[Senate Hearing 107-805]
[From the U.S. Government Publishing Office]
S. Hrg. 107-805
TERRORIST RISK INSURANCE
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
ON
HOW THE INSURANCE INDUSTRY SHOULD RESPOND TO RISKS POSED BY POTENTIAL
TERRORIST ATTACKS AND THE EXTENT TO WHICH THE GOVERNMENT SHOULD PLAY A
ROLE ALONGSIDE THE INDUSTRY TO ADDRESS THESE RISKS, IN LIGHT OF
SEPTEMBER 11, 2001, AND HOW THESE DECISIONS WILL EFFECT INSURANCE
COVERAGE AND PREMIUMS ON PROPERTY AND CASUALTY REINSURANCE CONTRACTS AS
THEY COME UP FOR RENEWAL
__________
OCTOBER 24 AND 25, 2001
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PAUL S. SARBANES, Maryland, Chairman
CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii JOHN ENSIGN, Nevada
Steven B. Harris, Staff Director and Chief Counsel
Wayne A. Abernathy, Republican Staff Director
Sarah Kline, Counsel
Aaron Klein, Economist
Stacie Thomas, Republican Economist
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
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WEDNESDAY, OCTOBER 24, 2001
Page
Opening statement of Chairman Sarbanes........................... 1
Opening statements, comments, or prepared statements of:
Senator Gramm................................................ 2
Senator Schumer.............................................. 9
Senator Bunning.............................................. 11
Prepared statement....................................... 73
Senator Bayh................................................. 11
Senator Miller............................................... 12
Senator Stabenow............................................. 12
Senator Corzine.............................................. 13
Senator Carper............................................... 13
Senator Allard............................................... 13
Senator Bennett.............................................. 31
WITNESSES
Bill Nelson, A U.S. Senator from the State of Florida............ 4
Prepared statement........................................... 73
Paul H. O'Neill, Secretary, U.S. Department of the Treasury...... 14
Prepared statement........................................... 75
R. Glenn Hubbard, Chairman, Council of Economic Advisers......... 37
Prepared statement........................................... 79
Kenneth A. Froot, Andre Jakurski Professor of Finance, Harvard
University, Cambridge, Massachusetts........................... 50
Prepared statement........................................... 81
Kathleen Sebelius, President, National Association of Insurance
Commissioners, Commissioner of Insurance, the State of Kansas.. 53
Prepared statement........................................... 86
J. Robert Hunter, Director of Insurance, Consumer Federation
of America..................................................... 55
Prepared statement........................................... 94
Thomas J. McCool, Managing Director, Financial Markets and
Community
Development, U.S. Government Accounting Office................. 58
Prepared statement........................................... 99
Additional Material Supplied for the Record
The following statement was submitted on behalf of the following
associations and their members:
American Council for Capital Formation, Associated General
Contractors of America, American Resort Development
Association, Building Owners and Managers Association
International, International Council of Shopping Centers,
Mortgage Bankers Association of America, National Apartment
Association, National Association of Industrial and Office
Properties, National Association of Real Estate Investment
Trusts, National Association of Realtors, National Multi
Housing Council, Pension Real Estate Association, The Real
Estate Board of New York, The Real Estate Roundtable, dated
October 24, 2001............................................... 121
THURSDAY, OCTOBER 25, 2001
Opening statement of Chairman Sarbanes........................... 131
Opening statements, comments, or prepared statements of:
Senator Gramm................................................ 145
Senator Dodd................................................. 147
Senator Corzine.............................................. 151
Senator Reed................................................. 154
Senator Carper............................................... 155
WITNESSES
Leslie M. (Bud) Baker, Jr., Chairman, Wachovia Corporation,
representing
The Financial Services Roundtable.............................. 133
Prepared statement........................................... 172
Robert E. Vagley, President, American Insurance Association...... 134
Prepared statement........................................... 173
Ronald E. Ferguson, Chairman, General Re Corporation,
representing
The Reinsurance Association of America......................... 136
Prepared statement........................................... 176
John T. Sinnott, Chairman and CEO, Marsh, Inc., representing
The Council of Insurance Agents and Brokers.................... 139
Prepared statement........................................... 179
Thomas J. Donohue, President and CEO, U.S. Chamber of Commerce... 161
Prepared statement........................................... 181
Thomas J. O'Brien, Senior Vice President of Finance and Chief
Financial
Officer, LCOR, Inc., representing The Real Estate Roundtable... 163
Prepared statement........................................... 183
Walter K. Knorr, Chief Financial Officer, City of Chicago,
Illinois....................................................... 166
Prepared statement........................................... 185
Additional Material Supplied for the Record
Statement of Steve Lehman, FCAS, MAAA, Vice President for
Property/Casualty, Amercian Academy of Actuaries, dated October
25, 2001..................................................... 185
Statement of The American Council of Life Insurers, dated October
25, 2001....................................................... 187
Letter submitted by The Financial Services Roundtable, dated
October 10, 2001............................................... 193
Statement of The Independent Insurance Agents of America, dated
October 25, 2001............................................... 196
Statement of Marc H. Morial, Mayor of New Oreleans, Lousiana and
President, U.S. Conference of Mayors, dated October 30, 2001... 197
TERRORISM RISK INSURANCE
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WEDNESDAY, OCTOBER 24, 2001
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:10 a.m., in room SC-5 of the
Capitol Building, Senator Paul S. Sarbanes (Chairman of the
Committee) presiding.
OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES
Chairman Sarbanes. The Committee will come to order.
We have a number of important witnesses this morning and
therefore, I am going to make a very brief opening statement. I
would invite my colleagues to do the same.
[Laughter.]
It is just an invitation. It is a request, not a demand.
This is the first of 2 days of hearings that the Banking
Committee intends to hold on the issue of terrorism insurance
in light of the attacks of September 11. Since that day, the
Congress has been moving in a number of directions to respond
to the challenges that has been presented.
This Committee, I think, did a first-rate piece of work
with respect to the money-laundering issue and we expect the
House to pass that bill today as part of the antiterrorism
package and it will be taken up in the Senate very shortly
thereafter.
Today, we examine the future availability of terrorism
insurance coverage for American business. There are a number of
key questions that we obviously need to address--to what extent
did the events of September 11 threaten the availability of
terrorism coverage? If such coverage should be unavailable,
what impact might that have on the functioning of our economy?
Is Federal intervention necessary to prevent disruption of the
economy? And if so, what form should that take?
I want to be clear at the outset that there seems to be no
question of the industry's ability to pay the claims arising
from the September 11 attack, and the industry has been clear
in stating that.
Currently, the U.S. insurance industry appears to be in
strong financial shape and able to weather those costs. The
question there is what is the situation going to be in the
future?
We have a number of witnesses with us this morning, and I
am going to turn to them now. First, we are going to hear from
our colleague, Bill Nelson, who spoke with me about the
opportunity to come before the Committee.
Of course, Bill served for 6 years as the Insurance
Commissioner of the State of Florida and oversaw State
insurance regulation. Of course, insurance regulation has been
at the State level traditionally in this country, not at the
Federal level. Another issue that arises in the course of
addressing this issue that is before us is what would that do
to the regulatory scheme in terms of the Federal-State
arrangements? And that is something I think we also need to
keep in mind.
Bill Nelson led the rebuilding of Florida's insurance
market in the wake of Hurricane Andrew, which was the most
expensive natural disaster in American history.
He will be followed by Secretary of the Treasury, Paul
O'Neill. Mr. Secretary, we are pleased that you are here with
us. Then we will hear from R. Glenn Hubbard, Chairman of the
Council of Economic Advisers.
We will conclude today's hearing with a panel of: Kathleen
Sebelius, President of the National Association of Insurance
Commissioners; Thomas McCool of the General Accounting Office;
J. Robert Hunter, Director of Insurance for the Consumer
Federation of America; and Professor Kenneth Froot of the
Harvard University School of Business.
Tomorrow, we will hear from two panels, one from the
insurance industry and another from business generally. It is
our current
intention that hearing will be in this room tomorrow as well,
although that could be dependent on whether the Dirksen Senate
Office Building, where the Committee rooms are located,
reopens.
As we all know, the Russell Building reopened today. But
the Hart and Dirksen buildings still remain closed while they
complete the environmental examinations.
Senator Gramm.
STATEMENT OF SENATOR PHIL GRAMM
Senator Gramm. Mr. Chairman, let me say that I do believe
that we wrote a good money-laundering bill. I believe it is a
prototype of bipartisanship and I want to congratulate you.
I cannot help but notice that the last time we were in this
room together was the Financial Services Modernization
Conference, and that all turned out well.
[Laughter.]
Chairman Sarbanes. Much to the surprise of many.
[Laughter.]
Senator Gramm. But not to the surprise of us.
[Laughter.]
Let me say on this issue, it is easy to frame the
parameters, but making decisions on those parameters becomes
more difficult. It is clear the Administration believes, and
most observers believe that, ultimately, we are going to build
the cost of terrorist insurance into the rate structure of the
American insurance system.
I believe it is also believed that 2 or 3 years from now,
we will have much better safeguards than we had on September
11. The basic question that is being debated so far as I am
aware, there may be people with other ideas that we have yet to
hear from, is how do we make this transition to building this
new risk into the base? The question it seems to me boils down
to what is going to happen on December 31, when current
insurance policies expire?
Some question has been raised about the ability of
insurance companies to bear risk, say, if I were the Hartford
and I wanted to insure, or I was asked to insure the John
Hancock Building. It seems to me that it is important for us to
remember that there is a reinsurance market. It is one of the
most active insurance markets in America. It is long-standing.
It is common policy for insurance companies to lay off part of
their risk.
Even before September 11, if a company was going to insure
the John Hancock Building, they probably would have laid off
part of that risk, either through a syndicate like a bank where
you have a loan that is so big that the capital of the bank
will not allow you to make the whole loan.
You can either do it through a syndication or you could
actually have a lead bank go out and lay off part of the loan
with other banks. I have no doubt that this would happen. The
question is what would the price be, and how quick would the
learning curve be in terms of this insurance?
The idea that somehow we have to have a Government-
sanctioned, Government-monopoly insurance pool is totally alien
to my thinking and I see that, from my personal view, as a
nonstarter. The question is, how do we get into the system?
I have no doubt that the Administration's proposal would
work. The question I have, however, and I think it is a real
question, is if you start off with the Federal Government
covering 80 cents out of the first dollar of exposure, so you
do not have massive pressure to set up a terrorism reinsurance
market in the first year, there is the possibility that the
industry would never set it up, and would simply come back to
Congress in 9 months or a year and say, we have to have this
continued because we cannot make the reinsurance market work.
I personally believe that the best thing to do if we are
going to do this is to have a threshold amount. I think it is
debatable what it is, that the insurance industry would be 100
percent liable for, putting pressure on them to go ahead and
establish this market and establish this mechanism if, in fact,
we mean for the Federal assistance to be temporary. And I do
not know of anybody who thinks the contrary.
These are the decisions we have to make. I do want to
affirm that this is our jurisdiction in this Committee. This is
about a loan and this is about guarantees. This is about
insurance. All insurance issues are under the jurisdiction of
this Committee.
I would argue that when we write the bill, that it would
probably be an amendment to the Defense Production Act. I want
to just reaffirm and I believe, Mr. Chairman, we are doing it
by this hearing, that this is our jurisdiction. This bill
should be written from this Committee. And I know that there
are other committees who have ambitions to have this
jurisdiction, but I think we are committed on a bipartisan
basis to see that we protect our jurisdiction.
I am also confident that, given the experience of the
Members of this Committee, that we could do a better job of
writing this bill than any other committee in the Congress, and
that it is very important that we do it.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you very much.
Senator Dodd, who has a very strong interest, as we know,
in this issue, is unable to be with us for today's hearing. He
is attending a funeral this morning. He has submitted a
statement for the record and we will have it included in the
record. Is there any other Member of the Committee who would
like to insert a statement into the record.
Senator Bunning. I just want to make sure that I can put my
statement into the record.
Chairman Sarbanes. Certainly. Well, we will turn to Senator
Nelson.
Bill, as I said, we are very pleased you are here. We know
you have had a lot of personal experience in dealing with the
insurance market and you were regarded as probably the most
effective State insurance commissioner in the country during
your tenure.
We very much welcome your observations this morning.
STATEMENT OF BILL NELSON
A U.S. SENATOR FROM THE STATE OF FLORIDA
Senator Nelson. Mr. Chairman, let me say what a great
privilege it is to serve with every one of you. It has been a
humbling experience for me. And whatever I can bring to the
table today, as we work through this very thorny problem, as we
grapple with a new kind of problem.
And I would like to begin my testimony, Mr. Chairman, by
saying that what we ought to approach this challenge with is
the question, how are we going to protect America's insurance
consumers by making sure that insurance is available and
affordable to protect them against the despicable acts that we
have seen? That is the thrust of where I am coming from.
Insurance we know is a crucial engine to our economy.
Without it, the banks are not going to make loans. Businesses
will not invest or expand. And millions of jobs would be lost
as the impact rippled through the economy. And so, you are
meeting today to make sure that this will not happen. But
neither can we allow the insurance industry, Mr. Chairman to
use the September attacks as an excuse to shirk its rightful
role and responsibilities. Already, reinsurance and insurance
companies are saying that they are no longer going to cover
terrorist attacks after December 31, when about 70 percent of
the commercial insurance contracts in the United States are
scheduled to expire.
Now I do not doubt that the industry's problem is a genuine
problem. In the immediate aftermath of September 11, it is
virtually impossible for insurers to calculate their potential
liability in the face of possible future terrorist attacks. We
cannot allow ourselves to be held hostage by high-pressure
tactics of any industry.
And I might just recall your attention to the fact of the
mistake that I personally believe that we made in the airline
bail-out bill where, on a Friday, we were faced with the fact
of the following Monday, that the insurers were going to pull
the ticket on both United and American Airlines, which was a
real possibility.
We acted. We acted in haste and in the process, what
happened was that we did not get the guarantees that all of, in
addition to the limited liability and the victims compensation
fund, we went beyond that and did the $5 billion of grants and
the additional $10 billion of loans. But we did not get in
return the fact that there was going to be commensurate saving
for consumers.
I have been on flights where they have a monopoly. There
were only five people on the plane and they kept the prices
still jacked up. Nor did we get, for example, the guarantee
that we were not going to only take care of the airline
companies, but we were going to take care of the airline
employees. And now, you see where we are. We cannot even get
that up because of the filibuster.
What I am saying is, in the haste to solve this problem,
let us not make a mistake on something that is so important to
keep the engine of this economy running. From our experience in
Florida, I know that the insurance industry is more willing to
walk away from its biggest risk and turn them over to somebody
else. And I can give you book, chapter, and verse, if you want
it, because when companies paid out $16 billion in claims after
Hurricane
Andrew slammed across south Florida in 1992, which was the
costliest natural disaster in insurance losses in the history
of this country, then the major players in the industry spent
the rest of the decade trying to slip through State legislation
that would shift responsibility for hurricane coverage to
Florida's government and its taxpayers.
I am not slamming the industry. I am telling you that they
provided the necessary support in crisis and they did it very
well under very difficult circumstances. But I am telling you
as an insurance commissioner, I had to battle how the insurance
industry consistently wanted to shift the risk of hurricanes
off onto Florida's government and to its taxpayers.
Fortunately, we headed off almost all of those efforts. And we
fought the industry's attempts since Andrew to force
unconscionable and ever-increasing rates on Florida's
homeowners.
Homeowner insurance rates are now stabilized in Florida and
competition has returned. And that was one of the main things
that we had to do. We had to have the Government step in
temporarily, help nurture the private marketplace back to life,
and then the competition started to stabilize the prices. It
was a solution that backed up the industry if and when it had
another mega-storm. And surely, there will be another mega-
storm. But the emergency fund that was created in Florida,
called the Florida Hurricane Catastrophe Fund, otherwise known
as the Cap Fund, it was created by the State and it requires
companies to pay for most of the hurricane loss and to shoulder
their share of the cost of major storms. And then it spreads
the risk by building up reserves with premium dollars, not
taxpayer dollars.
Whatever solution that we come up with at the Federal level
on terrorist coverage, I believe that the same principles of
private enterprise must be applied. Government can play an
important role in helping resolve the immediate crisis whose
impact would be felt far beyond the insurance industry. For the
most part, however, we should leave the business of insurance
to the insurance business.
As you know, there are two basic plans so far, and you will
hear about them in detail, the White House proposal and another
plan that seems to have broad support from the insurance
industry. And they are still being fleshed out. We do not have
all the details to fully judge them. But based on the
information that has emerged, I have some major concerns. For
example, what safeguards would be provided to protect--
correction--what safeguards would be
provided to prohibit insurers from doing what the industry
calls ``cherry-picking.'' That is, ``cherry-picking'' the
safest policies, or the flip side of that is, redlining the
others out. In other words, once Federal help is provided, what
is to stop the companies from covering only those properties or
businesses that are relatively safe from terrorism and leaving
the biggest risks to someone else? And what is to stop them
from simply passing on any of the terrorism losses they might
suffer in the form of sudden and steep surcharges against their
customers? Or from finding ways, in the complex array of State
regulations, of excluding acts of terrorism from the coverage
consumers buy on their homes, their automobiles, and their
lives? I say that anything we do here at the Federal level must
assume and require that companies cover the peril of terrorism,
a peril that looms so much larger since September 11.
Simply put, if the Federal Government's taxpayer resources
are granted, then the terrorism peril cannot be dumped by the
insurance industry. As I understand it, the Administration's
plan would make the Federal Government responsible for paying
80 percent of the first $20 billion in claims and 90 percent of
the next $80 billion resulting from any terrorist attacks next
year in 2002. This proposal would increase the industry's
liability from terrorist claims in the next 2 years, but still
cap it at $23 billion in 2003 and $36 billion in 2004, with the
Federal Government covering all the remaining claims. I have
strong concerns about requiring the taxpayers to assume, even
on a temporary basis, such a large percentage of the costs,
especially at the front end. A more responsible approach, in my
view, would be to require the companies to cover terrorist-
related losses up to a certain level before any Federal help
would kick in.
In other words, the primary insurer would cover it up to a
certain dollar retention level and above that level, the risk
could start to shift to the Federal Government. We should not
support any proposal involving the use of taxpayer dollars
unless we are convinced that the insurance companies have ample
``skin in the game.'' And of course, the risk to the insurance
companies could be spread by them purchasing reinsurance.
And then, under the separate industry-backed proposal,
apparently, their proposal is that insurers would pool their
premiums through the creation of a new Government-backed
insurance company called the Homeland Security Mutual
Reinsurance Company. And each participating company would
retain 5 percent of terrorism and 5 percent of workers'
compensation war risk, and leave the remaining 95 percent of
each to the insurance pool.
Well, I hold true to the belief that private market
solutions are more desirable than Federal intervention. But if
I understand this plan correctly, the Federal Government would
be responsible for covering 100 percent of any claims resulting
from terrorism next year, while the new insurance pool starts
to build up its capital. So look at it carefully, and as this
debate progresses, we must constantly keep in mind that
insurance companies are well equipped to handle most large-
scale disasters.
It is true, this is a new kind of disaster. But nobody
thought of the possibility a decade ago of a $50 billion
hurricane. And had
Andrew turned one degree to the north, instead of drawing a
bead on downtown Homestead, a relatively sparsely populated
area that produced a $16 billion storm loss, had it turned one
degree to the north and drawn a bead on downtown Ft.
Lauderdale, it would have been a $50 billion insurance storm
that would have taken down into insolvency almost every company
in the country that was doing business in the path of the
storm.
The industry is recognized by many financial rating
agencies, institutional investors, and economists as one of the
strongest in the global economy. They have a lot of experience
coming out of
Andrew as a result of the near-death experience that they had
there. Even one of the strongest companies, like State Farm, at
the time had about $17 billion in surplus. Had that storm gone
on one degree to the north, it would have just about wiped out
State Farm's surplus at the time.
The fact is the companies have learned a lot from that
experience and between them, the property and casualty and life
and health insurance industry now counts nearly $3 trillion in
invested assets. And the NAIC, whose president will testify
here later today, has estimated that the capital cushion for
the entire industry, including the life, is more than $550
billion of surplus to absorb unexpected downturns in the
financial markets and adverse loss experience on its policies,
including terrorist acts. In other words, the industry is flush
right now with huge surpluses.
Whatever our solution in the Congress is to this aspect of
the terrorist crisis, we must require insurers to pay their
fair share. And as we consider the public policy implications
of terrorism, reinsurance. I believe we must proceed in a
deliberative fashion. And in my view, Mr. Chairman, this is
just one suggestion from one Member of the Senate, that means
reaching agreement in the coming weeks because of the shortness
of time, on a short-term, what I would argue, no more than a 1
year or interim solution, to ensure that insurance protection
against terrorist attacks remains available for the new year in
2002, and then to resume our work after January 1, to develop a
more permanent plan.
That approach would also enable us to consider reform of
the current system of insuring against natural catastrophe
disasters. Despite our progress in Florida in dealing with the
hurricane threat, the fact remains that no single State, no
single industry, no single insurance company, could cope with
the kind of mega-catastrophe of the big one of the hurricane or
the earthquake located at exactly the right place because you
are talking about in excess of $50 billion in insurance losses
from the big one, either earthquake or hurricane.
In lieu of the perennial debate that we have over
establishing a Federally backed insurance pool, I have been
intrigued by other proposals of the way that you could approach
it, by setting aside part of the profits for a rainy day. The
idea is to let companies develop tax-deferred reserves and
thereby, increase their capacity to respond to catastrophic
loss. There needs to be a lot of deliberation on this and that
is why, when I respectfully suggest that you may want to meet
this immediate crisis that we are facing coming at the end of
this year, with an interim solution, and then come back next
year.
I know this Committee is clearly one of the ones that takes
a keen interest in these problems, along with the Commerce
Committee, and I look forward, Mr. Chairman, to working with
you toward legislation, both short-term and long-term, that
will keep our economic engines running, but also protect the
consumers that we all serve.
Thank you for the opportunity. I am happy to take your
questions or comments.
Chairman Sarbanes. Thank you for a very helpful statement.
I might just observe that, while you are not on this
Committee, you are a Member of the Senate, and every Member of
the Senate will have an opportunity to deal with this
legislation and to address this. We need to draw in as many
opinions in terms of what ought to be done and how people react
to the problems.
I have a couple of questions that I want to ask and they go
back to your experience as an insurance commissioner. Did you
have the authority to require insurance companies to offer
coverage for terrorism events as insurance commissioner?
Senator Nelson. Mr. Chairman, I believe so. That question
never came up because it was never a question of whether it was
not to be covered. It was always assumed to be covered. And
there was no exclusion.
Insurance companies are very specific about what are
excluded in the coverage in a policy. And under most
homeowners' policies in Florida, there was no specific
exclusion for terrorism.
Chairman Sarbanes. Well, suppose the companies were now to
say, we are not going to cover terrorism. Could a State
insurance commissioner say to the company, no, you are going to
cover terrorism. If you are going to offer a policy, the policy
must encompass terrorist coverage.
Senator Nelson. Were I still the insurance commissioner, I
would try, Mr. Chairman, but I am not sure I would be
successful.
Chairman Sarbanes. Well, did they try to exclude hurricane
coverage after the Florida experience?
Senator Nelson. No. That was required by law.
Chairman Sarbanes. By Florida law?
Senator Nelson. Yes, as part of the homeowner's policy.
Chairman Sarbanes. In other words, you could withdraw
altogether from the business. But if you are going to offer a
homeowner's policy, it had to encompass hurricane coverage.
Senator Nelson. That is correct.
Chairman Sarbanes. And was that the law before Hurricane
Andrew hit?
Senator Nelson. Yes, sir. It is called the Wind Risk.
Now there were times which, in the history of the
development of coverage of Wind Risk, that there were attempts
to, for example, in high wind risk areas, such as the Florida
Keys, a consortium of 250 to 300 insurance companies came
together to create a pool. And that was offered as an
alternative of covering the wind risk in that high-risk area.
That was part of the problem when Hurricane Andrew hit,
that they wanted to have that pool, that consortium of
companies, cover all of the wind risk instead of an individual
company, particularly in your high-density urban areas of south
Florida.
And that is where we drew the line and said that we are not
going to let you continue to expand and get rid of your wind or
hurricane risk.
Chairman Sarbanes. Did your authority as insurance
commissioner also extend to the reinsurance business?
Senator Nelson. Reinsurance typically is not regulated by a
State insurance commissioner or department of insurance.
However, we would require certain data to be set forth so that
we had some idea. But, typically, the reinsurance was not.
Chairman Sarbanes. Anything else?
Senator Gramm. Mr. Chairman, we have so many other
witnesses--first of all, Bill, thank you for your testimony. I
think it was very helpful to us. But out of respect for our
other witnesses, I believe Bill has given us a far more
comprehensive statement than we would have allowed anybody else
to give, so I am not going to ask any questions.
Thank you, Bill.
Chairman Sarbanes. Senator Schumer.
Senator Nelson. There is a similarity, Senator Gramm, on
some of the things that you expressed and some of the things
that I
expressed.
Senator Gramm. There are.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Well, thank you, Mr. Chairman, and I have
just a couple of questions for the witness.
First, I do want to thank you for having this hearing. From
my State of New York, it is vital that we get something done.
And having this hearing--this is a very interesting hearing
because we are not bouncing a proposal off, nor is it a general
exploratory hearing.
There is lots of division, Senator Nelson, as you ably
brought out. And therefore, having this hearing will really
help make up our minds on what to do and where to go to maybe
seek a consensus. Let me just express a couple of thoughts to
you and get your reaction to them.
I worry that if we do not have some kind of legislative
remedy, downtown New York will not be rebuilt, that given that
we are at the epicenter of what happened, given that, while the
insurance companies are clearly paying off all of the prior
claims, that no one is going to insure in the future. And that
may not just be for downtown Manhattan, although probably, we
have the greatest liability or risk. But it might be for any
new, large project anywhere, unless they can be assured of
getting insurance.
And so, right now, as we sit probably in a recession, we do
not want to have it decline much further. To risk not doing
anything because we all cannot come together on an agreement,
could really push us much further down the economic ladder. So
I think it is important we do something.
I also think that we have to look at two issues--pricing,
how do we, as you say, ensure the dense economic centers get
coverage, a large project. This is in the future, and that is
one thing that I guess I would like to make clear to everybody.
We are not looking at any bail-out of the past. The
insurance
industry is paying for everything that happened in downtown.
There are going to be disputes here and there. I hear there is
one, whether it is two incidents or one incident. But, overall,
they are stepping up to the plate and paying.
The issue is the future. And unlike hurricanes, you had the
most massive hurricane, but we had previous experience with
hurricanes. And the day after the hurricane occurred, or a
month or a week after, there were not warnings from our
Nation's leaders--expect something else again, like the
hurricane that occurred, the largest ever.
And so, I am not sure the analogy exactly applies. We have
more pricing experience with hurricanes and we also had some
experience with how regularly such a devastating hurricane over
a populated area would occur. We have no experience here.
I think that we are playing with fire by saying, well, let
us let the market see if it can solve this problem, and then
maybe next year, we will come back. That is one issue. And the
second issue is duration.
The solution that I think seems to be gathering a little
steam is let the Government come in and pay an agreed-upon
percentage for a year to help the industry renew contracts that
we know are coming up December 31.
The problem is, will anyone build anything if they do not
know what is going to happen a year later? Because these large
projects are not of 1 year duration.
I do agree that perhaps in 2 or 3 years, we will have a
little more experience and a little more market experience as
to where to go. But we do not have it now.
I think the analogy with the Florida hurricane, while we
certainly can learn from it, and your wisdom is going to be
really needed by all of us because you have more experience
with this than anybody else, but it is inexact. It is not
precise.
Senator Nelson. May I respond?
Senator Schumer. Yes, I do want you to respond. So I would
just like to know: Do you agree that the analysis is not
precise? And what do you say, not only to my constituents in
Manhattan, but to any large developer around the country?
The one other point that I would make is I think we have
some divergence of interest between the insurance companies,
which are very concerned, as they should be, with getting those
policies renewed come January 1. That is for existing
buildings.
But when I talk to real estate developers and entrepreneurs
and everybody like that, they say that without a longer-term
solution, they are not going to build a thing. That means
rebuilding downtown Manhattan, but it might mean building a
tall building in
Detroit, Atlanta, Indianapolis, or Trenton. Banks will not give
them the loan.
So that is the question I would like to ask you. Not so
much to do this for the sake of the industry, but to do it for
the sake of the economy of the country, which is hanging in the
balance.
Senator Nelson. Senator Schumer, you, we, are under the
gun. Insurance contracts that are to start 2\1/2\ months from
now, less than 2\1/2\ months from now, they have to have
notices sent out on cancellation, whatever the contract calls
for. Typically, it is 45 to 60 days.
We are under the gun right here to get something done for
the first of the year. And what my recommendation is to you,
that you just cannot get the long-term permanent solution done.
It needs more thought.
I have suggested to you that a potential solution is get
insurance companies' ``skin in the game.'' They have a
retention level that you all set in law that up to that level
that they pay, and above that, that the Federal Government
either pays or participates in whatever form you may--you will
hear a proposal later on about loans that would be paid back
and loans that would be like guarantees that have a direct
pass-through to the consumer. Bob Hunter of the Consumer
Federation of America is going to make a proposal like that to
you. It certainly entitles your consideration of that proposal.
I do not equate this to the hurricane risk. I am just
telling you about the last big insurance catastrophe that we
went through that I happened to be in the middle of the storm
and had the responsibility as the regulator of pulling us out
of, and want to share with you some of the things that I
learned in the process and some of the nature of the insurance
industry, which it will try to dump that risk if it can, when
in fact, it is fairly robust in its health, and it is in the
business of insuring risk. And again, we can all say that there
is just never been a risk like this, and what is that unknown
out there in the future?
That is why you have to act quickly. But I am not sure that
you can act totally comprehensively in the next week and a
half, is what we are talking about.
Senator Schumer. Would you agree, though, if we did no
solution or a 1 year solution, that it would create a
significant damper on economic growth next year?
Senator Nelson. Well, that is a consideration--we cannot do
no solution. I do not think we can do that. So let us find the
delicate balance.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Bunning.
COMMENT OF SENATOR JIM BUNNING
Senator Bunning. No questions at this time. Thank you.
Chairman Sarbanes. Senator Bayh.
STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Mr. Chairman. I have one question.
Senator I agree with so much of what you said. You gave an
excellent statement. Your endorsement of market-based
solutions, I think all of us would agree with that. I certainly
do. And your concern with consumers and taxpayers being at the
heart of our focus here I think is on target.
My question, you also mentioned at the very end about the
unique nature of this risk and at the beginning of your
statement, you mentioned about the impossibility of pricing
this risk at this moment in time. Isn't that at the heart of
the question here, which is, are we experiencing a market
failure that puts the interests of consumers and taxpayers at
peril?
That, it seems to me, is really the issue, and for
particularly large risks, bet-the-company type risks. Won't the
companies, if you go the consumer route, build in a risk
premium, that if the Government acts to reduce some of that
uncertainty, can be taken out, thereby reducing the aggregate
cost to society as a whole?
Because the American people are going to pay for this one
way or the other. You either pay for it through the consumer
mechanism, which is spread through the economy in everything we
buy, or you pay for it through the tax mechanism, in which case
the taxpayers pay.
The difference between consumers and taxpayers to me seems
to get blurred at the end of the day. So how do we reduce the
aggregate amount of risk in an inherently unstable situation,
it seems to me, seems to be the question. And if they really
cannot price the risk, is not there a legitimate role for
Government to step in a market failure and try and deal with
that?
Senator Nelson. All very legitimate points, Senator. There
is good news and bad news.
The good news is that the insurance industry is clearly
capable of taking care of the losses that occurred on September
11. The bad news is, as you have raised the question, on a
going-forward basis, how do you value that risk and how do you
pay for it?
And nobody knows what that cost is going to be in the
future. And that is why I am suggesting that you have to create
a formula whereby, at the outset, the insurance companies have
``skin in the game,'' so they will not walk away, and that they
have to cover that initial loss up to a certain level, called
the retention level, and then you can allow the Federal
Government to participate either in direct grants or in loan
guarantees. And you will hear two of those addressed by Mr.
Hunter later on.
Senator Bayh. The final point I would make, Senator Nelson,
and thank you for your contribution here today, is it seems to
me we are trying to reduce as much as possible the inherent
uncertainty in this unprecedented situation.
And the point Senator Schumer made I think is an excellent
one. We have economic decisions that need to be made in the
short run that are long-economic decisions, 6 to 7 year
investments, bank commitments, that kind of thing. And if that
uncertainty is not reduced, these decisions simply will be
deferred or cancelled outright. Unfortunately, we are in the
business, of having to make decisions now to protect the long-
term interests of the economy. Some of this is unavoidable.
Senator Nelson. Well, said.
Chairman Sarbanes. Senator Miller.
COMMENT OF SENATOR ZELL MILLER
Senator Miller. I have no questions.
Chairman Sarbanes. Senator Stabenow.
COMMENT OF SENATOR DEBBIE STABENOW
Senator Stabenow. No, thank you, Mr. Chairman.
Chairman Sarbanes. Senator Corzine.
COMMENT OF SENATOR JON S. CORZINE
Senator Corzine. Pass.
Chairman Sarbanes. Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. There are two Senators in the U.S. Senate
whose names are Nelson. And they are both former insurance
commissioners. I do not know if that has been pointed out here
today.
[Laughter.]
And I like to refer, when we have one of them on hand, as
the half nelson. And when they are both present, as to what is
referred to as the full nelson. But the half nelson is better
than no nelson.
So thank you for being here.
[Laughter.]
One quick question. You have referred a couple of times to
the financial health and strength, underlying the insurance
industry. I just want to ask you to expand on that, if you
could, please.
Senator Nelson. Yes. In the aftermath of Hurricane Andrew,
the reinsurance markets of the world went haywire. It was hard
to get reinsurance and when you got it, you had to pay through
the nose to get it.
Over time, as the nurturing of the private marketplace came
back, as the hurricanes did not hit that were devastating in
their losses, that reinsurance market came back vigorously. And
the insurance marketplace came back vigorously.
The surplus in the property and casualty lines is somewhere
in the range of about $300 to $350 billion these days. The
overall insurance industry surplus is in the range of about
$550 billion. And that is in an industry that has about $3
trillion worth of assets.
The insurance industry is strong. And that is why I say you
have to have some ``skin in the game'' as you devise what is
going to be the mechanism by which we offset these risks.
Senator Bayh. Thank you.
Chairman Sarbanes. Senator Allard.
COMMENT OF SENATOR WANYE ALLARD
Senator Allard. Mr. Chairman, I do not have any questions.
Thank you.
Chairman Sarbanes. Bill, thank you very much.
Senator Nelson. Thank you, Mr. Chairman.
Chairman Sarbanes. It is very helpful.
Senator Nelson. Thank you.
Chairman Sarbanes. Mr. Secretary, we would be happy to hear
from you and your colleagues.
Let me say to the Members of the Committee, given the
nature of the subject, its complexity, and the admission on the
part of all of us that we are searching for a solution and a
consensus, I am not going to rigorously hold witnesses to a
highly limited time. I think it is very important that they get
the opportunity to lay out their position because this is not
only a situation in which the concept is important, but the
details of the concept are in important and interrelate to the
judgment about what should be done.
Mr. Secretary, that is not a carte blanche to go on
forever----
[Laughter.]
----but it is a partial carte blanche to go ahead and lay
out your position.
We very much appreciate your being here this morning. I
might note that the Secretary was originally scheduled to come
before this Committee. This had been arranged a long time back,
to talk about the Treasury report on currency manipulation and
international trade and that complex of issues.
Given where we are, we thought we should change the nature
of the hearing. So we are pleased that you are here. We would
be happy to hear from you, sir.
STATEMENT OF PAUL H. O'NEILL
SECRETARY, U.S. DEPARTMENT OF THE TREASURY
Secretary O'Neill. Senator, thank you very much. And with
regard to the other----
Chairman Sarbanes. We will bring you back on the other
issue.
Secretary O'Neill. I was going to say, with regard to that,
I know that we must deal with this issue today. But I look
forward very much to coming back and sharing with you the
action the Administration is taking and thank you all very much
for what you are doing in strengthening our hand to deal with
money laundering and associated issues that we believe will
permit us to achieve the present objective of shutting down the
financial means the terrorists have to support their
activities.
So I look forward very much to coming back for that
engagement.
Mr. Chairman, I do have what I would characterize as a long
statement for me. But I have an oral statement that is quite a
bit shorter that I think carries the essential points.
Normally, as you know, I would submit my statement for the
record. But this is a sufficiently complicated subject, that,
if you do not mind, I am going to work my way through what I
think will take maybe 10 minutes to lay down the terms.
Chairman Sarbanes. Very good.
Secretary O'Neill. It is a pleasure to be with you, Senator
Gramm, Members of the Committee. I appreciate the opportunity
to comment on terrorism risk insurance. We believe that there
is a real and pressing need for Congress to act on this issue
now. Market mechanisms to provide terrorism risk insurance
coverage have broken down in the wake of September 11. Such
coverage is now being dropped from property and casualty
reinsurance contracts as they come up for renewal, with most
policies renewing at year-end. If we in Congress fail to Act,
reinsurers have signaled their intention to exclude such
coverage, meaning that primary insurers may have to drop this
coverage or institute dramatic price increases. As a result,
after January 1 the vast majority of businesses in this country
are at risk for either losing their terrorism risk insurance
coverage or paying steep premiums for dramatically curtailed
coverage. If businesses cannot obtain terrorism risk insurance,
they may be unable to obtain financing or financing may be
available only at a much higher cost. This would have
widespread
effects as businesses of all types may, for instance, be unable
to expand their facilities or build new facilities.
Let me state what I believe the problem to be. First,
insurance companies do not take risk. They knowingly accept and
mutualize risk. Because insurance companies do not know the
upper bound of terrorism risk exposure, they will protect
themselves by charg-
ing enormous premiums, dramatically curtailing coverage or, as
we have already seen with terrorism risk exclusions, simply
refuse to offer the coverage. Whatever avenue they choose, the
result is the same--increased premiums and/or increased risk
exposure for businesses that will be passed on to consumers in
the form of higher product prices, transportation costs, energy
costs, and reduced
production.
