicated that 
under TRIA, insurance market participants have made no progress to date 
toward the development of reliable methods for pricing terrorism risks 
and made little movement toward developing any mechanism that would 
enable insurers to provide terrorism insurance to businesses without 
government involvement.


What GAO Recommends:

GAO recommends that the Secretary of the Treasury, as part of 
Treasury’s study of the effectiveness of TRIA and after consultation 
with insurance industry participants, identify for Congress 
alternatives that may exist for expanding the availability and 
affordability of terrorism insurance after TRIA expires. These 
alternatives could assist Congress during its deliberations about 
terrorism insurance.

www.gao.gov/cgi-bin/getrpt?GAO-04-307.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Richard J. Hillman at 
(202) 512-8678 or hillmanr@gao.gov.

[End of section]

Contents:

Letter:

Results in Brief: 

Background: 

Treasury and Industry Participants Have Made Progress in Implementing 
TRIA, but Treasury Has Not Yet Achieved Key Goals: 

Despite Availability, Few Are Buying Terrorism Insurance, and the 
Industry Has Made Little Progress toward Post-TRIA Coverage: 

Conclusions: 

Recommendation for Executive Action: 

Agency Comments: 

Appendix:

Appendix I:Comments from the Department of the Treasury:

Table: 

Table 1: TRIA-Mandated Studies and Data Collection: 

Figures: 

Figure 1: Prerequisites and Limits of Coverage under TRIA:

Figure 2: Regulations and Procedures Necessary to Implement TRIA:

Abbreviations: 

GAO: U.S. General Accounting Office:

NAIC: National Association of Insurance Commissioners:

NBC: nuclear, biological, and chemical:

OMB: Office of Management and Budget:

RFP: Request for Proposal:

SFP: standard fire policy:

TRIA: Terrorism Risk Insurance Act of 2002:

TRIP: Terrorism Risk Insurance Program:

Letter April 23, 2004:

The Honorable Michael Oxley
Chairman, Committee on Financial Services 
House of Representatives:

Dear Mr. Chairman:

The terrorist attacks of September 11, 2001, drastically changed the 
way insurers viewed the risk of terrorism. An industry that had 
considered the risk of terrorism so low that it did not identify or 
price terrorism risk separate from property and casualty coverage will 
pay approximately $40 billion for losses arising from September 11, 
according to industry experts. In the aftermath, we reported that 
insurance coverage was disappearing for terrorist events, particularly 
for large businesses and those perceived to be at some risk.[Footnote 
1] As contracts between reinsurers and insurers came up for renewal, 
reinsurers excluded terrorism from coverage.[Footnote 2] Without 
reinsurance, insurers retained greater levels of risks than they could 
responsibly carry, and their reaction was to exclude these risks from 
commercial policies as they were renewed.

In light of concerns that the lack of terrorism insurance could have 
significant effects on the economy or that, in the event of another 
terrorist attack, the economic costs would fall directly on the victims 
and the government, Congress passed the Terrorism Risk Insurance Act of 
2002 (TRIA), which took effect on November 26, 2002.[Footnote 3] Under 
TRIA, the Department of the Treasury (Treasury) would reimburse 
insurers for a large share of the losses associated with certain acts 
of foreign terrorism that occur during the 3-year term of the act. The 
purpose of TRIA is twofold: to make terrorism insurance widely 
available and affordable to commercial policyholders for the duration 
of the act and to provide a transitional period during which insurance 
market participants could find ways to price terrorism insurance and 
develop market-driven resources and mechanisms that would offer 
terrorism insurance after TRIA expires on December 31, 2005.

TRIA requires that all insurers selling commercial lines of property 
and casualty insurance "make available" coverage for certain terrorist 
events in the first 2 years of the program. TRIA defines "make 
available" to mean that the coverage must be offered for insured losses 
arising from terrorist events and that coverage not differ materially 
from the terms, amounts, and limitations applicable to coverage for 
losses arising from other types of events. However, TRIA gives Treasury 
the option of determining whether the "make available" requirement 
should be extended through 2005, the third year of the act, and gives 
the agency until September 1, 2004, to do so. Also, not all acts of 
terrorism will trigger reimbursements under TRIA: the Secretary of the 
Treasury must "certify" that an act of terrorism meets the criteria 
specified in TRIA.[Footnote 4] For example, "an individual or 
individuals acting on behalf of any foreign person or foreign interest" 
must commit the act. After an event is certified, TRIA authorizes 
Treasury to reimburse insurers for most of the insured losses, after 
they have paid specified deductible amounts. Moreover, TRIA authorizes 
Treasury to administer the Terrorism Risk Insurance Program (TRIP) 
office, through which Treasury will administer TRIA provisions and 
would pay claims. TRIA also mandates various studies and data 
collection efforts and contains provisions affecting the National 
Association of Insurance Commissioners (NAIC).[Footnote 5]

Treasury and industry participants have operated under TRIA for more 
than a year. Consistent with your request, in this report we describe 
(1) the progress made by Treasury and insurance industry participants 
in implementing TRIA provisions and (2) changes in the market for 
terrorism insurance coverage under TRIA.

To address these objectives, we reviewed and analyzed Treasury's final 
and proposed regulations in the Federal Register, public comments that 
were submitted about the regulations, relevant information concerning 
state legislation, and publicly available and proprietary industry data 
and studies on the terrorism insurance market. We interviewed officials 
at Treasury, NAIC, and state insurance regulators from six states with 
high insurance sales volumes. We also interviewed representatives of 
insurance companies, reinsurance companies, brokers for insurance and 
reinsurance companies, industry associations, property owners and 
developers, and insurance filing services and credit rating 
agencies.[Footnote 6] In our discussions with these organizations, we 
endeavored to gain an understanding of their experience in implementing 
TRIA requirements, obtain their views on the effects of TRIA on the 
terrorism insurance market, and identify developments within the 
industry to address terrorism risks after TRIA expires.

We conducted our work in Chicago, New York City, and Washington, D.C., 
from January 2003 through April 2004 in accordance with generally 
accepted government auditing standards.

Results in Brief:

Treasury and industry participants have made significant progress in 
implementing TRIA to date, but Treasury has important actions to 
complete in order to comply with its responsibilities under TRIA. 
Between November 2002 and December 2003, Treasury issued implementing 
regulations, or final rules, on issues such as definitions of basic 
terms used in TRIA and written disclosure to policyholders about TRIA 
requirements, limits of coverage, and prices. During that same period, 
Treasury issued a proposed rule on basic claims procedures. According 
to Treasury officials, Treasury also fully staffed the TRIP office by 
September 2003, decided not to extend TRIA to group life insurance 
lines based on the results of a TRIA-mandated study, and began mandated 
studies and data collection efforts. However, Treasury has not yet 
decided whether to extend the requirement to policies issued or renewed 
in 2005 that insurers "make available" terrorism insurance on terms not 
differing materially from other coverage. In addition, it has not fully 
established a claims processing and payment structure. NAIC, in its 
advisory role, has effectively assisted Treasury in drafting guidance 
and regulations, and insurance companies generally have made policy and 
operational changes--including pricing decisions, policy language 
revisions, and policyholder notifications--to comply with TRIA. 
However, insurers have expressed concerns about some work Treasury has 
not yet completed and the time frames allotted in TRIA that drive its 
work and responsibilities. For example, insurers noted that if Treasury 
waited until the TRIA deadline, September 1 of this year, to decide 
whether insurers would have to make terrorism insurance available 
through 2005, the decision would come too late for them to make 
appropriate decisions for business planning for the third year of TRIA. 
Moreover, a delayed payment of claims by Treasury, whether because of 
the length of time taken to certify that an act of terrorism met the 
requirements for federal reimbursement or from inadequate claims 
processing capability, might seriously impact insurer cash flows or, in 
certain circumstances, solvency.

Under TRIA, insurers and, to a limited extent, reinsurers have made 
terrorism insurance available, but most commercial policyholders are 
not buying the coverage and those that do remain exposed to significant 
risks. According to real estate and risk management experts, TRIA 
primarily has benefited high-risk policyholders, such as owners and 
developers of large commercial properties located in major urban 
centers and geographic locations perceived at greater risk for 
terrorism. Limited, but consistent results from industry surveys 
suggest between 10 and 30 percent of commercial policyholders are 
purchasing terrorism insurance. However, according to insurance 
industry experts, many policyholders with businesses or properties not 
located near major urban centers or in perceived high-risk locations 
are not buying terrorism insurance because they perceive themselves at 
low risk for terrorism and thus view any price for terrorism insurance 
as high relative to their risk exposure. Some industry experts are 
concerned that adverse selection--where those most at risk from 
terrorism are generally the only ones buying terrorism insurance--may 
be occurring. The potential negative effects of low take-up, or 
purchase rates, in combination with adverse selection would become 
evident only in the aftermath of a terrorist attack and include more 
difficult economic recovery for businesses without terrorism coverage 
and potentially significant financial problems for insurers. Moreover, 
policyholders with terrorism insurance may still not be insured for 
certain significant perils resulting from terrorist events, even if the 
events were to be certified. These perils include losses resulting from 
nuclear, biological, and chemical (NBC) agents, radioactive 
contamination, and in a growing number of states, fire following 
terrorist events. The insurance industry has historically applied 
certain of these limitations and exclusions. In the aftermath of 
September 11, state legislatures have permitted their expansion and 
they remain in place. Finally, under TRIA insurance market participants 
have not yet developed a reliable method for pricing terrorism risks 
and made little movement toward any mechanism that would enable 
insurers to provide terrorism insurance to businesses without 
government involvement.