Another way, any of the choices has the potential to cause
severe economic dislocations in the near-term, either through
higher insurance costs or higher financing costs. Since
September 11, the uncertainty surrounding terrorism risk has
disrupted the ability of insurance companies to estimate price
and insure risk.
Now to the question of what I believe our objectives should
be. In grappling with this problem, we have several objectives.
First and foremost, we want to dampen the shock to the economy
of dramatic cost increases for insurance or curtailed coverage.
We also want to limit Federal intrusion into private economic
activity as much as possible, while still achieving the first
objective, and we want to rely on the existing State regulatory
infrastructure as much as it is practicable to do so.
I would like to talk briefly about a shared loss
compensation program, which is what we are recommending that
you consider. After reviewing an array of options, we have
developed an approach that we believe best accomplishes these
objectives. This approach reflects the current evolution of our
thinking on this issue. But I also want to say that we want to
work with you and with the Congress to achieve the best
possible solution. This is such a new and novel problem, that
we think we need to evolve in our thinking. I must say to you
that the real test will not come in what we produce. We will
only know if we have succeeded if life goes on in insuring a
risk in the private market and businesses have the ability to
achieve financing, so that our economy can return to a much
higher rate of real growth than we are now experiencing. There
is no other test that makes any difference. The real test is
does what we do allow our economy to go forward in a good way?
When terrorists target symbols of our Nation's political
and military power, they are attacking the Nation as a whole,
not the symbol. This argues for spreading the cost across all
taxpayers. Yet, there are also reasons to limit the Federal
role. If property owners do not face any liability from
potential attacks, they may underinvest in security measures
and backup facilities. In addition, the insurance industry has
sufficient experience and capacity to price some portion of the
risk associated with terrorism and has the infrastructure
necessary to assess and process claims.
Under the approach we are suggesting, individual's
businesses and other entities would continue to obtain property
and casualty insurance from insurance providers as they did
before September 11. The terms of the terrorism risk coverage
would be unchanged and would be the same as that for other
risks.
Any loss claims resulting from a future terrorist act would
be submitted by a policyholder to the insurance company. The
insurance company would process the claims and then submit an
invoice to the Government for the payment of its share. In
other words, we would use the existing insurance claims process
infrastructure to deal with potential claims experience.
The Treasury would establish a general process by which
insurance companies would submit their claims. The Treasury
would also institute a process for reviewing and auditing
claims and for insuring that the private/public loss-sharing
arrangement is apportioned among all insurance companies in a
consistent manner. State insurance regulators would also play
an important role in monitoring the claims process and insuring
the overall integrity of the system.
Through the end of 2002, the Government would absorb 80
percent of the first $20 billion of insured losses resulting
from terrorism, and 90 percent of insured losses above $20
billion. Thus, the private sector would pay 20 percent of the
first $20 billion in losses and 10 percent of losses above that
amount.
Let me say parenthetically here, when I say the private
sector, I mean the customers of insurance companies, not the
insurance companies, because if you understand how business
works, then you know there are no insurance companies who can
survive if they do not collect the loss values that they must
pay out from the people that they service in the form of
premiums. I think it is a very bad mistake of logic and
understanding of how economics works to believe in fact that
insurance companies actually pay for the losses that they
cover. They are simply the transmission belt that mutualizes
risk among people with similar exposures.
Under this approach, the Federal Government is absorbing a
portion, but only a portion, of the first dollar of losses,
which we believe is important to do in the first year of the
program. The key problem faced by insurance companies right now
is pricing the terrorism risk. We favor a first-dollar loss-
sharing approach in the first year because we are concerned
about premium increases over the next 12 months. We see this as
the best way to mitigate against premium increases, but it may
not be the only approach. And again, we want to work with you
in finding an approach that will work in the marketplace.
The role of the Federal Government would recede over time
under our proposal, with the expectation that the private
sector would further develop its capacity each year. In 2003,
we would have the private sector be responsible for 100 percent
of the first $10 billion of insured losses, 50 percent of the
insured losses between $10 and $20 billion, and 10 percent of
the insured losses above $20 billion. The Government would be
responsible for the remainder.
In 2004, the private sector would be responsible for 100
percent of the first $20 billion of insured losses, 50 percent
of the insured losses between $20 and $40 billion, and 10
percent of the insured losses above $40 billion. The Government
would be responsible for the remainder.
To preserve flexibility in an extraordinary attack,
combined public/private liability for losses under the program
would be capped at $100 billion in any year and it would be
left to the Congress to determine payments above $100 billion.
The Federal Government's involvement would sunset after 3
years. This approach would also provide certain legal
procedures to manage and structure litigation arising out of
mass tort terrorism incidents. This includes consolidation of
claims into a single forum, a prohibition on punitive damages,
and provisions to insure that defendants pay only for
noneconomic damages for which they are responsible. It is
important to insure that any liability arising from terrorist
attacks results from culpable behavior rather than overzealous
litigation. These procedures are important to mitigating losses
arising from any future terrorist attack on our Nation and are
an essential component of the program I have outlined.
In conclusion, Mr. Chairman, for the reasons I have set
forth, the Administration believes that the economy is facing a
temporary but critical market problem in the provision of
terrorism risk insurance. Leaving this problem unresolved
threatens our economic stability. The approach I have outlined
limits the Government's direct involvement and retains all of
those elements of our private insurance system that continue to
operate well and provides a transition period to allow the
private sector to establish market mechanisms to deal with this
insidious new risk that confronts our Nation.
Mr. Chairman, I would be pleased to respond to questions
that you and the Members may have.
Chairman Sarbanes. Well, thank you very much, Mr.
Secretary.
Did you all examine the riot reinsurance program that was
put in place after the 1968 riots?
Secretary O'Neill. Yes, I think we looked at what we
consider to be analogous kinds of situations and the staff
looked at the riot reinsurance. I think we did not find it to
be a very compelling equivalent to what we are facing with the
terrorism risk that we are now facing.
Chairman Sarbanes. Why not?
Secretary O'Neill. Sheila, come up here, would you?
You know Sheila Bair.
Chairman Sarbanes. Certainly. Sheila's nomination was
approved by this Committee in record time.
[Laughter.]
That is how well we know her.
Secretary O'Neill. And I must say that I greatly
appreciated it.
[Laughter.]
Ms. Bair. I must confess, that was one of the early
suggestions that we got. We looked at it. I think we thought it
involved too much of an infrastructure.
As I understand that program, the funds are set up on a
State-by-State basis. It looked like a more dramatic permanent
fix to a problem that we thought was very temporary. It has
been several weeks since we looked at it, but I would be happy
to talk to your staff later about more of our analysis.
Chairman Sarbanes. I think it is probably worth looking at.
Mr. Secretary, how would you assure, if the Government is
going to take a significant part of the cost of some of this
risk, if the premiums charged by the companies for the balance
of the risk will not be excessive, so that, in effect, the
taxpayer is on the hook to pay the responsibility that the
Government is assuming, and then the taxpayer as consumer is in
effect overpaying on the premium side for the risk that is
retained by the company?
Secretary O'Neill. In a way, I think your question goes to
the center of the problem.
If you walk around the problem from the point of view of
the different participants, let us say, first of all, that you
are a business owner and you need to have terrorism risk
insurance.
Why do you have to have it? Because your bank will not
continue to support you. They will not give you money, either
for continuation for rollover loans or for a future investment,
if you can prove to them that you have protected them and have
the ability to pay back the money that they have loaned you in
the event that you suffer the loss associated with a terrorist
catastrophe. And so, as a business person, you are forced into
a position where you must find some coverage.
And under the proposal that we have made, if you saw this
as an economy with one insurance company and one business
person and you, the insurance company, now were at risk for $4
billion. And let us say for purposes of illustration, that my
business had a $4 billion catastrophic loss potential. Then, as
an intelligent business person, you would probably seek to
charge me something close to the value of me being the target
of a terrorist event that costs me $4 billion.
How do we keep that being the experience in the situation
that we are talking about through the competitive process of
insurance companies seeking to provide coverage, which is how
they make their money, after all, by charging premiums with an
expectation that, through the combination of premiums and
investment, a flow of funds, that they are going to be able to
make a market rate of return? That is what insurance companies
do. Like all other business, they are out there trying to make
a market rate of return. And through the competitive process,
multiple millions of business owners will be approaching
insurance companies and hundreds of insurance companies will be
trying to make sales, if you will. And through that process,
there will be a determination of what the premium is that is
required on an insurable basis.
And that is part of the reason that we have suggested that
we take a 3 year approach to this. We are facing a cliff on the
first of January. And since we have not really priced terrorist
acts before, we are going to go through a learning process.
I guess I would say, in a succinct way, the response to
your answer is the competitive process will not permit
rapacious pricing by the insurance companies because the
competitive process will get this down to a level that the
general judgment says, at this premium rate and with
reinvestment of funds, we are protected against a $4 billion
loss.
Chairman Sarbanes. Well, I have other questions, but I will
defer to my colleagues.
Senator Gramm.
Senator Gramm. Well, thank you, Mr. Chairman. Let me say,
Mr. Secretary, that I have sat in many hearings on this
Committee and others. I have never heard a better statement on
the subject than you gave today and I want to thank you for it.
Secretary O'Neill. Thank you.
Senator Gramm. Let me go through three principles and see
if you agree with them and then I want to just talk about your
proposal and my own thinking on it. First of all, the question
was raised earlier about eliminating risk, other than through
law enforcement, private security, restructuring physically
potential targets, and the use of American military.
When we have used all of those vehicles, whatever risk
remains, I would say as a first principle, is that risk cannot
be eliminated. No bill that we could pass, no law that we could
write could eliminate that risk, that all we can do is
redistribute it, and ultimately, redistribute it from the
person paying insurance premiums to the taxpayer. Do you agree
with that principle?
Secretary O'Neill. I think, generally, with this one
caveat.
If you think about insurance, what it does is it mutualizes
the risk against people in like situations. If you think about
the insurance industry taking this $4 billion worth of exposure
in our first-year proposal, there is an assumption basically
that there are enough people out there who are willing to pay
premiums to have their terrorist coverage, that we have
effectively mutualized the cost of the risk that is associated
with their exposure to the people who choose to buy or who, for
financial reasons, are forced to buy policies, and that
population is a smaller subset than the general population. But
at the end of the day, you either have that subset of the
population that mutualizes and shares the cost and the risk, or
the taxpayers do, yes.
Senator Gramm. The second principle would be that private
insurance as the basic structure is the cheapest way to lay off
this risk and manage risk. And I do not know of any evidence
that Government has ever been more efficient than private
insurance.
Secretary O'Neill. I would agree with you completely.
Senator Gramm. The third is not a principle, but an
objective. I am sure you share my objective that nothing we do
here would in any way permanently get the Federal Government in
the insurance business.
Secretary O'Neill. That is the last thing we should do.
Senator Gramm. As I look at your proposal, let me first say
that I think your proposal is a good proposal. And I think if
we adopted your proposal, that it would be a dramatic
improvement over the status quo. Can anything be improved? I
guess you can always debate that.
It seems to me that, as I look at it, the various proposals
that are being made--first of all, the proposal by the
insurance industry, for us to sanction a monopoly reinsurance
pool, is an absolute nonstarter with me. I assume it is with
you.
Secretary O'Neill. You are right.
Senator Gramm. It seems to me that the real question is,
based on our experience with reinsurance, could we, to use Bill
Nelson's words, get the insurance--I do not want to use his
words.
[Laughter.]
But the point is, it seems to me that if we are talking
about a relatively small amount of risk given the size of the
industry, $10 billion, for example, that if the Federal
Government were backing up a program where the first $10
billion was the liability of the
insurance industry--in other words, moving your proposal really
1 year forward--the disadvantage of that is you have a very
compressed process whereby reinsurance would be marketed.
My guess is that in this interim, you would have a lot of
insurance companies that would become the primary insurer and
they would line up partners individually, and then the
reinsurance market would come in and say, well, we can really
do that more efficiently if you will just simply contract with
us. My guess is that that is how it would happen.
That is the cost of skipping a year in your program. I
think the advantage of skipping a year in your program is you
would put pressure for the reinsurance market to develop. And
one of my concerns is that the comforting effect of having the
Federal Government there with the first dollar coverage, 80
cents on the dollar, would be such that if I were in the
insurance business, I might want to come to Congress in 9
months and say, well, look, we have not developed this
reinsurance market and therefore, we want you to extend this
program. One of the advantages of skipping a year would be to
force the development of this market sooner.
I think also, from a political point of view, which is a
relevant factor here, is that Members would feel more
comfortable if the first exposure were private and the Federal
Government were a backup, part of the backup process, rather
than the Federal Government being on the hook for the first
dollar. Let me just get your reaction to those alternatives and
the trade-offs. It is not a question of right and wrong.
Secretary O'Neill. No, I understand, Senator.
I believe we have what you are saying as a suggestion for
the second year of our program. Let me tell you why we did not
end up with it as the first year of our program. We do not have
much time, and I do not want to name them because I do not want
television reporting that O'Neill said these are high-
visibility targets. But you all have in your own mind, there
are places in our country that are high-visibility targets that
have a billion dollars' worth of value. If I own one of those
places--let me be the owner first--and I have to have insurance
because my financing is going to walk away with me if I do not
have terrorist insurance.
So with the $10 billion, in effect, deductible that is out
there for the industry to absorb, I am one insurance company.
So if I am going to write insurance for one of these high-
visibility, multibillion dollar places, then I have to get a
very big premium because the Government does not do anything
until I have had a $10 billion loss. And it could be all my
loss as an individual company unless there is a reinsurance
pool possibility for a mutualization of the risk among
insurance companies somehow. It is really that question of
whether the market can develop quickly enough.
I have no doubt that there will be a reinsurance market
developed for this kind of risk-in-kind. But there is
uncertainty and in the early days, my guess would be, because
these are not fools who put their money into reinsurance or
into insurance companies, they will insist in the early days on
a higher risk premium than they will likely need going forward.
There is a counterpoint, which is this, and it is directly
related to what Senator Nelson said.
What the insurance companies had to do after they had huge
catastrophic losses because of hurricanes is they had to raise
the premiums going forward to put themselves on a sound
financial basis.
Again, we are reminding ourselves, insurance companies do
not accept risk. They mutualize it. And they pay their losses
out of premiums and earnings on premiums that have come in. And
it is that that provides the basis for our economy to operate
in the way that it does to absorb risk.
I do not have any trouble with your idea if we could
quickly test it. And if I may offer this. One thing is we have
talked about this. I do not think we are going to know whether
the terms that you all adopt in your legislative proposal are
going to work until we have had a real market test. And
therefore, it may be useful for you all to think about the
possibility of giving the Executive the ability to adjust these
terms.
If, in the first instance, after you have drawn a line and
it does not work, and we find that we are in trouble because we
do not have a whole lot of time to go through an elaborate
reconsideration of the legislation.
So just a thought for you. Believe me, not a reach for
power. We could do without this. But we need a mechanism that
is going to be able to adjust the market conditions and work in
the real world, and we need it quickly.
Senator Gramm. And my time is expired. But the problem is,
the fact that you have that power affects behavior.
Secretary O'Neill. You are right. You are absolutely right.
Senator Gramm. That is the problem.
Chairman Sarbanes. I say to my colleagues, we are going to
hand everyone--because we do not have the lights here--after 5
minutes, we will hand you a piece of paper. We do not want to
cut anyone off in midstream. But then we would like you to
start winding it up.
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman.
I want to thank you, Mr. Secretary. You have been out front
on this issue early, and that is really important, I think even
in terms of assuring the markets now that we are looking at a
solution. Just a quick question. There are some in the Congress
who say we do not need any solution at all next year. Do you
strongly disagree with that?
Secretary O'Neill. I just do not think that we are in a
workable position because with the reinsurance companies
pulling out, we are going to face real-life situations out
there where people will not be able to get financing.
Senator Schumer. My two other questions relate to the
specifics of your proposal. I am worried about two things and I
wish you could address both.
One is what Bill Nelson referred to as ``cherry-picking''
or ``fail-safe'' or whatever. Even if you do not do what
Senator Gramm suggested, and do this very generous proposal in
the first year, how do we know that some very important
existing entities, buildings or just large physical entities,
which is what is at the most risk, a lot of value, economic
value concentrated in a small space, I guess, how do we know
that they will get any insurance, that the insurance companies
will say, look, I will write with this 80 percent, I will write
for this, this, this, this, and this, but I will not write for
5 percent of the economy. And that would really create unusual
havoc.
Secretary O'Neill. I think there is no doubt in my mind
that the market will eventually provide risk insurance or
terrorism risk insurance for everyone.
But if we think about this problem in a way that we are all
more familiar with. If you are buying automobile insurance, it
is experience rated, which means if you are over 25 and you
have three children and you do not drink and smoke and do other
things, that insurance companies will like you and you will get
the preferred premiums. If you are 15 years old and you have
never been to driving school, your premiums are unbelievable.
Senator Schumer. And there are some people who no one will
insure.
Secretary O'Neill. That is right.
Senator Schumer. The State government steps in and does it.
Secretary O'Neill. All right. And what the insurance
companies do, though, effectively, and your example is the top-
off case, what they do is they create an experienced rate of
premiums and assigned risk pools and that is going to happen in
this case.
It is obvious that some of the high symbolic value things
have a higher risk associated with them than a suburban home in
a tract development.
Senator Schumer. Correct.
Secretary O'Neill. And the insurance industry will work
through its market process with bid and ask on the part of
buyers and sellers, and the premium rates will be established.
Senator Schumer. But how do we know--and I am going to ask
my second question now so you can answer both. But how do we
know that there are going to be some part of the economy, a
valuable part, albeit, a small part, for which there will
either be no insurance or the rate will be so high that, in
effect, there will be no insurance? And if you could answer
that. And then let me ask my second one.
Chairman Sarbanes. You cannot do that.
Senator Schumer. Yes, I understand.
Chairman Sarbanes. We have been through that before. I can
say, I have three questions.
[Laughter.]
Senator Schumer. I just want to hurry him up, so I get in
my second before you start singing, Mr. Chairman.
[Laughter.]
Secretary O'Neill. I think we need to work this issue
really hard. I think there are arguments that can be made on
your side that we need to anticipate uninsurable companies or
situations. We do not have a magic bullet answer that I am
going to throw my body on the fire for. We should work with the
Committee on this.
Senator Schumer. I would like to work with you on that.
My second question relates to my dialogue with Senator
Nelson. I have heard from numerous banks, that they will not
insure long-term projects if they are only given 1 year or 2
years, or even 3 years, of some certainty that insurance will
exist.
We are talking about prospective rather than retroactive.
We are talking about new projects rather than existing,
although it might apply to refinancing as well. And that
worries me.
Now, the alternative proposal, the pool proposal, deals
with that issue better, although, admittedly, it deals with
some issues worse. Could you please address your view about how
much dampening will be placed on the economy unless we have
some longer-term solution, a 1 to 3 year solution. I fear it is
moving back away from 3 years to 1, that if we do not have such
a thing in place, we are going to prevent lots of lending and
projects from being built. Even if the entrepreneur wants to go
ahead, the banks are cautious fellows and they do not lend
unless they are assured of insurance for the term of the
project.
Secretary O'Neill. Let me draw on my experience as an
industrialist who had properties that were worth in excess of a
billion dollars' apiece. And recall in that incarnation, what I
found is that the insurance policies that I had that were full
catastrophic coverage, including explosions, but not as a self-
initiated intentional act, but as a catastrophic failure of a
boiler or something, that all of my policies had cancellation
provisions in them and/or, and usually and/or, provision for
resetting the premium on an experience basis.
I think the idea that we have to provide 30 years' worth of
iron-clad insurance protection to people is just wrong-headed.
It seems like a plausible thing. But I have not found that to
be my experience that my financial backers insisted I had to
have 30 years' worth of iron-clad insurance coverage for a
property that was at risk.
It was at risk for cancellation and it was at risk for
premium adjustment. But I never found a bank or that my equity
investors said we cannot invest in you or we are going to
discount your value because you do not have 30 years' worth of
protection.
Senator Schumer. But in this new world we are in, wouldn't
the fact that we do not know what is going to happen create a
real dampening effect on the economy if we have a short-term
plan?
Secretary O'Neill. I think if we can do something and set
the terms down for a year, then we will have an experience base
and say to the American people, which I think we can all do in
good faith, if this does not work quite right, we are going to
revisit it and we will adjust the terms and conditions because
we are all determined that we are not going to be set back by
these people and we will figure out a way to do it. I think we
will be fine. As long as we make a good-faith commitment to the
American financial community and the individual investors, we
will be fine.
Senator Schumer. Thank you, Mr. Secretary. Thank you,
Chairman Sarbanes.
Chairman Sarbanes. Senator Bunning.
Senator Bunning. Mr. Secretary, I have real problems with
the Federal Government guaranteeing profits for insurance and
reinsurance companies.
Secretary O'Neill. I would not ever suggest that we do that
in any way, shape, or form.
Senator Bunning. Well, your proposal does--I mean, you are
guaranteeing whatever premium they charge, whatever risk and
investment they make, they cannot lose over a certain amount.
Secretary O'Neill. And I am assuming that the competitive
marketplace will bring them into a position where they will be
able to make a market rate of return on the risk that they are
taking and no more.
Senator Bunning. That is a debatable question in your
proposal.
Secretary O'Neill. I agree with what Senator Nelson said
about insurance companies being flush and all the rest of that.
I do not know about the rest of you, but I know a lot about
investment. I do not know anybody who is rushing out because
they think insurance companies are such a preferred investment
vehicle, that they prefer insurance companies over all the
other investments.
My experience is that the markets grind very finely. And is
anybody making a whole lot more than the market rate of return,
either competition or the process of competition and price
competition grinds people down so that it is very hard on a
sustainable basis to make more than the market rate of return.
I am assuming, with the event of terrorism, we did not lose our
ability to run a capitalist society that produces that result.
Senator Bunning. I am worried about the fact that if you
have first-dollar coverage on a terrorism act, why should I as
a reinsurer try to adjust to the market when the following
year, you are going to take a certain percentage also? And only
at the end of 3 years, I might want to change the way I
approach my reinsurance company or my insurance company.
Somebody brought the economy up and I think that is really
interesting, that this act, this hideous act that happened on
September 11, is a disaster for the economy.
The economy was a disaster before September 11. This is
just adding to it. We had an even growth in the second quarter,
a negative growth in the third, and a negative growth in the
fourth. And heaven help us, we had better not start out 2002
with a negative growth in the first quarter then. Or else,
these things will not mean a thing, what you are trying to
accomplish by your proposal. We do have State insurance
commissioners. They are capable of dealing with this problem.
As Senator Nelson said, he had to deal with premiums and
requiring premiums in law that required insurance companies to
write catastrophic insurance for hurricanes. Or else they could
not practice insurance or they could not do business in
Florida. Well, there is the same capability in New York,
Illinois, or wherever that we are capable of assuming there is
major risk.
I believe insurance companies intend to make money. And I
believe reinsurance companies intend to make money, or they
ought not be in business. What I am trying to say is, I like
part of your solution, but I do not like the first dollar
coverage of that. I think it is necessary we act quickly so
that we insure and reinsure as quickly as possible so there is
no more negative effect on the economy. But the Federal
Government does things so poorly, and writing insurance
policies would just be another one of those things that we do
poorly.
Secretary O'Neill. We do not want to write a single
insurance policy.
Senator Bunning. You want to have what we call an assigned
risk pool----
Secretary O'Neill. No.
Senator Bunning. That is almost exactly what it is.
Secretary O'Neill. No, no, no. We do not want to have an
assigned risk pool at all. We do not want any pool. We do not
want any Federal insurance policywriting or rating.
Senator Bunning. What is 80 percent of $20 billion, then?
That is your proposal for the first year.
Secretary O'Neill. It is basically saying that is the part
of a series of terrorist incident costs that we believe ought
to be mutualized to the general taxpayer.
Senator Bunning. In other words----
Secretary O'Neill. In the first year.
Senator Bunning. ----in the process of the insurance
companies doing that, and the reinsurance companies doing that,
you do not think that is possible?
Secretary O'Neill. We think that there is a substantial
risk if we do not do something like what we have recommended,
we will have a significant dislocation in the economy on the
first of January. And I can understand your view that maybe
this is not right and maybe it is the wish----
Senator Bunning. I like the other part.
Secretary O'Neill. Maybe it is the wish of the Congress to
take that risk. That certainly is a decision that you could
make. And we would find out. This is different from lots of
things we do here in Washington. This is going to either work
or it is not going to work.
Senator Bunning. I intend to work with the whole Committee
to see to it that we come up with a reasonable solution. I hope
you can work with us.
Secretary O'Neill. Absolutely.
Chairman Sarbanes. I am going to interject a question
because it flows from what Senator Bunning has said. Did you
consider the Government assuming the responsibility for all
terrorist claims?
Secretary O'Neill. Yes.
Chairman Sarbanes. In effect, saying, it is the
Government's responsibility to protect the society against
terrorism. And if we fall short of that, the Government will
pay these premiums. Therefore, to the insurance business, you
do not have to factor it in. You do not have to take up the
premiums. You do not have to have a record on which to
establish it. And we will assume it.
If there are no terrorist attacks, the Government does not
pay anything. If there are terrorist attacks, the Government
has to certify the claims and then pay them. Did you consider
that?
Secretary O'Neill. I think, Senator, it is fair to say
that, within the economic team, and eventually, in a process of
consultation with the President, we looked at every conceivable
way of thinking about this problem, including 100 percent
Federal role for costs directly associated with terrorism.
On balance, we came down with what we have recommended to
you, that we do this 3 year pilot process with the first year,
80/20. And the reason we got to 80/20 is because we think there
is a high probability that it will be possible for the private
industry to write policies and be in the process for claims
processing and working with companies, for companies to take
investment actions and the management actions to reduce risks
that otherwise might not be tended to.
So, yes, we have worked this issue very hard, including
everything that we thought was a logical possibility. And on
balance, we have come down with what I have said to you today.
Chairman Sarbanes. Senator Bayh.
Senator Bayh. Thank you, Mr. Chairman.
Thank you, Mr. Secretary. I was interested in your answer
to Senator Schumer's question. I would like to ask you, given
the state of the economy right now, the macroeconomic
situation, it seems to me this is a particularly inopportune
time to have a significant amount of additional risk put into
the marketplace.
We are trying to rebuild confidence on the part of
consumers and on the part of people who make investments and
all that thing. Now we are faced with a large, very difficult-
to-quantify risk.
So it seems to me that something other than just a stop-gap
measure was in order. We needed something to allow the industry
to be able to quantify this risk and then we get out of any
intervention and let them, assuming they have enough experience
to do what they do better than the Government possibly can.
But I took your response to Senator Schumer to be more of,
not along those lines. You mentioned the cancellation
provisions and the ability to increase premiums in light of
experience and that thing. Given that, why would we do
anything? So I am having trouble reconciling my own sense that
this is a particularly inopportune time for this amount of
additional risk, that we ought to do something, something more
than just 6 months or 12 months. But I took your comments to be
to the contrary. Maybe I did not understand you correctly.
Secretary O'Neill. Well, what I said is I think we should
put in place, by our thought process, we should put in place a
3 year commitment from the Federal Government. But I am going
to say to you again, the real test of what we do here is
whether it works in the marketplace. And if someone has 100
percent certainty about what is going to work in the
marketplace, I have not yet found one. I believe we have to
proceed with a sense of flexibility and caution and an
expectation that we may have to make some adjustments.
Senator Bayh. I guess that gets to the heart of my
question, Mr. Secretary. At this moment, with the economy being
in the shape that it is, perhaps it is better to err on the
side of caution rather than additional risk-taking. Is that a
fair way to characterize it?
Secretary O'Neill. I am not sure how that translates into
what conclusion you would draw.
Senator Bayh. That is why you have a 3 year----
Secretary O'Neill. On the side of caution, yes.
Senator Bayh. ----proposal rather than a 6 month proposal.
Secretary O'Neill. Six months, I would say, would not work.
People need to be able to rely on at least a year's worth of
understanding of what they are going to face and make a
contract.
Let me be a business person. And if you told me I have to
face this music every 3 months with great uncertainty, I would
say you are torturing me. Why are you doing this? It does not
make any sense. I need to get this out of my life after I have
made a decision for the next year and I will deal with it again
maybe next year, which I have to do anyway under conventional
and catastrophic provisions. You get revisited every year.
And believe me, if you think risk adjustment is not real, I
can tell you, if you have a boiler explosion, you know what the
premium increase is going to be next year. It is going to be
big enough so that, in an expected value time of 3 years or so,
the insurance company got back the money it needed to pay off
your claim.
Senator Bayh. Anybody who has reported an accident with
their automobile has gone through that, too.
Secretary O'Neill. You know that.
Senator Bayh. Just two other points. Something that Senator
Gramm said and I think Senator Bunning touched upon it, too.
The risk is what the risk is. We take steps to reduce it as
much as possible. But at the end of the day, it has to be dealt
with and distributed throughout society. But what we are
dealing with here is a temporary market imperfection where the
ability to quantify that risk is in doubt because we do not
have enough experience.
It seems to me that is what we are dealing with here. And
we are trying to get us through this period until the market is
able to perform the function it does much better than the
Government possibly could. It is just a temporary market
imperfection that we are attempting to address.
My final question, Mr. Secretary, what about the British
experience? They have had to deal with acts of terror for some
time. How does your proposal differ from what they have
instituted over there? And what has their experience been?
Secretary O'Neill. Basically, we think the UK decided to
put their national government into the insurance business. And
we have elected not to take that route. I think it is true both
for the UK and for Israel. They have both basically put the
government into the insurance business.
We just think it is a step way too far--in thinking about
the logical possibilities, we did look at that possibility. But
I think we would have to have some huge additional, horrendous,
ongoing experiences to get to the point where we said, this is
a sensible thing for us to do.
Senator Bayh. Let us all hope it does not come to that.
Thank you very much, Mr. Secretary.
Chairman Sarbanes. Senator Allard.
Senator Allard. Mr. Secretary, I agree with you on the
limited role of Government. And I also agree with Senator Phil
Gramm that we need to be very careful, again, about how
involved Government is in this whole process. I am searching
for ways to see just where that proper role might be. I would
hope that, with time, we can completely phase the Government
out of this. Terrorist acts are not anything new that happened
with the attack on September 11. There were terrorist acts
before.
There is one question that comes to mind. Did you look at
how the industry had factored in that risk, because some of
those terrorist acts, even prior to that, showed the
possibility--for example, in the bombing of the World Trade
Center--of being huge in nature and catastrophic in nature. It
seems like up to that point, the private sector had been
willing to respond, or did you find that at that point in time,
the private sector had not been willing to respond to that
potential type of accident?
Secretary O'Neill. You have the experts here from the
insurance industry and I think your best qualified answer will
come from them. Let me tell you my view of it, and this is from
talking with high-level insurance executives around the
country.
I think there had been the terrorist act provisions and
insurance policies and it was possible to have them as long as
we did not have terrorist acts. And what we are seeing now is
the realization that terrorist acts are not some unimaginable
impossibility. They are a reality in our society, hopefully,
not again and again. And therefore, the insurance companies are
now having to think about the possibility of having to deliver
on their promises to pay in the event of terrorist acts. And
that means they have to address the real issue of pricing for
these things, instead of it being a freebie that you would give
some people comfort that they were covered for terrorist acts,
when you had no intention of ever actually having to pay for a
terrorist act.
Senator Allard. Subtly, you implied, but there is a lot in
the definition of a terrorist act.
Secretary O'Neill. Yes.
Senator Allard. In your comments. Are you thinking about
leaving it up to each individual policyholder to define this,
or is this going to be something that you are going to suggest?
To me, that is a real bucket of worms.
Secretary O'Neill. I agree with you. But I think we need as
tight a definition as we can fashion of what a terrorist act
is. If we are going to put the Federal Government on the line,
then we need to know what it is that we are putting ourselves
on the line for.
Senator Allard. The other question I have is on foreign
assets.
In your proposal, I was not clear on how you would treat
property owned by Americans. Are you putting them into that
risk pool, or are you holding them out separately from that?
And how do you do that?
Secretary O'Neill. Well, what we fashioned is United
States.
But, again, as a business person who has operations in 36
countries, now having seen this kind of issue up front and very
clear, businesses are going to face this issue and different
countries will sort the problem out in different ways. And
equity-holders will pay attention to whether or not our risk
has been covered.
You know, I guess I can do this. There are lots of
terrorist acts in some other countries that we are very good
friends with and they have now incorporated these risks into
their premiums in some of these other countries. It is not as
though we are alone in the world. But businesses are going to
have a much more complicated set of issues to deal with now. In
fact, there is a different premium structure. If you are an
American company and you have assets in places that are subject
to lots of terrorist activity, you can tell the difference in
your insurance cost.
Senator Allard. I thought that was an important thing to
think about, the foreign coverage, because, like the Chairman
said, the question came to my mind, which government are you
talking about, foreign investments?
Secretary O'Neill. Right.
Senator Allard. Some do a better job than others. And I
would hope that we will improve and do a better job in this
country as far as trying to keep terrorist acts to a minimum. I
do not think it is a practical goal to completely eliminate all
terrorist acts. I think we can take up organized terrorist acts
perhaps that are international in nature.
Secretary O'Neill. Again, Senator, as a business person,
how you factor this in is important. Again, I do not want to
name countries, but the financial premium of the intelligent
business person requires in places that have more fragile
governments and less robust protections against terrorist acts
than the rest, then the discount rate that you can earn on your
money is 18 or 24 percent instead of the 11 or 12 percent that
is considered a reasonable rate of return in our economy before
September 11.
So there already is a risk adjustment mechanism in the
capitalist system to take into account exactly what you are
talking about. And it shows up in the premium that business
people require in order to deploy capital in other societies.
Senator Allard. Is my time up, Mr. Chairman?
Chairman Sarbanes. Yes.
Senator Allard. Okay. Thank you.
Chairman Sarbanes. Senator Corzine.
Senator Corzine. Thank you, Mr. Chairman. Secretary
O'Neill, I appreciate the thoughtfulness of your presentation,
even though I might not totally agree on all aspects.
Let me just make a point that has been made and reinforced.
This is a real economic issue for the moment and, in my view,
the intermediate and long run. I might dispute a little bit
about how much these risks get adjusted. People who write bond
issues for 7 years, 10 years, and we have already seen a very
significant erosion of yield spreads, virtual shutdown of the
high-yield market.
I saw where one of the great motor companies is paying
almost 300 over Treasuries in intermediate and long-range,
which is relatively unprecedented.
I think some of this risk is already there and I think it
will be an underminer of economic strength. So I think we need
something, certainly in the short run, to address these issues.
But I want to go to a statement you made, and you are talking
about insurance companies.
If we do not believe they can make money by underwriting a
particular risk, they will not cover it. There will not be
availability. And there is an assumption in this testimony and
from a number of my colleagues that, somehow or another, we are
going to be able to quantify terrorist risk next year. We are
going to get enough experience that we will be able to
understand that risk and therefore, people are going to want to
accept that.
And in its particulars comes the ``cherry-picking.'' But
there is no reason to believe in my mind the reinsurers are
going to say that this is a great deal and we ought to step
into it. As a matter of fact, most business people do not put
companies at risk on things that they do not know.
We need a long-term solution that is not just completely
dependent on the marketplace making a decision. I am actually
troubled that there is not an understanding that our national
defense somehow slips into what we are talking about here with
regard to the insurance activity.
There are examples and we do not need to debate the merits
and the pool, but I have some sympathy for that. And we have
actually practiced that in some ways, in ways that we would not
otherwise have been able to have insurance and think about
nuclear power plants as a perfect example. And while it is not
perfect, it is better than if we did not have it.
So I hope that we are not so firm in believing that we
understand how this risk is going to work its way through the
system. Are we going to be able to put a probability assessment
on terrorist risk in 4 years any better than we are today,
strikes me as a huge leap of intellectual view to be able to do
that.
At least one business person who would like to make money,
I would not bet the ranch on something that I did not
understand. That leads me to believe that there may be a reason
to think more broadly about what the long-term solutions are.
And since the President has talked about this as a long-term
situation, this is not a 1 year or other type program.
That said, I am sympathetic with what Senator Nelson said--
haste makes waste too often and there is a lot of reason to
think that we ought to analyze this in great detail before we
come to a long-term solution. And then I get to your
suggestions, which are some good ideas, and I actually like
Year Two or Year Three better because I do believe that the
industry ought to be responsible for managing a substantial
amount of this risk. It is the catastrophic risk that I am more
concerned about.
It just strikes me that this first dollar exposure is very
high. I have heard your arguments about it. I would love to
hear if there is any greater element on that. And then I have
one other question.
Do you have a feel for how much impact on the economy
failure to act would have? Do you have estimates, macroeconomic
views, about how much we would undermine the economy?
So, really, two questions. Do you think we could expand and
protect the economy by having a much larger first-dollar
exposure of insurance companies?
And have you all done a lot of market testing on that? And
what do you think the impact of failing to do anything would
have with regard to the economy?
Secretary O'Neill. R. Glenn Hubbard, Chairman of the CEA,
is here and I am going to let him answer the broader--and
Glenn, you can correct me.
[Laughter.]
Senator Corzine. What would be the long-term impact?
Secretary O'Neill. Absolutely. Again, Senator, if you think
about this, and I like working problems in a way that I can
understand them and think about them that reflects some
experience.
If I received a notice where I was before, that my
terrorism risk coverage was cancelled next year, it would not
have any immediate effect on a company of the size of Alcoa
with $36 billion worth of market cap. But the S&P and Moody's
would probably take a new look at my credit rating and because
we were so terrific, they probably would not knock us down. But
other companies that were not so terrific would probably get an
adjustment in their rating and that would cause them in their
next roll-over financing to pay more money and, in effect, the
risk value would be imposed through the financial system
indirectly instead of through a premium for insurance. And we
do not really know what that is.
To return to your question to the broader issue of what
happens in the general economy, where you would expect to see
the effect is in new project proposals. That kind of wash-
through effect that I have described would happen for things
that are already there.
Where you would see impact is in people not being able to
get financing at all because they were not able to get
terrorism insurance even during the construction period. How
does that translate? I do not know. I will let Glenn give you a
number for that.
[Laughter.]
Mr. Hubbard. I could do it now if you want.
Secretary O'Neill. I am going to say one more thing first,
Glenn.