The Assistant Secretary for Financial Institutions, Department of the 
Treasury, provided written comments on a draft of this report. Treasury 
generally believed the report was a thorough and well-balanced 
discussion of the impact and implementation of TRIA. Treasury's 
comments also explained how it prioritized its work at the inception of 
the program to help the insurance industry implement TRIA's 
requirements and expanded upon the details of its contingency plans for 
a terrorist event occurring before all regulations and structures were 
in place and contractors hired. Treasury's comments are reprinted in 
appendix I.

Background:

Under TRIA, Treasury is responsible for reimbursing insurers for a 
portion of terrorism losses under certain conditions. Payments are 
triggered when (1) the Secretary of the Treasury certifies that 
terrorists acting on behalf of foreign interests have carried out an 
act of terrorism and (2) aggregate insured losses for commercial 
property and casualty damages exceed $5,000,000 for a single 
event.[Footnote 7] TRIA specifies that an insurer is responsible (i.e., 
will not be reimbursed) for the first dollars of its insured losses--
its deductible amount. TRIA sets the deductible amount for each insurer 
equal to a percentage of its direct earned premiums for the previous 
year.[Footnote 8] Beyond the deductible, insurers also are responsible 
for paying a percentage of insured losses. Specifically, TRIA 
structures pay-out provisions so that the federal government shares the 
payment of insured losses with insurers at a 9:1 ratio--the federal 
government pays 90 percent of insured losses and insurers pay 10 
percent--until aggregate insured losses from all insurers reach $100 
billion in a calendar year (see fig. 1). Thus, under TRIA's formula for 
sharing losses, insurers are reimbursed for portions of the claims they 
have paid to policyholders. Furthermore, TRIA then releases insurers 
who have paid their deductibles from any further liability for losses 
that exceed aggregate insured losses of $100 billion in any one year. 
Congress is charged with determining how losses in excess of $100 
billion will be paid.[Footnote 9]

Figure 1: Prerequisites and Limits of Coverage under TRIA:

[See PDF for image]

[A] The percentage of direct earned premiums increases each year: 7 
percent in 2003, 10 percent in 2004, and 15 percent in 2005.

[End of figure]

TRIA also contains provisions and a formula requiring Treasury to 
recoup part of the federal share if the aggregate sum of all insurers' 
deductibles and 10 percent share is less than the amount prescribed in 
the act--the "insurance marketplace aggregate retention amount." TRIA 
also gives the Secretary of the Treasury discretion to recoup more of 
the federal payment if deemed appropriate.[Footnote 10] Commercial 
property-casualty policyholders would pay for the recoupment through a 
surcharge on premiums for all the property-casualty policies in force 
after Treasury established the surcharge amount; the insurers would 
collect the surcharge. TRIA limits the surcharge to a maximum of 3 
percent of annual premiums, to be assessed for as many years as 
necessary to recoup the mandatory amount. TRIA also gives the Secretary 
of the Treasury discretion to reduce the annual surcharge in 
consideration of various factors such as the economic impact on urban 
centers. However, if Treasury makes such adjustments, it has to extend 
the surcharges for additional years to collect the remainder of the 
recoupment.

Treasury is funding TRIP operations with "no-year money" under a TRIA 
provision that gives Treasury authority to utilize funds necessary to 
set up and run the program.[Footnote 11] The TRIP office had a budget 
of $8.97 million for fiscal year 2003 (of which TRIP spent $4 million), 
$9 million for fiscal year 2004, and a projected budget of $10.56 
million for fiscal year 2005--a total of $28.53 million over 3 years. 
The funding levels incorporate the estimated costs of running a claims-
processing operation in the aftermath of a terrorist event: $5 million 
in fiscal years 2003 and 2004 and $6.5 million in fiscal year 2005, 
representing about 55 to 60 percent of the budget for each fiscal year. 
If no certified terrorist event occurred, the claims-processing 
function would be maintained at a standby level, reducing the projected 
costs to $1.2 million annually, or about 23 percent of the office's 
budget in each fiscal year. Any funds ultimately used to pay the 
federal share after a certified terrorist event would be in addition to 
these budgeted amounts.

Treasury and Industry Participants Have Made Progress in Implementing 
TRIA, but Treasury Has Not Yet Achieved Key Goals:

More than a year after TRIA's enactment, Treasury and insurance 
industry participants have made progress in implementing and complying 
with its provisions, but Treasury has yet to fully implement the 3-year 
program. Treasury has issued regulations (final rules) to guide 
insurance market participants, fully staffed the TRIP office, and 
started collecting data and performing studies mandated by TRIA. 
However, Treasury has yet to make the claims payment function 
operational and decide whether to extend the "make available" 
requirement through 2005. In its advisory role, NAIC has effectively 
assisted Treasury in drafting guidance and regulations and planning 
mandated studies. Insurance companies are also generally complying with 
TRIA requirements by making changes to their operations, such as 
revising premiums and policy terms. However, insurers do not yet know 
whether they will be required to "make available" terrorism insurance 
for policies issued or renewed in 2005. Additionally, they have voiced 
concerns about the time Treasury might take to certify an act of 
terrorism as eligible for reimbursement under TRIA and process and pay 
claims after an act was certified.

Treasury Has Issued Some Regulations, Staffed the TRIP Office, and 
Begun Studies and Data Collection:

To implement TRIA and make TRIP functional, Treasury has taken numerous 
regulatory and administrative actions, which encompass rulemaking, 
creating a new program office, and collecting and analyzing data. To 
date, Treasury has issued three final rules and one proposed rule, 
which provide uniform definitions of TRIA terms, explain disclosure 
requirements, determine which insurers are subject to TRIA, and 
establish a basic claims-paying process. Treasury has also created and 
staffed the TRIP office, which will oversee claims processing, payment, 
and auditing. Finally, Treasury has completed a TRIA-mandated 
assessment and is working on other reporting and data collection 
mandates.

To Be Ready for Possible Terrorist Events, Treasury Quickly Issued 
Interim Guidance and Interim Final Rules:

After TRIA became effective, Treasury officials said they moved quickly 
to provide immediate guidance to the insurance industry on time-
sensitive requirements. Because the process required to issue final 
regulations would take a few months, Treasury published four sets of 
interim guidance in the Federal Register between December 2002 and 
March 2003. The first three sets of interim guidance were in a 
question-and-answer format to provide quick answers to specific 
questions, and the fourth interim guidance contained regulatory 
language. The purpose of the interim guidance was to help insurance 
companies and other entities determine if they were subject to TRIA and 
to help insurers quickly modify forms and policies and adjust 
operations by providing definitions and program parameters. Interim 
guidance in December 2002 covered requirements for disclosure (e.g., 
notification to policyholders), the "make available" provision, and 
which lines of property-casualty insurance were subject to TRIA. For 
example, the guidance explained that under TRIA insurers are required 
to send notices to their policyholders containing information about the 
availability and cost of terrorism insurance and the 90 percent federal 
share. Subsequent guidance provided information on topics such as how 
certain insurers should allocate direct earned premiums (which are used 
to determine what their deductibles would be), alternative methods for 
complying with TRIA's disclosure requirement, and the application of 
TRIA to non-U.S. insurers. The interim guidance remained in force while 
Treasury drafted final rules.

In addition to interim guidance, Treasury also published two interim 
final rules and a proposed rule. The first interim final rule laid the 
foundation of the program and key definitions for terms used in TRIA. 
The second interim final rule covered disclosure and "make available" 
requirements. The proposed rule addressed "state residual market 
insurance entities" and "state workers compensation funds"--two types 
of state-created entities that will be discussed below. The interim 
final rules had the force of law until they were superseded by final 
rules. As a result, Treasury officials stated, had a terrorist act 
occurred before final rules took effect, a regulatory structure would 
have been in place to allow a faster response than would otherwise have 
been possible.