With regard to the proposal with the 80/20, I would argue
that the companies, the reinsurance companies, will arbitrage
between their aggregate exposure and the premiums that they are
able to collect. And the more coverage that is written, the
more the premiums will come down.
The companies will make sure that whatever premiums they
collect, their complete exposure is covered. Otherwise, they
are not running a business. They are running a lottery. And
that is why I would start with what you would say is first-
dollar coverage, I would say is still a considerable exposure
for an individual company in the aggregate.
I expect that this competitive process will arbitrage
between the maximum exposure and they would collect all of the
maxi-
mum exposure in premiums. It is a reason to start with a fairly
small number and develop some experience instead of making the
exposure big upfront because, at least I cannot imagine that
the industry is going to collect less in premiums than what we
say is their first-line exposure.
Chairman Sarbanes. Well, the Secretary I know has to leave
at 12:15 p.m. We still have some Members and, Chairman Hubbard,
you will have a chance to go at some length.
Senator Bennett.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman.
Mr. Secretary, I appreciate you being here and I agree with
Senator Gramm that your opening statement was unusually clear.
We do not often get that. We appreciate the work that went into
it.
Let me just see if I understand what we are saying here,
because this is not an area where I have a great deal of
expertise or previous experience. I just paid the premiums and
went on running the business.
[Laughter.]
There is an assumption that in the uncertainty of what we
face, the initial premiums of the industry will be very high.
Is that a correct assumption?
Secretary O'Neill. First of all, there is an assumption
that if there is no reinsurance pool, that individual insurance
companies will have to collect premiums that are large enough
to cover all of their potential exposure.
Senator Bennett. I understand that. But even with the
reinsurance pool, as the green eyeshade folks sit down and
figure out what the risk is going to be, they are going to err
on the high side.
Secretary O'Neill. That is right.
Senator Bennett. Simply because they have no experience.
Secretary O'Neill. That is right.
Senator Bennett. And presumably, by the end of 3 years, you
will have had a track record of experience so that someone in
reinsurance Company X, can say, we can come in under the market
with this kind of a premium because we now have enough
experience to know that the exposure is not going to be as high
as we originally thought it would be and therefore, the
competitive forces will bring the premiums down. Is that a fair
assumption?
Secretary O'Neill. I believe so, although I want to go back
to the comment that Senator Corzine made about the difficulty
of pricing the risk of terrorism. I personally, and I am sure
you all join me, in not wanting to have enough actuarial
experience that we can price terrorism.
But if you know how insurance works, it is based on a set
of actuarial judgments and experience base that gives one a
basis for making some judgment about what the premiums should
be when there is an event.
And even for hurricanes and tornadoes, we have enough
weather experience that it is now possible to do that. I hope
we never have enough experience to figure out what the costs
should be, and that should be our ultimate objective.
But I think part of the reason we have suggested this
graded approach is because we think we need some learning. We
need to evolve our thinking. We have never really had to face
this kind of issue, and we honestly do not know if it is
possible to proceed in the way we have suggested and beyond to
basically turn this over to a private function and let it
forever be a private function.
I am saying we can, if we do not have more terrorist
experience. If we have lots of additional terrorist experience,
I do not know what we do next.
Senator Bennett. Well, you are going the same direction I
am. At the end of the 3 year period, we need to revisit this
and see exactly what we are because, put in a slightly
different context, we are dependent upon the success of the
Administration in conducting the war. And if the war goes
badly, at the end of 3 years we are going to be faced with an
entirely different problem than if the war goes well.
Now you talk about the British. Their principal source of
terrorism has been the IRA. And that has been going on for long
enough that they do, unfortunately, as you say, have a base of
experience on which to deal with it.
We are in a world where we do not know whether the attack
on the World Trade Center and the Pentagon was the ultimate
gasp of this group and the absolute most they could possibly
do, or if they have in the pipeline a whole series of attacks
that could replicate that over the next 3 years.
So I think you have had a thoughtful approach here, but as
I try to get my arms around it, that is what I keep coming up
against. I do not really know what I can endorse because I do
not know what the risk is going to be, and presumably, nobody
else does. Maybe Secretary Rumsfeld does, but he is not telling
us.
Senator Gramm. Because we would leak it to the media.
[Laughter.]
Senator Bennett. Not I.
[Laughter.]
Isn't that what is driving your decision as to the first-
year activity?
Secretary O'Neill. Yes, it is, Senator. You said it very
well.
Senator Bennett. As I read the criticisms and listen to the
criticisms, we say let's wait for the second and third year.
Aren't you telling us we cannot wait because we have a January
1 deadline with many of these policies and we do not know? And
given the fact that the insurance company does not know, that
means we hit January 1 with no insurance at all.
Secretary O'Neill. Exactly right.
Senator Bennett. Is that----
Secretary O'Neill. Yes, sir. You said it extremely well.
Senator Bennett. Well, I am not trying to say it extremely
well. I am trying to get it in my own head so that I understand
it when we come along.
Thank you.
Secretary O'Neill. Thank you.
Chairman Sarbanes. Thank you, Senator Bennett.
Senator Carper.
Senator Carper. Thanks, Mr. Chairman. And to the Secretary
we welcome you here. Thanks for joining us today.
You brought your written testimony and it has been entered
into the record. Everybody keeps saying how good your oral
testimony was. Who wrote your oral testimony?
Secretary O'Neill. You know, I am really delighted you
asked me because it gives me an opportunity to say, I believe
we have assembled the finest team of people that have ever been
at one time at the Treasury. Sheila Bair, who you probably
know, Peter Fisher, and David Ockhauser. I could go on naming
fabulous people at the Treasury. I am proud to represent them
and I am proud to say that Sheila wrote the oral testimony.
Senator Carper. I know because while you were speaking, her
lips were moving.
[Laughter.]
We are grateful for you and your team, for your
presentation today.
I want to go back to a question that I asked of Senator
Nelson. The question dealt with the underlying financial
strength of the industry itself.
As I read the Administration's proposal, and I add up the
industry's share of the potential cost, it looks like the
industry's share in the first year could be as much as $12
billion. In the second year, maybe $24 billion. And the third
year, as I recall it, it was $36 billion. That is a lot of
money. But compare that, if you will, to the reserves of the
industry itself and whether or not those are fair and
reasonable numbers.
Secretary O'Neill. I think the reserves are irrelevant. The
reason I think they are irrelevant is this. Again, if you are a
business person and you understand how business works, then you
know that the reserves that they have there are there for a
good reason. And if they are excessive, then competition will
grind them down over time.
But the reserves are there because they are required to be
there so that the company can operate in the jurisdictions
where it sells policies in the event that there is a loss, the
company can pay off the claims that it has contractually agreed
to pay off. And so, the fact that companies have huge values in
reserves has no relevance whatsoever to the taking on of new
risk.
Senator Carper. The second question I want to ask is this.
There are others who are going to testify after you, some
have liked what you suggested and some will not. You have heard
from critics within the Administration, Executive Branch,
Legislative Branch, and the industry itself, and others. What
are some of the most valid criticisms that you have heard of
the Administration proposals? How would you rebut those
criticisms?
Secretary O'Neill. Well, since we are near perfect, I do
not know how to answer that question.
[Laughter.]
What do I think are valid criticisms? Senator Sarbanes
asked me earlier, did we look at the possibility of simply
waving a wand and saying, the American people are ultimately
responsible for the cost of terrorist acts?
I think that is a legitimate question. But there is a
legitimate question beside it which says, or a legitimate
thought process beside it which says, we have demonstrated that
insurance companies are very good at assessing a risk and
handling the claims process and working with clients to assure
that clients take reasonable and necessary steps to reduce the
risk that they have because they do not have proper security,
say for this instance, or they do not have the structural
integrity that is required to deal with terrorist risks, and
the rest of that.
Using the insurance companies as an intermediary to make
sure that the Nation presses harder on building in reasonable
protections against terrorist acts seems to me to be an
intelligent argument and a reason to keep the insurance
companies out there interfacing the rest of the world so that
we do not have to create a huge Federal bureaucracy to run a
parallel insurance system.
But what this has the effect of doing by using the private
industry sector to cover part of this risk is a way of
spreading the cost to people who have assets at risk instead of
to the general taxpayer.
And there is an argument one can have about whether it is
reasonable to spread the cost through our tax and
redistribution system as compared to using an insurance vehicle
to accomplish it. It is an age-old argument. We will never be
done with it. But I think at the moment, one thing that is
really clear to me, that we need to take some action and we
need to do it very soon, or we are going to regret the
implication that no action has for our economy.
Senator Carper. Thank you very much.
Secretary O'Neill. My pleasure.
Chairman Sarbanes. Mr. Secretary, I just have a couple of
thoughts I want to leave with you. I know you have to get away.
First, presumably, whatever we do here becomes a precedent
for health and life insurance issues as well. Is that a fair
concern?
Secretary O'Neill. We would like for it not to be. We would
like to keep that off the table. But I can understand why you
would think that. For sure, I think we should talk with the
Committee about the reasons why we think it is not a good idea
to include those. But we can do that.
Second, the complexity of this issue is reflected in an
article in today's Wall Street Journal. I do not know if you
have seen it--``Insurers Have Easy Time Raising Money.''
For a business faced with pay-outs of $40 billion or more
in the wake of September 11 terrorist attacks, the property
casualty insurance industry is having a remarkably easy time
raising money from investors.
Then it goes on and tells about what is at work in the
market.
Behind the enthusiasm for the sector is the fact that
property and liability insurers, after a decade of competing
for business by lowering prices and thus squeezing profit
margins, now are in a position to increase the premiums they
charge.
And an analyst says, ``The pattern with catastrophic losses
is that the price increases are greater than the losses.''
And then they do a track in the market. They say, sudden
premium. And they show that the index for U.S. property and
casualty insurer stocks, which was trailing behind the S&P
prior to September 11, has now jumped substantially above the
S&P. I do not quite know what to make of that, except that I
believe that it is pertinent to get that observation out on the
table.
The final point, when we did the Chrysler guarantee, which
was done by this Committee, those of us who were Members of the
Committee then, we wrote in provisions of fee charges and
compensation to the Government for the guarantee for Chrysler,
which, over time--actually, the Government came out more than
whole in the situation.
Now the airlines, we moved so quickly, we did not do that,
although I think there is some discretionary authority in the
panel of which you were a member and which is chaired by
Chairman Greenspan who can place constraints of that sort on.
Now in this instance, I gather that there is no
compensation to the Government, is there, for taking on this
risk that you are talking about in your plan?
Secretary O'Neill. No.
Chairman Sarbanes. I have no further questions.
Senator Gramm. Mr. Chairman, let me just make the following
comment.
I think, first of all, I am not the least bit surprised
that capital is available to go into insurance and reinsurance.
This is obviously going to be a growth industry. We have had a
cataclysmic event. And clearly, this is going to be a new
market for a new product that, in essence, has not existed.
People, at least, did not know they were covering it. And that,
clearly, this market is going to come into existence.
I see this, what you read there, I am not surprised and I
view it as very good news because I think it is an indicator of
two things.
One, if I had to bet my life on whether or not the market
would not solve this problem if we did nothing, I would not be
willing to bet my life on it. My guess is they will solve it.
My guess is if we did absolutely zero, that this thing would
sort itself out. I think we are taking a risk that I am not
willing to take by doing that. But I am not convinced that the
market would not solve the problem.
But what this says is that we can get the extra protection
for the taxpayer by having a threshold or retention, as they
call it in the insurance industry, of, say, $10 million. We can
make that work.
And I think this cursory data indicates we could. And I
think, second, that this is something that at the end of 2
years or 3 years, the market will be able to deal with.
I think it is good news. I think it encourages us that if
we just did nothing, that we might survive it. And if we do a
bridge program, we probably will not have to do a permanent
program. Also I think it says to me, do as little as we can do
to hedge the risk for the economy, but do not do any more.
What I am fearful of, and I would just tell you, I would
rather have the Government come in and pay for every penny of
terrorist losses for the next 2 years, than to get the Federal
Government in the insurance business. That is the greatest fear
I have, is that we are going to step into this thing now and 20
years from now, we are going to still be in the insurance
business. That just scares the hell out of me, much more than
what is going to happen if we do not take the first step.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you, Senator Gramm.
I also note that The Wall Street Journal, which you
probably saw----
Secretary O'Neill. The cabbage article there.
Chairman Sarbanes. They are eating cabbage now up at The
Wall Street Journal.
[Laughter.]
It says, ``We loathe cabbage, so understand the sacrifice
involved when we say that we would rather eat cabbage for the
next 20 years than have to suggest that the insurance industry
needs some government help.''
And then they conclude, it needs some help, although they
are not very clear on exactly what that ought to be.
[Laughter.]
They do end up with this paragraph, ``We will also admit to
some nagging doubts about whether or not the industry is
bluffing about shutting down on December 31. But we would
rather eat cabbage than find out.''
[Laughter.]
Mr. Secretary, thank you very much. You have been very
helpful. We look forward to working closely with your people as
we continue to address this issue.
Secretary O'Neill. Thank you.
Chairman Sarbanes. Chairman Hubbard, if you can come on up
to the table, we look forward to hearing from you.
If I could have the attention of the next panel for a
moment, presumably, Ms. Sebelius, Mr. McCool, Mr. Hunter, and
Professor Froot are all in the audience.
We are considering doing Mr. Hubbard and then going over
until after lunch, say to 2:15 p.m. We will finish Mr. Hubbard
here before we adjourn for lunch and then go over and come back
to resume. But I need to know whether there are any of the four
people scheduled to appear on the concluding panel who would
not be able to accommodate that to their schedule.
[Pause.]
Well, not hearing anything to the contrary, I believe we
will call on Mr. Hubbard and then the Committee will recess
until 2:15 p.m. We will resume with the concluding panel.
We want to give that panel ample time because it has been
put together with--first of all, we very much appreciate the
witnesses being willing to come on short notice, and we think
it is a very balanced panel. We think it would give us the
benefit of a lot of points of view, which the Committee is
obviously trying to collect here this morning and tomorrow
morning.
Chairman Hubbard.
STATEMENT OF R. GLENN HUBBARD
CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS
Mr. Hubbard. Thank you, Mr. Chairman. It was somewhat
dangerous earlier when you suggested to a college professor
little time limits. But I will not abuse that.
In fact, I thought this morning's Wall Street Journal
editorial that you quoted was a nice summary and actually,
pretty supportive of what the Administration wants to do.
What I would like to do----
Chairman Sarbanes. Senator Gramm used to be a college
professor and he has gotten very good at controlling his time.
[Laughter.]
Senator Gramm. Fifty minutes on Monday, Wednesday, and
Friday, and it was a hour and 15 minutes on Tuesday and
Thursday.
[Laughter.]
Mr. Hubbard. Exactly. And I promise to be even more
abbreviated than that.
What I wanted to do, since the Secretary ably walked
through the Administration's proposal, was to spend some time
with you on the economic case of why we think this is so
important and for the areas where we find a lot of flexibility
in hoping to work with you.
I would like to begin by echoing what the Secretary said,
that we are very grateful to the Committee for what it is done
in the post-September 11 period and look forward to working
with you on the terrorism risk insurance problem. The timing of
these hearings is very significant, Mr. Chairman. Just to
underscore what the Secretary said, it is not only important,
but essential, that the Congress act on this issue before the
end of the year.
In the simplest economic terms, one could think of the
shocks to the economy that we have seen since September 11 as a
kind of supply shock to the economy's ability to supply goods
and services. It is in our interest as a Nation to contain the
increase in transaction costs broadly that these attacks have
raised.
A second feature that came up in discussion with Secretary
O'Neill, is that the attacks also raised the uncertainty in the
economic environment, uncertainty about the state of where the
economy is, uncertainty about demand for particular goods and
services like aviation to a myriad of other areas.
Commercial insurance, of course, lies directly at the
intersection of these two forces. Property and casualty
insurance is one mechanism by which private economies respond
efficiently to the risks that are presented in the environment.
Risks are spread, so that for each business, a potentially
large and perhaps even unknowable, cost, is turned into a
stream of smaller known premium payments. The events of
September 11 induced quite a large revision in perceived risks.
In normal circumstances, increased risks are simply translated
into higher premiums. That is a useful thing. There is an often
too quick criticism from an economic perspective to criticize
higher premiums. That is a useful economic function of pricing
risk. It leads the private sector toward those activities where
the risk is worth it, and away from foolhardy gambles.
At the moment, however, we are not in normal times. The
entire Nation is unsure about the likelihood of additional
terrorist events. For insurance markets, unfortunately, the
distinction between risk--that is, not knowing when an event
will happen, but knowing a great deal about the odds of
occurrence--and genuine uncertainty--where we do not know about
the frequency of an insured event--is the key to being able to
price efficiently. Experience with this new security
environment will doubtlessly mitigate this difficulty over
time. In the near-term, however, what we were concerned with in
the Administration and what you have been concerned with in the
Committee's efforts is the potential problem of a disruption in
the property and casualty market in the short run.
An interruption of coverage is a particular and extreme
version of this problem. It would be a very large potential
increase in transactions cost.
We are all familiar by now with what happened in the
commercial aviation sector--the disproportionate rises in
insurance coverage or potential withdrawals of insurance
coverage that hinder transitions to a new aviation operating
environment. The phenomenon is more widespread. And here I want
to walk through
essentially the question Senator Corzine raised with the
Secretary. Lenders typically require businesses of course to
insure property before securing loans. So one immediate
manifestation of the problem is to diminish bank lending for
new construction projects. More important, perhaps, in the
overall scheme of the economy is the impediment to transactions
in existing commercial properties. That is, the resale of
skyscrapers, pipelines, power plants, and other large assets.
This changing hands, or recirculating assets, in the private
economy is an important economic function. It goes to the heart
of how we are able to reallocate capital in the economy.
From an economic perspective, then, there are really three
issues. One is this new projects issue. Second is the issue of
capitalizing costs in existing projects. We know that the
1990's were a period where, loosely speaking, we were willing
to pay a lot for money in the future. Discount rates were low.
The concern here is that abrogation or interruption in the
insurance markets would raise discount rates capitalized into
the value of existing assets, a serious problem, indeed.
A specific numerical example is that about 3 percent of
domestic income is MC&P premiums, about $155 billion a year.
That was for Year 2000 where, arguably, very little terrorism
risk had been priced. If one thinks, then, a substantial
increase would have been priced in the short run, you can get a
sense of a very large flow cost to inaction.
And third, a well-functioning private insurance market has
to be a core part of our financial infrastructure in the
economy. And that is precisely why the Administration put
together an approach and we look forward to working with the
Committee and the Congress.
I think there are very important principles for any Federal
Government involvement here. And the first I think received
perhaps not the full attention it deserved in the earlier
discussion.
I think the key and perhaps the most important element is
that intervention should encourage and not discourage market
incentives to expand the industry's capacity to absorb and
diversify risk.
A lot of the concern here has been expressed about problems
in pricing. I will come back to that. That is an important
problem. But perhaps the more compelling role for any
government involvement at all would be in the issue of capacity
in the short run. Toward that end, again, going to the article
the Chairman noted in the paper, it is precisely high short-
term returns that induce investment in capacity and can be a
positive thing.
A second principle is that any intervention should be
temporary, permitting us and you to review in the future the
ability of the industry both to price risks and absorb losses.
Third, private market actors should face appropriate
incentives to encourage efforts to limit losses should such an
event occur. And if I might digress for a moment, one of the
problems with socializing all the costs that were discussed a
little bit is that it simply provides no such incentive to the
private sector, either to take responsible risks or for the
insurance industry to process claims efficiently. I would
submit that is a road down which you do not want to go.
The fourth principle is that private sector uncertainty
about liabilities that arise from litigation should be reduced,
and I want to come back to that in a few moments.
One thing that needs to be absolutely clear, and was
missing even from the otherwise well-done Wall Street Journal
editorial this morning, is that these principles do not imply
providing government assistance to the property and casualty
insurance industry. That is simply not the subject under
discussion. The issue is mitigating short-run cost increases
for an insurance scheme in an otherwise competitive market.
We believe that the Administration's approach--and I am
using the word approach rather than proposal simply because we
do want to work with you on all the elements--match those four
principles. I am not going to go over the approach again in
detail. The Secretary already did that.
But I will say again that the key element from an economic
perspective is to mitigate short run, sudden increases in costs
of insurance over the next year. The imposition of a
deductible, Year Two in the scheme we are proposing, Year One
perhaps in some of the proposals that the Committee is
considering, and a subsequent increase in the deductible as we
have proposed would permit the Federal Government to recede
gradually from the market as the insurance industry adapts the
measuring and pricing terrorism risk.
I asserted a moment ago that the Administration's proposal
as the Secretary outlined was consistent with the principles.
Let me just walk you through a quick economic argument as to
why.
First, I think our approach is dead-centered on building
private-sector capacity to absorb risk. It respects the
insurance industry's proven ability to develop the capacity to
price, to market, and to service products for new types of
risks. I think it is important to keep some perspective here.
In the past, there were naysayers who said that the private
sector would not figure out natural catastrophe reinsurance.
There are important differences in these occurrences, as I will
come back to, but also some similarities. And I think
experience has proven that the private sector has done very
well. By providing a temporary bridge--3 years in our
suggestion; we look forward to working with you on the length
of that bridge--and steadily receding Federal presence and
explicit sunset, we believe that the industry can grow, and it
can grow well into this market.
Second, and going back to a point that I made a few moments
ago, the Administration's proposal is centered on the idea that
a key limitation in the industry--the primary insurance
industry and the reinsurance industry--is one of total capacity
to absorb risk.
It is for this reason that we think the economic function here
is limiting maximum exposures in the event of very large catas-
trophes which would necessarily generate large transactional
cost increases for businesses. And let us be clear, that means
prices for consumers.
A third reason we feel our proposal is consistent with the
basic principles and economics outlined was that the industry
is sharing in the losses, or skin in the game, in Senator
Nelson's terms, up to a maximum loss, and the share that it
shoulders rises over time. We can quibble whether it starts in
Year One or Year Two, but I think I sense a pretty broad-
spirited agreement on that point. And there will be an
important profit motive for insurance companies to begin now to
refine pricing models. Again, I think that profit motive is
both good and essential to making that private market work.
There are economic benefits to the efficient pricing of risks
and that needs to be left to the industry. Now, having said all
of this, the potential losses that face insurers, whether they
are from a natural disaster like Hurricane Andrew or from a
man-made disaster like a terrorist act, depend not only on the
security environment we have been talking about, but on the
legal setting as well.
And let me give you a quick numerical example and walk you
through why we felt from the economics of the problem that some
tort issues were important. The initial physical costs from
Hurricane Andrew in 1992 of $6 billion became more than $20
billion, and still ticking, in part because of the cost of
litigation.
The Administration wanted to include certain legal
procedures that were designed to manage mass tort cases that
might arise out of terrorism incidents. We believe very
strongly that these procedures will bring damage claims closer
to economic fundamentals and more importantly, from an economic
perspective, reduce the uncertainty about the magnitude of
potential claims. Much has been made in the discussion thus far
this morning of uncertainty over costs of disasters, and that
is an important problem. But go back to the Andrew costs. The
morphing from 6 to 20 was not uncertainty about the hurricane.
It happened only once. It was uncertainty about the legal
system. We believe that consolidation of claims in a single
Federal forum would help to ensure that the claims would be
treated in a consistent manner, reducing uncertainty in the
private sector and eliminating redundancy costs of litigating
similar claims in multiple jurisdictions. We believe that
limitations on punitive damages, obviously other than those
that are directed literally against perpetrators and their
betters, and proportional liability for noneconomic harm,
reduces the potential for open-ended claims that would exhaust
not only initial defendants' resources, but potential
collateral defendants. This is the kind of uncertainty that we
can work together to address, even while we are working
together on the larger concern of terrorism.
We believe these reforms are not just add-ons to an
otherwise good proposal. They are absolutely essential to
getting a private market and insurance up and running, and that
appears to be not only our goal, but I think the goal of all in
the discussion thus far.
Let me say briefly a word about three roads not taken, at
least in our approach that came up this morning. One was the
issue of the monopoly pool model. Our concerns there were to--
to put them in economic terms. One was, while I characterized
the insurance business as, roughly speaking, competitive, we
believe these pools could generate the potential for
significant monopoly power. Let
us be clear where that goes. It is a higher cost of doing
business, higher prices for consumers. We view that as
unnecessary, while still preserving a legitimate role for
intervention you might take.
The second I referred to earlier--full government
socialization. While it is possible to make an argument in that
direction, I do not believe that argument holds much water upon
closer inspection, precisely because of the failure to grant
incentives both to individuals as managers of buildings and
properties, and to the insurance industry as it processes
claims.
The third that came up was the issue of charging premiums.
One of the things that I hope we all can agree, or I hope we
can all agree, is that we do not want the Federal Government in
the long-term insurance business. We believe that the short-run
issue of cost-sharing that the Secretary outlined earlier is a
way to get private-sector participation and some of the costs
borne directly in the P&C insurance base, without charging
explicit premiums.
If we are all arguing among ourselves as to when we think
the private sector will be able to efficiently price risk, let
us ask the question when we think government officials would be
able to do that. I think that would be close to a nonstarter.
To conclude, I think it is our view that the economy as a
whole is very resilient. And we believe that the combined
efforts not only of what the Administration is doing, but,
importantly, its work with the Congress, can provide
transitional public policies to make sure that what might
otherwise be temporary disruptions do not become permanent.
Again, I think the property and casualty industry raises
important issues. These issues are not issues about the
industry. They are issues about consumers and the businesses
that provide goods and services for them.
Thank you, again, Mr. Chairman, for the opportunity and I
look forward to yours, Senator Gramm's, or Members' questions.
Chairman Sarbanes. Thank you very much. Is it your view
that it is the cost of insurance that leads the insured to take
steps against terrorism?
Mr. Hubbard. Well, one appropriate--people, of course, have
incentives for a variety of reasons to take measures against
terrorism. The larger the financial incentive, the greater the
incentive for hardening buildings, providing extra security
systems, and so on, much as you might in your own home if you
were faced with different pricing if you did different things.
Chairman Sarbanes. It is your view that if the Government
assumes the responsibility for paying the cost of terrorism, so
that was then not factored into the insurance cost, that the
insured would then be lax in guarding against terrorism. Is
that your view?
Mr. Hubbard. I think these are questions of degree.
You are painting them as poles. I think the question is,
what are the incentives for me to harden a building that I own
or to make sure that, if there is an act of terrorism, that the
damage is not any larger than----
Chairman Sarbanes. I understand that. And you think you
need to put a cost into the insurance in order to get you to do
that. Is that right?
Mr. Hubbard. That is correct. I think there are two reasons
for that cost.
One is for the private sector to face the right incentives.
The other is for the industry to face the efficient incentives
in processing claims.
Chairman Sarbanes. Well, that is a different issue, the
processing of claims. I recognize that point about using the
expertise.
Mr. Hubbard. Keep in mind----
Chairman Sarbanes. In order to process the claims. But I am
trying to get at apparently this view of yours that the really
motivating factor to get building owners and managers to guard
against terrorism is that it is factored into the cost of their
property in casualty insurance. Is that your view?
Mr. Hubbard. No. Keep in mind, Senator, that the difference
between what is the premise of your question of what is in the
Administration's proposal is 90/10 versus 100/0. So we are not
talking about polar extremes.
Chairman Sarbanes. That is right, which only underscores
the thrust of the question.
Let me ask you this question. Why are you putting the
Administration in on first-dollar damages? If you say that the
problem the industry has is limiting the maximum exposure, that
is what creates the problem for them. So they do not know. They
might have some huge bill to pay and therefore, they have to
guard against that, some enormous amount of money.
And I understand that argument. But why does the resolution
of that argument require coming in for first-dollar damages on
the part of the Government?
Mr. Hubbard. The question is one of timing, Mr. Chairman It
certainly is a long-run matter. If there were any role for
government at all, it would be only on the back end, which is
the premise of your question. But the problem we are facing is
in the short run, in the market trying to figure out how to
price things.
Our view was, particularly in the current economic
situation,
we wanted to have as minimal a disruption, as minimal and
necessary increase in property and casualty rates to move to
that new environment.
We have a deductible beginning in Year Two. You may well
decide to do a deductible in Year One. But our philosophy was
simply to keep the first year of this as blunting cost
increases as possible.
Chairman Sarbanes. And to ask the question that I asked
earlier, how are you assured the companies do not use the
premium boost in effect to overprice the risk to their pocket
advantage?
Mr. Hubbard. Well, I think the short answer to that is the
single word, competition.
The longer answer would be that, in the short run, it is
quite likely that an industry like this could underprice as
well as overprice if the problem is uncertainty. And the
increased premium----
Chairman Sarbanes. How likely do you think it is that they
will underprice in this circumstance?
Mr. Hubbard. One does not know until we put a specific
policy on the table. But I have no doubt that the industry in
the long run would not have significant competitive price
discipline.
In the short run, if the behavior you indicated happened,
you would see a pretty rapid rebuilding of capacity in the
industry precisely as the article that you referred to in The
Journal suggests.
Chairman Sarbanes. Well, the industry has very significant
capacity now, does it not?
Mr. Hubbard. Well, the P&C capital base is around $300
billion. There are different lines and commitments of that. But
that is a pretty significant capital base.
Chairman Sarbanes. Yes. Senator Gramm.
Senator Gramm. Mr. Chairman, let me say that I do not know
that it is an extraordinarily relevant point, but I think the
argument that you are making against just Government providing
the coverage----
Chairman Sarbanes. I am not making that point.
Senator Gramm. I know.
Chairman Sarbanes. I am just trying to explore the
parameters here so we get some idea of where they are coming
from.
Senator Gramm. The point I made earlier, if I knew we were
getting into the insurance business, I would take it as a
preferable alternative for 3 years.
The problem is getting out of it once you have gotten in
it. Second, it gives you no bridge to get out of it. And you
had added what I think is a very small factor in it, and that
is, for example, as a business, and in some case, homeowners,
you get lower insurance rates if you put in smoke and fire
alarms.
You might say, well, your children are sleeping in this
house. Why didn't you do that anyway? Well, the problem is, you
figured, well, it may not be essential, but if I am going to
get an immediate reward, I do it. People do respond to this.
You get lower life insurance for not smoking. Only an idiot
would smoke cigarettes, given everything we know. I know many
idiots.
[Laughter.]
And respect them on all other subjects.
[Laughter.]
On that subject, they act like idiots. But, anyway, so much
for antismoking.
[Laughter.]
Let me say that I strongly agree with you, Glenn, and I
just want to emphasize it, on this liability. The Federal
Government is stepping in--however we do this, there is going
to be Federal Government exposure. And I think the taxpayer is
going to want to be sure that we are providing this assistance
to keep the economy going. And since we are giving this
coverage, the idea that someone could sue us for punitive
damages or that we would be subject to class-action lawsuits,
or that a substantial amount of the cost could end up being
what at least a person like me calls frivolous lawsuits, is
almost unthinkable.
I think that is an important component here. And since we
are backing up private money, if we do not give that coverage,
at least in this interim program, to that money, it ends up
being eaten up by those things and we end up being the payer
sooner. So I think that is the important ingredient in your
proposal, and I want to urge you to stand by it.
Let me just conclude, Mr. Chairman, by saying that I think
that the Administration's proposal has a lot of good
ingredients in it. I think if you just throw away the first
year of your program and start with the second year the first
year, you will be making a major step in the right direction.
Based on having listened to my colleagues today, we are not
going on the hook for 80 cents out of the first dollar of loss.
It may very well be a logical place for us to get together--and
I think we can make it a bipartisan proposal, and if we can end
up with something that the Administration supports, and we
support it, it would be helpful.
I think we do not want--whatever agendas we have that have
nothing to do with this, I think we all agree that we want to
leave it out of this. I think that is the way to do it.
But I just want to thank you and the Administration for
putting this, even though I do not support it, for putting
together a very thoughtful and a very helpful proposal, and one
that I think we can work on together, and I look forward to
working with you on it.
Mr. Hubbard. I think I will count you as a two-thirds
supporter.
[Laughter.]
Senator Gramm. Well, two-thirds is not bad.
[Laughter.]
You win a lot of elections with two-thirds. I have never
achieved that total.
[Laughter.]
Thank you very much.
Chairman Sarbanes. Senator Corzine.
Senator Corzine. Yes. Mr. Hubbard, I wonder if you have
done any economic analysis if we do not act with regard to
this. You talked about the categories of things that might be
enacted in the economy. But have you done any runs of economic
models to see how much it might actually cost the economy if we
do not deal with this issue?
Mr. Hubbard. Well, the quickest thing that we did that is
to look again at the importance of premium domestic income and
just make a range of assumptions about what might happen to
premiums. The total amount of the premium paid is $155 billion
in narrowest terms in the year 2000, a little over 3 percent of
domestic income. So you can pick your favorite increase in that
and get a sense of the cost hit to industry.
I think perhaps the more serious concern is the
capitalization factor if discount rates in projects get changed
because of a belief in the lack of insurance. That changes the
value of existing skyscrapers, power plants, and so on.
Senator Corzine. I am not sure I fully understand the
analysis, but that sounds like you are pushing upward of 1\1/
2\, 2 percent of GDP.
Mr. Hubbard. I am not sure how you get to 1\1/2\. Just
because the $155 billion----
Senator Corzine. Knowing that is not going to be dollar for
dollar translated through, and then you are going to have the
secondary impacts with regard to the discounting numbers.
Mr. Hubbard. Right.
Senator Corzine. You are talking about a serious impact.
Mr. Hubbard. That is a little too big. One hundred fifty-
five billion dollars is what was actually paid before when
arguing there were pricing risks at zero.
So the question is, how much do you think that would go up
if you were pricing the terrorism risk? With 1\1/2\ percent of
GDP, that is probably too extreme.
But that calculation misses, I think, the capitalization
effects and the value of assets, and that is probably what
slows down development the most, the fear that lenders have
that the projects would be worth less.
Senator Corzine. Even by that analysis, it is a very
substantial amount.
Mr. Hubbard. Yes.
Senator Corzine. How much of the $300 billion of the
capital base of P&C's do you believe has been designated for
terrorism risk?
Mr. Hubbard. You mean that is available to pay?
Senator Corzine. No, no. We have other lines, as you
suggested. So there are all kinds of other calls on that
surplus.
Mr. Hubbard. My understanding from Sheila is that they have
not reserved.
Senator Corzine. I think that is the point, when we talk
about how healthy the industry is with regard to surplus. And I
am not particularly in favor of no first dollar participation,
the first dollar position that we have here.
I think that people take false security in thinking about
$300 billion worth of surplus when we still have natural
disasters and fires and other things that go on.
I also would like to know if your intent with regard to the
legal recommendations that you are making are designed only to
fit to the bridge proposal you have here, or are they intended
to be long-term recommendations with regard to terrorism risk
insurance?
Mr. Hubbard. Well, that, of course, would be up to the
Committee and the Congress. Our view is that they go hand-in-
glove with a reform in this area. We are only considering----
Senator Corzine. When they are proposed, do you expect that
they would be proposed only limited to the proposal that you
have and not deal with the overall context of terrorism
insurance?
Mr. Hubbard. If your question is beyond 3 years, if you
decided to go the route of a more permanent program, I do not
believe that the private market will function in the way we
want and hope it will without these legal reforms.
Chairman Sarbanes. So you are now reaching for permanent
tort reform. Is that right?
Mr. Hubbard. The question was if there were a permanent
proposal. We are asking for a 3 year in our proposal set of
packages. If you were designing a permanent system, it would be
my advice to you as an economist that that system would not
take off very well with private-market participation without
these legal reforms.
Chairman Sarbanes. You are complicating further a very
complicated situation. I just want to make that observation.
Tort reform is not a matter under the jurisdiction of this
Committee, and it is a highly controversial issue. Now, in a
sense, you are piggybacking it on here and we just have to take
a look at that.
Mr. Hubbard. If I might, Mr. Chairman, this is not a
piggybacking. This is absolutely essential. If you go back to
the argument that I gave you about Hurricane Andrew----
Chairman Sarbanes. Well, some aspects of it may be and some
may not be.
Mr. Hubbard. No, that is right. What you need to do is take
a look at what----
Chairman Sarbanes. You are going to have one venue for
hearing all these cases?
Mr. Hubbard. Yes, Mr. Chairman.
Chairman Sarbanes. Where would that venue be?
Mr. Hubbard. It would be a single Federal jurisdiction.
Chairman Sarbanes. Where?
Ms. Bair. It would be the multidistrict panel on tort
litigation.
Chairman Sarbanes. Which is located, where?
Ms. Bair. Federal Government court structure.
Chairman Sarbanes. I know, but where is it physically
located?
Ms. Bair. Well, they would make the determination about
where.
Mr. Hubbard. How about Maryland?
Ms. Bair. It would be in Federal Court. And this panel
would make the determination depending on where the incident
occurred.
Chairman Sarbanes. You know, you all seem to assume that
witnesses and aggrieved parties can travel all over the country
in order to press their claims without experiencing great
difficulties in doing that. I find that a fantastic assumption,
if that is the premise of the system you are setting up.
Ms. Bair. Senator, I think claims consolidation and
punitive damages limits are very important.
Chairman Sarbanes. No, no, you are adding other things in
there. I am slicing this thing now.
Ms. Bair. Right.
Chairman Sarbanes. I am slicing it now to the venue. And as
I understand it, you are going to have one venue nationwide. I
am raising a very simple question, it seems to me; What does
that do to litigants who would have to travel great distances
at great expense and inconvenience in order to assert their
legal claims? That is the question. What is the answer to that
question?
Mr. Hubbard. I am not an attorney. So the economic key to
this is that you have a single jurisdiction. You can have
different single jurisdictions, but there needs to be a single
jurisdiction. The counter-argument to your claim is the venue
shopping.
Chairman Sarbanes. No, no. You suffer a terrorist problem
and you live in Los Angeles, where it happened. And you have to
go to Washington, DC or New York City in order to assert your
claim. Do you see a problem connected with that?
Mr. Hubbard. Well, again, you have a single jurisdiction
per incident----
Chairman Sarbanes. Do you think that has no problems
connected with it?
Mr. Hubbard. As opposed to the lack of consolidation of
claims, then we are in an empirical argument, Mr. Chairman. The
important thing is to reduce the transactions costs in the
process so that the litigation costs do not wind up dwarfing
the physical costs.
Chairman Sarbanes. If you suffered the damage and you had
to come all the way from Los Angeles to Washington in order to
assert your claim, it would be an imposition on you, would it
not?
Ms. Bair. Senator, I just want to clarify. I do not think
the Administration is talking about a single Federal district
court to hear all terrorism claims. It would be per-incident,
just the way consolidated claims in the Southern District of
New York for the attacks in Manhattan.
On a per-incident basis, we would envision going forward
that those claims would be consolidated, presumably, in the
Federal district court where the incident occurred. But I think
that is the kind of thing that we are talking about.
Chairman Sarbanes. Well, that is a more sensitive and
rational response to what I have been getting.
Do you have anything else, Senator Corzine?
Senator Corzine. I am troubled by this context because if
we think that this program is necessary to deal with a short-
run problem by the industry and its inability to price this
risk and, somehow or another, we are going to get greater
comfort 2 years and 3 years from now, which I am not certain
that I accept that assumption, but let us just do that for
conversational purposes, and we are going to change the tort
structure for the period of time while it is on, and then it is
going to come off, how is the insurance industry going to learn
anything?
Again, I am not arguing that we should do anything with
regard to tort activities, but you are changing the whole
rationale when you come back to go to the private market
solution, pure private market solution, for the operation of
this bridge.
That does not make sense to me. You say we want this so
that we will be able to have the price discovery mechanism have
enough time to go through it, but we are not going to allow for
any discovery with regard to litigation that might come from
personal liability, culpability, or other issues.
I do not think that the insurance companies are going to
develop a book that allows them to be able to do that in that
timeframe, unless you are arguing that we are basically for
broad tort reform that goes beyond the timeframe of the bridge.
Mr. Hubbard. I do not think that is any different from any
other major element of the proposal. The theory is that you
would review this in 3 years or whatever horizon you choose.
That would include not only the legal process issues, but every
other element.
I accept that uncertainty, but precisely for the reason
that the Chairman indicated, we did not want to use this as an
occasion to look for an entirely different permanent piece of
legislation. We wanted to focus this on the property and
casualty problem.
Chairman Sarbanes. Well, obviously we will have to continue
to explore this. I think we have to simplify this so that we
have a better feel for what the ramifications or consequences
are, and so that it is more easily explainable in terms of the
public understanding.
But we will hear from the next panel, which I assume the
Treasury will monitor. I certainly hope so, because I think the
views expressed there will need to be taken into account. And
we will hear from our two panels tomorrow and then see what we
can sort out in terms of what is a reasonable and rational way
to deal with the situation.
I want to say to the Chairman of the Council of Economic
Advisers because I am looking here at an article by John
Sweeney in this morning's paper, which you have probably seen.
The essential thrust of it is that there is an inadequate
consideration of the question of emergency jobless benefits for
workers and emergency health care coverage for workers.
I think there is a growing danger that we are responding to
this crisis and challenge in an unbalanced way. As someone
said, actually, right at the witness table earlier today, the
airline companies got help, but the airline workers did not get
help. We are looking at trying to address a problem confronting
the insurance industry, but there are other things that are not
being done.
They are less directly related than the airline situation
where they did one side and not the other. But, nevertheless, I
think the Administration needs to give some additional and
careful thought to having a more balanced response to this
challenge, so that there is a sense in the country that it is
equitable in how it is seeking to deal with the situation.
This is obviously bringing in a lot of issues that are not
the focus of this hearing, and some that are well beyond the
jurisdiction of this Committee. But I simply want to make that
point to you, and I think the Administration needs to be
thinking more broadly in those terms, in terms of having a
balance in what they are putting forward and seeking that
provides an assurance to the country that this is being done in
a fair and equitable fashion. And I would leave you with that
thought.
Mr. Hubbard. Well, if I might just offer a quick thought in
return, Mr. Chairman. The President proposed the displaced
worker package that did indeed offer an expansion of
unemployment insurance and increased the funding for national
emergency grants, which would have provided a great deal of
flexibility for Governors, not only in the jobless problem that
we are now facing, but also in health insurance.
Chairman Sarbanes. You are taking the CHIP money for health
care for children and shifting it over, and a lot of us--it is
not the purpose of this hearing to engage in that. But a lot of
us think that that is just playing shell games.
We have some CHIP money out there that has been provided to
the States to get health care for children. That is the
approach. Some of that money has not yet been spent by the
States because we are still gearing up to it, and so forth. And
you are proposing to take that money and move it over here to
get health insurance to unemployed people. Now we want to get
health insurance to unemployed people, but I do not think we
want to do it at the expense of taking it away from children.
Mr. Hubbard. I am afraid I could not just let that comment
stand, Senator. That is not really the intent at all. The CHIP
program, for reasons we do not have to go into here, has a lot
of inflexibility in it and does not well cover populations it
is designed to cover. And this would improve that flexibility
greatly.
Chairman Sarbanes. Mr. Hubbard, look. We could go at this
all day long. Let me just say this to you. I think there is a
percep-
tion in the country on the part of a substantial number of
people, and a perception in the Congress on the part of a
substantial number of people, that what is being done does not
have a full equity component.
I am just putting that to you in a sense, hopefully, of
some friendly advice. Now you may choose not to act on it, and
if so, I think this impression will continue to grow.
But this Committee has certainly tried very hard in order
to do that, if you witness the speed, and I think the care as
well, in which we acted on the money-laundering issue. I am
just passing this along to you. You may simply consider it as
gratuitous advice and proceed to ignore it.
Mr. Hubbard. No, I appreciate it very much, Senator. Again,
we are very grateful for the work the Committee did on the
money-laundering front.
The one closing thought I would leave you with is, again,
in your reference to the insurance industry, I would submit
that is not why you wisely held this hearing. I think you
wisely held this hearing about the cost of doing business in
the country. And that is the problem that you are working
toward and we hope to work with you.
Chairman Sarbanes. We are trying to address this issue,
otherwise, we would not have scheduled 2 days of hearings.
Thank you very much.
Mr. Hubbard. Thank you, Senator.
Chairman Sarbanes. The Committee stands in recess until
2:15 p.m., at which point we will take the panel that I
indicated earlier that had been scheduled.
[Whereupon, at 1:05 p.m., the Committee was recessed, to
reconvene at 2:15 p.m., of the same day.]
Chairman Sarbanes. The Committee will reconvene.
I apologize to the witnesses. There are a lot of things
happening all over the place here, as you can well appreciate.
I see we have some time constraints here. Professor Froot,
you have to leave, I gather, at 3:30 p.m.
Mr. Froot. 3:30 p.m. or 3:45 p.m.
Chairman Sarbanes. Why don't we go ahead and hear from you
first, and then we will pick up with the others.
And you, Ms. Sebelius, have to leave at 4:30 p.m. And we
should be all right on that. Why don't we hear from you because
then we will take the rest of the panel. And by that time, you
may have to excuse yourself.
So why don't you go ahead?
STATEMENT OF KENNETH FROOT
ANDRE R. JAKURSKI PROFESSOR OF FINANCE
HARVARD UNIVERSITY
Mr. Froot. Mr. Chairman, Senator Gramm, and Members of the
Committee, I appreciate the opportunity to appear before you
and discuss the insurance and reinsurance markets in the
aftermath of the events of September 11.
I come to this issue really as an academic economist, which
I think of as a person who is good with numbers, but lacks the
charisma of an actuary.
[Laughter.]
I am also very pleased to share with you this after-lunch
session and note that it is an established fact that auto
accidents peak between 1 p.m. and 3 p.m., after lunch each day.
[Laughter.]
What I would like to do is give you a little bit of a
background on my own impression of the events surrounding
Hurricane Andrew and Northridge and pull that forward to today.
I think we run the risk of considerable dislocation in
these markets going forward, given especially the annual nature
of reinsurance renewals. However, at the same time, we need to
preserve the benefits of a vibrant insurance marketplace, high
quality, evaluation, pricing, allocation, and mitigation of
risk.
In the early 1990's, the United States experienced two very
large natural disasters--Hurricane Andrew and the Northridge
earthquake. The losses from these events were a shock to an
industry that had rarely considered and had never seen losses
of these magnitudes from natural perils. Firms were obviously
stressed, along with their capital.
Let me spend a second of my testimony here tracing out the
industry response. First, as one might expect, insurance and
reinsurance prices rose spectacularly immediately following
Andrew, doubling between 1992 and 1993.
The second point to make is that after these events, prices
then fell steadily between 1994 and 1999, as the effect
dissipated to about half of their level. Additional risk-
bearing capital and new firms entered the reinsurance industry,
increasing competitiveness, and approximately $10 billion of
additional capital flowed into new reinsurers, much of which
was the result of the attractive post-event prices.
I should comment that, in fact, as the stock prices we have
seen in The Wall Street Journal today have increased, so, too,
it has been regularly with natural catastrophes in the past, as
the opportunities for insurers to write and as the demand
increases following events. We see stock prices rise and
capital then wanting to flow into that sector.
The third point I take from this is that the growth that
has occurred through the creation of a variety of new
instruments and new institutional reinsurance mechanisms. For
example, there have been new prototypes for reinsurers
domiciled in tax- and regulation-favorable countries. These
have been developed and highly streamlined over this time
period.
Fourth, additional sources of capital outside the
reinsurance sector have become quite active. Cat bonds, and
related financial
instruments which could be purchased by investors became viable
alternatives to reinsurance treaties as a way of transferring
risk. Even though relatively few cat bonds have been issued,
they have nevertheless promoted competition substantially in
the industry.
Fifth, while this is hard to summarize in numbers, the
entire discourse surrounding natural catastrophe events changed
during the post-event period. Insurers, reinsurers,
commissioners, regulators, rating agencies, brokers,
consultants, third-party risk assessment firms, all of them
became much more aware of the possibility of these events,
where they might occur, what kinds of buildings were at risk,
how construction techniques can be approved, et cetera. The
language and vocabulary surrounding these events grew
enormously, and that led, of course, to better pricing in the
reinsurance and insurance markets and a better awareness, not
just for risk allocation, but also for risk mitigation.
These changes have helped reduce the post-event price of
reinsurance. But I think perhaps more importantly, they have
also increased the amount of reinsurance protection that is
commonly purchased today. If you look at the second graph of
those color pictures, the ones down at the bottom labelled 4-D,
it shows the fraction of reinsured losses covered at different
levels of losses for the industry in 2000. The results are
striking here. Before Andrew and Northridge, the most common
layer of protection purchased against industry-wide events
covered events of about $4 billion. As of 2000, the most
popular level of loss protection had about tripled, to $12
billion. In addition, today substantial coverage has been
extended to much larger levels. Protection against natural
catastrophe losses of $25 billion or more is not uncommon. This
is the legacy of Andrew and Northridge, and it is a permanent
one, given the changes discussed above. What do I take from
this little bit of retrospective for policy pointers for today?
First, I think it is very clear from this evidence that the
reinsurance industry is efficient over the medium term. The
industry can and does respond to large disasters. High prices
certainly occur, but these motivate the response. Figure 4b
shows prices have returned to their pre-Andrew levels, even as
the lower Figure 4d shows that demand today for reinsurance has
increased enormously. This is the sign of an economically
efficient industry, one that can expand capacity, have
financial innovation, and accommodate a large increase in
demand with virtually no increase in price.
Second, there is evidence that this medium-term response
time has grown shorter today. Following Andrew, the post-event
spike in prices took several years to undo. But there are a
number of reasons to believe that the response would be much
faster now.
First of all, we built what I like to call hardware,
institutions, Bermudan reinsurers, transformers, other
financial institutional forms, including capital-market
instruments, that can rapidly and smoothly incorporate new
capital.
Second, there is the software around that hardware. The
expertise and knowledge of the brokers, the investment bankers,
the reinsurers, insurers, rating agencies, investors,
regulators, all of whom are much more familiar and fluent in
the activities of risk transfer in these areas.
I think there is plenty of direct evidence now that this
hardware and software is at work. In just a month after these
terrible events of September 11, one is aware of billions of
dollars--to be precise, around $5 or $6 billion of committed
funds already moving into the reinsurance sector.
We have alluded already to The Wall Street Journal article
in the paper today that cites another billion dollars from AIG,
Goldman Sachs, and one other firm. And I am aware of at least
another billion and a half of funds that are in the process of
being raised.
That would come to about $6 or $7 billion worth of funds,
which is fully half of the entire industry requirement under
the Administration proposal for the first year, all done, or
not completely done, but all certainly moving very rapidly, and
much of which is done in the first 6 weeks after these events,
the first 6 weeks being of course the most shocking.
Third, I would say that any form of sustained provision of
reinsurance by the Government will impede the kind of progress
we have made in developing the software and hardware and the
ability to process these kinds of issues. The decisions that
need to be made throughout the economy affect exposure in real
ways. What types of steel and concrete reinforcements help
reinforce buildings of various heights? What kinds of physical
barriers around buildings shall we have? What kinds of
equipment for checking, opening, or possibly sterilizing mail
would we expect? I think it is not really a question, as we
heard earlier this morning, of whether we will rebuild downtown
New York. The question is how will we rebuild it? What kinds of
coverage will be available for specific types of buildings? I
think that is going to lead, in the end, to more rational
mitigation of risk and better risk allocation.
Fourth, the sheer level of uncertainty about the likelihood
of terrorist attacks is not in itself a reason to replace
market functions with Government programs. Critics of
catastrophe modeling, of which there are many, including some
of the most important reinsurance underwriters, argue that
models provide false precision about the probabilities of
disasters and that they are unknowable. The uncertainty
surrounding the one-time potential impact of the Year 2000
computer bug was certainly extreme. Yet, this did not stop the
creation of private insurance dedicated to protecting against
Y2K damages.
And in that event, of course, with respect to Y2K, one
might expect as an insurer that the firm's purchasing insurance
might know a good deal more and have considerable more control
over their exposure to that bug than the insurer would know
about. That certainly is not the case with respect to terrorist
events.
In terms of the Administration's proposal, I support in a
qualified way this approach of a limited, temporary, Federal
intervention in the insurance market. A measured response is
appropriate to assure continuity in the insurance markets and
to support renewed economic growth. I agree with three of the
basic principles of intervention that were discussed earlier,
that intervention should generate appropriate price incentives,
that it needs to encourage private market incentives to expand
capacity as needed, and that it needs to help produce
uncertainty about liabilities that are associated with
litigation. In addition, I believe that if these three
principles are to be satisfied, the sunset feature of the
program is absolutely essential.
In that spirit, I would also strengthen the second
principle of this program that deals directly with the sunset
feature. In my view, it should read that the intervention shall
be absolutely temporary and primarily intended to resolve
severe, short-term dislocations of the market due to a sudden
shift in risk and coverage perceptions. I believe that is what
we have and I believe that is a concern, indeed, for January 1,
but I believe that these concerns die away considerably over
time. I do concur with Senators Gramm and Nelson that a greater
participation by the industry in the first-year losses is, at
least for the first dollar claims, is probably appropriate.
Over 1 or 2 years, however, I believe the market is fully
capable of evaluating pricing and designing exposure to large
risks. The existence of anything more than a targeted, highly
temporary, Federal program is likely to forestall development
of better insurance markets and pricing, better risk
allocation, and mitigation decisions by the private sector.
Thank you, again, Mr. Chairman.
Chairman Sarbanes. Well, thank you very much. We appreciate
your statement and the effort that went into preparing it. And
we very much appreciate your being with us.
Ms. Sebelius, we would be happy to hear from you.
STATEMENT OF KATHLEEN SEBELIUS
PRESIDENT, NATIONAL ASSOCIATION
OF INSURANCE COMMISSIONERS
COMMISSIONER OF INSURANCE, THE STATE OF KANSAS
Ms. Sebelius. Thank you, Mr. Chairman.
I am Kathleen Sebelius. I am the elected Insurance
Commissioner from Kansas and serve this year as the President
of the National Association of Insurance Commissioners. We
appreciate the opportunity to be with the Committee Members
today.
Today, I really want to focus on three basic points. First,
the NAIC and our members believe there is presently a need for
the Federal Government, working with the State regulatory
system, to provide appropriate financial backup to the private
insurance market in order to ensure that the Nation's economy
does not falter due to a lack of insurance coverage for
terrorism. Although we have not endorsed any specific proposal
for Federal assistance, we have adopted a set of 19 principles
that are attached to my testimony that we believe should form
the basis of a sound program of the Federal Government.
Second, we believe Federal assistance should be a short-
term solution to stabilize the commercial marketplace, while it
regains the risk assessment and pricing equilibrium needed for
private insurers to underwrite terrorism exposures. Any Federal
terrorism insurance program should be limited in scope and
duration.
And third, a Federal insurance program should maximize the
use of market forces to add efficiency and reduce the risk of
losses from terrorism and the potential cost to Federal
taxpayers.
Let me just start by saying that we really do believe that
the insurance industry is well capitalized and financially able
to withstand the pressures created by the September 11
terrorist attacks, which right now are estimated to be upward
of $30 billion. The industry is a $1 trillion business with
assets of more than $3 trillion. And the preliminary loss
estimates of $30 to $40 billion represents just 3 to 4 percent
of the premiums written in the Year 2000.
As regulators, my colleagues and I will continue monitoring
the process to make sure that insurance promises are kept. To
do our job, we have an array of human and technical resources,
including our center office, the NAIC, of 51 State insurance
departments that collectively employ more than 10,000 people
and spend about $900 million annually on insurance supervision.
In addition, the State insurance guarantee funds have the
capacity to provide up to $10 billion to compensate American
consumers in the event of insuring insolvencies.
We would urge Congress to structure any Federal assistance
program to take full advantage of the existing regulatory
system. We have mechanisms in place to monitor solvency and to
handle claims payment issues.
The business of insurance is about measuring risks and
selling promises to cover them with a reasonable profit. Over
time, insurance experts have demonstrated a remarkable ability
to adapt to unforeseen circumstances, while making available
the insurance products that are essential to the growth and
productivity of American business. As expected in a free
competitive market, individual companies may stumble, falter,
and even fail when substantial adversity strikes. However, the
industry as a whole has a long and proud record of finding ways
to overcome new obstacles, while advancing its business goals
and serving the interests of the insurance-buying public.
Thus, the NAIC believes Congress should begin its
consideration of Federal assistance to the industry by
recognizing the strength and adaptability of the private
markets. Federal actions that disrupt or interfere with private
market forces are likely to end up causing more harm than good
for both consumers and taxpayers.
State regulators know from their own experiences that
Government action can help the market recover when it becomes
overwhelmed by changing risk factors or catastrophic losses. We
found successful Government assistance involves tailoring
actions to fix specific problems and keeping the program as
narrow as possible.
State insurance regulators believe the current situation
affecting the availability of insurance for active terrorism is
similar in nature to other catastrophic events. Enacting a very
temporary Federal solution will provide the necessary time to
craft a more thoughtful, long-term solution.
Here are three market factors that we would like to keep in
mind. First, following the September 11 attack, Government and
commercial facilities across America have begun to add security
measures to prevent acts of terrorism and limit potential
damages. As commercial risk managers review these new
precautions, it is likely that they will become more inclined
to offer terrorism insurance because the possibility and extent
of potential losses will be reduced. At that point, we expect
market forces will start filling the gap by making terrorism
insurance available through the private industry.
Second, the private market instills policyholder discipline
to avoid insurance claims through the concept of coinsurance.
Coinsurance means that policyholders are liable to pay part of
any losses covered by insurance before expecting recovery from
an insurer. It is a common concept known by everybody who buys
car insurance or health insurance as a deductible, which you
pay before receiving payment from the insurance company. And we
think coinsurance should be considered by Congress as an
important market discipline tool that works equally well with
Government programs.
Third, the scope and duration of any Federal assistance
program will itself become a factor in the private market. Even
though Congress is considering special Government assistance
intended to operate as a supplement to normal business
channels, the very fact that you will pay certain costs of a
commercial business becomes a factor to be taken into account
when the private market decisions are made.
We think that it is appropriate in the short-term to have
the Congress involved, but basically feel that it is
appropriate to have that very short-term and very strategic and
not disrupt the private market forces. We look forward to
working with Congress, with insurers, with the Administration,
so that the needs of individual Americans and our Nation's
economy are met in a timely way.
Thank you.
Chairman Sarbanes. Thank you very much.
Mr. Hunter, why do not we hear from you, and then we will
conclude by hearing from the GAO.
STATEMENT OF J. ROBERT HUNTER
DIRECTOR OF INSURANCE
CONSUMER FEDERATION OF AMERICA
Mr. Hunter. Thank you, Mr. Chairman. And thank you for
holding this important hearing and I particularly thank you for
doing the Nation's business in these hard days. We appreciate
it.
This hearing seems very familiar to me since, when I was
young man and starting out as Chief Actuary of the Federal
Insurance Administration back in the early 1970's, I was asked
to calculate actuarially sound rates for the riot reinsurance
program that Congress enacted to keep insurance available and
affordable in the inner cities of America in the riot era of
the late 1960's. There is a lot to fear in uncertainty then, as
now. We were very concerned about whether there would be
markets for insurance.
Further, it is very familiar because the Banking Committee
was where we held all the hearings where we developed the plan
and implemented the plan. And Senator Proxmire, who was
Chairman at the time, and others, were doing all of our
oversight work. And so, here we go again together, Mr.
Chairman, on another similar venture.
I would like to start off by saying that CFA supports a
Federal backup of the insurance business for the peril of
terrorism. We think that there is need. In the testimony that I
provided for the record, was a list of the principles that
consumer groups will use to measure the acceptability of any
plan for terrorism coverage from the perspective of the
consumer.
Chairman Sarbanes. Let me say that all of the statements
will be included in the record in full. I know that people are
now in the process of summarizing prepared statements. But the
entire prepared statements will be included in the record.
Mr. Hunter. Key among our principles that you will see that
the taxpayers as well as insurers should be protected. By this
we mean that actuarial rates should be charged for any Federal
backup coverage. ``Cherry-picking'' by insurers should not be
allowed. And the claims presented for Federal payment should be
subject to Federal audit. The second principle is that State
consumer protection should be maintained. The third principle
is that consumers should be protected by making sure affordable
and available insurance for terrorism is maintained. Fourth,
insurance prices must reflect security-enhancing incentives so
that free Government reinsurance would undermine that goal.
Fifth, terrorism must be clearly defined and national in
application.
There are several serious flaws in both the industry
approach and the Administration approach. Clearly, neither bill
requires actuarial soundness. Indeed, insurers pay nothing for
reinsurance in the first year of the industry program and never
under the Treasury approach. Apparently, free Government
reinsurance would even cover policies already in force for
which insurers have been paid premium and are fully at risk
today. This is a grossly improper use of taxpayer dollars.
Neither approach is simple enough to be up and running on
January 1, 2002, when the bulk of private reinsurance against
the peril of terrorism expires.
That is another serious problem. The insurer plan is worse
than the Administration plan in that it provides an end of rate
regulation and overrides any remnant of State or Federal
antitrust law and sweeps in tort reform and is basically a
Christmas tree.
Unfortunately, the Administration plan shows that they do
not really understand insurance, and if there are questions, I
can explain at least two areas of what I mean. It is in my
testimony that neither plan assures affordability or
availability of coverage to reasonably secure risks. Congress
should not rush to pass either of these severely flawed plans
or a combination of such flawed plans.
CFA proposes a plan that is simple and is constructed so
that Congress can easily have it up and running on January 1,
2002. In the written statement, I call it an interim plan, but
since I put it forth at the NAIC yesterday and talked to a lot
of experts, I think I am going to go bolder and say that maybe
you could make it the plan. Here is the idea.
The industry today has $300 billion of surplus which could
be applied to any risk. Surplus is nondivisible. It is
available for any risk. Considerably more than is needed for an
efficient market. That is why premiums have been falling. It is
overcapitalized the insurance industry. Even after September
11, the vast majority of insurers could withstand easily
another event of the magnitude of September 11. So we are sure
that the plan need not cover first-dollar losses.
CFA proposes that a retention for each insurer of 5 percent
of its surplus as of December 31, 2001, the end of this year,
when the program starts, be used as a retention for each
company group. This protects weaker insurers from insolvency
risk and minimizes interference with insurance pricing
decisions.
Terrorism must be defined clearly and a Federal official
will determine the availability of the rest of the program,
which is loans by the Government to insurers if losses exceed
the 5 percent.
If a terrorist attack occurs and an insurer suffers claims
greater than 5 percent of its surplus, the insurer would be
eligible for Federal low- or no-interest loans--that is up to
you all--the term of which would be negotiated for up to 30
years. This would spread the cost over time, an important goal.
For each insurer, the discounted value of the loan would be
limited to an additional 5 percent of that insurer's surplus.
This is needed, this limit, in order to make sure that
individual company balance sheets are not impacted by very
large losses and the companies become technically insolvent.
Amounts of money loaned in excess of the 10 percent of the
surplus by a company would be repaid to the U.S. Treasury
through a property casualty insurance industry-wide loan
repayment mechanism. This loan repayment would be collected
over a number of years sufficient to minimize the rate impact
on consumers who would ultimately pay the cost of the coverage.
Let me give you an example. If there was a $100 billion
loss, next year, the first 5 percent would roughly produce $15
billion that the industry would have to pay out of pocket. The
next 5 percent, where the individual companies would come in,
would produce another $15 billion. That would leave $70 billion
for the spreading mechanism.
Seventy billion dollars happens to be about 20 percent of
the premium charged last year. If you capped it at 2\1/2\
percent, then the loan would have to be repaid over an 8 year
period and that would be passed through to consumers.
The loan would be repaid by the industry. It would be based
on premium. And it would be piggy-backed. The States could
collect it piggy-backed on the State premium tax mechanism,
which is based on premium.
This plan leaves the regulation of insurance fully in the
State hands. The States should be required by the bill to
assure availability and affordability of the terrorism risk,
using their usual regulatory methods, including pooling by
State, if necessary. Such pools are actually in place in about
30 States.
Further, the States should be asked to assure that the
plans enhance security through discounts or other incentives.
Congress should set goals for the States in this regulatory
effort, but the States should do it. This requires little, if
any, new bureaucracy at the State level since much of the work
is already part of the State insurance department
responsibility.
And as to the Federal bureaucracy, the plan would require
only a handful of people to monitor the request for loans,
write up loan documents, advise the States on the amount of
monies needed if the losses exceeded the 10 percent level, and
monitor claims, which you must do under any, to make sure that
they really meet the definition of terrorism.
If there is no terrorist attack after January 1, 2002, the
program never becomes operative. But you have given surety to
the insurance companies that they know exactly what their
maximum annual loss is.
Congress should enact this plan, which protects the
insurance industry, the consumer, and the taxpayer. It is
certain, it has actuarially sound basis, it is simple, there is
no hand-out, there is no bail-out, it works, and, more
importantly, it can be fully operational on January 1, 2002.
Chairman Sarbanes. Thank you very much. A very interesting
statement.
Mr. McCool.
STATEMENT OF THOMAS J. McCOOL
U.S. GENERAL ACCOUNTING OFFICE
Mr. McCool. Mr. Chairman, Members of the Committee, we
appreciate the opportunity to discuss the response of the
insurance industry to the losses resulting from potential
terrorist attacks and the extent to which the Government should
play a role in addressing these risks.
My testimony today presents features of selected insurance
programs covering catastrophic or terrorist events, information
on alternative mechanisms for funding insured losses, and
outlines some broad principles or guidance that the Congress
may wish to consider as it reviews possible ways to support the
insurance industry in case of future catastrophic losses due to
terrorist attacks.
Regarding the first point, my full statement has fairly
elaborate discussion of existing insurance programs. But in my
short statement, I will just say that a number of the programs
exist in the United States and other countries to help insure
that insurance will be available to cover risks that the
private sector has been unable or unwilling to cover by itself,
including losses from catastrophic events and terrorism.
Certain insurance programs are completely controlled and
managed by the Government, while others have little or no
explicit Government involvement. Likewise, in many programs,
the public and private sector share risks and go in several
different ways.
With respect to the different mechanisms, funding
mechanisms for funding insured losses, clearly one of the major
issues that has been discussed in most of the testimonies today
has to do with
pricing. And again, I am restating something that was stated
this morning, pricing for a program like this will be as
difficult for
the Government as it will be for the private sector, and maybe
more so.
In any case, you must try to balance concerns about
underpricing and potential issues of insolvency for the private
sector or oversubsidy for the Government sector if the
Government sector is doing the pricing versus concerns about
overpricing and the potential distortions in the market that
could result.
Part of the discussion that has come up in many of these
programs is the extent that you engage in a pooling
arrangement. Again, pooling arrangements can be pooled amongst
private-sector parties or shared with the Government. And there
is again a number of examples in some of the programs that
exist currently throughout the world where the pooling
arrangements are an important part of the program.
Another issue that has to be determined by any program will
be whether you try to prefund losses or try to do after-the-
fact assessment. And even within the option of after-the-fact
assessments, one of the issues is whether you pay as claims
come in or whether the Government provides when the initial
claims come in and then the firms would pay these assessments
over time through some type of a loan program.
So there are a number of different ways in which such a
program could be set up, again, with or without pools and with
or without prefunding, and all of these are options for
consideration.
The Government could also fund any contingent liability in
a variety of ways. It could charge a premium for the
reinsurance protection it provides, accumulate a fund it could
use to pay for losses. Alternatively, the Government could
provide loans to the industry or fund its losses out of tax
revenues, either with or without repayment requirements.
In conclusion, a financially secure insurance industry is
essential to the smooth functioning of the economy. There have
been reports that without insurance coverage against potential
catastrophic consequences of a terrorist act, investors and
providers of finance may not be willing to provide capital or
may impose very stringent terms. Any mechanism established by
the Federal Government to support the ability of individuals
and businesses to get insurance for terrorist attacks should
address many significant concerns.
First, the program should not displace the private market.
It should create an environment in which the private market can
displace the Government program. As a result, any program
should be temporary. I think, again, these are principles that
have been stated by others. And the third principle, which is
one that GAO always supports, and again, it has been mentioned
earlier, any program should be designed to ensure private
market incentives for prudent and efficient behavior are not
replaced by an attitude that says, do not worry about it. The
Government is paying.
So, Mr. Chairman, that is my prepared remarks and I would
be happy to respond to any questions you or the Members of the
Committee may have.
Chairman Sarbanes. Well, thank you very much, sir. First,
let me ask, I want to ask each member of the panel what they
think would happen if nothing were done. And why do not we take
you in the order in which you delivered your testimony.
Mr. Froot. If nothing was done at all, I think there would
be a substantial dislocation because of the calendar effects
associated with the January 1 renewals. My guess is that that
would be resolved within a year. But that, in the first year--
again, this is back to something we said earlier--I would not
want to bet that we would not end up in a situation with
extreme exposure in a few financial intermediaries or insurers,
and perhaps some reinsurers, that was unable to be spread and
therefore, in the event of a crisis, actually led to a severe
collapse.
Chairman Sarbanes. Do you think the people seeking
insurance would be able to get it?
Mr. Froot. I think in some circumstances, it would be very
expensive. And, yes, I believe it would be hard to assure that
insurance would be available in all cases.
Chairman Sarbanes. So it would be expensive and it might
not be obtainable? Is that what you are saying? Or it would be
obtainable, but only at a very high cost?
Mr. Froot. I do not think there is any guarantee that it
would be unobtainable.
Chairman Sarbanes. Ms. Sebelius.
Ms. Sebelius. Senator, In the short term, we have a real
crisis in the commercial marketplace because I do not think
that money is going to be available for the development or
financing of large commercial properties without insurance.
We are already as regulators getting notices from companies
who would like immediately to institute restrictions on
terrorism coverage. Those are being filed across the country as
we speak.
And if this were a different timing, I think if we were
having this hearing in February or March, and we had gone
through the renewal period, it is conceivable that the private
market could figure out a solution by the renewals the
following January. What we are faced with here is a calendar
problem because the renewals are imminent. And I really think
it is highly likely that it would be very difficult, if not
impossible, to get any kind of coverage at any price for this
risk in the short run without some program.
Chairman Sarbanes. Both for existing buildings and for new
development?
Ms. Sebelius. I am not the capital market expert. But we
have been told that the real problem is not initially with the
insurance itself. It is really without the guarantee that you
could insure an attack in the future in the short run. Nobody
is going to put substantial amounts of money down for ongoing
financing or for new developments. So it would dry up the
capital market. And I think that could happen very quickly.
Chairman Sarbanes. Mr. Hunter.
Mr. Hunter. It does hinge on what type of policy you are
talking about. A company like State Farm, which is insuring
homes and cars, many of them all over the country, a big spread
of risk, probably would not have much of a problem dealing with
not having terrorism reinsurance. It does not buy much
reinsurance anyway because it effectively reinsures itself with
the spread, and so on.
But when you get into the commercial accounts, that is
where you would have the crunch, big accounts that this morning
Senator Nelson called target risks, would have trouble getting
insurance.
There would be applications made to the State insurance
departments to allow the exclusion of terrorism. Now some
States might disapprove those filings and therefore, then
companies would have to make a decision whether to cancel the
whole policy or not cancel, but nonrenew the whole policy. But
that is a potential that--how do you put a number on it? I
believe it is severe enough that Congress should worry about
it.
Chairman Sarbanes. Mr. McCool.
Mr. McCool. Well, again, I think that the problem would
exist, clearly. The question of how large it would be and how
it would show up, there is a number of different ways it could
show up.
Clearly, you could have cases of--there would be no doubt
that there would be much higher premiums applied to commercial
insurance in particular, and possibly there is going to be
nonavailability of insurance.
I guess the next question would be, if someone did not have
insurance, either it was not available to them or the price was
so high that they would think about opting out, what would be
the impact on someone providing financing to them?
And again, there would be ways for the financiers to adjust
by asking for more upfront equity, by lower loan-to-value
ratio, by asking for higher returns. But there would be a lot
of different ways in which this could show up. And it would
clearly have a potential significant impact.
Chairman Sarbanes. I want to repeat the question I asked
and get two of you to answer. Is there a divide or difference
between getting the insurance for existing buildings and
getting the insurance for new development, new buildings?
Mr. Hunter. Again, it depends on the building. If you are
talking about big target-type buildings, I think they would
have trouble keeping the insurance they had and the new
buildings would be even more problematic because they do not
have the history of
insurance.
Now, obviously, these big accounts also have some ability
to self-insure and so on. So they may have some ways to get
through that and find some kind of reinsurance at very high
levels. But until the reinsurance market is assured, I think
you would have trouble with those big accounts.
Mr. McCool. Again, I would agree that new construction
would probably be more affected. But I do not think that you
could ignore the effects on existing structures.
Chairman Sarbanes. I see my time is up and I yield to
Senator Miller.
Senator Miller. Just a couple of things, Mr. Hunter, help
us to understand this better. What kind of distortions would
there be in the insurance market if we created the
Administration proposal? In other words, what happens to a
market when you give away a Federal guarantee that does not
cost the industry anything?
Mr. Hunter. Well, it means that the rates can be much lower
obviously than they might otherwise because the insurance
companies do not have to find actuarially priced reinsurance
protection. They know they have free reinsurance for 80 percent
from dollar one, and a $12 billion maximum loss in a year.
That is a lot of assurance and it means the pricing of
things like security would be less enhanced. There would be
less reason for people to toughen their buildings and put
security guards out there and spend that kind of money,
whereas, if insurance was fully priced, there would be that
additional incentive, besides saving lives and the other good
things that happen. The financial incentive to do those, that
would be weakened.
Senator Miller. Thank you. Let me ask this question of
everyone on the panel, except Mr. Hunter.
[Laughter.]
What do you think of Mr. Hunter's proposal?
[Laughter.]
Mr. Froot. Let's see. I like it to the extent that
allegations that parts of the insurance industry are over-
capitalized are true.
That is, that, in certain sectors, mutuals in particular,
it may be very difficult to reduce the amount of capital, even
as risks decline. And so, therefore, putting that capital to
work, in a sense, directly through this kind of program would
make a lot of sense.
For companies that are not overcapitalized, it would be a
mistake because, in the end, after the event, they would be
burdened going forward with a substantial liability, additional
liability, which would place them in a financially inflexible
and relatively fragile position compared to where, judiciously,
they would believe they should be.
Ms. Sebelius. Senator, I am not sure I can make a terribly
well qualified review of Mr. Hunter's program. I have heard the
basic outlines now twice. But there is a bit of misconception.
Regulators want companies to build reserves. You want companies
to build reserves as a policy program because without those
reserves, they may end up not being able to pay the claim.
So I do think that we want to be careful about assuming
that if they have assets in reserve, that somehow, that is
extra money. That is there to back up the policies that are in
force in the marketplace.
I think the concepts are interesting about the notion that
there would be some repayment scheme at some level and probably
is one that should be looked at by the Congress.
Some of these issues really are kind of insurance-related
principles. Some of them are really public policy decisions.
And I am not sure that, as an insurance regulator, I am very
well qualified to suggest what your public policy decisions may
be. And I believe a lot of what Mr. Hunter has outlined really
falls into more the public policy area.
Is it a good idea that taxpayers should expect this money
to be repaid? How much should the industry count on? We
certainly support the notion that dollar one involvement from
the Federal Government may not be the best way to approach
this, a deductible system, setting a level that gets some
insurance capital involved before there would be any kind of
Government involvement may be a more appropriate approach, and
that is part of what Mr. Hunter has talked about. So I do not
know if that is helpful, but I do not know a lot about the
plan.
Chairman Sarbanes. Could I just ask a simple question? It
is possible that if the reserves are built up too much, that
they have been charging too much on the premium side, is not
it?
Ms. Sebelius. That is something that regulators look at on
a fairly regular basis when companies apply to us, that
certainly more of that regulatory oversight is exercised in the
personal lines market less than in the commercial market
because we assume in a competitive market that the
sophisticated buyer will essentially use the marketplace to
drive rates down. And markets are pretty competitive at that
level and they have the ability to do that.
Chairman Sarbanes. Thank you. Senator Miller.
Senator Miller. Let me ask Ms. Sebelius a question while
she has the microphone. The industry's concern about the
Administration's proposal is that they will not be able to
price risk. Do you agree with this concern about their ability
to price risk?