Treasury Also Has Published Final Rules:

As of March 1, 2004, Treasury's interim guidance, interim final rules, 
and proposed rule had been superseded by three final rules. The first 
final rule was published in the Federal Register on July 11, 2003, and 
addressed basic definitions of words used in TRIA, such as "insurer" 
and "property and casualty insurance."[Footnote 12] Treasury officials 
said they completed this regulation first to provide a foundation for 
subsequent regulations, which would use these terms frequently. 
Although TRIA provided definitions for these terms, TRIA also specified 
that state insurance regulations be preserved where possible. According 
to Treasury officials, Treasury thus devoted much effort to ensure that 
TRIA's definitions of property-casualty insurance terms would be 
consistently applied across jurisdictions--a difficult task because 
Treasury did not have existing uniform or consistent definitions of the 
terms used in TRIA. For example, the term "commercial property-casualty 
insurance" includes slightly different lines of insurance in each 
state's definition. Treasury decided to use information that insurers 
submitted in annual statements to NAIC as the basis for defining 
property-casualty insurance.[Footnote 13]

On October 17, 2003, Treasury issued its second final rule on 
disclosure and "make available" requirements for insurers (see fig. 2). 
These time-sensitive requirements, which insurers had to meet to be 
eligible to receive federal reimbursement for terrorist losses, had 
originally been spelled out in the interim final rule. Among other 
things, the rule stated that insurers that had used NAIC's model 
disclosure forms to notify their policyholders about TRIA and terrorism 
insurance premiums had complied with TRIA disclosure requirements. The 
rule also clarified that insurers did not have to make available 
coverage for certain risks if the insurer's state regulator permitted 
the exclusion of those risks and the insurer had made the same 
exclusion from coverage on all other types of policies. For example, 
Treasury's explanations in the rule specifically used policy exclusions 
for NBC events to illustrate this point. (We discuss these exclusions 
in more detail later in this report.):

The third final rule, also issued on October 17, 2003, instructed two 
kinds of insurers that are typically created by state governments--
"state residual market insurance entities" and "state workers' 
compensation funds"--on how TRIA provisions apply to them (see fig. 2). 
States establish residual market insurance entities to assume risks 
that are generally unacceptable to the normal insurance market, and 
state workers' compensation funds are state funds established to 
provide workers injured on the job with guaranteed benefits. The other 
insurance companies operating in the state usually fund these state-
created entities. The rule explained how a state residual market 
insurance entity and its insurance company members should allocate 
direct earned premiums among themselves for the purposes of calculating 
deductibles under TRIA, because the size of the TRIA deductible is 
determined by the size of a company's direct earned premium. Treasury 
crafted provisions specific to state residual market insurance entities 
because, depending on the particular state law, both the premiums and 
the profits and losses of these entities may be shared with their 
insurance company members. Absent these specific provisions, in those 
cases where premiums were shared the premiums would be double counted, 
resulting in an unfair increase in the deductible of the insurance 
company. The rule also applied TRIA's disclosure provisions to both 
types of state-created entities.

Treasury also issued a proposed rule on December 1, 2003, which would 
establish the first stages of a basic claims-paying process (see fig. 
2). According to Treasury officials, this proposed regulation sets up 
an initial framework for the claims process, including instructions to 
insurers to notify Treasury when they have reached 50 percent of their 
deductible. This notification provides Treasury with advance notice of 
possible impending claims. The proposed rule also contains, among other 
things, requirements for insurers to receive federal reimbursements and 
provides associated recordkeeping requirements. Treasury intends to 
supplement the proposed rule with additional, separate guidance that 
will provide detailed operating procedures for claims filing and 
processing. According to the officials, Treasury took this phased 
approach to get the basic rules out to insurers in case a terrorist 
event occurred.

Finally, a Treasury official said that Treasury staff drafted another 
rule, which is currently under review by the Office of Management and 
Budget (OMB). The draft, which will be published and available for 
public comment as a proposed rule after OMB approves it, addresses 
litigation management (see fig. 2). The draft proposed rule would apply 
a TRIA provision that establishes that suits arising from certified 
terrorist events are federal causes of action and establishes 
litigation management procedures.

Figure 2: Regulations and Procedures Necessary to Implement TRIA:

[See PDF for image]

[A] TRIA sections that establish specific mandates or provide authority 
for Treasury to develop regulations.

[B] TRIA sections for which Treasury has said that it would issue 
regulations.

[C] TRIA sections that by inference require Treasury to take regulatory 
or administrative actions.

[D] For example, Treasury published a final rule on July 11, 2003 that 
provided basic definitions.

[E] The proposed rule details basic procedures insurers would follow to 
file a claim for reimbursement of the 90 percent federal share. 
Treasury also plans to issue more detailed guidance that, for example, 
would provide standardized forms and explain the method of payment.

[End of figure]

Writing the regulations has been a lengthy and difficult process, not 
only because of the multiple procedural review requirements of federal 
rulemaking, but also because TRIA established that state insurance 
regulations should be preserved where possible.[Footnote 14] For 
example, as previously discussed, creating definitions in accord with 
the statutory definitions of more than 50 jurisdictions (the states, 
District of Columbia, Puerto Rico, and U.S. territories) required 
extensive discussions among the state regulators, which in turn 
required additional time to plan and execute.

Treasury Has Fully Staffed the TRIP Office:

In addition to developing regulations to implement TRIA, Treasury fully 
staffed the TRIP office by September 2003. The TRIP office develops and 
oversees the operational aspects of TRIA, which encompass claims 
management--processing, review, and payment--and auditing functions. 
The TRIP staff consists of an executive director, a senior advisor, two 
attorneys, two policy analysts, and two administrative staff. Since 
becoming operational, TRIP staff have drafted regulations and performed 
other tasks necessary to make the program functional. For example, 
staff reviewed and incorporated appropriate public comments to proposed 
regulations and visited reinsurers to learn more about paying claims 
submitted by insurers as a prelude to developing criteria for claims 
payment and processing. Staff also will be issuing contracts for 
vendors to supply these claims services. (We discuss the claims 
processing function in more detail later in this report.) Additionally, 
TRIP staff have ongoing work such as issuing interpretive letters in 
response to questions submitted by the public and participating in 
conferences across the United States to inform regulators, industry 
participants, and the public about TRIA provisions.

Treasury Has Begun Mandated Data Collection and Analysis:

Treasury has completed one TRIA mandate for data collection and a study 
and has begun work on others. Specifically, TRIA mandated that Treasury 
provide information to Congress in four areas: (1) the effects of 
terrorism on the availability of group life insurance, (2) the effects 
of terrorism on the availability of life and other lines of insurance, 
(3) annual data on premium rates, and (4) the effectiveness of TRIA 
(see table 1). Treasury's Office of Economic Policy is responsible for 
organizing and analyzing information associated with the mandated 
studies and assessments.

Table 1: TRIA-Mandated Studies and Data Collection:

TRIA citation: Sec. 103(h)(1); 
Description of study or data-collection effort: 
* Determine whether adequate and affordable catastrophe reinsurance for 
terrorist events is available to life insurers that issue group life 
insurance; 
* Determine the extent to which the threat of terrorism is reducing the 
availability of group life insurance.

TRIA citation: Sec. 103(i); 
Description of study or data-collection effort: 
* Study the potential effects of terrorism on the availability of life 
insurance and other lines of insurance, including personal lines; 
* Report results to Congress no later than 9 months from enactment of 
TRIA.

TRIA citation: Sec. 104(f); 
Description of study or data-collection effort: 
* Annually collect information on terrorism insurance risk premium 
rates for previous year; 
* Make results available upon request of Congress.

TRIA citation: Sec. 108(d)(1); 
Description of study or data-collection effort: 
* Assess the effectiveness of TRIA; 
* Project the capacity of the property-casualty insurance industry to 
offer terrorism coverage after TRIA expires; 
* Project the availability and affordability of terrorism insurance for 
different types of policyholders, including railroads, trucking, and 
public transit; 
* Report results to Congress no later than June 30, 2005. 

Sources: TRIA (data); GAO (analysis).

[End of table]

Pursuant to TRIA section 103(h)(1), Treasury completed an assessment of 
the availability of group life insurance and reinsurance for insurers 
issuing group life policies. Treasury concluded that the terrorism 
threat had not reduced the availability of group life insurance, but 
had reduced the availability of reinsurance, finding a general lack of 
catastrophic reinsurance for group life coverage. After completing the 
assessment, Treasury issued a press release in August 2003 stating that 
it had decided not to make group life insurance subject to TRIA because 
it found that insurers had continued to provide group life coverage. 
According to life insurance experts, life insurers have done so to 
maintain customer relations that would be difficult to reestablish if 
the coverage were discontinued. Additionally, life insurance experts 
noted that business from other lines of insurance would be lost if 
insurers were to discontinue group life, which is typically sold as 
part of a package with disability and medical coverage.

Treasury has not yet completed a mandated study on the effects of 
terrorism on the availability of life and other lines of insurance. The 
study was to have been completed by August 2003, 9 months after TRIA 
was enacted. As of March 1, 2004, according to Treasury officials, the 
report based on this study was in draft form. Because internal Treasury 
reviews of the draft have not been completed, the draft report has not 
yet been made public.