Ms. Sebelius. We have had this discussion, all the
regulators in the country, frankly, who have been in town for
the last couple of days, to look at the aftermath of September
11 events on the industry. We have talked a lot about the
industry's really amazing ability to price anything. I mean,
not that anyone would have foreseen September 11, but they have
had lots of unforeseen issues in the past and have relatively
quickly, as the Professor suggested, figured out a pricing
mechanism. It may tend to be very conservative initially, over-
reserving, charging too high, and then the market drives that
down.
I think the issue here is how quickly can that happen? And
our concern is that the timetable of the January 1 policy
renewals are such that we do not have a lot of faith that can
happen in that kind of timespan. But I am very optimistic that
within the course of the next year, they can begin to
appropriately price this risk, they will price it, and they
will sell it.
Senator Miller. Thank you. My time has run out.
Chairman Sarbanes. No, go ahead, Senator.
Senator Miller. Mr. McCool, do you have a statement on Mr.
Hunter's proposal?
Mr. McCool. Well, again, we do not endorse or die.
[Laughter.]
I think it has some interesting features. It does have
first-dollar coverage, which again we think is something that
is a good idea. It has a formula for allocating the first-
dollar coverage on a firm-by-firm basis, which again is an
attractive feature. Whether capital is the right basis or some
other basis could be used, the fact that it does have an
allocation formula on a firm-by-firm basis I think is a useful
feature. Again, the fact that it repays the Government over
time is something that the GAO would never be against.
[Laughter.]
And again, at what rate is up to you to decide.
Senator Miller. That is an attractive feature. Thank you.
Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Schumer.
Senator Schumer. Thank you. I appreciate the panel being
here. I have looked at the testimony and I am sorry I could not
be here the whole time.
Let me ask each of you, and particularly those who seem to
like the Administration's proposal, how do we prevent ``cherry-
picking?'' How do we prevent 5 percent of the most vulnerable,
or at least as perceived, the most vulnerable properties from
just being excluded and not getting insurance?
Professor Froot.
Mr. Froot. I would have said that ``cherry-picking'' is a
great problem when it comes to someone trying to buy for you
life insurance or for themselves more extensive medical
coverage, or any of those things. I think those are examples
where, in those markets, the individuals have some control over
the risk and they have some knowledge about the risk that the
insurer would not have. That is where we tend to see ``cherry-
picking'' most severely.
I do not think that is the case here. I do not think there
is much risk that a particular building owner knows more about
the risks of terrorist attack than can be easily established by
someone looking to write a policy for that building.
Senator Schumer. I do not follow you. I do not understand.
The Empire State Building, Disney World, the Hoover Dam might
be places that might be much riskier.
Mr. Froot. Much riskier.
Senator Schumer. To insure after September 11. And if we
just say that the Government will pick up 80 percent of the
costs of whatever insurance you write, some might say, well, 20
percent is still too much to be dangling out there for these
type risky things. We are not going to insure them any more.
Mr. Froot. But I tend to agree with Ms. Sebelius, that,
basically, that there will be competition, there will be a
desire to write that policy, and there will not be a concern
that one is being adversely selected in writing that.
That is to say, that because you come to me and are willing
to pay a very high premium, that means an even higher risk than
I would have ever guessed.
Senator Schumer. Again, we are talking past each other. I
am not worried about competition between the two. I am saying,
if
everybody comes to the conclusion that $10 a square foot to
rent the Empire State Building in insurance, the owners will
not be able to make any money and the building will go under,
the building will not be insured. That is what I worry about. I
worry about a significant portion of properties not being
insured.
Ms. Sebelius.
Ms. Sebelius. One of the features that you may want to look
at, as a possibility in partnership in this Government
involvement, would be to disallow exclusions for terrorism
coverage, which forces the risk to be spread, essentially, and
tie that or tie any opportunity to participate in the Federal
program to not having the exclusions. The issue we are dealing
with right now State-by-State is really holding those to see
what is going to happen.
Senator Schumer. That is a pool of a sort, but a pool you
could live with.
Ms. Sebelius. But one of the issues may be spreading that
risk so that every company is in the game from the outset and
then you have a realistic possibility. If you let people begin
to exclude out of the pool the price against the pool to, as
you say, cherry-pick the properties, I think then you really
have the potential of a very distorted marketplace very
quickly.
Chairman Sarbanes. Could I ask on that very point? You say
in your statement, and I am now quoting, ``Many people in
Congress apparently think that States require private
businesses to carry insurance against terrorism, and that
failure of the private insurance market to offer terrorism
coverage will result in violating State laws and regulations.
We believe there is a misunderstanding of what State laws
require and what State insurance regulators do.'' And then you
say you did an electronic search of State laws and regulations
with references to terrorism and you found nothing.
Now, maybe I have a misunderstanding. It was not my premise
that the current law and regulations require terrorism coverage
because, in a sense, it is not been at the forefront of our
concerns.
But I thought that you could require that the State
insurance regulators have the authority to require that the
policies cover terrorism. Is that correct?
Ms. Sebelius. I do not think that is accurate, Mr.
Chairman, without legislative intervention. For instance,
legislators in some States have said health care policies must
have the following features in it.
At the State office level--some of us have and all of us do
not even have this authority, is actually to deny exclusions.
We do it in reverse. When exclusions are filed with our office,
there are statutes right now in some States that have deemer
provisions. Unless you take some action and that could be
administratively overruled, they go into effect. So it is
really the reverse.
The issues that come as exclusions are looked at by our
office, but there is really not an affirmative requirement that
policies must have a variety of features in them unless that is
something that the legislature has actually taken on as a
legislative initiative.
Chairman Sarbanes. But if you did not give the exclusion,
wouldn't terrorism be covered?
Ms. Sebelius. At this point, that is the likelihood, that
as a State insurance commissioner--most of us either could deny
the exclusion or take some emergency rule to not allow the
exclusion to exist. Now having said that, they do not have to
offer the policy at all. I mean, that is step two. You could
deny the exclusion, but that does not mean the company has to
write the policy.
Chairman Sarbanes. Well, I understand that.
Senator Schumer.
Senator Schumer. Just one other question. I think earlier,
Senator Gramm said that he might consider supporting 100
percent insurance for 2 years, Federal, 100 percent coverage
Federally--did he say this? Yes? I am surprised--to avoid the
Federal Government being involved permanently.
Now, of course, if we had a series of terrorist incidents
even at the end of Year 2, or after Year 3, we would have to
come back, is my guess, of great magnitude. So I do not quite
get it because that really depends on what happens post-
September 11. But would any of you want to comment on that
idea?
Mr. Hunter. That is a terrible idea. Part of the reason it
is bad to have no premium is it would undermine all the various
normal market workings and incentives for more secure risks.
You really want to have safer places out there.
Senator Schumer. Hunter says Gramm ignores free market.
[Laughter.]
Ms. Sebelius. Senator, I also think that we, at least,
believe you really want the private market forces to get back
in the game as quickly as possible and to begin to figure this
out.
A 2 year hiatus with no risk, no capital, no anything, may
really be exactly the wrong message to send. I believe very
limited, very strategic backup help, but urging the private-
market forces, essentially, to regroup quickly, recapitalize
quickly, and sell the policies.
Senator Schumer. Could I ask each of you one final
question?
First, in writing, if any of you have ideas on how you deal
with this ``cherry-picking'' issue beyond what we have
discussed today because, to me, it is a very vexing issue,
could you send them?
Would that be okay, Mr. Chairman?
Chairman Sarbanes. Sure. Certainly.
Senator Schumer. For a week. It is not mandatory, but if
you have some good idea, I would love to hear it and I bet the
Committee would as well.
My final question is, as you may have heard, if you were
here earlier, I am very worried that people will not endeavor
to begin large new projects if they are worried even if they
know that in the first year there will be insurance, if they
worry that there will not be in subsequent years. Is that a
valid worry? And should that play a role in what we pass here,
if we were to pass something?
Do any of the witnesses----
Mr. Hunter. It is a valid worry. But you could set up a
program that said, if you enter into a multiyear project,
requiring multiyear insurance, you have to notify the
Government, and perhaps you could even have a multiyear policy,
even if the program ended. You still might be able to do
something.
Senator Schumer. The policy could be backed up in Year One.
Mr. Hunter. Either a policy or a loan guarantee, or however
you do it, you could have a multiyear basis for that.
Senator Schumer. Right. Any other comments? Ms. Sebelius.
Ms. Sebelius. I did hear or was able to watch some of the
hearing this morning and heard that concern voiced. I guess we
are fairly confident and, again, it is based on looking at what
happened after Northridge and Hurricane Andrew, what happened
in various situations, that the multiyear funding issue is
probably less a problem, assuming that we do not have a series
of attacks, less of a problem than this strategic issue right
now. I am fairly confident the market would rebound and be
issuing policies in the future.
Chairman Sarbanes. I take it it's your view that if this
had happened next February, that the private sector might have
been able to work it out by the end of the year, given the 9 or
10 month period within which to do it. Is that right?
Ms. Sebelius. Well, there has been some discussion that
certainly the problem is really exacerbated by the timing,
given the proximity to the January 1 expiration of virtually
all--not all, but a large portion of the reinsurance treaties.
We are in a particularly difficult time. I think what you would
have had in a different timetable is at least several months to
see how much capital came back in, what the market solutions
were. We just do not have that luxury at this point.
Chairman Sarbanes. Of course, one could then, carrying the
logic of that out, say, well, we have a situation where we have
to get over this hurdle or this hump that is facing us, and
enough time to see how it works. If it does not work out, it
could be revisited, I guess, would be the argument.
Ms. Sebelius. Well, that is certainly why we would support
a firm sunset, a very short timetable, and the opportunity
certainly is there to revisit or renew. But we think having a
time certain where the program ceases of fairly short duration
makes very good sense and it keeps pressure on everybody to
figure out the solution.
Chairman Sarbanes. Now, Mr. Hunter, let me try to take your
proposal and see if I--and Mr. Froot, I know you have a time
problem. So any time you have to go, just excuse yourself. We
understand your situation and we very much appreciate that you
came.
Not that these are minor differences, but is it accurate to
say that you differ from the Administration in that you would
require the industry, in effect, bear the burden upfront up to
a certain amount? As I understand your testimony, your figure
was I think $35 billion. Is that right?
Mr. Hunter. That is what I said in my testimony. In the
plan that I just outlined, it would probably be more like $30.
But, yes.
Chairman Sarbanes. And then beyond that, the Government
would come in to cover the loss, but it would do it on a loan
rather than a grant basis. Is that right?
Mr. Hunter. That is correct.
Chairman Sarbanes. And then the industry would repay the
loan over whatever terms you have worked out over an extended
period of time.
Mr. Hunter. Yes.
Chairman Sarbanes. They would have to keep the premiums up
in order to do that.
Mr. Hunter. Yes. You could put a cap on how much that could
be per year, like 2, 3, or 4 percent per year, so that the
premiums would be maintained at a relatively low level for the
loan repayment period.
For a typical homeowner's policy, you are talking maybe
between $16 and $24 a year additional. Obviously, for a big
target risk, it might be several thousand dollars a year.
Chairman Sarbanes. What is your reaction, Ms. Sebelius, to
that scheme--plan, I guess.
[Laughter.]
Ms. Sebelius. I guess, Senator, I do not know quite what my
reaction is. I do think that it shifts a lot of the burden for
terrorism coverage in the short-run particularly on to those
Americans who are buying insurance policies and away from, if
you accept the notion that, somehow, this is a public policy
issue and the Government has some legitimate role, then I think
having the taxpayers at large bear some of this burden as
opposed to just the insuring consumers bearing it through the
higher premiums they are paying, I think a lot of Mr. Hunter's
concept really assumes that consumers who are buying insurance
products over a longer period of time would be paying off the
loans as opposed to the taxpayers at large paying them. That
may be too narrow a focus for that to bear all that risk.
The insured public are also taxpayers. But, essentially,
they would be picking up more of a burden than the average
person who may not be buying car insurance, homeowner's
insurance, having to develop property, whatever.
So I guess I do not find a great deal of--I do not have a
real problem looking at the issues of public policy issues,
saying a portion of this rightfully may belong to the
Government, may be spread among taxpayers at large, and not
require the repayment, which essentially gets transferred
through higher premiums over a longer period of time just to
insure the public.
Chairman Sarbanes. Mr. McCool, do you have an analysis?
Mr. McCool. In most of these issues, the GAO would prefer
that the Government not be--I agree with Ms. Sebelius. You
really are to some extent talking about over what base you are
spreading the increase. There is probably a fairly large
overlap between the taxpayers and the people who pay for
insurance. It is not 100 percent, but it is probably fairly
high.
Mr. Hunter. But there is also a question of equity, of
course. And that is, the people with the higher risks pay
higher premiums and particularly will pay higher terrorism
premiums in the future. And they will then bear the 2 percent
per year burden more heavily than the average taxpayer. And
that is fairer because they are the ones with the exposure.
Senator Miller. One more question, Mr. Hunter. Let us say
that the plan, as you put it, is not adopted. And instead, what
is passed is something like what the Administration has
offered. In your opinion, what kind of oversight capacities
would be necessary for the Federal Government to engage in that
kind of temporary reinsurance commitment with the private
sector?
Mr. Hunter. Well, first of all, you would have to write
reinsurance contracts with the insurance companies because they
would not certainly--they would want to have certainties, so
they would want a policy. Even though there was no premium, I
guess, you would still have to have some kind of a legal
document that you would work with them that would define
terrorism and explain who decides what. You would have to have
a system of auditing the claims. You would have to have a
bureaucracy. Claims is fairly complex. And of course, you would
not ever get the taxpayer reimbursed, is my key problem with
that system.
But I do think that--
Senator Miller. There are no oversight provisions that you
would propose that we write in there?
Mr. Hunter. I still think that you could rely a lot on the
States, although there is a lot of preemption in the insurance
proposal of State regulations, so you would need some Federal
thing to take the place of that in the insurance industry
proposal.
But in the Administration proposal, there seems to be less
override of the States. So you could still task the States with
various things like assuring affordability, availability,
making sure that there are surcharges or discounts that would
enhance security. I think some of those things could be added
to the Administration proposal.
Senator Miller. Are you saying they should be added or
could be added?
Mr. Hunter. Should be.
Chairman Sarbanes. Well, now, the Administration's own
proposal has them withdrawing after 3 years, apparently on the
premise that reinsurance would then be available to the primary
carriers. Is that how you understand it?
Mr. Hunter. Yes.
Chairman Sarbanes. If you got through that period without a
major terrorism attack, then the whole thing would be back in
the private market and there would have been no Government
cost. Correct?
Mr. Hunter. Right. You still have to have the
administrative costs of running the program.
Chairman Sarbanes. Those would be relatively
inconsequential.
Mr. Hunter. Right. Yes.
Chairman Sarbanes. Now what do you all think, if you read
about this proposal that the insurance companies put forward.
Mr. Hunter. I will start. It is terrible. I have a long
list of complaints about it in my written testimony, including
the fact that it is not an actuarially sound program because it
has no premium the first year. Additionally, it allows
``cherry-picking'' of the worst sort. That is, individual
companies can opt in or out of the plan. And the individual
companies within a group can individually opt in and out of the
plan.
So if you have these target risks that we have been talking
about, you can put one company, reinsure that one with the
Federal Government, and leave all your good business not for
the Federal Government. And I do not believe the Federal
Government should be put in a position of the taxpayers only
picking up the bad risks and having the good risks left for the
private sector.
The selection of Illinois as the sole regulator and
creating, in effect, a cartel at the front end in Illinois, and
overriding the bill, not only would there be no rate
regulation, but there will be no residual Federal or State
antitrust law enforcement against it. So it waives all those.
There is no guarantee of affordability or availability and so
on, and it is a very large overreach by the industry with a lot
of their wish list in it.
Chairman Sarbanes. Mr. McCool.
Mr. McCool. Well, again, we have----
Chairman Sarbanes. What does your analysis show? I know you
have to frame it in terms of analysis.
Mr. McCool. I was going to say, our list of concerns is not
quite as long. But we are concerned about the pooling
arrangement being in one State. Again, there is a certain
monopolistic element to that.
There are again concerns about, in this case, what I guess
would be ``cherry-picking'' as opposed to some other
arrangement that we were talking about earlier. It is a
problem, but it is a different one, that you could end up with
the better risks in the pool and the worst risks outside the
pool.
Chairman Sarbanes. Ms. Sebelius.
Ms. Sebelius. Well, I think Mr. Hunter outlined a number of
the key issues that would be of grave concern to regulators,
``cherry-picking'' not the least among them. The antitrust
provision, there is fairly broad preemption of State laws and
regulations.
We think it would abdicate a lot of consumer protection
initiatives that are currently in place and they would cease to
exist.
And I think the mandating of the pooling arrangement--I do
think the industry has a keen interest in pooling risk, but it
is something that we feel could be accomplished voluntarily.
That is part of the kind of regrouping mechanism that they
could go through. And I am not sure that you need a Federal law
or a kind of bureaucratic structure to have that done and
create a new company. I think that is very much a private
market phenomenon that will happen.
Chairman Sarbanes. Well, one of the issues that is raised
here in the backdrop, so to speak, is, as you say, the
preemption of various State requirements that have heretofore
applied to the insurance industry.
Now, if that is going to happen, it seems to me,
particularly if you are asking for a major contribution of
resources from the Federal Government, there is going to have
to be monitoring and oversight and, indeed, regulation at the
Federal level. So I think one of the issues here is whether we
are going to start down this path of altering the Federalism
arrangement with respect to insurance.
Now I am prompted to say that because there are people
moving around the halls of the Congress who want to do Federal
insurance charters and so on. That is an issue, it seems to me,
with far-ranging implications, which would need to be addressed
on their own terms. I do not think we want to do it through the
back door on a terrorism bill. So, presumably, the Association
of Insurance Commissioners has some concern about that issue.
Am I correct?
Ms. Sebelius. I think that is safe to say.
[Laughter.]
That we do have concern. We think, Senator, that the
ability of the industry to pay the September 11 events is a
strong testimony to the fact that the regulatory system in
place works. The reserves are there. The companies are
capitalized. They are monitored. The claims are going to be
paid.
We think what you are looking at at this instant is a
short-term problem dealing with recapitalization and
availability of what is a bit of an unknown risk up until
September 11. Hopefully, we will not know a lot more about it,
but we can price it more accurately going forward.
A lot of the monitoring and oversight I think that would be
required for any kind of Federal involvement frankly is in
place right now around the country and could be detailed to the
States to go ahead and do, following up on claims payments,
auditing. Those are things that we have experts doing as we
speak. We have actuaries. We have a variety of technical staff,
both at the national office and locally.
We think it is appropriate in terms of preemption issues
that you look at things like, one, uniform definition of
terrorism. You clearly could not have 50 different definitions
floating around. In fact, we have a group working on that very
issue because we think we are going to need that one way or the
other.
The issue about whether or not all companies would be
required to, or would be disallowed from having terrorism
coverage, is an issue that may appropriately rest with you.
So there are some issues that we would be very supportive
of having uniform definitions across the country put in place
very quickly. But in terms of a long-term need to either
duplicate or preempt the State system that functions very well,
we would urge you not to use this opportunity as a way to sweep
away what is a 100-plus year-old regulatory system that
actually functions pretty well. Totally unforeseen loss, nobody
could have predicted it. They are up at the table paying the
claims, and I think that is testimony to the fact that it
actually works.
Chairman Sarbanes. Does anyone else have any observation on
that issue?
[No response.]
Now let me ask this question.
Mr. Hunter. Let me just say, there is no question that if
you adopt something like the industry approach, I think you
have to get in there because, otherwise, there is going to be
nobody checking the rates or anything. And you had better get
in there because, otherwise, you are going to be handing away
all this free insurance by taxpayers and you are not going to
have any guarantee that the prices are affordable or anything.
You need, it seems to me, some way of assuring that.
Chairman Sarbanes. I take it all three of you would rate
the Administration's proposal above the insurance industry's
proposal, as you know those proposals. Is that correct?
Ms. Sebelius. Yes.
Mr. McCool. [Nods in the affirmative.]
Mr. Hunter. [Nods in the affirmative.]
Chairman Sarbanes. And I take it that all three of you
would also--there are modifications you feel can be made to the
Administration's proposal which would make it better than it
is. Is that correct as well?
Ms. Sebelius. Yes.
Mr. McCool. [Nods in the affirmative.]
Mr. Hunter. [Nods in the affirmative.]
Chairman Sarbanes. Well, this has been a very helpful
panel. I hope we can continue to call on you for your counsel
and advice as we wrestle with this issue. You can be very
helpful to the Committee. And, of course, the State insurance
commissioners have a tremendous amount of expertise built up
over the years. And Mr. McCool, we always look to the GAO
around here. And Mr. Hunter, you have actually come in with
some very imaginative and helpful suggestions. And so, we will
continue to work with this issue.
Ms. Sebelius. Senator, we look forward to working with the
Committee, with the Administration, on moving this issue
forward. We think it is a high priority and we do think it is
appropriate that the Federal Government play a role, and it is
probably got to be done pretty quickly, given our timetable
issue. But we look forward to helping in any way we can. We do
have a lot of technical expertise that we would be happy to
lend to the process.
Chairman Sarbanes. I think, as we think about it, we need
to try to--well, you can never deal with a complex issue
necessarily in a simple way. I understand that complexity has
to be met to some extent with complexity.
On the other hand, we need to get this thing down to the
essentials and deal with the essentials. We need to push back
overreaching, if that is, in fact, occurring.
And I do not know that we can take on other agendas that
people of one sort or another that have been hanging around
here and have not been acted upon, and then they fasten upon
this vehicle to move that agenda. That is not what we are
about. We are willing to try to address what everyone has said
needs to be addressed on the problem. But if people start
piling in on this, either with some long-standing agenda or
seeking to overreach on the relevant agenda, we are going to
have difficulty. We have to work through this toward a
consensus we can close ranks on and move ahead.
But your testimony has been very helpful. And again, I want
to express my appreciation. I know that people were given a lot
of time to prepare and obviously, a great deal of care and
thought has gone into these statements.
The Committee will resume its session. We will reconvene
tomorrow morning at 10 a.m. in this room. The Dirksen Building
where the Committee's hearing room is has not yet been opened.
It may be opened by the end of the week or the first of next
week. The Russell Building has been opened and the Hart
Building apparently, which is where the Daschle office was and
so forth, will remain closed while they continue to carry
through on the environmental check-out.
Tomorrow, we have two panels. Panel One is: Robert Vagley,
President of the American Insurance Association; Ron Ferguson,
the CEO of General Ray, representing the Reinsurance
Association of America; and John T. Sinnott, the CEO of Marsh,
Inc., representing the Council of Insurance Agents and Brokers.
That will the first panel.
And the second panel will be: Tom Donohue, President and
CEO of the Chamber of Commerce; Ellen Baker, Chairman of
Wacovia Corporation, who will be speaking for the Financial
Services Roundtable; and Thomas Carr, President and CEO of Carr
America Realty Corporation, representing the National
Association of Realty Investment Trust.
And that will obviously give us an opportunity to hear from
both the insurance industry itself and then the second panel,
from broader representatives of the business community. I know
it has been a long day for you. We very much appreciate your
staying with us.
The Committee is adjourned until tomorrow at 10 a.m.
[Whereupon, at 4 p.m., the hearing was adjourned.]
[Prepared statements and additional materials supplied for
the record follow:]
PREPARED STATEMENT OF SENATOR JIM BUNNING
I would like to thank you, Mr. Chairman, for holding this important
hearing, and I would like to thank Secretary O'Neill and Chairman
Hubbard for testifying today. The tragic events of September 11 have
had many repercussions. In addition to the obvious losses to those
directly affected, the attacks wreaked havoc throughout our economy.
One critical part of the economy the attacks have affected is the
insurance industry. I am very grateful that Secretary O'Neill and
Chairman Hubbard were able to come before this Committee and explain
the Administration's insurance proposal. I believe there is a serious
problem facing us that must be addressed by January 1. As my colleagues
know, many insurance policies will be up for renewal on January 1.
If Congress does nothing, many of these policies will not be
renewed, and many businesses and properties will not be able to
purchase insurance. The Administration has a proposal that frankly
gives me some heartburn. However, something needs to be done and done
quickly and I have not seen a better plan. Hopefully today we can start
to come up with some better ideas. However, I do agree with the
Administration that there must be a sunset on assistance we give the
insurance and reinsurance industry. This is absolutely critical. We
must allow the market to figure out how to price this new risk.
We can help give the industry time to sort this out and collect
data, but we can not set the market. We also must make sure this is not
a way to create a back-door federalization of insurance. I know there
are many in Congress who would like a Federal insurance charter and a
greater Federal involvement in insurance, but this is neither the time
nor the place. It is also crucial that we make sure the industry
assumes some of the risk. We cannot ask the taxpayer to pick up the
entire bill.
I believe it is crucial that we act thoughtfully and we act
quickly. We must do what we can to avoid the unintended consequences
that could harm our vibrant insurance industry but we must also assist
the industry so they can figure out how to price this new risk before
the end of the year. If we do not, not only will we have businesses
failing because of a lack of insurance, we may have the taxpayer
completely on the hook if another catastrophic event hits our county,
be it act of God or act of evil.
Thank you, Mr. Chairman.
----------
PREPARED STATEMENT OF BILL NELSON
A U.S. Senator From the State of Florida
Chairman Sarbanes, Members of the Committee, thank you for inviting
me to address one of the many challenges facing us in the wake of the
terrorist attacks on September 11, and the bioterrorism attacks since
then. I hope my prior experience as Florida's insurance commissioner
will be helpful as we grapple with the challenge ahead, which is to
protect all of America's insurance consumers by making sure coverage
remains available and affordable to protect them against such
despicable acts.
We all know that insurance is one of the crucial engines of our
economy. Without it, banks will not make loans for real estate or other
ventures, and businesses will not invest or expand. Millions of jobs
would be lost as the impact rippled through our economy. We cannot let
that happen. Neither can we allow the insurance industry to use the
September attacks as an excuse to shirk its rightful role and
responsibilities. Already, reinsurance and insurance companies are
saying they no longer will cover terrorist attacks after December 31 .
. . when about 70 percent of the commercial insurance contracts in the
United States are scheduled to expire.
I do not doubt that the industry's problem is genuine. In the
immediate aftermath of September 11, it is virtually impossible for
insurers to calculate their potential liability in the face of possible
future terrorist attacks. But we cannot allow ourselves to be held
hostage by high-pressure tactics of any industry.
Nor can we make the same mistakes we made with the airline
industry. In that legislation we did not hold the industry's feet to
the fire and make sure that they took care of their employees and the
consumers.
I know from our experience in Florida that the insurance industry
is more than willing to walk away from its biggest risks and turn them
over to somebody else. Companies paid out $16 billion in claims after
Hurricane Andrew slammed across South Florida in 1992--the costliest
natural disaster ever. Then major players in the industry spent the
rest of the decade trying to slip through State legislation that would
shift responsibility for hurricane coverage to Florida's government and
its taxpayers. We headed off every one of those efforts. And we fought
the industry's attempts, since Andrew, to force unconscionable, ever-
increasing rates on Florida's homeowners.
Homeowner insurance rates are now stabilized in Florida, and
competition has returned--because we worked out a solution that will
back up the industry if and when another mega-storm hits. But the
emergency fund created by the State requires companies to pay for most
hurricanes and to shoulder their share of cost of major storms. And it
spreads the risk by building up reserves with premium dollars--not
taxpayers' dollars.
Whatever solution we come up with at the Federal level on terrorist
coverage, I believe the same principles of private enterprise must be
applied. Government can play an important role in helping to resolve
the immediate crisis--whose impact would be felt far beyond the
insurance industry. For the most part, however, we should leave the
business of insurance to the insurance business.
As you know, there are two basic plans so far--the White House
proposal and another plan that seems to have broad support from the
insurance industry. They are still being fleshed out, so we do not have
the details needed to fully and fairly judge them. But, based on the
information that has emerged so far, I have some major concerns. For
example, what safeguards would be provided to prohibit insurers from
doing what the industry calls ``cherry-picking?'' In other words, once
Federal help is provided, what is to stop the companies from covering
only those properties or businesses that are relatively safe from
terrorism and leaving the bigger risks for someone else? And, what is
to stop them from simply passing on any terrorism losses they might
suffer in the form of sudden and steep surcharges against their
customers? Or from finding ways, in the complex array of State
regulations, of excluding acts of terrorism from the coverage consumers
buy on their homes, their automobiles, or their lives?
I say that anything we do here, at the Federal level, must assume
and require that companies cover the peril of terrorism--a peril that
looms so much larger since September 11. Simply put, if taxpayer's help
foot the bill, then the terrorism peril cannot be dumped by the
insurance industry.
As I understand it, the Administration's plan would make the
Federal Government responsible for paying 80 percent of the first $20
billion in claims, and 90
percent of the next $80 billion, resulting from any terrorist attacks
in 2002. This proposal would increase the industry's liability from
terrorist claims in the next 2 years, but still cap it at $23 billion
in 2003, and $36 billion in 2004, with the Federal Government covering
all remaining claims. I have strong concerns about requiring the
taxpayers to assume, even on a temporary basis, such a large percentage
of the cost--especially at the front end.
A more responsible approach, in my view, would be to require the
companies to, cover terrorist-related losses up to a certain level
before any Federal help would kick in. The primary insurer would cover
up to a certain dollar retention level, and above that level, the risk
could shift to the Federal Government. We should not support any
proposal involving the use of taxpayer dollars unless we are convinced
that the insurance companies have ample ``skin in the game.''
Under the separate, industry-backed proposal, insurers would pool
their premiums through creation of a new Government-backed insurance
company called the Homeland Security Mutual Reinsurance Company. Each
participating company would retain 5 percent of terrorism and 5 percent
of workers' compensation war risk, and leave the remaining 95 percent
of each to the insurance pool.
I hold true to the belief that private market solutions are more
desirable than Federal intervention. But--if I understand this plan
correctly--the Federal Government would be responsible for covering 100
percent of any claims resulting from terrorism next year, while the new
insurance pool begins building its capital.
As this debate progresses, we must constantly keep in mind that
insurance companies are well equipped to handle most large-scale
disasters. The industry is recognized by many financial rating
agencies, institutional investors, and economists as one of the
strongest in the global economy.
Between them, the property-and-casualty and life-and-health
insurance industries count nearly $3 trillion in invested assets.
The National Association of Insurance Commissioners estimates
that the industry has a capital cushion of more $550 billion to
absorb unexpected downturns in the financial markets and adverse
loss experience on its policies.
In other words, the industry is flush right now with huge
surpluses. And, whatever our solution to this aspect of the terrorist
crisis, we must require insurers to pay their fair share. As we
consider the public policy implications of terrorism reinsurance, I
believe we must proceed in a deliberative fashion. In my view, that
means reaching agreement in the coming weeks on a short-term, interim
solution--no more than 1 year--to ensure that insurance protection
against terrorist attacks remains available in 2002. And then resuming
our work after January 1 to develop a more permanent plan.
That approach also would enable us to consider reform of the
current system of insuring against natural catastrophic disasters.
Despite our progress in Florida in dealing with the hurricane threat,
the fact remains that no single State, nor any single industry, could
cope with the kind of mega catastrophe we now know Mother Nature could
bring our way.
In lieu of the perennial debate over establishing a Federally
backed insurance pool, I am personally intrigued by proposals that
would require insurers to set aside part of their profits for a rainy
day. The idea is to let companies develop tax-deferred reserves and
thereby increase their capacity to respond to catastrophic losses. I
know this Committee takes a keen interest in these problems, as does
the Commerce Committee.
I look forward to working with you on legislation--both short- and
long-range solutions--that not only will keep our economic engines
running but also protect the consumers we all serve.
----------
PREPARED STATEMENT OF PAUL H. O'NEILL
Secretary, U.S. Department of the Treasury
October 24, 2001
Mr. Chairman, Senator Gramm and Members of the Committee, I
appreciate the opportunity to comment on terrorism risk insurance.
These hearings are extremely important. We believe that there is a real
and pressing need for Congress to act on this issue now. As I will
discuss in more detail, market mechanisms to provide terrorism risk
insurance coverage have broken down in the wake of September 11. Such
coverage is now being dropped from property and casualty reinsurance
contracts as they come up for renewal, with most policies renewing at
year-end. If Congress fails to act, reinsurers have signaled their
intention to exclude such coverage meaning that primary insurers may
have to drop this coverage or institute dramatic price increases. As a
result, after January 1 the vast majority of businesses in this country
are at risk for either losing their terrorism risk insurance coverage
or paying steep premiums for dramatically curtailed coverage. This
dynamic can, in turn, be expected to cause dislocations throughout our
economy, particularly in the real estate, transportation, and energy
sectors.
The Problem
The terrorist attacks of September 11 created widespread
uncertainty about the risk and potential costs of future terrorist
acts. Since September 11, we have endured this uncertainty every day as
a country. It has permeated every sector of our economy.
A key part of the Federal Government's response to the events of
September 11 is to ensure that our economic stability is not undermined
by terrorist acts. Continued economic activity is dependent on well
functioning financial markets--where the lifeblood of capital is
provided to business enterprises. Financial markets allocate capital
based on the potential success of a business. In doing so, financial
markets rely on the insurance sector to mitigate certain types of risk
that are not directly related to the plans or operations of a business.
Insurance companies manage risk in economic activity and facilitate
the efficient deployment of capital in our economy by estimating
probabilities of possible adverse outcomes and pooling risk across a
large group. Since September 11 the uncertainty surrounding terrorism
risk has disrupted the ability of insurance companies to estimate,
price, and insure the risk.
We learned on September 11 that, while perhaps highly improbable,
terrorists are capable of enormous destruction. Could such an event be
repeated? As a country and a Government, we are doing everything in our
power to prevent a repetition of anything like the events of September
11. But how does an insurance company assess this uncertainty? How does
an insurance company price for it? At the moment, there are no models,
no meaningful experience, no reasonable upper bound on what an
individual company's risk exposure may be.
Insurance companies do not ``take'' risks. They knowingly accept
and mutualize risks. They are private, for-profit enterprises. If they
do not believe they can make money by underwriting a particular risk,
they will not cover it. Because insurance companies do not know the
upper bound of terrorism risk exposure, they will protect themselves by
charging enormous premiums, dramatically curtailing coverage, or--as we
have already seen with terrorism risk exclusions--simply refusing to
offer the coverage. Whatever avenue they choose, the result is the same
increased premiums and/or increased risk exposure for businesses that
will be passed on to consumers in the form of higher product prices,
transportation costs, energy costs, and reduced production.
The consequences of uncertainties surrounding terrorism risk are
already evident in the airline sector. The Department of
Transportation's initial projection is that, as a result of the
September 11 attacks, airlines will pay nearly $1 billion in premium
increases for terrorism risk insurance in the next year despite a
congressionally imposed cap on third-party liability. Within the next
few months, similar
increases can be expected for other forms of economic activity deemed
``high risk''--if coverage is available at all. Higher premiums will
divert capital away from other forms of business investment.
The need for action is urgent. From our conversations with
insurance company representatives, State insurance regulators,
policyholders, banks, and other entities which provide financing for
property transactions, the next 2 months are critical. The insurance
industry relies on a complicated structure of risk sharing. Risk is
shared among primary insurers, reinsurers, and retrocessionairs (that
is, providing reinsurance to the reinsurers). This structure has worked
well in the past and greatly contributed to widely spreading losses
associated with the events of September 11 across the insurance
industry.
However, in light of the uncertainty created by September 11,
reinsurers have told us that they will no longer cover acts of
terrorism in their reinsurance contracts with primary insurers. And as
I have said, most property and casualty insurance contracts are up for
renewal at year end. This will create the following choices for
insurers: assume all of the risk of terrorism coverage and raise prices
to cover all of the associated, unshared costs; reduce coverage levels;
or cancel coverage. Any of these choices has the potential to cause
severe economic dislocations in the near-term either through higher
insurance costs or higher financing costs.
Objectives
In grappling with this problem, we have had several objectives.
First and foremost, we want to dampen the shock to the economy of
dramatic cost increases for insurance or curtailed coverage. We also
want to limit Federal intrusion into private economic activity as much
as possible while still achieving the first objective. And we want to
rely on the existing State regulatory infrastructure as much as
practicable. Note that none of these objectives are directed at
providing Government assistance to the insurance industry. The industry
is absorbing the financial losses it contracted for as a result of the
September 11 attacks, and is fully capable of making good on those
losses. The industry is also capable of continuing to provide insurance
for nonterrorist hazards. The problem, as I have said, is one of
uncertainty about future terrorist risk. At the moment, there is no
basis upon which to price terrorism risk and no sense of the upper
bound on the risk exposure.
Options
Over the past few weeks, a variety of proposals have emerged to
deal with the problem I have outlined. Before turning to the approach
we have developed, I will briefly discuss a few of the alternatives we
considered and some of the shortcomings we identified with each.
A case could be made to treat terrorism risk insurance like war
risk insurance. During World War II, the Federal Government provided
property owners with insurance protection against loss from attack.
Similarly, the Israeli Government provides insurance for terrorism
risk. This approach would recognize the terrorist threat as one made
against all Americans and would establish the broadest possible risk
pool for insuring against this risk. At the same time, such an approach
implies a permanent Federal intrusion in the market so long as any
terrorism risk remains.
A second approach, one suggested, in various forms by insurance
industry representatives, involves the creation of a reinsurance
company to pool terrorism risk. This model follows an approach
developed in the United Kingdom in response to IRA terrorist
activities. This approach has some appeal, especially in providing a
vehicle for pooling the industry's risk while providing an upper bound
on industry losses through a Government backstop. With more time, or in
different circum-
stances, this approach may have been desirable.
In our judgement it has several significant shortcomings. First,
the approach ultimately leads to the Federal Government setting premium
rates by establishing the rate charged to the pool for the Government's
backstop. If the basic problem is that the insurance industry whose
business it is to measure and price risk--cannot currently price
terrorism risk without distorting markets, why would we think the
Government can do a better job?
Establishing a pool would also take time, and time is very limited
since most policies expire at year-end. It is unclear how long it would
take industry to capitalize the pool. In the interim, the Government's
exposure could be substantial, insofar as it would be liable for 100
percent of losses that exceeded the pool's capitalization. In addition,
we question whether the Government could move quickly enough on its end
to establish the contracts, the pricing structure, and the regulatory
structure needed to make the proposal work.
Finally, the pool approach creates a Federal insurance regulatory
apparatus with some presumption of permanence and a potentially
enormous pool of captive capital that we may never need to use. We
believe that there will be less uncertainty about terrorism risk a few
years from now and that uncertainty will be more manageable by the
private sector than is the case today. Given that, why undertake the
effort to create a monopoly reinsurer and give a new Federal regulator
the power to both set prices and regulate insurance companies and their
activities?
A third option would be to simply set a large industry deductible
and let the Federal Government cover all losses from acts of terrorism
past that point. For instance, the Federal Government could require the
insurance industry to cover all losses up to, say, $40 billion in a
given year and the Federal Government would pay all losses above that
amount.
This approach has two substantial drawbacks. First, it does not
address the fundamental problem: the industry has no basis for
knowing--and hence pricing--terrorism risk. A large deductible would
require them to assess premiums large enough to cover a large potential
loss. In the absence of better information, we might well expect
companies to price insurance as if they fully expected losses up to the
deductible amount. Second, this approach makes it difficult to control
losses above the deductible as insurance companies would have no
incentive to limit costs once their deductible has been paid.
A Shared Loss Compensation Program
After reviewing these and other options, and discussing these
issues with Congressional and industry leadership and the State
insurance regulatory community, we developed an approach that we
believe best accomplishes the objectives I set forth. Let me say at the
outset that this approach reflects the current evolution of our
thinking on this issue. We want to work with Congress to achieve the
best possible solution. As I have said, the insurance industry can
easily protect itself by eliminating coverage or charging very high
premiums. What we are trying to do is craft a plan that will prevent
the economic dislocations that will otherwise take place if private
insurers follow the course they are now on. It is imperative that we
find a solution that works in the marketplace. We must get it right,
and we must get it right now.
When terrorists target symbols of our Nation's economic, political,
and military power, they are attacking the Nation as a whole, not the
symbol. This argues for spreading the cost across all taxpayers. Yet
there are also reasons to limit the Federal role. If property owners do
not face any liability from potential attacks, they may underinvest in
security measures and backup facilities. In addition, the insurance
industry has sufficient experience and capacity to price some portion
of the risk associated with terrorism and has the infrastructure
necessary to assess and process claims.
Under the approach we are suggesting, individuals, businesses, and
other entities would continue to obtain property and casualty insurance
from insurance providers as they did before September 11. The terms of
the terrorism risk coverage would be unchanged and would be the same as
that for other risks.
Any loss claims resulting from a future terrorist act would be
submitted by the policyholder to the insurance company. The insurance
company would process the claims, and then submit an invoice to the
Government for payment of its share.
The Treasury would establish a general process by which insurance
companies submit claims. The Treasury would also institute a process
for reviewing and auditing claims and for ensuring that the private/
public loss sharing arrangement is apportioned among all insurance
companies in a consistent manner. State insurance regulators would also
play an important role in monitoring the claims process and ensuring
the overall integrity of the insurance system.
Through the end of 2002, the Government would absorb 80 percent of
the first $20 billion of insured losses resulting from terrorism and 90
percent of insured losses above $20 billion. Thus, the private sector
would pay 20 percent of the first $20 billion in losses and 10 percent
of losses above that amount.
Under this approach the Federal Government is absorbing a portion--
but only a portion--of the first dollar of losses, which we believe is
important to do in the first year of the program. The key problem faced
by insurance companies right now is pricing for terrorism risk. While
this type of loss sharing approach does not completely alleviate that
problem, it does provide insurance companies with the ability to
evaluate potential losses on a policy-by-policy basis, with clearly
defined maximum exposures. For example, on a $100 million commercial
policy the insurance company's maximum exposure would be $20 million.
If industry losses were greater than $20 billion that exposure would be
reduced even further.
More importantly, price increases to policyholders should be lower
under this approach than under an approach that requires companies to
absorb 100 percent of losses up to a large, aggregate industry loss
deductible. Under this approach, if an insurance company's maximum
exposure was defined at $20 million on a $100 million policy, the
insurance company could then price that $20 million exposure on the
probability of a complete loss event occurring.
Suppose instead that the insurance industry had to absorb $20
billion in losses before any Government loss sharing began. Then, in
our example, the insurance company's maximum loss exposure would be
$100 million on that policy, not $20 million. Pricing to this maximum
loss would create the economic dislocation we are trying to avoid.
The role of the Federal Government would recede over time, with the
expectation that the private sector would further develop its capacity
each year. As private sector capacity increases, the nature of the
Government's loss sharing agreement would also change. Given more time
and experience, we believe that the insurance industry could
reestablish robust risk-sharing arrangements such as reinsurance that
would enable the private sector to insure losses from terrorism before
the Government loss sharing commenced.
Thus, in 2003, we would have the private sector be responsible for
100 percent of the first $10 billion of insured losses, 50 percent of
the insured losses between $10 and $20 billion, and 10 percent of the
insured losses above $20 billion. The Government would be responsible
for the remainder.
In 2004, the private sector would be responsible for 100 percent of
the first $20 billion of insured losses, 50 percent of the insured
losses between $20 and $40 billion, and 10 percent of the insured
losses above $40 billion. The Government would be responsible for the
remainder.
To preserve flexibility in an extraordinary attack, combined
private/public liability for losses under the program would be capped
at $100 billion in any year. It would be left to Congress to determine
payments above $100 billion.
The Federal Government's involvement would sunset after 3 years. It
is our hope, indeed our expectation, that the market problem we face
today will have been corrected by then so that the private sector will
be able to effectively price and manage terrorism risk insurance going
forward. Of course, should that prove not to be the case, Congress and
the President can reevaluate the program in place and decide at that
time on an extension of the program or establishment of another
approach.
This approach would also provide certain legal procedures to manage
and structure litigation arising out of mass tort terrorism incidents.
This includes consolidation of claims into a single forum, a
prohibition on punitive damages, and provisions to ensure that
defendants pay only for noneconomic damages for which they are
responsible. It is important to ensure that any liability arising from
terrorist attacks results from culpable behavior rather than
overzealous litigation. These procedures are important to mitigating
losses arising from any future terrorist attack on our Nation, and are
an absolutely essential component of the program I have outlined.
Finally, this approach requires a clear definition of an ``act of
terrorism.'' We suggest that the Secretary of the Treasury, with the
concurrence of the Attorney General, and in consultation with other
members of the Cabinet, be given authority to certify that a terrorist
act had taken place for purposes of activating the shared loss
compensation arrangement.
We believe that this approach dampens any adverse economic impact
from a sudden increase in the cost from terrorism risk insurance over
the next 12 months. The imposition of a deductible in the second year,
and an increase in the deductible in the third year, permits the
Federal Government to gradually withdraw from the market as the private
sector adapts to measuring and pricing terrorism risk.
Conclusion
Mr. Chairman, for the reasons I have set forth, the Administration
believes that the economy is facing a temporary, but critical, market
problem in the provision of terrorism risk insurance. Keeping our
economy moving must be our overriding concern. Leaving this problem
unresolved threatens our economic stability. The approach I have
outlined limits the Government's direct involvement, retains all those
elements of our private insurance system that continue to operate well,
and provides a transition period to allow the private sector to
establish market mechanisms to deal with this insidious new risk that
confronts our Nation.
There are no perfect solutions to this problem. We have developed
what we believe is a sound approach. As I explained earlier, we do not
believe that creation of a reinsurance pool can be accomplished under
the time constraints we face, but we would be glad to explore
modifications to our approach with the Committee.
I would be pleased to answer any questions the Committee may have.
----------
PREPARED STATEMENT OF R. GLENN HUBBARD
Chairman, Council of Economic Advisers
October 24, 2001
Mr. Chairman, Senator Gramm, and Members of the Committee, I
appreciate the opportunity to appear before you today to discuss the
situation facing insurance markets in the context of the current
terrorist threat. In a very real sense, the timing of these hearings is
significant; it is important that Congress act on the issue of
terrorism risk insurance before the end of the year.
The terrible tragedy associated with the terrorist attacks on New
York and Washington exacted an economic toll on the United States as
well as a human toll, and the Administration is working with Congress
to address both losses. Among the direct repercussions of these attacks
has been an increased appreciation of the need to focus public policy
on security, including efforts toward defending American economic
activity against terrorist intrusions. The need for security in
economic activity--whether in such visible forms as Federal Air
Marshals or more mundane needs like additional backup computer systems
raises the overall cost of transacting business. In this sense, the
attacks acted as a shock to the costs of supplying goods and services
in the economy. It is in our economic interest to contain these
transactions costs as much as possible.
The attacks also raised the degree of uncertainty in the economic
environment--from the state of aggregate demand, to the demand for
particular goods and services (air travel, for example), to a myriad of
other areas. Commercial insurance lies at the intersection of these two
forces. Property and casualty insurance is one mechanism by which
economies respond efficiently to risks in the environment. Risks are
spread, converting for each business a potential cost of unknowable
size and timing into a set of smaller, known premium payments. The
events of September 11 induced a dramatic revision in perceived risks.
In normal circumstances, increased risks are translated into higher
premiums. This serves the useful economic function of pricing risk,
leading the private sector toward those activities where the risk is
``worth it''--there might be losses now and then, but on average
society will benefit--and away from foolhardy gambles.
At the moment, however, the entire Nation is unsure of the genuine
likelihood of additional terrorist events. For insurance markets,
unfortunately, the distinction between risk not knowing when an event
will happen, but having solid knowledge of the odds of an occurrence--
and genuine uncertainty about the frequency of an insured event is the
key to being able to price efficiently. Experience with our new
security environment will mitigate this difficulty over time. In the
near term, however, it would not be terribly surprising to experience
disruption of the property and casualty market. In the extreme,
customers may not be able to renew policies until the market resolves
pricing difficulties. That is, reinsurers may no longer cover acts of
terrorism in their reinsurance contracts with primary insurers.
An interruption of coverage is a particular, and extreme, version
of an increase in transactions costs as a result of terrorist-
associated risks. Still, there is the possibility that existing lines
of coverage will be renewed only with quite substantial increases in
premiums. I believe we are all now familiar with the difficulties
facing aviation; disproportionate rises in insurance coverage or, in
the extreme, withdrawal of insurance coverage, would hinder transition
to a new operating environment. This phenomenon is more widespread,
however. Lenders usually require businesses to insure any property they
use to secure loans. The terms of terrorism coverage could diminish
bank lending for new construction projects. It could as well act as a
sharp impediment to transactions that permit existing, commercial
properties--skyscrapers, pipelines, power plants, and so forth--to
change hands. It is important to point out that this ``changing hands''
is an important economic function. The relative efficiency with which
our economy reallocates capital from less productive to more productive
uses sets it apart from many other nations.
In short, a well-functioning insurance market is part of the
financial infrastructure that underpins our economy. The Administration
and Congress worked together to restore the institutional underpinnings
of the financial markets in the week after September 11. In the same
way, the Administration looks forward to working with the Congress to
bolster the capacity of private insurance markets to provide the risk-
sharing services that benefit commerce and consumers.
Principles for Government Involvement
To this end, the Administration believes that any Federal
intervention in the insurance market should adhere to four key
principles:
1. Intervention should encourage, not discourage, private market
incentives to expand the industry's capacity to absorb and diversify
risk.
2. Intervention should be temporary, permitting us to review in the
future the ability of the insurance industry to price these risks and
absorb losses.
3. Private market actors should face appropriate price incentives
to encourage efforts to minimize the probability of a terrorist event
and to limit losses should such an event occur.
4. Private sector uncertainty about liabilities that arise from
litigation should be reduced.
Importantly, these principles do not imply an objective of
providing Government assistance to the property and casualty insurance
industry; rather, the principles address implementation of the
objective of mitigating short-run cost increases for insurance. The
Administration's approach to terrorism risk insurance adheres to each
of these four principles. In order to see this, please allow me to
first explain the basic outlines of how this approach would work.
The Administration's Approach
After reviewing several options and discussing terrorism risk
insurance with industry lenders, insurance regulators, and academics,
the Administration developed an approach, one with which we look
forward to working with Congress. Upon enactment of this legislation,
if the United States were the victim of a terrorist attack before the
end of 2002, the Federal Government would pay for 80 percent of the
first $20 billion of insured losses, and 90 percent of insured losses
in excess of this amount. The private insurance industry would pay for
the remaining insured losses.
In 2003, the industry would be responsible for the first $10
billion in insured losses, and 50 percent of insured losses between $10
billion and $20 billion. Above $20 billion, the Federal Government
would continue to pay 90 percent of all losses.
In 2004, the third and final year of this program, the industry
would be responsible for 100 percent of the first $20 billion in
losses, and 50 percent of insured losses between $20 billion and $40
billion. Above $40 billion, the Federal Government would continue to
pay 90 percent of all losses. In the event that total insured losses
exceed $100 billion in any calendar year, Congress would determine the
procedures for and source of any such payments.
In addition to this insurance component, the Administration
approach would also consolidate all claims arising from a terrorist
incident in a single Federal forum. In addition, it would prohibit
claims for punitive damages (other than those directed at the
perpetrators), and require that noneconomic damages be proportional to
a defendant's responsibility (for economic losses, ordinary rules of
joint and several liability would apply).
This approach is designed to mitigate economic consequences from
sudden increases in the cost of terrorism insurance over the next year.
The imposition of a deductible (in the second year) and a subsequent
increase in the deductible (in the third year) permits the Federal
Government to recede gradually from the market as the insurance
industry adapts to measuring and pricing terrorism risk.
Consistency of Approach With Principles
The approach I outlined is consistent with the Administration
principles outlined above. This proposal encourages private sector
capacity building in several ways. First, it is forward-looking. It
respects the insurance industry's proven ability to develop the
capacity to price, market, and service products for new types of risks.
In the past, naysayers deemed reinsurance against the risks of natural
catastrophes such as hurricanes as beyond the reach of private
insurance markets. Experience has proven them wrong. By providing a
temporary bridge of 3 years, a steadily receding Federal presence, and
an explicit sunset, we will permit the industry to grow into this new
market.
Second, the Administration's proposal recognizes that a limitation
facing the insurance and reinsurance industry is its total capacity to
absorb risk. For this reason, we provide the economic function of
limiting its maximum exposure in order to provide a backstop against
catastrophic losses, which could generate large increases in
transactions costs for businesses and, ultimately, for consumers.
Third, because the industry shares in the losses--up to a maximum
loss--and the share it shoulders rises over time, there will be a
profit motive for insurance companies--and actuaries and economists--to
begin now to refine pricing models. As I noted earlier, there are
economic benefits to the efficient pricing of risks. While no covered
individual company can control whether terrorists strike, efficient
pricing can lead every covered company to take actions lessen the
damage that results from terrorist incidents. After the approach
sunsets, the industry will have made progress toward efficient pricing
of risks. At that time, issues of pricing and the industry's capacity
to absorb losses can be revisited.
In addition, having the industry participate will control costs
after any event. If the Government agrees to pick up 100 percent of all
claims, the insurance industry has no incentive to do careful claims
adjustments.
The potential losses facing insurers depend not only upon the
security and economic environment, but on the legal setting as well.
That is why the Administration approach would also include certain
legal procedures designed to manage mass tort cases arising out of
terrorism incidents. These procedures will bring damage claims closer
to their economic foundation and reduce the uncertainty about the
magnitude of potential claims. The consolidation of claims in a single
Federal forum, for example, helps to ensure that the claims will be
treated in a consistent manner and eliminates the redundancy costs of
litigating similar claims in multiple courts. In addition,
consolidation tends to expedite the claims process, reducing the
uncertainty about the length of the litigation. Limitations on punitive
damages (other than those directed at perpetrators or abettors) and
proportional liability for noneconomic harms (except those caused by
perpetrators or abettors) reduces the potential for open-ended claims
that would exhaust the defendants' resources in mass tort cases. Such
reforms are essential for economically enhancing the efficiency of the
insurance market by increasing the ability of the insurance industry to
price and absorb the risks associated with terrorism.
Conclusion
To conclude, the U.S. economy is very resilient, and, through the
combined efforts of the Administration and Congress it is possible to
provide transitional public policy to support the needs of purchasers
of property and casualty insurance. Thank you again, Mr. Chairman, for
the opportunity to appear before you today. I am happy to answer your
questions.
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PREPARED STATEMENT OF KENNETH A. FROOT
Andre R. Jakurski Professor of Finance, Harvard University
October 24, 2001
Mr. Chairman, Senator Graham, and Members of the Committee, I
appreciate the chance to appear before you today to discuss the
insurance and reinsurance markets in the aftermath of the tragic events
of September 11. We run the risk of considerable short-term dislocation
in these markets going forward, given especially the annual nature of
reinsurance renewals. At the same time, we need to preserve the
benefits of a vibrant insurance marketplace: the high-quality
evaluation, pricing, allocation, and mitigation of risk. So the issue
before the Committee is extremely important as well as timely.
Some Useful Background
This is not the first important upset in insurance and reinsurance
markets. In the mid-1980's, as the U.S. courts entered new territory,
large insurer and reinsurer exposure to product and environmental
liability became apparent. Insurance prices rose rapidly. Some firms
failed, and insurance and reinsurance capital was stressed by the
additional liabilities. The industry responded by developing
specialized contracts, and treaties to cover these liabilities. They
developed schemes for pricing that, especially in the early years,
proved remunerative. Major financial intermediaries came together to
sponsor the creation of new major reinsurers to write new liability
coverage.
In the early 1990's, the United States experienced two very large
natural disasters, Hurricane Andrew and the Northridge Earthquake. The
losses from these events (currently estimated at approximately $20
billion and $17 billion, respectively) were a shock to an industry that
rarely considered, and have never before seen, such losses from natural
perils. Once again, some firms were bankrupted and risk capital was
stressed.
Let me trace out the industry response. First, as one might expect,
insurance and reinsurance prices rose spectacularly immediately after
Andrew, doubling between 1992 and 1993. Figure 4b shows an index of
Rate on Line (ROL), the ratio of premiums to policy limits, for
catastrophe reinsurance. ROL rose strongly in 1993. However, ROL
actually understates the change in the cost of reinsurance. When the
price of reinsurance goes up, buyers tend to purchase less,
specifically by using higher deductibles. The expected claim against
the policy goes down relative to the limit, thus making the protection
more expensive than ROL makes apparent. The line labeled ``price''
adjusts for this effect. Price is the ratio of the premium paid to the
expected loss. This is a much truer index of reinsurance cost. The
event impact on price is considerably greater using this measure of
price.
Second, after these very large post-event increases, prices fell
steadily between 1994 and 1999. The effect of Andrew and Northridge
dissipated. By 2000 prices were at half of their earlier values. Why
did this occur? Additional risk-bearing capital and new firms entered
the reinsurance industry, increasing competitiveness. Approximately $10
billion of additional capital flowed into these reinsurers, much of
which is a result of the attractive post-event prices.
Third, this growth occurred through the creation of a variety of
new institutional reinsurance mechanisms. For example, the basic
prototypes for reinsurers domiciled in tax- and regulation-favorable
countries--Bermuda in particular--were developed and streamlined. These
tax and regulatory advantages benefit the U.S. insurance industry by
providing more competitive reinsurance products.
Fourth, during this same period, additional sources of capital
outside of the reinsurance sector became active. ``Cat'' bonds and
related financial instruments, which could be purchased by investors,
became viable alternatives to reinsurance treaties as a way of
transferring risk. Even though relatively few ``cat'' bonds have been
issued, they have promoted competition in the industry. Over the past 3
or 4 years there have been a number of episodes where major reinsurers
have succeeded in undercutting the price of ``cat'' bonds. While it is
unclear whether the motives have been tactical or predatory, what is
clear is that competition has been enhanced.
Fifth, while hard to summarize in numbers, the entire discourse
surrounding natural catastrophe events changed during this post-event
period. Third-party firms specializing in building objective models of
potential natural disaster losses grew and, unlike before, became
popular with insurers, reinsurers, investors, and intermediaries.
Critics of the objective models engaged them. Conferences and
specialist groups began to discuss catastrophe risk both qualitatively
and quantitatively. Insurers, reinsurers, commissioners, regulators,
rating agencies, and even the general public became far more aware of
the possibilities of these events, where they might occur, what kinds
of buildings are at risk, how construction techniques can be improved,
how damage can be contained, etc. Insurance and reinsurance prices
increasingly impounded this information. The increase in awareness and
planning has resulted in significant risk mitigation, better decisions
about risk exposure and financial capital, and corporate, financial,
and household sectors that are more stable.
These changes have helped reduce the post-event price of
reinsurance. But, perhaps more importantly, they have increased the
amount of reinsurance protection that is commonly purchased today. To
see this, Figure 4d shows the reinsurance buying patterns of insurers
who purchase reinsurance. Specifically, it shows the fraction of
reinsurer losses covered at different levels of industry losses (in
2000 dollars). Because this chart covers only insurers who purchase
protection, it is not representative of the entire insurance industry.
Nevertheless, it is representative of the level of industry losses for
which protection is purchased. And the results are striking. Before
Andrew and Northridge, the most common layer of protection helped
protect against events generating industry-wide losses of about $4
billion. As of 2000, the most popular level of loss protection had
about tripled, to about $12 billion. In addition, today substantial
coverage has been extended to much larger events. Protection against
natural catastrophe losses of $20-$25 billion and more is not uncommon.
This is the legacy of Andrew and Northridge, and it is a permanent one,
given the changes discussed above.
Some Implications for Today
This brief retrospective provides context for policymaking in the
aftermath of the latest, largest ever losses from September 11. First,
it is clear that reinsurance industry is efficient over the medium
term. The industry can and does respond to large disasters. High prices
occur, but these motivate the response. Figure 4b shows that prices
have fully returned to their pre-Andrew levels, even as Figure 4d shows
that demand today for reinsurance has increased enormously. This is the
sign of an economically efficient industry: financial innovation and
capacity expansion have accommodated a large increase in demand with
virtually no increase in price.
Second, there is evidence that the ``medium term'' has today grown
shorter. Following Andrew, the post-event spike in prices took several
years to undo. With the losses of September 11 following so closely
thereafter, there are a number of reasons to believe that the response
will be considerably quicker going forward.
Bermudan reinsurers, transformers, and other financial
institutional forms including capital-markets instruments can
rapidly and smoothly impound new capital. A variety of vehicles
allow investors to participate in the reinsurance function through
equity in new or existing reinsurance companies, closed-end mutual
funds, convertible close-end funds, bonds, convertible bonds, etc.
In addition to the ``hardware''--meaning explicit
organizational forms, contractual and financial instruments--for
transferring risk, much ``software'' has also been built. This
includes the expertise and knowledge of brokers, investment
bankers, reinsurers, insurers, rating agencies, investors, and
regulators, who are much more fluent in the activities of risk
transfer in property/casualty lines.
There is direct evidence that the combination of this
``hardware'' and ``software'' works effectively today. As I write,
I am aware of approximately $3.0 billion that has already been
newly committed to reinsurance capacity directly as a result of the
September 11 events. These additional capital infusions involve the
expansion or creation of Marsh Axis Specialty Re, AIG, GE,
Renaissance Re, Hartford Financial, QBE, Zenith National, Da Vinci
Re. These are committed fund raising efforts, fully in place in
less than 6 weeks.
At the end of the post-Andrew price cycle, prices had returned to
where they began. However, durable progress had been made. The
``hardware'' and ``software'' create a kind of infrastructure. As a
result, the catastrophe marketplace today has become more flexible and
responsive. The risk associated with natural disasters is better
mitigated and better spread as a result.
Third, any form of sustained provision of reinsurance by the
Government will impede this kind of progress. Many decisions throughout
the economy need to be made that affect exposure to terrorist actions.
What types of steel and concrete reinforcements help reduce risk in
buildings of various heights? What kinds of physical barriers around
tall buildings, stadiums, public works projects are appropriate? What
kinds of equipment for checking, opening, or possibly sterilizing mail
should employees reasonably expect? What kinds of security is it
appropriate for the travel and other industries to provide their
employees and customers? Insurance and reinsurance markets help provide
answers to these questions by evaluating and pricing risk, and
formulating detailed policy requirements. The result is that risk is
both mitigated and better spread throughout the economy.
Fourth, the sheer level of uncertainty about the likelihood of
terrorist attacks is not itself a reason to replace market functions
with Government programs. Critics of catastrophe modeling including
some of the most important reinsurance underwriters--argue that the
models provide false provision and that the probabilities of natural
disasters are unknowable. The uncertainty surrounding the potential
one-time impact of the Year 2000 computer bug was certainly extreme,
yet this did not stop the creation of private insurance dedicated to
protecting against Y2K damages. The history of the last 5 years
strongly suggests that market can and does function even when risk is
hard to evaluate.
The Administration's Proposal
I support and applaud the Administration's proposal of a limited,
temporary Federal intervention in the insurance market. A measured
response is appropriate at this time to assure continuity in insurance
markets and support renewed economic growth. I am comfortable with all
but one of the four key principles articulated by Chairman Hubbard in
his earlier testimony. The intervention should encourage private market
incentives to expand capacity as needed and diversify risk. It should
generate appropriate price incentives to encourage the private sector
to mitigate the losses and risk of a terrorist event. And it should
help reduce uncertainty about liabilities that arise from associated
litigation. In addition, I believe that if these three principles are
to be satisfied, the short sunset feature of the program is absolutely
essential.
In that spirit, I would strengthen the second of the
Administration's principles, which deals with the sunset feature. In my
view, it should read, ``The intervention should be absolutely
temporary, and primarily intended to resolve short-term dislocations in
the market due to a sudden shift in risk and coverage perceptions.''
Given the magnitude of the change in expectations that we have just
experienced, and the very tight calendar before year-end, I believe
that an intervention is justified. The risk profile of major firms--
both financial and nonfinancial--would be otherwise unbalanced and a
deterrent to economic growth.
Over 2 or 3 years, I believe the market is fully capable of
evaluating, pricing and designing exposure to large risks. If we
experience losses beyond what the markets are willing and able to
tolerate, then Government involvement is, at that point, virtually
assured. This is, and has been, the case for natural disasters. There,
private market policies are not open-ended; they extend to losses that
are only so great. Since the largest events are often unknowable
beforehand, the sensible approach is to define the intervention ex
post, based on the then-existing circumstances. The existence of a
Federal program ex ante is unlikely to forestall Federal actions after
another event should that program then be considered inadequate. As I
have argued, the existence of anything more than a targeted, highly
temporary, Federal program is likely to forestall development of better
insurance markets and pricing, and better risk allocation and
mitigation decisions by the private sector.
Thank you again, Mr. Chairman, for the opportunity to express my
views.
PREPARED STATEMENT OF KATHLEEN SEBELIUS
President, National Association of Insurance Commissioners
Commissioner of Insurance, The State of Kansas
October 24, 2001
Introduction
My name is Kathleen Sebelius. I am the Commissioner of Insurance
for the State of Kansas, and this year I am serving as President of the
National Association of Insurance Commissioners (NAIC). Speaking for
myself and my fellow insurance commissioners, we appreciate the
opportunity to testify regarding the potential role of the Federal
Government in making sure that insurance against acts of terrorism
remains available to American consumers and businesses.
Today, I want to make three basic points:
First, NAIC and its members believe there is presently a need
for the Federal Government, working with the State regulatory
system, to provide appropriate financial backup to the private
insurance market in order to assure that our Nation's economy does
not falter due to a lack of insurance coverage for terrorism.
Although NAIC has not endorsed a specific proposal for Federal
assistance at this time, we have adopted a set of 19 guiding
principles that we believe should form the basis of any successful
Federal program. A copy of the NAIC's guiding principles is
attached at the end of my testimony.
Second, we believe Federal assistance should be a relatively
short-term solution to stabilize the commercial marketplace while
it regains the risk assessment and pricing equilibrium needed for
private insurers to underwrite terrorism exposures. Thus, any
Federal terrorism insurance program should be limited in scope and
duration.
Third, a Federal assistance program should maximize the use of
market forces to add efficiency and reduce the risk of losses from
terrorism and the potential costs to Federal taxpayers.
The U.S. Insurance System Remains Fundamentally Sound
Let me start by saying that NAIC believes the insurance industry is
well-capitalized and financially able to withstand the pressures
created by the September 11 terrorist attacks, despite losses projected
to exceed $30 billion. The U.S. insurance industry is a $1 trillion
business with assets of more than $3 trillion. Preliminary loss
estimates of $30 billion to $40 billion represent just 3 to 4 percent
of the premiums written in 2000.
America's insurance companies have time and again shown their
ability to respond to huge disasters and successfully recover. Adjusted
for inflation, Hurricane Andrew in 1992 caused $19.7 billion in insured
losses, and California's Northridge Earthquake in 1994 cost $16.3
billion in insured losses. As with previous disasters, we believe
insurers affected by the recent terrorist attacks will be able to pay
their projected claims, as they themselves have said.
Insurance is the sale of a promise to pay claims when losses occur.
As regulators, my colleagues and I will continue monitoring the process
to make sure that insurance promises are kept. To do our job, we are
backed by an impressive array of human and technical resources,
including the NAIC and 51 State insurance departments that collectively
employ more than 10,400 people and spend $910 million annually on
insurance supervision. In addition, at this time State insurance
guaranty funds have the capacity to provide up to $10 billion to
compensate American consumers in the event of insurer insolvencies.
We would urge Congress to structure any Federal assistance program
to take full advantage of the existing State regulatory system. We have
the mechanisms in place to monitor insurer solvency and handle claims
payment issues.
Congress Should Not Disrupt the Power of Private Market Competition
The international commercial property/casualty insurance market is
very powerful, dynamic, and competitive. As a free market, it responds
to new information quickly, and sometimes with great volatility. Like
the stock exchanges, insurance market participants often react in
unison to reach the same conclusion at the same time with regard to
what products are viable and profitable, meaning that the price and
availability of specific products will rise and fall in conjunction
with the industry's collective willingness to sell them. Substantially
negative information, such as the September 11 terrorist attacks, can
disrupt the entire market until new information becomes available that
makes insuring terrorist risks acceptable.
Given sufficient time to adjust, however, the commercial insurance
market has found ways in the past to assess and insure extremely large
and difficult risks that were initially considered uninsurable. During
the 1980's and 1990's, the insurance industry weathered enormous
financial losses from asbestos, medical malpractice, and environmental
pollution claims against corporate policyholders that were not foreseen
by insurers. In those instances, insurers said they had not reasonably
expected to be held responsible for such colossal claims, and therefore
had not collected sufficient premiums or established sufficient loss
reserves to cover them.
In the short term, the insurance market responded to huge
environmental exposures with policy cancellations, coverage
limitations, exclusions, and increased prices, as is being threatened
now with regard to terrorism risk coverage. In the longer term,
coverage for these risks became available through a combination of
aggressive risk management, self-insurance, captive insurance pools,
other alternative risk-sharing mechanisms, and renewed interest by
commercial insurers as they gained confidence in their abilities to
adapt their policies and pricing to a level where they could underwrite
the business profitably. Ultimately, the creativity and competitive
discipline of the market overcame its initial period of contraction and
volatility to provide viable insurance solutions for enormous risks
that were previously considered uninsurable.
The business of insurance is about measuring risks and selling
promises to cover them at a reasonable profit. Insurance experts who
perform these tasks are exceptionally talented. Over time, they have
demonstrated a remarkable ability to adapt to unforeseen circumstances,
while making available the insurance products that are essential to the
growth and productivity of American business. As expected in a free
competitive market, individual companies may stumble, falter, and even
fail when substantial adversity strikes, but the U.S. insurance
industry as a whole has a long and proud record of finding ways to
overcome new obstacles while advancing its business goals and serving
the interests of the insurance-buying public.
Thus, the NAIC believes Congress should begin its consideration of
Federal assistance to the insurance industry by recognizing the
strength and adaptability of the private insurance markets. Federal
actions that unduly disrupt or interfere with private market forces are
likely to end up causing more harm than good for American consumers and
Federal taxpayers.
Appropriate Government Action Can Help the Private Market Recover
State regulators know from their own experiences that Government
action can help the insurance market recover when it becomes
overwhelmed by changing risk factors or catastrophic losses. When the
psychology of the market results in industry reactions that harm the
public, Government has unique powers to alter the insurance marketplace
for the benefit of consumers. We have found that successful Government
assistance involves tailoring actions to fix specific problems and
keeping the program as narrow as possible.
Hurricane Andrew provides a useful example of limited Government
intervention that works. Following the tremendous losses from this
hurricane in 1992, commercial reinsurers restricted their coverage for
windstorms and raised prices. This caused a corresponding reaction from
primary insurers, who moved to raise prices, cancel coverage for
coastal properties, and increase deductible amounts for consumers
having significant hurricane exposure. Within a couple of years,
normalcy returned to the reinsurance market, and then to the primary
market. The Florida Insurance Department assisted with the recovery of
the industry by introducing a moratorium on policy cancellations and
beginning the discussion of the need for a State catastrophe pool. The
Florida legislature later adopted a Hurricane Catastrophe Insurance
Pool that provides a State-based backstop for catastrophic windstorms
in Florida. These collective actions have resulted in a robust and
competitive market for homeowners insurance in the State of Florida.
State insurance regulators believe the current situation affecting
the availability of insurance for acts of terrorism is similar in
nature to other catastrophic events. Due to the magnitude and
unpredictable nature of terrorism as it is currently perceived by
insurers, a temporary level of Federal assistance to spread risk
appropriately should provide time for the marketplace to adjust its
thinking about how insurance coverage for terrorist acts should be
handled. If the Federal Government and business customers make quick
progress in lessening exposure from acts of terrorism, the insurance
industry may start providing the coverage American businesses and
families demand. Enacting a temporary Federal solution will provide the
necessary time to craft a more thoughtful long-term solution.
Three Important Market Factors for Congress to Keep in Mind
As Congress considers what type of Federal assistance may be
appropriate to steady the commercial market while it adjusts to new
demands, the NAIC recommends that you keep in mind three very important
factors. These factors will greatly affect the costs of any Federal
program, as well as its lasting impact on America's consumers and
private insurance markets.
First, risk management precautions that reduce the likelihood of
losses from terrorist attacks will have a large impact on the
willingness of private insurers to offer terrorism insurance coverage
to customers. Risk management--the implementation of safety and
security measures to prevent harm--is a standard part of insuring
commercial and Government facilities that are most susceptible to
terrorist attacks. Large firms have professional risk management
departments whose mission is to reduce a company's exposure to
potential accidents and intentional harm, thereby improving the
company's chances to get insurance at the lowest rates possible.
Following the September 11 attacks, Government and commercial
facilities across America have added security measures to prevent acts
of terrorism and limit potential damages. As commercial risk managers
review these new precautions, it seems likely they will become more
inclined to offer terrorism insurance because the possibility and
extent of potential insured losses occurring will be greatly reduced.
At that point, we expect market forces will start working to fill the
gap by making terrorism insurance available through private industry.
The NAIC recommends that Congress build-in strong incentives for
insurers or companies receiving Federal assistance to implement and
maintain effective risk management measures to prevent acts of
terrorism from occurring. In that way, the Federal Government will be
building upon standard risk-reducing steps that are well accepted in
the private marketplace for insurance products.
Second, the private market instills policyholder discipline to
avoid insurance claims through the concept of co-insurance. Co-
insurance means that policyholders are liable to pay part of any losses
covered by insurance before expecting a recovery from an insurer.
Obviously, the higher the dollar amount covered by the policyholder
himself, the greater will be his incentive to take steps to avoid
losses. This concept is commonly understood by everyone owning a car or
a home who agrees to bear the cost of a ``deductible'' before receiving
payment from an insurance company. Co-insurance should be considered by
Congress as an important market discipline tool that works equally well
with Government programs.
Third, the scope and duration of any Federal assistance program
will itself become a factor in the private insurance market. Even
though Congress is considering special Government assistance intended
to operate as a supplement to normal business channels, the very fact
that Government will pay certain costs of a commercial business becomes
a factor to be taken into account when private market decisions on
terrorism insurance are made.
The NAIC urges you to keep in mind that Federal Government policy
regarding terrorism insurance assistance will not occur in a vacuum. It
will become a private market consideration affecting prices and
availability of insurance, and it may impact insurance products having
nothing to do with terrorism. The extent of the Federal influence on
private market insurance products can be expected to be directly
commensurate with the size, details, and length of the Federal
assistance program.
State Actions Are Not Driving the Market Demand for
Terrorism Insurance
The NAIC and its members have recently been asked to explain how
requirements of State law impact the market demand for terrorism
insurance. Many people in Congress apparently think that States require
private businesses to carry insurance against terrorism, and that
failure of the private insurance market to offer terrorism coverage
will result in violating State laws and regulations. We believe there
is a misunderstanding of what State laws require and what State
insurance regulators actually do.
Let me say that States do not drive the private market for
terrorism insurance. To our knowledge, no State currently requires that
business entities maintain insurance against acts of terrorism. In
fact, the NAIC recently performed an electronic search of State laws
and regulation for references to ``terrorism.'' We found nothing.
Furthermore, it is important to understand that State insurance
regulators do not normally get involved in the details of property/
casualty insurance policies for large business operations. These are
considered to be the product of free market negotiations among
sophisticated insurance underwriters, brokers, and professional
corporate risk managers who rely upon the traditional powers of buyers
and sellers to bargain for the best deal they can get. The State
regulatory interest in such large transactions is mainly that they not
impair the overall financial health of an insurer, since monitoring
insurer solvency is a major responsibility of regulators.
Banks and investors typically use their private market influence to
require that large business and Government entities maintain adequate
property/casualty insurance coverage against foreseeable harm. As a
result of September 11, foreseeable harm may now start to include
possible terrorist acts in addition to normal hazards. However,
terrorism coverage would usually be just one part of a comprehensive
insurance package that insurers want to sell. Their desire to avoid
terrorist risk exposures may be offset by their need to include it in
order to sell a package of insurance coverage judged to be profitable
overall.
State Actions Having a Limited and Indirect Impact on
Terrorism Insurance
What, then, is the impact of State laws on terrorism insurance?
Primarily, it falls into three areas--workers' compensation
requirements, policy form regulations, and rate regulations. We believe
these areas have a limited and indirect effect upon the price and
availability of terrorism coverage in commercial property/casualty
policies for large business projects that significantly affect the
American economy. It is important to recognize that States are not
initiating market requirements in these areas, but only reacting to
market forces that threaten to deny consumers fair insurance coverage.