Pursuant to TRIA sections 104(f)(1) and 108(d)(1), Treasury officials 
said they began collecting data on annual premium rates and working on 
the study that would assess the effectiveness of TRIA and project the 
availability and affordability of terrorism insurance for certain 
groups of policyholders after TRIA expires. Treasury hired a private 
firm to collect premium data and other information in surveys from 
policyholders, insurers, and reinsurers. In the surveys, policyholders 
are asked to provide information such as business size, geographic 
locations of insured properties, premium data for TRIA-related 
terrorism insurance, and risk management measures used. Insurers are 
asked about the types of insurance sold that contain TRIA coverage, 
number of policies sold, number of policies sold with TRIA coverage, 
and methods used for estimating risks.[Footnote 15] Reinsurers will be 
asked for similar information. The data collected from the survey will 
provide information for the data collection efforts on annual premium 
rates and also provide the basis for assessing the effectiveness of 
TRIA. According to Treasury officials, Treasury began sending surveys 
to a nationally representative sample of 25,000 policyholders in 
November 2003 and approximately 700 insurers and insurance groups in 
January 2004. The first surveys will collect data for 2003, as well as 
2002, to establish a baseline for analysis and reporting. The second 
and third surveys will be sent in 2004 and 2005.

Treasury Has Tasks to Complete before TRIA Can Be Fully Implemented:

Before TRIA can be fully implemented, Treasury has to make certain 
decisions, develop additional regulations, and make certain TRIP 
functions operational. More specifically, TRIA gave Treasury until 
September 1, 2004, to decide if the requirement that insurers offer 
terrorism coverage on terms that do not differ materially from other 
coverage should be extended for policies issued or renewed in 2005, the 
third and final year of the program. Treasury did issue a press release 
on December 23, 2003, clarifying that the "make available" requirement 
for annual policies issued or renewed in 2004 extends until the policy 
expiration date, even though the coverage period extends into 2005. As 
of March 1, 2004, Treasury officials said they had not made a decision 
on the "make available" extension for policies that will be issued or 
renewed in 2005. The officials indicated that they would be in a better 
position to make this decision after they obtained enough preliminary 
data from their surveys, which they anticipate receiving in spring 
2004. The survey data are expected to provide an analytical framework 
for Treasury's decisions by collecting information on factors such as 
premium rates, geographic locations of covered property, policy limits 
and deductibles, and the extent to which certain terrorism risks are 
covered.

Treasury has yet to develop all the regulations necessary to carry out 
TRIA provisions and make operational certain functions relating to 
claims administration, auditing, and oversight. While the 
implementation of some of these provisions and functions was covered by 
the proposed rule (see fig. 2), Treasury has not drafted final rules to 
cover the latter stages of the claims process, which would encompass 
resolving disputed claims with insurance companies, dealing with 
insurers that become insolvent, adjusting claims payments for over-and 
underpayments (netting), and handling claims submitted by insurers 
after aggregate insured losses have exceeded the $100 billion cap. 
Treasury officials said they plan to complete these regulations in the 
spring and summer of 2004, after they have fully addressed the claims-
paying process. Treasury also has yet to write regulations addressing 
recoupment and surcharges and the collection of civil monetary 
penalties in cases of noncompliance or fraud. Treasury also plans to 
assess the need to develop additional regulations or refine past 
regulations on captive insurers and self-funded pools--types of self-
insurers. Additionally, Treasury has not yet developed processes for 
auditing claims payments to insurers. However, Treasury plans to issue 
a request for proposal (RFP) for a postclaims auditing contractor in 
the third quarter of fiscal year 2004. The contractor will review 
claims and conduct field audits of insurers after an event to ensure 
that underlying documents support claims submitted to Treasury. 
Treasury officials anticipate awarding a contract in the fourth quarter 
of fiscal year 2004. Moreover, Treasury plans to develop guidance 
encompassing business procedures and audit parameters that will trigger 
reviews and audits. Treasury officials also said that other ongoing and 
completed work associated with the claims-processing function lays the 
foundation for the claims auditing process. Finally, a Treasury 
official estimated that by the end of fiscal year 2004, Treasury would 
implement all of the processes that would have to be in place before an 
event occurred. After fiscal year 2004, Treasury plans to develop 
procedures for requirements that will not need to be in place until 
after an event has occurred--such as recoupment and surcharge.

Lastly, a key TRIP function--the actual processing and payment of 
claims--is not yet operational. From the beginning of its planning 
efforts, Treasury had envisioned that contractors would handle TRIA 
claims processing in the aftermath of a terrorist attack. According to 
TRIP officials, after incorporating a basic regulatory framework, one 
of the first priorities for the TRIP office was to write and issue a 
RFP to procure contractors to perform claims services. Treasury issued 
an RFP for claims-processing and payment services in December 2003, but 
had not hired any contractors as of March 1, 2004. Treasury attempted 
to accelerate the procurement process by reducing the number of days 
allowed for bidders to respond to the RFP and dedicating all TRIP staff 
to reviewing the proposals. However, the number of proposals received 
has pushed the contract award date beyond original estimates of 
February 2004. Treasury officials now believe they will award a 
contract by April 2004. Treasury has also continued to develop a 
proposed rule, related guidance, claims management requirements for the 
claims contractor and processes necessary to manage the claims 
function, and worked with industry to devise standard forms. Moreover, 
once the claims processing contract is awarded, Treasury plans to 
establish electronic interfaces between itself and the contractor, test 
the contractor's systems and processes by using "dummy" claims 
submitted by insurers, and establish an electronic fund transferring 
process to speed reimbursement of insured losses.

NAIC Is Fulfilling Its Advisory Role under TRIA:

NAIC is working with Treasury on various aspects of implementing TRIA, 
effectively fulfilling its advisory role. In January 2003, NAIC formed 
the Terrorism Insurance Implementation Working Group to work with 
Treasury. The working group consists of representatives from nine 
states and the District of Columbia, who are led by a state insurance 
commissioner, and has provided input to Treasury on an ongoing 
basis.[Footnote 16] In particular, the working group assisted Treasury 
each time it issued guidance and rules, according to Treasury and NAIC 
officials. For example, Treasury officials reported that NAIC aided 
them in writing a detailed definition for "insurer" for its first 
interim final rule published in the Federal Register in February 2003. 
NAIC coordinated meetings between Treasury and state insurance 
regulators to align or address differences in definitions that exist 
across the 50 states, the District of Columbia, Puerto Rico, and three 
U.S. territories. As noted previously, TRIA directed that state 
regulations be preserved when possible; thus, the definitions had to be 
highly consistent with state regulations. The NAIC official also 
explained that NAIC tried to ensure that the language of its 
suggestions to Treasury, when implemented, would be enforceable by all 
state insurance regulators.

NAIC also aided Treasury in outreach and education efforts. In the 
weeks before TRIA was enacted, NAIC issued press releases informing 
insurers of the impending act and urging them to prepare for its new 
requirements. Moreover, NAIC applied its expertise in developing a 
model bulletin, regulations, and forms to help state regulators and 
insurers expeditiously carry out TRIA responsibilities. For example, 
NAIC issued a model bulletin, which state regulators could use to 
communicate key terms and definitions and explain the application of 
TRIA to losses resulting from foreign sources versus domestic sources 
of terrorism. NAIC made the model bulletin available on its Web site 
immediately upon the enactment of TRIA. NAIC also developed model 
disclosure forms for insurers to use when informing their policyholders 
about the availability of terrorism insurance under TRIA. As discussed 
previously, TRIA requires insurers to send disclosure notices to their 
policyholders about the availability and cost of terrorism insurance 
and the 90 percent federal share.

Insurance Companies Made Changes to Their Operations to Comply with 
TRIA:

In order to comply with TRIA requirements, primarily those concerning 
disclosure to policyholders, insurers generally have made changes to 
their operations. According to an official of a large insurance 
company, to develop and disseminate information about TRIA terms and 
coverage, insurers have changed policies, software, and forms; trained 
staff; revised actuarial information and underwriting procedures; and 
expanded outreach and marketing. For example, the insurers had to send 
revised premium information in disclosure notices to hundreds of 
thousands of policyholders as well as submit thousands of new premium 
rates and the associated policy language to state regulators for 
approval. If the insurers had failed to make these disclosures, they 
would have lost their eligibility for reimbursement under TRIA.

While the disclosure requirements required many revisions to insurer 
operations, the insurers did have the benefit of a "safe harbor." As 
previously discussed, Treasury determined that use of NAIC's model 
disclosure form constituted compliance with TRIA's disclosure 
requirements. Moreover, insurers using NAIC's model form could get 
coverage decisions from their policyholders without first investing 
time in devising a disclosure notice--a time-consuming process that 
would include review by an insurer's legal staff for compliance with 
TRIA requirements. Given that TRIA invalidated terrorism exclusions as 
soon as it was enacted, insurers were exposed to uncompensated risks 
(i.e., the potential for having to pay for all the losses in a 
terrorism event without having received a premium) until their existing 
policyholders received written disclosures, accepted the coverage, or 
rejected it.

Insurers Are Concerned That the Pace of TRIA Implementation Could 
Affect Business Planning, Reduce Cash Flow, or Result in Insolvency:

Insurers have expressed a number of concerns about Treasury's 
implementation of TRIA. Insurers are concerned that Treasury has not 
already made a decision about extending the "make available" 
requirement through 2005; they are also concerned about the potential 
length of time it may take for the Secretary of the Treasury to certify 
a terrorist event, potential inefficiencies and time lags in processing 
and paying claims once an event is certified, and the issue of TRIA 
expiration. TRIA gives Treasury until September 2004 to make a decision 
about whether to require insurers to make terrorism insurance 
available--on terms that do not differ materially from that of other 
coverage--for policies issued or renewed in 2005, the third year of the 
program. Insurers have stated that this deadline is too late. Insurers 
need to make underwriting, price, and coverage decisions for these 
policies in mid-2004. However, Treasury has yet to make a decision 
about the "make available" requirement for policies issued or renewed 
in 2005.

If Treasury did not extend the requirements through 2005, insurers 
would have to evaluate and possibly revise prices and terms for newly 
issued and renewing policies, according to an insurance official. 
Moreover, regulatory approval for these changes might take longer than 
the time it took to approve the changes to policies and procedures that 
insurers initially made to implement TRIA. TRIA allowed for federal 
preemption of the states' authority to approve insurance policy rates 
and conditions, but the preemption expired on December 31, 2003--
returning insurers to the previous regulatory scheme in which they must 
obtain regulatory approvals from each state that has these requirements 
to sell insurance. Thus, the timing of Treasury's announcement on the 
extension may cost both companies and policyholders money if policy 
changes cannot be implemented in time to issue or renew policies.

Insurers also are concerned that a delay in Treasury's certification of 
a terrorist event as eligible for federal reimbursement, in conjunction 
with state regulations requiring prompt payment of claims, could create 
cash flow problems or even lead to insolvency for some insurers. While 
TRIA does not specify the length of time available for determining 
whether an event meets the criteria for certification, insurers are 
bound by law and regulations in most states to pay claims in a timely 
manner, which means they may have to pay policyholder claims in full 
without waiting for Treasury to certify an event, said an NAIC 
official.

Because of this requirement to pay claims in a timely manner, insurers 
face potentially negative financial consequences under two possible 
scenarios: if Treasury made the certification decision after an 
extended period of time or if Treasury ultimately made the decision not 
to certify an event after an extended period of time.

Under the first scenario, insurance industry observers have said that 
they could potentially experience a cash flow problem while awaiting a 
certification decision, and thus for reimbursement of the 90 percent 
federal share, because they have already paid 100 percent of the 
claimed losses. Insurers brought up the anthrax letter incidents as an 
example of their concerns about certification time frames, because law 
enforcement officials still have not identified the source, whether 
foreign or domestic, more than 2 years after the incidents. Under the 
second scenario, insurers could become insolvent if Treasury decided 
not to certify an event (i.e., decided the act was not the work of 
terrorists working on behalf of foreign interests) after insurers had 
already paid policyholder claims. Unless the policyholder had paid for 
coverage of all terrorist events--including those caused by domestic 
terrorists, which would be excluded from reimbursement under TRIA--
insurers would have paid for losses for which they had collected no 
premium. Insurers would have no way to recover payments already made to 
policyholders for losses associated with the event other than to seek 
remedies through the courts, an NAIC official explained.

Treasury has responded that the certification process is complex and 
possibly would require extensive investigation and correlation of 
information from many sources, most not under Treasury's control. As a 
result, although Treasury officials said that they understood the 
difficulties facing insurers, they also felt that placing specific time 
limits on those making the certification decision would impose 
unworkable constraints on an already complex and difficult process. 
Treasury has taken some steps to facilitate the certification process 
by communicating with the Department of Justice and the Department of 
State. Specifically, Treasury has identified contacts within these 
agencies and has met with relevant individuals to discuss their roles 
in the certification process.

Insurers are also concerned that the length of time Treasury may take 
to process and pay claims could impact an insurer's cash flow. 
Treasury's capacity to pay claims relatively quickly will determine how 
fast insurers receive the 90 percent federal share. According to an 
insurance company official, because of the long-standing relationships 
and familiarity that insurers have with reinsurers, it is often 
possible to receive speedy payment for losses.[Footnote 17] Insurers 
are concerned that this might not be possible with the TRIP office, 
especially since the claims-paying mechanism has yet to be created. 
Treasury officials explained that without a close preexisting 
relationship like that between an insurer and reinsurer, some 
procedures may, of necessity, differ. As noted previously, Treasury 
published a proposed rule addressing the claims-paying process. 
However, the proposed rule does not specify the maximum number of days 
in which Treasury must pay claims. According to a Treasury official, 
establishing a time frame for payment would not be appropriate. 
However, to address insurer concerns about prompt payment, Treasury has 
taken into consideration input received from the insurance industry and 
has been developing mechanisms to expedite the review, approval, and 
payment of claims. Treasury has also decided to use electronic fund 
transfers to insurer's accounts to speed reimbursement to insurers with 
approved claims. Treasury officials said such a mechanism should reduce 
the potential for insurers to experience cash flow problems by 
eliminating the wait for Treasury to issue checks.

Finally, insurance industry officials are worried that uncertainty 
about TRIA's extension past 2005 will impede their business and 
planning processes. Although TRIA does not contain any specific 
extension provisions, Treasury officials have used forums such as NAIC 
and industry meetings to state that TRIA was designed to provide a 
program of three years duration. However, industry participants 
continue to believe that an extension is both possible and likely. As a 
result, they are concerned that a late decision to extend TRIA would 
create confusion and disarray in the industry because of the lead time 
needed to tailor business operations and plans to an insurance 
environment with TRIA or a federal government backup or, alternatively, 
without one.

Despite Availability, Few Are Buying Terrorism Insurance, and the 
Industry Has Made Little Progress toward Post-TRIA Coverage:

While TRIA has improved the availability of terrorism insurance, 
particularly for high-risk properties in major metropolitan areas, most 
commercial policyholders are not buying the coverage. Limited industry 
data suggest that 10 to 30 percent of commercial policyholders are 
purchasing terrorism insurance, perhaps because most policyholders 
perceive themselves at relatively low risk for a terrorist event. Some 
industry experts are concerned that those most at risk from terrorism 
are generally the ones buying terrorism insurance. In combination with 
low purchase rates, these conditions could result in uninsured losses 
for those businesses without terrorism coverage or cause financial 
problems for insurers, should a terrorist event occur. Moreover, even 
policyholders who have purchased terrorism insurance may remain 
uninsured for significant risks arising from certified terrorist events 
involving NBC agents, radioactive contamination, or fire following the 
events. Finally, although insurers and some reinsurers have cautiously 
reentered the terrorism risk market, insurance industry participants 
have made little progress toward developing a mechanism that could 
permit the commercial insurance market to resume providing terrorism 
coverage without a government backstop.

TRIA Has Improved the Availability of Terrorism Insurance, and Some 
High-Risk Policyholders Have Bought Coverage:

TRIA has improved the availability of terrorism insurance, especially 
for some high-risk policyholders. According to insurance and risk 
management experts, these were the policyholders who had difficulty 
finding coverage before TRIA. Although industry data on policyholder 
characteristics are limited and cannot be generalized to all 
policyholders in the United States, risk management and real estate 
representatives generally agree that after TRIA was passed, 
policyholders--including borrowers obtaining mortgages for "trophy" 
properties, owners and developers of high-risk properties in major city 
centers, and those in or near "trophy" properties--were able to 
purchase terrorism insurance.

Additionally, TRIA contributed to better credit ratings for some 
commercial mortgage-backed securities. For example, prior to TRIA's 
passage, the credit ratings of certain mortgage-backed securities, in 
which the underlying collateral consisted of a single high-risk 
commercial property, were downgraded because the property lacked or had 
inadequate terrorism insurance. The credit ratings for other types of 
mortgage-backed securities, in which the underlying assets were pools 
of many types of commercial properties, were also downgraded but not to 
the same extent because the number and variety of properties in the 
pool diversified their risk of terrorism. Because TRIA made terrorism 
insurance available for the underlying assets, thus reducing the risk 
of losses from terrorist events, it improved the overall credit ratings 
of mortgage-backed securities, particularly single-asset mortgage-
backed securities. Credit ratings affect investment decisions that 
revolve around factors such as interest rates because higher credit 
ratings result in lower costs of capital. According to an industry 
expert, investors use credit ratings as guidance when evaluating the 
risk of mortgage-backed securities for investment purposes. Higher 
credit ratings reflect lower credit risks. The typical investor 
response to lower credit risks is to accept lower returns, thereby 
reducing the cost of capital, which translates into lower interest 
rates for the borrower.