Workers' Compensation Requirements
State workers' compensation laws were developed early in the 20th
Century. In the late 1800's and early 1900's, the number of
occupational injuries and illnesses occurring in the American workplace
was hindering the Industrial Revolution. Businesses were asking how
they could assure that working men and women who are injured on the job
get the care they need, while protecting industry and commerce from the
financially crippling and demoralizing prospect of employees suing
their bosses for every work-related injury. The question was answered
with the State Workers' Compensation System, which covers employees'
medical expenses and lost wages for work-related injuries and disease,
regardless of who was at fault. In return, employees are limited to the
benefits provided by the workers' compensation system as their
exclusive remedy.
State workers' compensation laws require a set of benefits that are
guaranteed by employers to their employees who are injured on the job.
Insurers play a key role in the delivery of the benefits promised by
employers. Typically, insurers assume by contract the obligation to
provide the employer's share of medical benefits, rehabilitation
benefits, and survivor's benefits in exchange for premiums the employer
pays the insurer. Since State law obligates the employer--and therefore
the insurer that has assumed the employer's obligations--to provide the
benefits specified in a State's Workers' Compensation Act, the insurer
cannot introduce either an exclusion for war or an exclusion for
terrorist acts.
As a no-fault safety net for workers' injuries on the job, State
workers' compensation laws do not permit coverage exclusions as a
matter of public policy. Workers' compensation insurance is one part of
the commercial coverage maintained by significant employers.
State Policy Form Regulations
Many States have statutory authority over insurance contract
language through general policy form regulations. These requirements
typically prohibit contract language that is misleading, illusory,
inconsistent, ambiguous, deceptive, or contrary to public policy. Since
no currently enacted State laws specifically prohibit an insurer's
request to exclude coverage for terrorist acts, States would have to
rely upon the general provisions above if they seek to deny an
insurer's request to exclude terrorism coverage. Under State law, an
adverse regulatory decision can be challenged by an insurer through the
State insurance department's administrative process, with the right of
appeal to State courts.
State insurance regulators are also charged with solvency oversight
of insurers. Thus, an action to deny an exclusion of terrorist
activities under general policy form provisions could cause financial
difficulties for insurance companies. However, it is ultimately the
insurer's choice whether to provide coverage for a specific business
event or peril. Primary insurers may be hesitant to exclude coverage
for terrorist acts because they know their business and individual
customers will want assurances the coverage is provided. Reinsurers do
not directly deal with businesses and families, and therefore do not
face the same pressures to provide terrorism coverage.
State Rate Regulations
State rate regulations are primarily focused on protecting small
businesses and individual policyholders. For commercial lines insurance
products, only 13 States still require that the insurance department
exercise prior approval requirement for most rate changes. The
remaining 38 jurisdictions have some form of competitive rating
mechanism that allows insurers to file and use rates, or use them even
before they are filed with insurance regulators. Moreover, in recent
years insurers have been successful in convincing State legislatures to
create rate regulation exemptions for large commercial policyholders.
The NAIC does not believe State rate regulations are preventing
insurers from charging adequate rates for terrorism insurance.
Conclusion
The NAIC and State regulators believe the insurance industry
remains strong, and that it retains tremendous strength to recover from
the September 11 attacks and adjust its business practices to new
conditions in the marketplace. State insurance regulators are working
together to help assure that any glitches which occur do not disrupt
the process of getting people's lives back in order and America's
businesses back to work. The NAIC and its members plan to work closely
with Congress and fellow regulators, as set forth in the Gramm-Leach-
Bliley Act, so that the needs of individual Americans and our Nation's
economy are met in a timely way.
PREPARED STATEMENT OF J. ROBERT HUNTER
Director of Insurance, Consumer Federation of America
October 24, 2001
Good day Mr. Chairman and Members of the Committee. My name is Bob
Hunter. I am Director of Insurance for CFA. I previously served as
Texas Insurance Commissioner and, of particular relevance to today's
subject, as Federal Insurance Administrator under Presidents Ford and
Carter.
I served at FIA between 1971 and 1980. My first task was to assist
in establishing the Riot Reinsurance Program under the provisions of
the Urban Property Protection Act. I encourage you to look at the Riot
Reinsurance Program for guidance in your current important effort for
reasons I will cover in the next few minutes.
In the late 1960's, the Nation faced great uncertainty from a form
of terror from within. There were an awful series of riots in the land.
If this were not bad enough for the people in the inner cities who were
at the equivalent of what we now call ``ground zero,'' the reinsurers
panicked and began to cut off reinsurance protection from the American
primary insurance market. The primary insurers, without their layoff
arrangements were poised to pull out of the inner cities. Then lenders
would have to call mortgages . . . the set up for a true crisis.
Congress, wisely, stepped in, creating the riot reinsurance
program. The program adhered to good insurance principles, requiring
the Government to charge full actuarial rates for the reinsurance and
making sure that claims were appropriate for payment.
I was tasked with the job of coming up with actuarially sound rates
for the Riot Reinsurance Program. This was about as fearful a job as I
ever faced. There was great uncertainty. But actuarial soundness is not
defined as precise prices. It relates to procedures such as using the
best information available, making reasoned judgements and basically
doing your best. We did that, full well expecting to be too high or too
low since future events such as riots are hard to predict.
I met with insurers, actuaries from the actuarial societies and
other interested parties and came up with prices. Insurers thought they
were OK since they bought the reinsurance. The taxpayer was protected
and, indeed, profited from the transaction. Sound insurance principles
require proper prices and require adequate supervision of the claims
payment process.
CFA Supports a Federal Reinsurance Program for Terrorism
CFA supports a sound program of reinsurance for the terrorism risk
underwritten by the Federal Government.\1\ I attached a list of
principles CFA developed for Congress to consider when developing the
program. Foremost among the principles are that the insurance industry
must be able to purchase affordable reinsurance and that the taxpayer
be protected.
---------------------------------------------------------------------------
\1\ This testimony relates to property/casualty insurance. The life
insurance industry has requested a Commission to study if they need
backup. CFA believes that a Commission is not needed. The life
insurance industry should make its case for when they might need help
and Congress should call hearings to critique that analysis. CFA looks
forward to participating in that separate process.
---------------------------------------------------------------------------
Interim Terrorism Insurance Proposal
CFA understands that creation of the permanent plan we espouse
below might take more time than we have to protect insurers as of
January 1, 2002, when most reinsurance runs out. We, therefore, suggest
that an interim, actuarially sound plan be developed.
Simply, we believe that most insurers could withstand at least
another event of the magnitude of the September 11 tragedy. So we do
not think that the interim plan should cover first dollar losses. CFA
proposes that a retention be used for each insurer of 5 percent of
surplus, as of December 31, 2001. ``Terrorism'' must be defined for
this interim plan and should be determined by a Federal official.
If a terrorist attack occurs and an insurer suffers claims greater
than the retention amount, the insurer would be eligible for Federal
low or no interest loans, the term of which would be negotiated up to
30 years. This would spread the cost over time, an important goal. For
each insurer, the discounted value of the loan would be limited to an
additional 5 percent of surplus.
Amounts of money loaned in excess of the 5 percent of surplus by
company would be repaid to the U.S. Treasury through a property/
casualty insurance industry-wide loan repayment mechanism. This loan
repayment would be collected over a number of that years are sufficient
to minimize the rate impact on consumers (Congress should set the
maximum surcharge, perhaps at about 2.5 percent per year, until the
loan is repaid). The surcharge would be collected by the States as a
piggyback on their State premium tax mechanism and forwarded on to the
U.S. Treasury. This step is needed in order to make sure that
individual company balance sheets are not impacted by very large losses
due to terrorist activity.
This plan leaves the regulation of insurance fully in State hands.
The States should be required to assure availability and affordability
of the terrorism risk, using their usual regulatory methods, including
pooling by State, if necessary. Further, the States should be asked to
assure that the plans enhance security through discounts or other
incentives. Congress could set goals for the States in this effort.
This requires little, if any, new bureaucracy since much of this work
is already part of the State insurance department responsibility.
Needed Protections for the Taxpayer
Any longer term plan should protect consumers and taxpayers in the
following manner: First, insurance companies should pay full
actuarially sound rates for any reinsurance protection they enjoy. Any
plan that requires no premium is not actuarially sound. The insurers
need a plan to protect their interests--they do not need a hand out.
Insurers should be loathe to set a precedent where inadequate premiums
are acceptable when they are paying the premium, if they do not expect
consumers to press for inadequately priced home, auto, life, and other
coverages. When the insurers offer free insurance to us, we will
consider free reinsurance for them.
Free insurance is particularly galling in Year One of the coverage.
Do not forget the insurers made contracts with Americans to cover
terrorism fully. These contracts are being entered into even as we
speak. So, for a year for policies being written today and for an
average of about 6 months for policies already in force, there would be
terrorism coverage even if Congress did nothing. To come in after-the-
fact and give away insurance to the industry, which is a very healthy
industry \2\ even after September 11, would be foolish.
---------------------------------------------------------------------------
\2\ At year-end 2000, the property/casualty industry had surplus of
$321 billion and net premium written of $303 billion. The rule of thumb
for a very safe industry is a ratio of $1 of surplus for each $2 of net
premium written. Thus, the industry had ``excess'' surplus of $170
Billion. ($321-$303/2). So, even if the industry has another WTC event
they can afford it.
---------------------------------------------------------------------------
Actuarial soundness is possible. The taxpayer can be assured that,
over time, the program would, at worst, cost the taxpayer nothing. Here
is how to do it:
Congress should require actuarially sound reinsurance
premiums. That does not mean precision, it means doing the best you
can to set a price you think is based on reason.
The plan should include assessments against the industry if
terrorism reinsurance claims exceed certain dollar thresholds.
During the riot reinsurance days, the industry had to agree to a
2.5 percent of their total premium assessment provision in the
reinsurance contract.
The plan should have a provision stating that if the taxpayer
has paid more into the plan than the premiums and investment of
premiums, the premium collection aspects of the plan will stay in
effect until the taxpayer is made whole. Just as in the Riot
Reinsurance Program, the plan can be self-sustaining over time.
Uncertainty will end and the costs shifted to taxpayers during the
uncertain times can be recouped as certainty returns.
The plan should include a wise payout plan that minimizes
taxpayer exposure. The second year of the White House proposal is a
good start. That should be the first year of the program. The
industry can easily afford a first layer of coverage where they are
100 percent at risk for tens of billions. I would set it at $35
billion \3\ for Year One. The industry could easily afford three
such events even today.
---------------------------------------------------------------------------
\3\ Some have maintained that this is difficult to do since some
who suffered loss early would be more exposed than those with later
claims. This is a red herring. What you should do, I think, is to
allocate the deductible by insurer based on the sorts of risks they
have and their surplus level. Then a smaller insurer might be paid even
if a terrorist loss was relatively small but in the locus of the
exposure that that insurer wrote.
---------------------------------------------------------------------------
The Federal Government should have a claims audit role to
assure that only claims that meet the definition of terrorism and
are within the contractual provisions of the reinsurance policy are
paid.
Second, private insurers should not be able to ``cherry-pick''
against the taxpayer. By ``cherry-picking'' I mean sending bad risks to
the Federal reinsurance program and keeping good risks for the industry
accounts. Thus, all primary insurance companies should be required to
participate in the reinsurance program. At the very least, groups of
insurers should not be allowed to reinsure one company with ``target''
risks (for example the Empire State Building) but not reinsure another
company in the group (say, insuring farm risks).
State Consumer Protections Should NOT Be Impacted by Any
Reinsurance Plan
One of the beauties of reinsurance by the Federal Government is
that it is simply a contractual arrangement with the insurer, it does
nothing to interfere with the carefully constructed system of State
regulation in place.
There Must Be a Degree of Bureaucracy To Administer the Program
While it can be minimized, you need staff to develop the contract
and administer the claims payment process. You cannot just pay claims.
If you do, the taxpayer will be ripped off. You need a small but not
insignificant staff (maybe 50) to do this job. The setting of the
premium charge and the collection of the reinsurance premium requires
very few staff (maybe 5).
Availability and Affordability of Insurance Must Be Assured
The reason for Congress to step into this situation with Federal
backup is to make sure that the economy is not frozen by lack of
insurance for the terrorism risk. To write a plan that does not do the
necessary to assure that insurance is written and the price is
reasonable would be foolish.
This means that the plan should include a requirement of
continuation of direct provision of terrorism coverage by insurers as
part of the ``deal'' for taxpayer backup for those risks that meet
minimum security standards. Further it means that the rate charged for
primary insurance should be correlated with the reinsurance charges so
that there is no gouging by insurance companies at this time of
national emergency. Congress should not infringe on the ability of
State regulators to assure that price gouging for primary insurance
does not occur.
Critique of Industry Proposal
The Consumer Federation of America strongly opposes the industry
drafted ``Insurance Stabilization and Availability Act of 2001.'' This
proposal is a massive overreach that unnecessarily exposes taxpayers to
billions of dollars in risk. There are several serious problems with
the industry approach:
The bill does not require actuarial soundness. Indeed,
insurers would pay nothing for reinsurance for the first year of
the program, until the mutual insurance company created under the
bill builds up a $10 billion net asset base. Apparently, this free
Government reinsurance would even cover policies already in force
for which insurers are fully at risk today. This is a grossly
improper use of taxpayer monies.
Insurers can ``cherry-pick'' risks since they could opt in or
out of the reinsurance program at will. One insurer of a group of
companies could be set up to take all of the ``bad'' risks and buy
the reinsurance, effectively adversely selecting against the
taxpayer. Further, ``cherry-picking'' is allowed in that the
insurers can decide whether to reinsure personal risks and
commercial risks separately.
The selection of Illinois as the sole regulator of the new
Federally backed mutual insurer puts consumers at risk. Illinois,
unlike most other States, does not control prices. Congress should
not interfere with normal insurance protections afforded business
and personal consumers. If Congress decides to interfere, a Federal
agency should be empowered to regulate the insurers, including the
rates charged for the reinsured coverages, to assure that no price
gouging occurs. (Why enact a terrorism reinsurance program to make
insurance affordable and then let insurers charge whatever they
want for the coverage?) If one State were to be used to regulate
the rates and policies offered (something CFA does not favor), the
most advantageous for consumers would be the largest State,
California. Studies show that California insurance oversight has
been the best in the country over the last decade.
The bill would cover war events only for workers'
compensation. The bill should cover war for all lines of insurance
and the reinsurance program should be so constructed.
The bill waives the application of all Federal and State
antitrust laws. This is unnecessary and inappropriate.
The bill allows territorial differences in pricing, which
means that New York City will likely pay much higher rates than
other cities, particularly if there is no Government review of
insurer pricing decisions, as the bill proposes.
There is no guarantee of affordability or availability of
coverage to reasonably secure risks.
We urge you to reject the insurance industry proposal and, instead,
use the very successful Urban Property Protection Act of 1969 as the
precedent for this program, as reflected in the principles developed by
CFA (printed below).
Critique of the White House Proposal
The White House proposal is flawed for several reasons. First, it
is actuarially unsound. The taxpayer should not give away reinsurance.
Second, the first year payout plan shows a fundamental
misunderstanding of insurance. The 80/20 percent split starting at the
first dollar of terrorism loss will actually leave the taxpayer exposed
to 100 percent of the risk. This is because the plan will reinsure the
reinsurers. So, the primary insurers will reinsure the 20 percent the
taxpayer is not on the hook for with the reinsurers. The reinsurers
will then ``buy'' (for no premium) the 80/20 percent cover. This will
increase the taxpayer share to 96 percent (100 percent-[20 percent*20
percent]). But that is not the end of the reinsurance process. The
reinsurers will again reinsure (called ``retrocession'') with other
reinsurers (possibly including the primary carriers themselves). The
taxpayer share will then go to 99.2 percent (100 percent-[20 percent*20
percent*20 percent]). If they reinsure again (there is no limit on how
many times the risk can be ping-ponged to lay off risk on the taxpayer)
the taxpayer share would be 99.8 percent. And so on. This could be
corrected by not exposing the taxpayer to private reinsurance payouts.
A better approach would be to change the plan to have a large
deductible. As indicated earlier, I think that amount should be $35
billion. Over that, there should be sharing as in Year Two of the White
House plan . . . but no reinsurance should be allowed on private
reinsurance claims even in that scenario. The White House plan also
does not guarantee affordability or availability of coverage to
reasonably secure risks.
Conclusion
Congress can and should backup the private insurance market with
reinsurance for the peril of terrorism. It can and should do it in a
wise way that protects the taxpayer and, over time, assures that the
taxpayer is reimbursed for the costs of the program so that the cost
goes to ratepayers rather than to taxpayers.
CFA looks forward to working with the Congress on this most
important effort.
Guiding Principles for Insurance
Legislation Related to War and Terrorism
1. CFA supports the concept of Federal backup of the private
insurance industry for the perils of war and terrorism. We suggest the
riot reinsurance program as a precedent for this backup.
2. Legislation should supplement but not replace other private and
public insurance mechanisms where those mechanisms can provide coverage
more efficiently. However, all insurers should be required to reinsure
against the perils of war and terrorism through the Federal Government
at the outset of the program. In time, as conditions warrant, private
reinsurance should be encouraged. To avoid undue taxpayer exposure,
however, the program should include a requirement of minimum extended
terms for reinsured insurers with claims paid to allow taxpayers to
recoup some of the losses.
3. There should be a reasonable coordination and structuring of
State and Federal regulatory responsibilities with respect to a Federal
terrorism reinsurance program that achieves the objectives of the
program without unnecessarily compromising or preempting State
regulatory authority and consumer protections. Necessary preemption of
or limits on State regulatory authority should be compensated by
requisite Federal oversight.
4. There should be an appropriate balance of different private and
public interests in the governance of regulatory oversight over the
program. Consumers (business and personal), insurers, reinsurers, and
State regulators of insurance should be on the board of advisers for
such program.
5. All records relating to the program, including the records of
the reinsured insurance companies should be available for Federal audit
and, to the maximum extent possible, made public.
6. Rates for the war and terrorism perils charged for the
Government reinsurance should be actuarially sound and should consider
all reasonable factors that can be feasibly measured and supported by
theoretical and empirical analysis.
7. The Federal Government should assure that the cost of terrorism/
war coverage charged by reinsured insurance companies to the consumer
is actuarially based and correlated in price with the reinsurance
offered by the Government.
8. The legislation must clearly define ``terrorism'' and ``war''
and exclude any coverage beyond those definitions. A top Federal
official should determine if a specific event falls into either of
those definitions.
9. Anti ``cherry-picking'' provisions such as the following should
be included: Legislation should recognize that many war or terrorism
exposures subject the Government to potential adverse selection as
insurers with less catastrophe risk are less likely to voluntarily
purchase coverage, while those with greater risk are more likely to
purchase coverage. If legislation were to create a Government
reinsurance program, the program should encourage the inclusion of both
low-risk and high-risk insureds to promote greater risk spreading in a
way that does not subject the Government to adverse selection.
10. Legislation should promote or encourage coverage that is
available to any property that meets reasonable standards of
insurability. Federal security requirements should be met within
reasonable time periods by insured risks and policed by inspection by
reinsured insurers.
11. State residual market mechanisms and other pooling mechanisms
for insurance should be allowed to participate in the entity
established by legislation to
provide war and terrorism insurance, in such a way as to not create
incentives for business to be placed in the residual market. To the
extent that a risk meets the minimum security requirements, it should
be able to get war and terrorism coverage through some source . . . a
residual market if necessary.
12. Jurisdiction over claim settlement practices should remain with
the States.
13. Tax law changes should be encouraged to avoid penalties on and
encourage the accumulation of reserves for war and terrorism losses.
14. Legislation should encourage loss reduction and hazard
mitigation efforts through enhanced security.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
TERRORISM RISK INSURANCE
----------
THURSDAY, OCTOBER 25, 2001
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10 a.m. in room SC-5 of the Capitol
Building, Senator Paul S. Sarbanes (Chairman of the Committee)
presiding.
OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES
Chairman Sarbanes. If the witnesses will take their seats,
we can get the hearing underway. Mr. Baker, I understand you
have a time constraint so why don't we move you up from the
second panel to this panel, and that will give us an
opportunity to hear from you. By what time do you have to
leave?
Mr. Baker. Around noon.
Chairman Sarbanes. Oh, well, we are in good shape here. I
might even have kept you on the second panel.
[Laughter.]
But we will not want to take that chance. Today we continue
our consideration of the question of terrorism insurance in
light of the attacks of September 11. We began our examination
of this issue on yesterday, both morning and afternoon as you
are probably aware, and we had a very informative hearing and
the opportunity to explore a variety of views, including
hearing from the Administration and in particular Secretary
O'Neill.
I believe we gained a number of valuable insights as the
Committee seeks to deal with this issue. And, of course, we
have been exploring the extent to which the events of September
11 threaten the availability of terrorism coverage for
commercial property owners. If such coverage should be
unavailable, what impact that would have on the functioning of
the economy. And, is Federal intervention necessary to prevent
any such disruption? If so, what form should that intervention
take? We are increasingly focusing on the last question there,
but we would appreciate the witnesses helping to build a record
by walking us through the other issues as well.
We have been looking forward to hearing from this panel. I
want to assure the witnesses at the table that we are here to
hear you with a very open mind, so this headline here in the
Financial Times ought not to set you back or dissuade you,
which says, ``Industry plan to aid insurance groups labeled
nonstarter.'' That was not a statement by me, and I do not
think--we have a more open mind than that. So we are happy to
hear any plan that you might want to put forth.
We will have two panels this morning. The first panel will
include Robert Vagley, President of the American Insurance
Association; Ron Ferguson, CEO of General Re Corporation,
representing the Reinsurance Association of America; and John
Sinnott, CEO of Marsh, Inc., representing the Council of
Insurance Agents and Brokers. And they have been joined on this
panel by Leslie M. Baker, the Chairman of Wachovia.
The second panel, which will follow immediately after we
conclude with this one, will include Tom Donohue, President and
CEO of the U.S. Chamber of Commerce; Tom O'Brien, Chief
Financial Officer of LCOR, who is representing the Real Estate
Roundtable; and Walter Knorr, Chief Financial Officer of the
City of Chicago.
I just want to take a moment before we go into this panel
to express my very deep appreciation to my colleagues on the
Committee and even more so to the Committee staff on both
sides, Members' staff, for the extraordinary work that has been
done with respect to the Committee's agenda over the last few
weeks.
This afternoon we are scheduled to vote on and presumably--
not only presumably, but certainly pass the antiterrorism
legislation which will contain within it a title on money
laundering, which was the work product of this Committee and
our colleagues over on the House side. And that represented an
incredible concentrated effort on the part of the staff working
through the night on a number of occasions over a 2 week period
in order to complete that legislation and resolve the
differences with the House and move it forward. We think that
is an important piece in the fight against terrorism.
We believe it is carefully worked out and considered
legislation. We sought to consult with all interested parties.
All interested parties did not get exactly what they wanted.
That is never possible. But we do think it will provide an
effective framework for our authorities to crack down on money
laundering and do it in a way in which the banking industry
will be able to work in a cooperative fashion. They will have
to assume some additional burdens, but the whole country is
assuming additional burdens at this point. And so I want to
thank the staff for this terrific work.
And we have also, of course, tried to move ahead on the
issue that we are considering this morning. Hearings are now
being held elsewhere on the Hill as well. But, of course, we
launched these hearings yesterday. We are carrying them on
today. We seek to distill out of all of what we are hearing
hopefully a consensus position. We need to work out something
that commands the general support or at least acceptance if we
are to move forward on this issue in the time period that is
remaining.
Having said that, Mr. Baker, why don't we go with you
first? We are really moving you up.
[Laughter.]
Chairman Sarbanes. We moved from your panel, and now we are
going to move you to the front of this panel. And we would be
happy to hear from you, sir, and then we will go to Mr. Vagley.
Am I pronouncing it correctly?
Mr. Vagley. Right.
Chairman Sarbanes. We would be happy to hear from you, Mr
Baker.
STATEMENT OF LESLIE M. (BUD) BAKER, JR.
CHAIRMAN, WACHOVIA CORPORATION
REPRESENTING
THE FINANCIAL SERVICES ROUNDTABLE
Mr. Baker. Mr. Chairman and Members of the Committee, thank
you for the opportunity to testify on a critical matter. My
name is Bud Baker, Chairman of Wachovia, here on behalf of the
Financial Services Roundtable.
I am also here today to tell you that without cooperation
between our Government and America's private industry in
support of insurance activities, there could be major
disruption in the marketplace and potential harm to the
economy.
On October 10, thirty chief executive officers from
Roundtable member companies signed a letter to the Congress
expressing concern over the impending lack of terrorism
coverage and urging Congress to act this year. It is important
to note that 22 of those 30 signatories are bankers, including
Wachovia.
The President of the United States, the Chairman of the
Federal Reserve, the Secretary of the Treasury, and many
Members of Congress have recognized that our economy needs an
economic stimulus package. Without Congressional action to
provide a Federal backstop for terrorism insurance, efforts to
provide an economic stimulus could be rendered ineffective.
This is an issue about the ability of the United States to
recovery from the terrorist attacks of September 11 and the
ongoing issues of uncertainty which now weigh upon the economy.
Without insurance coverage for terrorist acts, it will be
much more difficult for bankers to extend or renew commercial
loans or lines of credit for business purposes, construction,
or development. If the insurance industry cannot offer adequate
insurance to a borrower or a bank because it cannot properly
price or reinsure the risk, the bank is faced with a serious
risk assessment problem. Is it prudent to make a loan to
construct a pipeline or a power plant, a large shopping center
or office building when the potential for the borrower to repay
is diminished by inadequate insurance coverage? For most banks,
the answer will be ``no.'' In many cases such a loan most
assuredly would be considered unsound.
Wachovia is one of the five largest commercial real estate
lenders in the United States. Our company has total commercial
exposure of approximately $252 billion, including real estate
and small business loans. I am particularly concerned about the
impact on small business customers who are already experiencing
wide disparity in quoted premiums due to insurers' inability to
price products consistent with standard actuarial analysis. In
the case of large or small business, only the Federal
Government can provide the insurance industry with the
breathing room it needs to return to a stable, rational market.
Without a Federal backstop, businesses will have to self-
insure, putting their capital and ours at risk. Magnify that
potential loss of capital across the domestic banking
sector to gain an appreciation for the dramatic impact a loss
of insurance could have on our economy.
Mr. Chairman, it is impossible to determine if, when or
where a terrorist might strike. But it is quite clear what the
business ramifications can be. We are certain, however, that
the lack of insurance coverage for terrorism will mean fewer
loans, and that will mean constriction of the economic activity
across the country. When a loan is not made, the jobs that
build the plant or run an office cannot be created. With
appropriate support and assistance from the Federal Government,
the insurance industry can be in a position to accept the risk
associated with terrorist attack, and our economy can continue
its march to recovery.
The Roundtable is familiar with the various proposals that
have been developed. We have deliberately not stated a
preference for any particular one. From my perspective, any
proposal must pass a simple test: It must return predictability
to the market. I am certain that given the close collaboration
between the Congress, the Administration, and the industries
affected, we can work together to develop a fine solution.
Thank you very much, Mr. Chairman. I would be pleased to
answer any questions.
Chairman Sarbanes. Thank you very much.
Mr. Vagley.
STATEMENT OF ROBERT E. VAGLEY
PRESIDENT, AMERICAN INSURANCE ASSOCIATION
Mr. Vagley. Thank you very much, Mr. Chairman. My name is
Robert Vagley and I am President of the American Insurance
Association, a leading property and casualty trade association
in the United States. Before beginning my formal remarks, Mr.
Chairman, I would like to thank you so much for your
willingness to consider this matter and to thank you and
Senators Gramm, Dodd, and Schumer for your leadership on this
issue.
Mr. Chairman, the tragic events of September 11 forever
changed our collective understanding of and concern about
terrorism. We lost many valued business colleagues and dear
friends in the attacks on the World Trade Center and the
Pentagon, and no discussion of this subject should proceed
without a heartfelt remembrance of them. Mr. Chairman, the new
post-September 11 world is fundamentally different than that
which existed before, surely for Americans in general, and very
specifically for property/casualty insurers and our customers.
Current estimates of total insured losses resulting from
the September 11 attacks are between $30 billion and $60
billion, although the final number could end up being higher.
The September 11 attack is by far the most costly insured event
in history. The amount of losses from September 11 may well
exceed the entire U.S. property/casualty industry's net income
for the past 3 years.
Notwithstanding the enormity of this loss, the insurance
industry is committed to meeting our promises to policyholders
affected by the events of September 11. We are paying claims
quickly and fully, and have received in excess of $20 billion
in declared claims to date. We are not seeking any financial
assistance to meet these obligations.
Looking ahead, however, we are very concerned about what
will happen if, heaven forbid, there are additional terrorist
attacks on our country. The financial capacity of our industry,
while sizable, is limited and finite. Unfortunately, the
potential harm the terrorist can inflict is both totally
unpredictable in frequency and
almost infinite in severity. These two factors combined make
terrorism risks uninsurable.
There is another important aspect to this issue. Over two-
thirds of annual reinsurance contracts are renewed each January
1. Reinsurers already have notified primary carriers that they
intend to exclude or dramatically scale back terrorism coverage
in the reinsurance contracts coming up for renewal. They are
not to blame for this. These risks are no more insurable for
them than for us.
Primary carriers do not have the same flexibility as
reinsurers with respect to our own products, because we are
subject to tighter regulatory controls. Any terrorism
exclusions we might choose to introduce must be approved by
individual State insurance departments. If approved, our
customers could find themselves bearing 100 percent of the
risks associated with terrorism. Certainly the repercussions of
this are clear. However, if exclusions were denied, the
insurers would be left to shoulder 100 percent of future
terrorist losses, which we simply cannot afford to do. Our only
remaining option, and one we would prefer not to consider, is
to simply withdraw from certain markets and/or lines of
coverage.
So we face a very difficult dilemma. How can we remain
solvent and still serve the real needs of our customers for
financial protection against terrorism? We believe that the
only course of action is enactment of legislation to create a
Federal financial backstop for losses that result from future
terrorist attacks. This backstop could be temporary, but must
be enacted before Congress recesses in order to avert the
market crisis that will occur on January 1.
This is not--repeat, not--a bailout for the insurance
industry. In fact, the primary beneficiaries of such
legislation would be our customers and the U.S. economy. The
purpose of the legislation would be to ensure that adequate
insurance coverage remains available to American businesses.
There are a few ways in which this can be done. One is the
British-style reinsurance pool concept which we have advanced.
Another is the quota share approach recently offered by the
Administration. A third could involve some industrywide
deductible or retention. We are not wedded to the details of
any particular proposal, not even our own, though we do believe
it offers the best hope for restoring this market. However, in
order for any legislative plan to be successful in averting the
looming economic crisis, it must be drafted in a way that
improves predictability, stabilizes the market, and preserves
insurer solvency.
We understand that in all likelihood, any new risk-sharing
mechanism for terrorism coverage will include some significant
retention of future losses by private insurers. On that point,
I would like to note that the more risk insurers are forced to
retain, the less stability there will be in the marketplace,
and the higher the retention, the higher premiums will have to
be.
Mr. Chairman, terrorism has become uninsurable in the
private marketplace as currently structured. Appreciating that
an immediate stopgap solution may be somewhat imperfect, we
expect that dislocations will still occur as insurers may
cautiously reenter the marketplace. It is our hope that with
time and experience, we will be able to craft longer-term, more
complete solutions that avoid such disruptions.
In the absence of Federal legislation to prevent the
complete collapse of the commercial insurance market, entire
sectors of the U.S. economy could be left wholly exposed and
unable to continue the normal course of business. I urge you to
act quickly and decisively to ensure that all businesses are
able to obtain much needed protection against future losses.
Thank you for your attention.
Chairman Sarbanes. Thank you very much, sir. Before I turn
to Mr. Ferguson, what percent of the property and casualty
insurance companies belong to the AIA?
Mr. Vagley. Of the affected losses, probably about 70
percent of the affected companies.
Chairman Sarbanes. And just as a general picture, the total
coverage?
Mr. Vagley. The total coverage, including personal lines
and lines that are unaffected, probably about 35 percent.
Chairman Sarbanes. Okay. Mr. Ferguson, we will be happy to
hear from you.
STATEMENT OF RONALD E. FERGUSON
CHAIRMAN, GENERAL RE CORPORATION
REPRESENTING
THE REINSURANCE ASSOCIATION OF AMERICA
Mr. Ferguson. Thank you. Mr. Chairman, Senator Gramm, good
morning. I am Ron Ferguson. I am one of the 2,400,000 people
that work in the insurance business in the United States. I am
proud of our industry. I am proud of the role we play in our
society and our economy.
As you well know, the insurance business was front and
center in the tragedy of September 11 in terms of claim
dollars, which we will talk about, but also in terms of lives
lost. We will individually and collectively as a Nation recover
from this and move forward. We will get back on our feet. We
are all working to do that under the leadership of President
Bush, Congress, the heroes on the ground and now overseas, we
are assured of doing that.
I have five main messages here this morning, Mr. Chairman:
One, the September 11 claims will be paid. Two, there is a
crisis brewing right now, today, on the availability of
terrorist coverage. Three, I believe that in time we will win
the war on terrorism and we will see a return to a normal
private sector insurance market for these coverages. Four, we
do need a transition period that, in my humble opinion, will
inevitably involve the Federal Government in a backstop role.
Five, as we go down this path, I believe there are a few
principles that we need to articulate and follow. If I may, Mr.
Chairman, I would like to elaborate just a bit on each of those
five headlines.
Chairman Sarbanes. Certainly.
Mr. Ferguson. Thank you. As for the September 11 claims,
there is no way to measure or dimension the grief, but we can
tote up the insurance dollars. As Mr. Vagley said, analysts
indicate that the range of insured losses for all lines,
including life insurance, is likely to be between $25 billion
and $40 billion. A lot of guesswork, but that is the best
guess. My own personal opinion, which should be accorded no
special weight or credibility, is that we are going to be at
the high end of that range.
How will these losses be paid? First, there was never a
nickel of premium collected for these coverages because no one
expected them to happen. That is the plain and simple truth.
Second, there are no assets on insurance company balance sheets
or reserves that are earmarked for this coverage. Third, there
are no hidden reserves in the balance sheet of the insurance
industry. These losses will be paid out of the capital account,
out of the shareholder, or in case of mutuals, policyholder
funds.
Let us talk about those funds for a moment. Broadly
speaking, the entire insurance industry--life, health, casualty
and all lines--has policyholder surplus or net worth of about
$500 billion. The property/casualty industry, which bears the
great bulk of these claims in this instance, has a policyholder
surplus of about $300 billion at June 30. But we need to narrow
the focus and analysis a little more, and we have to talk
about, as Mr. Vagley did, the affected companies--those
companies that write the commercial lines business, the
workers' compensation, the property that indeed generated these
losses.
If you then go down from the $300 billion to the affected
companies and lines of business, I believe that the capital
account that supports that business is about $125 billion. So
we quickly have to go from the $500 billion headline down to
the surplus that is directly supporting these lines of
business, and that is about $125 billion. Tillinghast, which is
a very well respected actuarial firm, has actually come up with
an even lower number than I did, and they estimated it at $80
to $100 billion capital that is supporting these lines of
business.
In any event, numerically, you can certainly make the
argument, and I am here to do that, that the losses of $25 to
$40 billion can be funded out of that capital account. But that
capital account, it must be understood, also supports other
operating risks, other investment risks. And so now it has been
reduced or impaired and we have to collectively ask the
question, ``and then what?'' What happens after this? What if
there are multiple events?
All of the normal actuarial pricing and predictive models
do not hold up here. We have one horrific data point. That is
all we have to go on. The rational response for individual
companies, Mr. Chairman, is likely to be that they will either
restrict the amount of terrorism coverage they write or they
may not offer it at all in certain cases, or they may try to
simply underwrite around it and not provide insurance in
certain targeted areas. And different companies will choose
different paths, and it is very hard if not impossible for me
to dimension that for you. But I think absent some backstop and
plan to go forward, it is inevitable that will happen and it is
starting to happen today.
Chairman Sarbanes. Mr. Ferguson, have you ever been at a
stoplight when it was red and wished you could go on through?
[Laughter.]
Mr. Ferguson. Yes. That is the way I feel right now.
Chairman Sarbanes. Well, I am telling you here we can give
dispensation. So just ignore that red light.
Mr. Ferguson. No ticket?
Chairman Sarbanes. No ticket.
Senator Gramm. But do not forget it is there.
[Laughter.]
Mr. Ferguson. And it can come back at a moment's notice.
Chairman Sarbanes. Yes. Do not get carried away, but we are
really very anxious to get the benefit of what you gentlemen
have to tell us.
Mr. Ferguson. I will try to move along. I understand. I
appreciate it. Thank you, sir.
So we do have an availability crisis in the making. It is
not just a January 1 problem. It is easy to slip into that
thinking. It is a today problem. All those policies that were
out there on September 10 and exposed on September 11 still
exist today. It could happen again this afternoon.
Steve Bartlett from the Financial Services Roundtable said
it in the shortest possible way. He said, ``No insurance, no
lending; no lending, no economy.'' I could not improve on that
short statement.
Chairman Sarbanes. Steve is pretty good.
[Laughter.]
Mr. Ferguson. In time we are going to win this war. We are
going to win the war on terrorism and the markets are going to
return to normal. They always do. We have the examples of the
nuclear energy business which in the late 1950's had to set up
some special pools and a Government backstop. We had the urban
riots in 1965. But it takes time. It takes time to run these
transitions. But with a Federal backstop program, it can be
done. The nuclear risk matter was handled successfully in the
1950's. The urban riot insurance was handled successfully. And
today, there is little or no Federal involvement in either of
those areas, because the private market has come back in.
Now we have several models in play today, as Mr. Vagley
said. I am not wedded to any one particular model. I am only
wedded to the idea of going forward from here. I do have a
couple of principles I would like to articulate very quickly
before the red light comes on again.
Chairman Sarbanes. No, no. Do not worry about that. You
take your time.
Mr. Ferguson. You are very kind. I would like to offer a
few principles that need to be agreed on, I think and followed.
One, we need to very clearly define the problem and the
objectives lest we get into objective creep and unintended
consequences.
Two, we need to make sure that all the interests--the
insurance companies, the insureds, the policyholders, the State
regulators, and the Government--that we have a plan that aligns
all of those interests. We need a plan that is workable at the
micro level. What I mean by that is, it is companies and it is
underwriters and companies that make the decisions every day.
It is not the industry as a whole. And we need to provide for
the people at the companies, the underwriters that price this
risk and make the go/no-go decisions every day have reasonable
certainty as to what they are signing onto, that they have an
agreed definition of what terrorism is so we do not end up with
51 different definitions, 52 counting the Federal Government.
We need to have consistency there.
Three, we need some latitude in the ratemaking from the
traditional rate regulatory system that is applied at the State
level.
Four, I believe any plan must allow for current and future
private sector response. It will come back. It is just a
question of time.
Five, any plan--this is the tricky part--it has to be long
enough to restore the confidence and the predictability Mr.
Baker was talking about but short enough to avoid being
institutionalized. And that is the hard part of this.
My boss is Warren Buffett. And Warren Buffett has a truly
remarkable way of cutting through complex issues and putting
them into common sense, everyday words. He did that the other
day in The New York Times on this issue. He said two things I
would like to share with you. He said, number one, ``We do not
want to write coverages. We do not want to make promises as an
insurance company, as Berkshire Hathaway, unless we are
absolutely certain we can fulfill those promises. Otherwise, it
is a cruel hoax.''
Number two, he said that, ``This is not a bailout of the
insurance industry, it is a bail-in. Let's find out how we can
get together and bail-in and find the way forward.'' I wish I
could turn phrases the way he does. I cannot, so I can only
quote them. Mr. Chairman, we can do the job, but we need your
help for now. Thank you for your time and thank you for the
dispensation on the traffic ticket.
Chairman Sarbanes. Thank you very much, sir.
Mr. Sinnott.
STATEMENT OF JOHN T. SINNOTT
CHAIRMAN AND CEO, MARSH, INC.
REPRESENTING
THE COUNCIL OF INSURANCE AGENTS AND BROKERS
Mr. Sinnott. Thank you, Mr. Chairman. I would like to
explain what Marsh, Inc. is because some people cast us as an
insurance company. We are not. We are the largest risk advisor
and insurance broker in the world with 35,000 employees with
offices in about 100 countries around the world.
We represent and advise clients, the consumers of
insurance. We represent all aspects of all levels of business
clients, from the smallest business client up to the Global
1,000 if you will. We also serve private clients. And finally,
we also serve as a reinsurance broker and service provider for
insurance companies.
So I am speaking today from a different perspective that my
colleague is. I am speaking from the consumer standpoint, both
the insurance consumer and the reinsurance consumer, who needs
the reinsurance. And we have a very good perspective as to what
the current conditions are in the world today. And we think we
have a very good perspective as to the immediate future.
I should also say that I speak today not just representing
Marsh, Inc., but I also speak as a member firm of the Council
of Insurance Agents and Brokers. That is our national industry
association. It represents about 245 of the larger firms which
comprise somewhere in the neighborhood of 75 to 80 percent of
the commercial insurance transacted in the United States.
I will not repeat some of the points already made. However,
there are really two problems as we see it. First of all is the
size of the event that took place on September 11. I might
disagree with Ron. I would say that our best estimates are
that, yes, it will be at the top end, and maybe even more
because of the uncertainty that still exists. That is twice as
large as the next largest catastrophe event that ever occurred,
more than twice.
Looked at another way, if we added to Andrew, which was the
next largest, the next five largest catastrophe claims that
took place in the last 10 years and we aggregate those
together, that in my estimation will equal September 11. So we
have a very significant severity problem.
Second, the problem is uncertainty. And insurance is an
important social instrument, and it is used to dealing with
uncertainty. That is the nature of its business. But if the
uncertainty gets to such size and the probability of losses
becomes so large, then it creates a situation where the
instrument does not respond. And that is what we have today.
And January 1 is a very key date. But I can tell you that
right now, working for our clients in putting together their
insurance programs, some of which renew prior to January 1, we
are already faced with exclusions for terrorism.
So what we see here is that the primary insurers will not
be able to provide our clients with what they need if the
reinsurers that back them, that provide the spread of risk,
feel that they cannot underwrite this particular risk. Simply
stated, without sufficient insurance coverages, businesses and
other entities will be handcuffed at a time when they are
already wrestling with a slowdown in the economy.
My message is fairly simple. When there is a cure for the
current environment, and that cure will only take place if
there is a partnership between the Government and the private
industry, business doing its best to better secure its
environment, Government working to secure the country's
environment, I am convinced, we will be back to where what we
are talking about today will not be needed.
I will make one final comment. Marsh was in the World Trade
Center in 1993 when the first terrorist attack took place.
Fortunately, we did not lose a single employee. And the insured
loss--because we are also an insurance consumer, and quite a
large insurance consumer--the insured loss that we collected
was less than $5 million on our property and business
interruption.
On September 11, we lost almost 300 colleagues. I mean,
that is the real tragedy, and that is what we carry as we walk
through our office and all my colleagues around the world, that
is what we are carrying today.
But in addition, the insured claim that we will have to
submit to our insurers will not be measured in a few millions,
it will be measured in the hundreds of millions, and that is
not the type of exposure or occupancy that the market would
ever have expected from our type of business. We are an office
occupancy.
So I think that best explains the change of environment
that was created on September 11. Whatever is done here, we
believe must be a partnership between the Government and
private industry. It should be short-term. We need something
that gets us beyond January 1. And as my colleagues have said
already, the devil is in the details. But our view is that we
do not like Government involved in our business. That is not
good for us because we are in the risk advisory business. And
when the Government takes over part of that, that gets into our
advice piece. The same thing is true with the risk-bearing
part. If they constantly give off risk to the Government, they
are losing part of their business. This has to be temporary,
but right now, for the consumer, we need a partnership
between the Government and private industry.
Thank you, Mr. Chairman.
Chairman Sarbanes. Well, thank you very much. I thank all
of the panel. And Mr. Sinnott, we understand, of course, that
the first plane that hit the towers hit directly into your
offices.
Mr. Sinnott. That is right.
Chairman Sarbanes. And we certainly extend our sympathies
to your corporate family. I understand that you lost 295 people
out of 1,900. You had offices in both towers?
Mr. Sinnott. In both. Everyone got out of the south tower.
We had about 900 there, which was where the second plane hit.
But anyone who was on our floor in the north tower, no one got
out.
Chairman Sarbanes. I am going to ask a few questions just
to try to get some sense of the parameters of this. What
percent of the loss that you are estimate--you say 25 to 40,
you took the high figure. I mean, who knows, in a sense, but in
any event--is property and casualty and what percent would be
life and health? Do you have any idea?
Mr. Vagley. Yes. We have estimates, Mr. Chairman. Let us
stick with the 40 for the minute, and I certainly take Mr.
Sinnott's point of view, it could be higher. But let us stick
with that for the moment. The estimate would be about $5
billion of that 40 would be life and health.
Chairman Sarbanes. Is what we would do here set a precedent
for what we might have to do for life and health? Since we are
now worried about bioterrorism, chemical, things of that sort.
Do we have to keep that in mind as we work on this problem?
Mr. Vagley. My opinion would be yes.
Mr. Sinnott. I am less sure. Because even with the life
insurance industry which is a vast industry with individuals--
let's face it, it happens every day. We have not to date had
the same issues raised on the life side that we have had on the
property/casualty side.
Chairman Sarbanes. Yes, I know. But this event, this
terrorist event was one that by its nature impacted financially
at least more greatly I think on the property and casualty
side. But you could have a terrorist event, as we are now
seeing as we deal with anthrax. If you refer back to the
chemicals in the Tokyo subway and things of that sort, which
would come down heavy on the life and health problem.
Mr. Ferguson. May I add that I think the key phrase that
Mr. Sinnott used is ``to date.'' And the life industry will
handle this one just fine. But you are absolutely right, Mr.
Chairman. I think we have to think beyond this particular
event. And I almost hate to say it, we have to think about
nuclear terrorism where then the life insurance industry could
be very seriously affected.
We all tend to think about the life insurance industry as
being huge, which by some measures it is. But I must tell you
that the capital base of the life insurance industry in round
numbers is about $200 billion. It is not the behemoth that many
of us might think it is. And you can imagine, as you have just
started to, terrorism scenarios where it would affect the life
insurance industry.
Chairman Sarbanes. Mr. Vagley, you said in your--and I am
just trying to get a sense of the parameters here. We have to
understand the lay of the land. You say on in your testimony,
``Our only remaining option--this is if something were not done
here . . .'' and ``. . . one we would not prefer to consider
would be to simply withdraw from certain markets, and/or lines
of coverage.'' What markets would you anticipate insurers would
withdraw from?
Mr. Vagley. Again, Mr. Chairman, with the same reluctance
that Mr. Ferguson shared, because you almost hate to identify
these areas for fear that somebody will act on them. But
certainly there are a number of American companies that are
icons, that are very visible targets. There are a number of
American industries that it would not require a great stretch
of the imagination to believe would be exposed. Certainly large
office buildings in major cities, transportation networks,
electric utilities, petroleum facilities. There are a number of
businesses that would seem to be more at risk than others.
Chairman Sarbanes. And lines of coverage?
Mr. Vagley. Well, lines of coverage, some of the most
exposed here, workers' compensation would be a very precarious
line of coverage. I think the losses coming out of the World
Trade Center for workers' compensation could indeed be
staggering and could even reach or exceed some of the
commercial property losses. And some of these markets, Mr.
Chairman, already are firming up and are considered hard
markets.
Chairman Sarbanes. Yesterday the NAIC President, Kathleen
Sebelius, who is the Insurance Commissioner in Kansas--this
goes to the duration issue that someone raised at the table--
she said, ``Well, you know, if this had been February instead
of September, that there might have been enough time for the
industry to have sorted it out before the renewal questions
came up.'' What is your reaction to that?
Mr. Ferguson. In a very narrow sense, you can make that
argument. But I would have to broaden it and say that it is a
problem today. You know, all those policies, as I mentioned a
moment ago, that were in existence on September 10 are still
affording this coverage today. And if we have a couple of more
events like September 11, you are going to have a serious
impairment of the capital of the property/casualty business.
That could be February, that could be October. It would not
matter.
So in the narrow sense, I agree with her. There is a little
broader issue here, the financial solidity of the industry
which is exposed every day of the year.
Mr. Sinnott. I would add to that. I would say that 10 extra
months would help because there would be the opportunity to
develop more capacity and capital in the market. By the same
token, the environment is still the same today as if this had
happened in February. And we are no more secure in that regard.
So there is two parts to this. There is the environment and the
ability to secure. I do not think we will ever get back to the
way we were before September 11.
Remember in 1993 when we had the terrorist attack, no one
was sitting here saying we needed help, because there was not a
perception that the environment had changed that radically. So
that is an important issue as well in the timing.
Chairman Sarbanes. I am going to impose on my colleagues
and go on with just a couple of more questions. Mr. Baker, I
wanted to ask you, from the banker's point of view, is there a
difference on the insurance question between existing
structures and new development as you would evaluate the
insurance issue?
Mr. Baker. Mr. Chairman, we will look at all of our
customers the same way. In other words, we will go forward with
existing customers. The question I suppose that is apparent
right now is the need to renew policies as we go forward and
the changing of the risk structure for these people, not just
because of their loans from us but because of their position
and their own risk evaluation in the marketplace.
So our view of them will not change. I think as we look
forward, this becomes an economic issue as we try to think
about what can be done for our customers. So I do not believe
there will be any disparity in how we treat existing customers
or new ones. We do have this renewal issue coming up where we
have a lot of policies that will come up for renewal between
now and the end of the year, and that is what gives some
urgency to this.
Chairman Sarbanes. There is some discussion about whether
the Government should share upfront. That was discussed here
yesterday and has been debated by others.
I take it from the industry point of view, of course you do
not want the figure to be large--you would rather it be smaller
than larger--but it is important to you to have a figure that
would represent your exposure. Then you could calculate. Is
that correct?
Mr. Ferguson. In a word, yes.
Chairman Sarbanes. I mean, whether it was $20, $30, $40
billion, whatever. If you knew that and whatever the formulas
were that the balance then would go off on the Government, at
least you could calculate where you are. Is that correct?
Mr. Ferguson. Yes. You begin to have some certainty and you
could begin with admittedly crude pricing and underwriting
tools to try to do it.
Chairman Sarbanes. Now on the question of certainty, the
Treasury's proposal, if you get over $100 billion says--and I
am looking at their chart--``discretion of Congress.'' Now that
is not a lot of certainty I would think.
[Laughter.]
Chairman Sarbanes. On the other hand, the figure is very
large--very large. Now how would you handle that? Essentially
figure, one, we may never get there? And two, if we do get
there, Congress will, in fact, do something, and therefore it
is taken out of the pricing equation?
Mr. Ferguson. Well, you have correctly framed the bet that
you as a company would have to make. And I cannot predict how
individual companies would react. You have framed the argument
exactly. Some companies would look at it and say the $100
billion is sufficiently large. The risk of a frequency, a
number of events is sufficiently remote that we feel we can
underwrite and accept risk in this environment. Other companies
may look at it and say it is not enough. It does not give me
enough certainty.
So we cannot, Mr. Chairman, in advance predict how
individual companies would react. Sorry to give you kind of a
wishy-washy answer.
Chairman Sarbanes. This may be an admission against
interest, but if I were trying to calculate how much of a
burden I think the industry should carry, given its financial
position, what figures would I look at? What indices would I
look at in order to make some calculation in that regard?
Mr. Ferguson. I would start, respectfully, with Exhibit A
in my attachment to the prepared testimony where I make the
case that the capital base on September 10 for the affected
lines of business is about $125 billion. And as I say, some
experts think my number is a little high, but let us stick with
it for discussion purposes.
So we need to look at that. You know, that capital base is
supporting all of the commercial business, commercial lines
insurance business in the United States. All the operating
risks that attend that business, investment risks that attend
that business. So it is not a huge capital base. It is big, but
it is not huge. So that would be one of the indices that I
would look at.
Another statistic to look at is the amount of premiums in
the commercial lines insurance sector and in round numbers--
this is workers' compensation, property, general liability, and
so on, business interruption insurance, add it all up--in round
numbers, it is about $145 billion of premium annually. So that
is another factoid or another statistic that enters the
equation.
But to me, the important one is the first one. What is the
capital base that is supporting this business? And how many
September 11's can we handle? And the answer is, we can do this
one, but I do not know what happens after that on the existing
capital base.
Mr. Sinnott. I might----
Senator Dodd. You ought to review these numbers, by the
way. The first number on the capital is very important.
Mr. Sinnott. Did that number, represent just U.S.
companies?
Mr. Ferguson. Oh, yes. U.S.-licensed companies.
Mr. Sinnott. Okay. Therefore, it does not include capital
outside the United States?
Mr. Ferguson. That is correct.
Mr. Sinnott. I would add to that, the fact that our
business is a global business. Reinsurance carriers, alien
carriers who provide capital need to be included. So if I
calculated it, I think my number might be up. The United States
has at least half of the surplus that exists in the world,
about half is what it is.
So you could make a calculation. I might come up with
something higher, but it is still not some of the numbers that
have been thrown out as to the assets and such that the
industry has.
Mr. Vagley. Mr. Chairman, if I could add further, clearly a
part of the calculation could be, should be, how much more pain
can the industry bear? But the focus really ought to be on what
will it take to restore the marketplace. And simple economics
will suggest that the higher the amount the industry is
required to retain, the more reluctance the industry will have
to move comfortably back into this market, even uncomfortably
back into this market, and the greater the retention levels,
the greater will have to be the price of that coverage to the
policyholders. I mean, there is no way to escape those
fundamental economic principles.
Chairman Sarbanes. Well, if you knew what your exposure
was, you could calculate what the premium level had to be to
cover that exposure, could you not?
Mr. Vagley. Well right now the exposure is infinite.
Chairman Sarbanes. No, no. I understand that. If you are
dealing with an infinite.
Mr. Vagley. Just some plan to be sure. And the more that
retention is constrained and made definite and comprehensible,
the greater will be the ability of the industry to move back
into those markets and to take on those risks.
Chairman Sarbanes. Now are you suggesting--well, I will
wait and do it on the next round. I yield to Senator Gramm.
STATEMENT OF SENATOR PHIL GRAMM
Senator Gramm. Thank you, Mr. Chairman. Let me just say in
terms of capital levels, we have to be very careful. A witness
at these hearings yesterday suggested that the existing capital
level of the industry told us something about our ability to
extract that as part of some kind of mandatory process. The
bottom line is, no matter what your capital is, you are not
going to invest it unless you believe that ultimately you can
end up selling a viable product.
It is always tempting to say, well, let us pool the assets
of this industry and then I will be able to afford these
things. The problem is, it is other people's money.
I do not expect any insurance company to put its capital at
risk in an enterprise that has no hope of being successful. We
had better be sure we organize what we do based on that thesis.
Let me make a couple of comments and then I want to pose a
question or two since I missed the opening statement. First of
all, I would like to say that I think the insurance industry
has been about as responsible as any industry in America. And
people often accuse me of being pro-business. Actually, I am
pro-free enterprise, and I agree with Adam Smith's observation
that, ``Never do two merchants meet even for merriment lest the
topic turn to conspiracy and restraint of trade.''
[Laughter.]
Senator Gramm. So I am not free with my compliments to
businesspeople, and I just want to say that I think the
position of the insurance industry and the people who run it
has been about as admirable as any business that has dealt with
this crisis. You are not at the heart of it like firemen and
policemen in New York, but in terms of the secondary effect,
pretty substantially affected.
We had a talk this morning with Jose Montemayor, who is our
Insurance Commissioner in Texas. And in our State, you can
cancel a policy with 7 days' notice. We are already beginning
to see some terrorism policies canceled with regard to private
aviation, which makes it very difficult for these charter
companies to fly into big airports. So we are already beginning
to see an effect. I do think it is interesting. My State is
about as proud of its rights as any State in the Union. We were
a country at one time.
[Laughter.]
Senator Gramm. But here are the points that our insurance
commissioner made about the whole State sovereignty issue. That
as long as whatever we are doing is limited to terrorism, he is
not worried about infringements on States' insurance powers.
And as long as it is limited to 2 or 3 years, he is not worried
about it. And I think that is pretty important. I am not saying
he speaks for every insurance commissioner in the country, but
I think that is relevant. That if it is very narrowly defined
terrorism where we are going to define it in law and perhaps
have a panel--the Secretary of the Treasury, the Attorney
General and the head of the Federal Reserve Bank--based on that
law, make a determination when an act occurs, is this
terrorism, and we are not going to let the media decide whether
it is terrorism or not, on that basis, what we do there is
going to be a lot more acceptable within those narrow limits
than if we were talking about a Federal action in insurance
that was going to have a profound and lasting effect on the
States. And, if we are talking about a 2 or 3 year emergency
program, I think people understand and they do not see it as a
precedent for the Federal Government taking powers away from
States.
It is clear from our hearings we had yesterday that on a
bipartisan basis that for us to do a bill--and I think The Wall
Street Journal article says it correctly. In fact, I said a
similar thing before I read it and I totally agree with what
they said. And that is, my guess is that we might be able to
get through this thing without a Federal program. I just think
the risk of doing that is too great. And I am not willing to
take the risk.
I think listening to the people we listened to yesterday on
this Committee on a bipartisan basis, we are going to have to
have some degree of retention so that the Federal Government is
not the first dollar payor. We could debate as to what that was
going to be. The Administration has a proposal where that is
the case in the second year, not the first. And a simple way of
bringing us together with the Administration would be just to
make their second year program the first year program.
The President's proposal, other than the first year, has a
lot of good features and it is a very good start for us to work
with. And for us to do something in 2 weeks, there is no way we
are going to write a program and get into a debate with the
Administration or get involved in any partisanship and get that
job done. It is distinctly possible we might not get it done.
And that it is important that everybody make an effort to make
it happen. I just want to assure you of my best faith effort to
see that we do get it done.
Let me ask you a question. In 1993, we had a group of
terrorists try to blow up the World Trade Center. What happened
to insurance property and casualty rates after that? What
happened to them in 1994 and 1995?
Mr. Sinnott. I do not recall a great impact. I mean, it was
a catastrophe, but, you know, it was not as big as Hurricane
Andrew or some of the other catastrophes like Northridge
Earthquake. In total, it was less than $1 billion.
Senator Gramm. No, I am not talking about the cost in
paying out of your reserves. I am talking about changing
expectations. I mean, we had had a terrorist attack. People had
tried to blow up the World Trade Center. Did anybody
reevaluate--is there any evidence that anybody reevaluated and
said, well, if we are going to provide terrorist insurance,
maybe there should be a change in the rates that we charge? I
am just trying to see how sensitive the market was to that.
Mr. Sinnott. From a broker's standpoint, we did not see a
change. The result of terrorist acts has been covered in the
United States under insurance policies. That is not necessarily
the standard in all parts of the world, but here it has been.
And I think the World Trade Center at that time, as I recall,
was viewed as, okay. That is what insurance is all about.
Senator Gramm. So you did not see any change in premiums?
Mr. Ferguson. That is my recollection as well. It did not
create much of a ripple in the market. It should have been a
wake-up call, but it was not. And to take Mr. Sinnott's point,
it was regarded as a discrepancy, and it was not of such a
magnitude that it caused huge problems for the industry. What
we are facing now, of course, is a whole different category
where we see a systematic aura of terrorism. No one thought
that in 1993. Maybe we should have, but we did not. The short
answer to your question is, it did not really create much of a
ripple in the industry.
Mr. Baker. Senator, I think it is important to remember
that in that incident also the system worked. The industry kept
going. Insurance was available. We did not have any problems.
Senator Gramm. Let me say, Mr. Chairman, that I think again
what we are going to have to decide is are we willing to take
the risk that we are going to have a huge spike in insurance
rates and generate an economic ripple in the economy of some
substantial size? Or can we come up with a workable, short-term
program to help us build a bridge to where hopefully we will
eliminate much of the threat, and that ultimately this can be
built into the structure of the system, and the Federal
Government can get out? I think that is everybody's goal. I had
not heard anybody on this Committee or in Congress or anybody I
am talking to talking about getting the Federal Government
permanently into the insurance business.
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. [Presiding.] Thank you. Senator Sarbanes will
be back. Let me again apologize to my colleagues for not being
here yesterday. But I had a staff member who had been with me a
long time who lost her mother, so I was at a funeral in upstate
New York all morning and afternoon yesterday. So I apologize.
I think for us not to act is too high a risk in my opinion.
What we do has to be done carefully because we are dealing with
100 Members of this body and 435 in the other. And apparently
there is some reluctance on the part of the House to move on
some legislation here. I hope that mood is changing a bit. I
know that people have been talking to them.
I worked with Bob Bennett of Utah on the Y2K Committee. We
spent 2 years urging business and industry, Governmental
entities to make corrections and to get up to speed. And when
the clock turned, the world did not collapse. And there were
some who looked around and said, well, what did we waste our
time doing that for? It is always hard to prove a negative I
suppose, except that I can tell you the other day I was in
Ground Zero in New York at the operations center there.
The fellow who took me around had no idea that I had been
involved in the Y2K issue but volunteered and said, you know, I
do not know who was responsible for it, but had it not been for
that effort made on this Y2K stuff, this operation center would
not exist. Because the Federal Government pushed us to
modernize, to update, to correct our systems, we were able to
put in place a system here that has allowed us to respond to
this savage attack in ways we could not have even imagined
without the Y2K effort.
And so my hope would be we will act, and in doing so, will
avoid the kind of problems that have occurred. I am sure there
will be those who then say, well, you did not need to act. So I
agree with Phil Gramm that for us not do something here would
be highly irresponsible. We are talking about stimulus packages
that are going to be passed to try and shore up a weak economy.
And in my view, it would be a huge mistake if we were to take
some sensible action there and not do something here.
Ron, it was in your statement--I believe it was in yours.
No, Les Baker. There you are right there. You said this. I
think it is true. Is it prudent to make a loan to construct a
pipeline, a power plant, an airplane, or a ship, a large
shopping center, or an office building when the potential for
the borrower to repay the loan is diminished by inadequate
insurance coverage? For most banks, the answer will be no. And
that is the real danger we face here.
So this is really--we have insurance here. We are going to
hear from Tom Donohue and others--but this is far more of an
economic issue than an insurance issue. And there is a tendency
to talk about this in insurance terms, which is obviously
important, because the industry is involved directly. But the
people who are going to be adversely affected here if the
insurance does not show up in January with 70 percent of these
contracts are up for renewal in about 8 weeks, and if they are
not renewed, the insurance industry will be here. The question
is, is whether or not those other industries out there that
depend upon that insurance are going to be able to survive.
So when we have our hearings about the effects of all of
this, we will have a very viable insurance industry at the end
of all of this, but we may not have a viable economy or
economic interests as a result of our failure to act.
So my hope is that we will. There is no perfect plan, and
it ought to be relatively short-term in my view if we are going
to do something in a way that we can come back and during that
period of time review maybe on a longer-term basis what steps
need to be taken to improve the potential for the damage to be
caused by terrorist acts.
So the question of capacity I was going to raise with you
which you have already indicated where we stand with the
capacity issues, but let me ask this panel if I can, first of
all just quickly, two questions. One is, I mentioned short
duration. We have been talking about 2 years with a possible
third year with the President giving that authority. I would
like you to comment on whether or not that is adequate or too
long. And then second, I would like you just to mention and
respond if you could to the effects on the economy, what your
own thoughts would be in terms of what this could mean if we do
not act here and come up with a plan that works.
And then last let me just say, my view is the economic
interests always are important, but I worry deeply. This
economy begins to crater more. You are going to watch a public
reaction that is going to have an impact on policy setting in
dealing with September 11 and other events. You have
unemployment rates going up. You have interest rates and all of
these problems that are going to create tremendous pressures on
our society, and that is we have to be very mindful of. And we
do not want to make the perfect enemy of the good here, and we
realize we are sailing in some uncharted waters, but it is my
hope we would be willing to take a chance and do something that
I think would protect against a far greater tragedy occurring
if we did not act.
So with that, Mr. Chairman, I thank you immensely for
holding these hearings. They have been very worthwhile. And my
hope is that we will move very quickly now and come up with a
proposal here that we can present to our colleagues, and
hopefully one that will enjoy broad-based support. All of us
who have been around here any length of time will tell you, at
this stage of the year,
the clock is the 101st Senator and a tiny group of people could
be highly disruptive in terms of stopping something from
happening. And my hope is that our colleagues will recognize
the potential dangers here of not acting and will help us
construct a plan here that will provide the needed assurance
and help. And I again want to compliment the industry for
acting so responsibly. Just those two questions if you want to
comment on duration and economic impact.
Mr. Vagley. Senator Dodd, thank you very much. And in your
absence and Senator Gramm's absence, I really thank you and
would like to do so again for your extraordinary leadership,
your joint leadership on this very important issue.
I certainly agree with the sentiments that you both have
expressed in the last several minutes and the challenges to
restore some stability in the commercial insurance marketplace.
It is not about saving insurance companies. We do not need to
be saved in that respect. The consequences really fall more
broadly on the American economy.
With respect to your two questions, I think from our
standpoint, longer is better than shorter because it does
correlate with stability. But the kind of architecture that you
and Senator Gramm have described is perfectly adequate in light
of the business and the political circumstances and would
provide a sufficient bridge to get us through this period, and
perhaps in the calm of the fullness of time, the industry could
get more comfortable with this, the marketplace could settle
down, and private mechanisms could begin to move in, or there
might be a determination made that some additional support
needs to be provided.
I think with respect to the economic dislocations, there
are others on the panel who are better suited to speak to that
than me. But without engaging in too much hyperbole, we are on
the frontlines of a growing economic crisis. We are seeing it
already in the lack of reinsurance availability, which is
washing back on us, and that is translating currently into the
lack of insurance availability, and that message is beginning
to impact the business community at large. But there may be a
lag time there in terms of the kinds of communications you are
hearing from businesses generally, but I promise you it is
there and it is going to wash over that community very soon.
Mr. Ferguson. Senator Dodd, as to the period, my personal
opinion is, 2 to 3 years is the minimum. I hope and think that
can work. If we look for historical precedent and look back at
the nuclear energy reinsurance program and the urban riot
reinsurance program, it did take longer. I am not saying that
is a perfect precedent, but it did take about 10 years for
those things to settle down. I certainly hope that is not the
case here. We as citizens cannot afford to wait that long. So I
think 2 to 3 years is the minimum is the short answer.
As for the economy, obviously the frontline where you are
going to see it first, as Mr. Baker indicated and Mr. Bartlett
has indicated in comments, is going to be in lending. Quickly
behind that, the real estate industry. And then you get into
kind of the confidence factor, and then the second and third
order effects that I do not know how to judge any better than
anyone else, but it really gets to the confidence and
predictability factor that Mr. Baker was talking about before.
Mr. Sinnott. On the duration question, I have two answers
to that. If the environment does not change, let us say we are
sitting here a year from now and there is no change in the
environment, in my view, will there be more private capacity
available? Yes, there will be more capital. There is more
capital coming in now in general across the board. And that
will include, the ability to mitigate the withdrawal that is
taking place. That will be very slow. And as I said earlier, if
there is no change in the environment, however, a year from
now, it is a matter of degree. There will still need to be
Government involvement.
If however the environment is secure, and we no longer see
on television the ``Attack on America'' and we are some way
able to get back anywhere close to the way we were before,
then, we can accelerate the withdrawal of the Government. But,
you know, there are two issues there.
And on the investment side, Mr. Baker probably has the best
answer on this or the best information, but I can think of one,
and that is large construction projects, which involve not just
physical assets but significant numbers of workers, so you have
both workers' comp and you have big asset values. If there is
not adequate insurance for those particular projects, they will
not go forward.
Senator Dodd. Mr. Baker.
Mr. Baker. Mr. Chairman, I would make a brief comment on
the duration issue from a banking standpoint simply to say that
a great deal of our financing is in the 2 to 3 year range, and
so when we look at projects, it could be a big project, a large
office building or a power plant, typically things take a while
to get built. So you have to begin to think of this link to
projects. That is the best guidance I can give you on duration
that you are trying to bring stability to the market over time.
On the economy, I would like to address this, because I
think it is critically important at this time. I would like to
say first that I am an absolute optimist on the American
economy. I believe that when you look at the demographics, for
example of North America, the population will increase about 40
percent over the next 50 years. It virtually assures us of a
growing, sound economy over the first half of this century. So
put me in the optimist column.
Right now the weakness that we are seeing is a global
weakness in the economy. It is lower nominal growth within our
domestic economy, and now it is very severe employment
pressure. We lost something on the order of 77,000 jobs out of
the economy in the last week alone. So my sense of this is, it
is a very critical point right now, because I believe the
American consumer is in the process of making up his or her
mind about where this economy is going to grow. And so
stability is important. And what we do not want to see happen
is to see the economy lapse back into a self-defeating
proposition. We do have this global weakness in Europe, Latin
America, and Asia.
I would like to finish my comments by saying that I think
particularly this is a small business issue. We tend to focus
on large power plants and things like that, but I think this is
particularly difficult for small business. I think you should
consider the business interruption insurance. That is a small
business issue if there ever was one. So that is the critical
thing on the economy. The economy is going to grow. It is going
to be good, but it is a very critical point right now.
Chairman Sarbanes. [Presiding.] Thank you very much.
Senator Corzine.
STATEMENT OF SENATOR JON S. CORZINE
Senator Corzine. Thank you very much, Mr. Chairman. I
apologize to the panel for being late. I was at another
hearing, but I too would like to give my congratulations and
laud you for how the industry has reacted in the post-September
11 time. It has been very responsible.
I have a question with respect to the knowledge base that
you think you will have gained over the next 2 or 3 years in
this exercise of bridging which we are about. Is this the kind
of activity that we can bring actuarial knowledge and
applications to in a way that you might be able to deal with
natural disasters? I am very much of the view that the long-run
solution may have to wait so that we can be careful about the
short-run. I am troubled with the assumption that somehow or
another we are going to have actuarial knowledge with regard to
crazy behavior that comes from terrorism. I would love to hear
your propositions on that.
Mr. Baker, you talked about 2 or 3 year financing programs
through the banking industry, but as you know, there are other
capital markets that have longer duration, and what kind of
impact do you think a short duration program may have with
regard to the free flow of capital? And have we seen any
indication that that may be drying or at least dampening down?
I do believe this is a serious economic dislocation issue that
needs to be addressed, and the business interruption issue with
regard to small business, I would love to hear your comments.
And I would love to be respectful to my colleague, Senator
Stabenow, who had to leave, but she was very interested in
understanding whether if we implemented this bridge program for
2 or 3 years, do you anticipate insurance rates for consumers
in particular would stay the same or go up? Would you be
withdrawing from lines? I ask any and all of you to take on any
piece of that.
Mr. Baker. Senator, you are the expert on debt markets, and
so I will not try to----
Senator Dodd. He would like you to bring that microphone
and say that again.
[Laughter.]
Mr. Baker. I think there are markets where financing is of
longer term, but the point should be made that these markets
are very sensitive. And when we have issues that come up, we
see debt markets that have cracked almost immediately. We see
difficulties in risk assessment. So what plea I would make here
this morning is as we are looking for continuity and stability
in the underlying economy, that is what keeps debt markets
going.
Senator Corzine. The commitment committee process that you
have at a bank on an interim financing basis is not unlike what
you would have in putting together a prospectus of investors.
Mr. Baker. I was just trying to logically think about the
kind of project time that you have when you build a building or
a power plant. On your point, if I may say so, about risk
assessment, there are pretty startling things going on in that
field, so my guess is we will learn a lot from this and other
events as we go forward.
Mr. Sinnott. I will comment on the rates and the actuarial
question. Ron would probably have good ideas on this. We do it
through our reinsurance broking operation. We do modeling, and
that is catastrophe modeling for earthquakes, hurricanes. And
to do that modeling, you do need some frequency. So I will have
to go back and ask some of my modeling experts. But I am a bit
skeptical. We do not want frequency, that is for sure here.
I think that they would probably say if we do not have that
frequency, which we hope we do not, it is very difficult to
model something like this, and if you cannot model it, it is
difficult to come up with any actuarial precision.
The second part as to the consumer, the business consumer
in this particular case, what will happen with rates? Rates
have gone up very significantly already. Since September 11, we
have seen property rates go up on average, that includes
business interruptions, 65 percent sometimes 100 percent,
sometimes 150 percent. Do I expect if I were sitting here a
year from now that will have moderated? No, I do not think it
will have moderated.
We went through 13 years of a very soft market from 1987 on
to 2000, and if you look at the loss experience, and again, my
colleagues here can speak to that directly since they were
impacted, but if you look at the loss record for the industry
up to that point absent September 11, particularly in property,
it was not good to say the least.
So I would have said I do not expect that we are going to
see another 65 percent, but I am just saying I do not think we
are going to see a moderation of rate increases. And I guess
the question is, are we dealing with that with our clients?
Yes, we are dealing with that.
Three aspects: There is capacity, the scope of coverage,
and there is cost. We do not play loosely with our clients'
money. But scope of coverage is the thing that can really be
extremely harmful to the security that insurance is supposed to
provide. And what we are talking about here is scope of
coverage.
There is capacity loss as well. The capacity issue we can
deal with, capacity across the board, not just for terrorism.
There is a reduction in capacity. So that is my view, Mr.
Chairman.
Mr. Ferguson. Senator Corzine, first with respect to your
colleague's question, I agree with Mr. Sinnott. It is important
that we realize there are two things going on here. We are
coming off a sustained period of poor returns in the insurance
business that has nothing to do with the tragic events of
September 11. If it had never happened rates would still be
going up for that fact.
It is awfully hard, as you would note, to break that
envelope apart. You know, which part is going to be
attributable to the September 11, and which part is
attributable to the fact that the industry was earning subpar
returns?
With respect to the actuarial point, if I may, you are
absolutely right. There is no actuarial technique. There is no
statistical extrapolative process that allows you to deal with
one horrible data point. We can try to take the Bayesian
approach, and if we get two data points maybe we will make
something of it, but we all hope that we only have one data
point. So my real answer to your question is this. As long as
the actuaries and the underwriters can put this in a box--by
that, I mean know with reasonable certainty what they are
signing up for when they write a risk--they will be willing to
exercise their collective judgment. It will not be actuarially
based. It will not be statistically based. It will be the
judgment of underwriters and pricers who have been doing this,
admittedly not terrorist coverage, for decades.
The insurance business kind of lives by its wits in that
there is not a nice black box. You do not know the cost of
goods sold, let us put it that way, beforehand. But if we know
what the box is, you are going to find underwriters that are
willing to step up to the challenge, even though it will not be
actuarially based.
Mr. Vagley. There is little I can add to the views of the
businesspeople, Senator. In terms of actuarial experience, I am
reminded by something I read recently which was, in the light
of the IRA attacks in Central London, it took the London market
about 5 years to get comfortable with doing that business
again. So there is a period of experience that will promote
stability if here, assuming, again, and the important
assumption of no additional terrorist acts, which could create
even further angst and anxiety.
And in terms of rates, maybe juxtaposing what might happen
on January 1, which is commercial insurance for some risks
simply will not be available is a way of making the comparison.
There may well be in the absence of support no rate which is
acceptable to an underwriter to write that risk.
Chairman Sarbanes. Senator Reed.
COMMENT OF SENATOR JACK REED
Senator Reed. Thank you very much, Mr. Chairman. Gentlemen,
thank you for your testimony. This is a critical issue that is
in need of your attention and your testimony today. Let me just
ask a few questions. Unlike my colleagues, I am not an expert
in debt.
[Laughter.]
Senator Dodd. We are all involved in debt.
Senator Reed. But I cannot make money on my debt.
[Laughter.]
Chairman Sarbanes. He is an expert on other people's debt.
Senator Reed. Let us talk about other people's insurance
for the moment. Both proposals are on the table. You have a
proposal from the White House and you have a proposal from the
industry. I apologize if I am covering ground that has already
been trodded, but is there any way that if either of these
proposals is adopted we can guarantee affordable, available
coverage to reasonably secure risk?
Mr. Sinnott.
Mr. Sinnott. Yes. In my view, if there is coverage in the
broadest sense as there has been, as I said a moment ago, yes,
prices have gone up, but I deem that to be something that can
be dealt with by the business consumers.
Senator Reed. So your view is that if we enact either one
of these points that we can create a climate where it might be
more expensive but only marginally so, that we effectively
could secure in a reasonable way the risk we face