Most Policyholders Have Not Bought Terrorism Insurance:

Although TRIA improved the availability of terrorism insurance, 
relatively few policyholders have purchased terrorism coverage. We 
testified previously that prior to September 11, 2001, policyholders 
enjoyed "free" coverage for terrorism risks because insurers believed 
that this risk was so low that they provided the coverage without 
additional premiums as part of the policyholder's general property 
insurance policy.[Footnote 18] After September 11, prices for coverage 
increased rapidly and, in some cases, insurance became very difficult 
to find at any price. Although a purpose of TRIA is to make terrorism 
insurance available and affordable, the act does not specify a price 
structure.

However, experts in the insurance industry generally agree that after 
the passage of TRIA, low-risk policyholders (e.g., those not in major 
urban centers) received relatively low-priced offers for terrorism 
insurance compared to high-risk policyholders, and some policyholders 
received terrorism coverage without additional premium 
charges.[Footnote 19] Yet according to insurance experts, despite low 
premiums, many businesses (especially those not in "target" localities 
or industries) did not buy terrorism insurance. Some simply may not 
have perceived themselves at risk from terrorist events and considered 
terrorism insurance, even at low premiums (relative to high-risk 
areas), a bad investment.[Footnote 20] According to insurance sources, 
other policyholders may have deferred their decision to buy terrorism 
insurance until their policy renewal date.

Some industry experts have voiced concerns that low purchase rates may 
indicate adverse selection--where those at the most risk from terrorism 
are generally the only ones buying terrorism insurance. Although 
industry surveys are limited in their scope and not appropriate for 
market-wide projections, the surveys are consistent with each other in 
finding low "take-up" rates, the percentage of policyholders buying 
terrorism insurance, ranging from 10 to 30 percent. According to one 
industry survey, the highest take-up rates have occurred in the 
Northeast, where premiums were generally higher than the rest of the 
country.

The combination of low take-up rates and high concentration of 
purchases in an area thought to be most at risk raises concerns that, 
depending on its location, a terrorist event could have additional 
negative effects.

* If a terrorist event took place in a location not thought to be a 
terrorist "target," where most businesses had chosen not to purchase 
terrorism insurance, then businesses would receive little funding from 
insurance claims for business recovery efforts, with consequent 
negative effects on owners, employers, suppliers, and customers.

* Alternatively, if the terrorist event took place in a location deemed 
to be a "target," where most businesses had purchased terrorism 
insurance, then adverse selection could result in significant financial 
problems for insurers. A small customer base of geographically 
concentrated, high-risk policyholders could leave insurers unable to 
cover potential losses facing possible insolvency. If, however, a 
higher percentage of business owners had chosen to buy the coverage, 
the increased number of policyholders would have reduced the chance 
that losses in any one geographic location would create a significant 
financial problem for an insurer.[Footnote 21]

Tighter Exclusions Leave Policyholders Exposed to Significant Perils:

Since September 11, 2001, the insurance industry has moved to tighten 
long-standing exclusions from coverage for losses resulting from NBC 
attacks and radiation contamination. As a result of these exclusions 
and the actions of a growing number of state legislatures to exclude 
losses from fire following a terrorist attack, even those policyholders 
who choose to buy terrorism insurance may be exposed to potentially 
significant losses. Although NBC coverage was generally not available 
before September 11, after that event insurers and reinsurers 
recognized the enormity of potential losses from terrorist events and 
introduced new practices and tightened treaty language to further limit 
as much of their loss exposures as possible. (We discuss some of these 
practices and exclusions in more detail in the next section.) State 
regulators and legislatures have approved these exclusions, allowing 
insurers to restrict the terms and conditions of coverage for these 
perils. Moreover, because TRIA's "make available" requirements state 
that terms for terrorism coverage be similar to those offered for other 
types of policies, insurers may choose to exclude the perils from 
terrorism coverage just as they have in other types of coverage. 
According to Treasury officials, TRIA does not preclude Treasury from 
providing reimbursement for NBC events, if insurers offered this 
coverage. However, policyholder losses from perils excluded from 
coverage, such as NBCs, would not be "insured losses" as defined by 
TRIA and would not be covered even in the event of a certified 
terrorist attack.

In an increasing number of states, policyholders may not be able to 
recover losses from fire following a terrorist event if the coverage in 
those states is not purchased as part of the offered terrorism 
coverage. We have previously reported that approximately 30 states had 
laws requiring coverage for "fire-following" an event --known as the 
standard fire policy (SFP)--irrespective of the fire's cause.[Footnote 
22] Therefore, in SFP states fire following a terrorist event is 
covered whether there is insurance coverage for terrorism or not. After 
the terrorist attacks of September 11, 2001, some legislatures in SFP 
states amended their laws to allow the exclusion of fire following a 
terrorist event from coverage. As of March 1, 2004, 7 of the 30 SFP 
states had amended their laws to allow for the exclusion of acts of 
terrorism from statutory coverage requirements.[Footnote 23] However as 
discussed previously, the "make available" provision requires coverage 
terms offered for terrorist events to be similar to coverage for other 
events. Treasury officials explained that in all non-SFP states, and 
the 7 states with modified-SFPs, insurers must include in their offer 
of terrorism insurance, coverage for fire following a certified 
terrorist event because coverage for fire is part of the property 
coverage for all other risks. Thus, policyholders who have accepted the 
offer would be covered for fire following a terrorist event, even 
though their state allows exclusion of the coverage. However, 
policyholders who have rejected their offer of coverage for terrorism 
insurance would not be covered for fire following a terrorist event. 
According to insurance experts, losses from fire damage can be a 
relatively large proportion of the total property loss. As a result, 
excluding terrorist events from SFP requirements could result in 
potentially large losses that cannot be recovered if the policyholder 
did not purchase terrorism coverage. For example, following the 1994 
Northridge earthquake in California, total insured losses for the 
earthquake were $15 billion--$12.5 billion of which were for fire 
damage. According to an insurance expert, policyholders were able to 
recover losses from fire damage, because California is an SFP state, 
even though most policies had excluded coverage for earthquakes.

Reinsurers Have Cautiously Returned to the Terrorism Insurance Market, 
but Many Insurers Have Not Bought Reinsurance:

Under TRIA, reinsurers are offering a limited amount of coverage for 
terrorist events, specifically for the insurer deductibles and 10 
percent share, but insurers have not been buying much of this 
reinsurance. According to insurance industry sources, TRIA's ceiling on 
potential losses has enabled reinsurers to return cautiously to the 
market. That is, reinsurers generally are not offering coverage for 
terrorism risk beyond the limits of the insurer deductibles and the 10 
percent share that insurers may have to pay under TRIA. In spite of 
reinsurers' willingness to offer this coverage, company representatives 
have said that many insurers have not purchased reinsurance. Insurance 
experts suggested that the low demand for the reinsurance might 
reflect, in part, commercial policyholders' generally low take-up rate 
for terrorism insurance. Moreover, insurance experts also have 
suggested that insurers may believe that the price of reinsurance is 
too high relative to the premiums they are earning from policyholders 
for terrorism insurance.

The relatively high prices charged for the limited amounts of terrorism 
reinsurance available are probably the result of interrelated factors. 
First, even before September 11 both insurance and reinsurance markets 
were beginning to harden; that is, prices were beginning to increase 
after several years of lower prices. Reinsurance losses resulting from 
September 11 also depressed reinsurance capacity and accelerated the 
rise in prices.[Footnote 24] The resulting hard market for property-
casualty insurance affected the price of most lines of insurance and 
reinsurance. A notable example has been the market for medical 
malpractice insurance.[Footnote 25] The hard market is only now showing 
signs of coming to an end, with a resulting stabilization of prices for 
most lines of insurance. In addition to the effects of the hard market, 
reinsurer awareness of the adverse selection that may be occurring in 
the commercial insurance market could be another factor contributing to 
higher reinsurance prices. Adverse selection usually represents a 
larger-than-expected exposure to loss. Reinsurers are likely to react 
by increasing prices for the terrorism coverage that they do sell.

In spite of the reentry of reinsurers into the terrorism market, 
insurance experts said that without TRIA caps on potential losses, both 
insurers and reinsurers likely would still be unwilling to sell 
terrorism coverage because they have not found a reliable way to price 
their exposure to terrorist losses. According to industry 
representatives, neither insurers nor reinsurers can estimate potential 
losses from terrorism or determine prices for terrorism insurance 
without a pricing model that can estimate both the frequency and the 
severity of terrorist events. Reinsurance experts said that current 
models of risks for terrorist events do not have enough historical data 
to dependably estimate the frequency or severity of terrorist events, 
and therefore cannot be relied upon for pricing terrorism insurance. 
According to the experts, the models can predict a likely range of 
insured losses resulting from the damage if specific event parameters 
such as type and size of weapon and the location are specified. 
However, the models are unable to predict the probability of such an 
attack.

Even as they are charging high prices, reinsurers are covering less. In 
response to the losses of September 11, industry sources have said that 
reinsurers have changed some practices to limit their exposures to acts 
of terrorism. For example, reinsurers have begun monitoring their 
exposures by geographic area, requiring more detailed information from 
insurers, introducing annual aggregate limits and event limits, 
excluding large insurable values, and requiring stricter measures to 
safeguard assets and lives where risks are high.[Footnote 26] And as 
discussed previously, almost immediately after September 11 reinsurers 
began broadening NBC exclusions beyond scenarios involving industrial 
accidents, such as nuclear plant accidents and chemical spills, to 
encompass intentional destruction from terrorists. For example, post-
September 11 exclusions for nuclear risks include losses from 
radioactive contamination to property and radiation sickness from dirty 
bombs.

As of March 1, 2004, industry sources indicated that there has been 
little development or movement among insurers or reinsurers toward 
developing a private-sector mechanism that could provide capacity, 
without government involvement, to absorb losses from terrorist events. 
Industry officials have said that their level of willingness to 
participate more fully in the terrorism insurance market in the future 
will be determined, in part, by whether any more events occur. Industry 
sources could not predict if reinsurers would return to the terrorism 
insurance market after TRIA expires, even after several years and even 
if no more major terrorist attacks were to occur in the United States. 
They explained that reinsurers are still recovering from the enormous 
losses of September 11 and still cannot price terrorism coverage. In 
the long term and without another major terrorist attack, insurance and 
reinsurance companies might eventually return. However, should another 
major terrorist attack take place, reinsurers told us that they would 
not return to this market--with or without TRIA.

Conclusions:

TRIA gave Treasury a very challenging task--to develop what is 
effectively the world's largest reinsurer. This task was complicated by 
the very real possibility that Treasury could have been called on to 
perform at any time, without advance notice. More than a year after 
TRIA took effect, key pieces of this reinsurance entity are either in 
place or nearly in place. Perhaps most importantly for Treasury, the 
U.S. government, and the American people, no further terrorist attack, 
major or minor, has yet occurred on American soil. In spite of this 
breathing space and all that Treasury has accomplished, considerable 
work remains. Key components of the Terrorism Risk Insurance Program 
defined by TRIA remain uncompleted. At best, all the components will be 
in place shortly before the second anniversary of the 3-year program. 
Recognizing the complexity of the task, it is difficult to be critical, 
particularly given the lack of a terrorist event. However, had an 
attack occurred, the incomplete preparation could have added to the 
plight of the victims.

Congress had two major objectives in establishing TRIA. The first was 
to ensure that business activity did not suffer from the lack of 
insurance by requiring insurers to continue to provide protection from 
the financial consequences of another terrorist attack. Since TRIA was 
enacted in November 2002, terrorism insurance generally has been 
available to businesses. While most have not purchased this coverage, 
purchases have been higher in areas considered to be at high risk of 
another terrorist attack. Quantifiable evidence is lacking on whether 
having TRIA coverage available has contributed to the economy. However, 
the current revival of economic activity suggests that the decision of 
most commercial policyholders to decline terrorism coverage has not 
resulted in widespread, negative economic effects. As a result, the 
first objective of TRIA appears largely to have been achieved.

Congress's second objective was to give the insurance industry a 
transitional period during which it could begin pricing terrorism risks 
and developing ways to provide such insurance after TRIA expires. The 
insurance industry has not yet achieved this goal. We observed after 
September 11 the crucial importance of reinsurers for the survival of 
the terrorism insurance market and reported that reinsurers' inability 
to price terrorism risks was a major factor in their departure from the 
market.[Footnote 27] Additionally, most industry experts are tentative 
about predictions of the level of reinsurer and insurer participation 
in the terrorism insurance market after TRIA expires. Unfortunately, 
insurers and reinsurers still have not found a reliable method for 
pricing terrorism insurance, and although TRIA has provided reinsurers 
the opportunity to reenter the market to a limited extent, industry 
participants have not developed a mechanism to replace TRIA. As a 
result, reinsurer and, consequently, insurer participation in the 
terrorism insurance market likely will decline significantly after TRIA 
expires.

Not only has no private-sector mechanism emerged for supplying 
terrorism insurance after TRIA expires, but also to date there has been 
little discussion of possible alternatives for ensuring the 
availability and affordability of terrorism coverage after TRIA 
expires. Congress may benefit from an informed assessment of possible 
alternatives--including both wholly private alternatives and 
alternatives that could involve some government participation or 
action. Such an assessment could be a part of Treasury's TRIA-mandated 
study to "assess…the likely capacity of the property and casualty 
insurance industry to offer insurance for terrorism risk after 
termination of the Program.":

Recommendation for Executive Action:

As part of the response to Treasury's TRIA-mandated study requiring an 
assessment of the effectiveness of TRIA and evaluating the capacity of 
the industry to offer terrorism insurance after TRIA expires, we 
recommend that the Secretary of the Treasury, after consulting with the 
insurance industry and other interested parties, also identify for 
Congress an array of alternatives that may exist for expanding the 
availability and affordability of terrorism insurance after TRIA 
expires. These alternatives could assist Congress during its 
deliberations on how best to ensure the availability and affordability 
of terrorism insurance after December 2005.

Agency Comments:

We requested comments on a draft of this report from the head of the 
Department of the Treasury or his designee. The Assistant Secretary for 
Financial Institutions at Treasury provided written comments that are 
included in appendix I stating, in general, that Treasury believed our 
report provided a thorough and well-balanced discussion of the impact 
and implementation of the Terrorism Risk Insurance Act of 2002. These 
written comments also provided amplification of certain points related 
to Treasury's implementation of the Act. For example, Treasury 
commented that its "… implementation of TRIA has been guided by 
prioritizing the actions that were needed to make the program 
operational right away." Treasury also described the emergency 
procedures in place since "the early days of the program." Treasury 
believes these contingency plans would have allowed it to establish and 
implement a process for receiving, reviewing, and paying claims that 
would have enabled it to respond quickly to a terrorist event, if it 
had been necessary. Treasury also provided technical comments on the 
report that were incorporated as appropriate.

As agreed with your offices, unless you publicly release its contents 
earlier, we plan no further distribution of this report until 30 days 
after its issuance date. At that time, we will send copies of this 
report to the Chair and Ranking Minority Member, Senate Committee on 
Banking, Housing and Urban Affairs; the Ranking Minority Member, 
Committee on Financial Services, House of Representatives; and other 
interested congressional members and committees. We will also make 
copies available to others upon request. In addition, this report will 
also be available at no charge on GAO's Web site at [Hyperlink, 
http://www.gao.gov].

This report was prepared under the direction of Lawrence D. Cluff, 
Assistant Director. If you or your staff have any questions regarding 
this report, please contact the Assistant Director or me at (202) 512-
8678. Barry Kirby, Tarek Mahmassani, Angela Pun and Barbara Roesmann 
also made key contributions to this report.

Sincerely yours,

Signed by: 

Richard J. Hillman: 
Director, Financial Markets and Community Investments:

[End of section]

Appendixes: 

Appendix I: Comments from the Department of the Treasury:

DEPARTMENT OF THE TREASURY WASHINGTON, D.C.

ASSISTANT SECRETARY:

April 15, 2004:

Mr. Richard J. Hillman:

Director of Financial Markets and Community Investment 
United States General Accounting Office:
411 G Street, NW 
Washington, DC 20508:

Dear Mr. Hillman:

Thank you for providing the United States Department of the Treasury 
the opportunity to comment on the General Accounting Office's (GAO) 
report entitled "Terrorism Insurance: Implementation of the Terrorism 
Risk Insurance Act of 2002.":

In general, we believe the GAO has drafted a thorough, well-balanced 
report on the impact and implementation of the Terrorism Risk Insurance 
Act of 2002 (TRIA). As it relates to the implementation of TRIA, we 
would like to stress a couple of points:

First, because TRIA became effective immediately on November 26, 2002, 
when the President signed the bill into law, Treasury's implementation 
of TRIA has been guided by prioritizing the actions that were needed to 
make the program operational right away. To meet this challenge, 
Treasury issued three interim guidance notices from December 3, 2002, 
through January 22, 2003. These actions and formal rulemakings that 
took place beginning in early 2003, set forth the basic framework of 
TRIA; they provided the insurance industry with the information and 
guidance to make the Program operational on the part of insurance 
companies, enabling the companies, for example, to comply with 
policyholder disclosure requirements and the "make available" 
requirement, calculate their insurer deductibles, and understand the 
scope of the Program.

Second, from the early days of the program we have been prepared at 
short notice to be able to process claims, initially standing ready to 
exercise emergency procurement and regulatory procedures to implement a 
claims process expeditiously if needed, while moving forward under more 
formal procedures to develop a more regular claims process. The 
subsequent development of the formal claims procedures regulation also 
reflects Treasury's prioritization of issues. The proposed claims 
regulation that was published on December 1, 2003, sets forth a 
complete framework for the claims process under the Program. In 
conjunction with this rulemaking, Treasury has also developed detailed 
operating procedures and forms for claims filing, processing and 
payment, which will be issued under the authority of this regulation. 
Other issues secondary to those associated with the claims process 
(e.g., final netting of losses and how to address the $100 billion cap) 
being of a lower operational priority, will be addressed subsequently-
though we will continue to be ready to invoke expedited procedures in 
this case as well should the need arise.

In summary, the extensive work done by Treasury in developing the basic 
framework of TRIA through interim guidance notices and regulations, the 
proposed claims regulations, the drafting of claims forms and review 
with industry organizations and the National Association of Insurance 
Commissioners, and contingency procurement plans, all have contributed 
to the Department being ready to respond in case of a covered event 
from the very early days of the Program.

In addition to these general comments, we have separately provided 
technical comments to your staff and hope that such comments were 
useful. Thank you again for the opportunity to comment on your report.

Signed by: 

Wayne A. Abernathy:

Assistant Secretary for Financial Institutions:

[End of section]

(250124):

FOOTNOTES

[1] U.S. General Accounting Office, Terrorism Insurance: Rising 
Uninsured Exposure to Attacks Heightens Potential Economic 
Vulnerabilities, GAO-02-472T (Washington, D.C.: Feb. 27, 2002).

[2] Reinsurance is a mechanism that insurance companies routinely use 
to spread risk associated with insurance policies. Simply put, it is 
insurance for insurance companies. Reinsurance is a normal business 
practice that satisfies a number of needs in the insurance marketplace, 
including the need to expand capacity and obtain protection against 
potential catastrophes.

[3] When the President signed TRIA into law on November 26, 2002, its 
provisions took effect immediately.

[4] Section 102 of TRIA provides that the Secretary of the Treasury, in 
concurrence with the Secretary of State and the Attorney General of the 
United States, shall determine whether an event should be certified as 
an act of terrorism, based on certain criteria.

[5] NAIC is a voluntary organization of the chief insurance regulatory 
officials of the 50 states, the District of Columbia, and four U.S. 
territories.

[6] Filing services perform many services for insurance companies, 
including submitting to state insurance regulators the documents 
required to sell a line of insurance. 

[7] Aggregate insured losses are the sum of insured property and 
casualty losses from all commercial policyholders as a result of a 
certified act of terrorism.

[8] Section 102(4) of TRIA defines direct earned premiums as "a direct 
earned premium for property and casualty insurance issued by any 
insurer for insurance against losses…." Treasury provided further 
clarification that direct earned premiums are "earned as reported to 
the NAIC in the Annual Statement in column 2 of Exhibit of Premiums and 
Losses (commonly known as Statutory Page 14)" and cover all risks, not 
only for risks from terrorism. The percentage of the direct earned 
premium allowed as an insurer deductible varies over the program years: 
7 percent in 2003, 10 percent in 2004, and 15 percent in 2005.

[9] Sections 103(e)(2)(A)(i-ii) and 103(e)(3) of TRIA.

[10] According to Treasury officials, the formula for the mandatory 
portion of the recoupment is intended to ensure that the insurance 
industry is financially responsible for a prescribed level of the first 
dollars of losses. The prescribed loss levels are as follows: $10 
billion in 2003, $12.5 billion in 2004, and $15 billion in 2005. 
Therefore, if the sum of insurers' aggregate payments for deductibles 
and the 10 percent share--the amounts paid by industry--is less than 
the level prescribed for that year, then a recoupment would be required 
to collect the difference. On the other hand, if the amounts paid by 
industry exceed the prescribed level, then a recoupment would not be 
needed.

[11] "No-year money" is budget authority that remains available for 
obligation until expended, usually until the objectives for which the 
authority was made available are attained.

[12] The first final rule received a technical revision, dealing with 
the definition of direct earned premium. Treasury published this 
technical revision in August 2003 in volume 68 of the Federal Register, 
page 48280.

[13] As previously noted, the information to define "property-casualty 
insurance" comes from the exhibit of premiums and losses found in the 
annual statement that insurers submit to NAIC.

[14] The procedural requirements for federal rulemaking include 
reviewing proposed regulations prior to publication in the Federal 
Register. Pursuant to the "Regulatory Planning and Review" rule 
(Executive Order 12866), the Regulatory Flexibility Act (5 U.S.C. 601 
et seq.), and the Paperwork Reduction Act (44 U.S.C. 3501 et seq.), 
respectively: (1) all regulatory actions that are considered 
significant should be reviewed by OMB; (2) the economic impact of the 
proposed regulation on small entities should be assessed; and (3) the 
recordkeeping requirements of the proposed regulation should be 
assessed. In addition, Section 101(b)(2) of TRIA provides that state 
insurance regulations should be preserved.

[15] Treasury has implemented mechanisms to ensure that sensitive 
business data on individual insurers would not be made public through 
the Freedom of Information Act.

[16] In 2003, the working group was chaired by the insurance 
commissioner for the state of Iowa and representatives from the 
insurance departments of the District of Columbia, Florida, Montana, 
Nebraska, New Jersey, New York, North Dakota, Oklahoma, and South 
Dakota.

[17] For example, the insurance official explained that to abate the 
risk in lines of business that cover catastrophic risks such as 
terrorism, an insurer would typically obtain reinsurance. Through 
repeated interactions, the insurer and reinsurer develop a relationship 
in which the reinsurer becomes familiar with the insurer's operations 
and finances. When a catastrophe strikes, the reinsurer is already 
familiar with the information that is necessary to substantiate the 
claims and can pay the insurer without first completing a review of the 
insurer's accounting information; differences in over-or underpayment 
are settled later. 

[18] GAO-02-472T.

[19] According to industry experts, the insurers that provided "free" 
terrorism insurance likely did so for policies already in place at the 
time TRIA was enacted and may have deferred operational changes and 
difficult pricing decisions because they lacked the resources to do so.

[20] Howard Kunreuther, Erwann Michel-Kerjan, and Beverly Porter, 
Assessing, Managing and Financing Extreme Events: Dealing with 
Terrorism (National Bureau of Economic Research: December 2003), 13.

[21] Casualty Actuarial Society, Foundations of Casualty Actuarial 
Science, 4TH ed. (United Book Press, Inc.: 2001), 51, 86.

[22] GAO-02-472T.

[23] According to the National Association of Mutual Insurance 
Companies, Louisiana, Michigan, Minnesota, Nebraska, New Hampshire, 
Oklahoma, and Virginia have amended their standard fire policy to allow 
for exclusion of terrorism from their statutory fire coverage. State 
legislators in Massachusetts have introduced a similar bill.

[24] Capacity is the amount of reinsurance or insurance that is 
available for a defined risk.

[25] U.S. General Accounting Office, Medical Malpractice Insurance: 
Multiple Factors Have Contributed to Increased Premium Rates, GAO-03-
702 (Washington, D.C.: June 27, 2003).

[26] Christian Brauner and Georges Galey, "Terrorism Risks in Property 
Insurance and Their Insurability after 11 September 2001," (Swiss 
Reinsurance Company: 2003), 25.

[27] GAO-02-472T.

GAO's Mission:

The General Accounting Office, the investigative arm of Congress, 
exists to support Congress in meeting its constitutional 
responsibilities and to help improve the performance and accountability 
of the federal government for the American people. GAO examines the use 
of public funds; evaluates federal programs and policies; and provides 
analyses, recommendations, and other assistance to help Congress make 
informed oversight, policy, and funding decisions. GAO's commitment to 
good government is reflected in its core values of accountability, 
integrity, and reliability.

Obtaining Copies of GAO Reports and Testimony:

The fastest and easiest way to obtain copies of GAO documents at no 
cost is through the Internet. GAO's Web site ( www.gao.gov ) contains 
abstracts and full-text files of current reports and testimony and an 
expanding archive of older products. The Web site features a search 
engine to help you locate documents using key words and phrases. You 
can print these documents in their entirety, including charts and other 
graphics.

Each day, GAO issues a list of newly released reports, testimony, and 
correspondence. GAO posts this list, known as "Today's Reports," on its 
Web site daily. The list contains links to the full-text document 
files. To have GAO e-mail this list to you every afternoon, go to 
www.gao.gov and select "Subscribe to e-mail alerts" under the "Order 
GAO Products" heading.

Order by Mail or Phone:

The first copy of each printed report is free. Additional copies are $2 
each. A check or money order should be made out to the Superintendent 
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 
more copies mailed to a single address are discounted 25 percent. 
Orders should be sent to:

U.S. General Accounting Office

441 G Street NW,

Room LM Washington,

D.C. 20548:

To order by Phone: 

Voice: (202) 512-6000:

TDD: (202) 512-2537:

Fax: (202) 512-6061:

To Report Fraud, Waste, and Abuse in Federal Programs:

Contact:

Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470:

Public Affairs:

Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800 U.S.

General Accounting Office, 441 G Street NW, Room 7149 Washington, D.C.

20548: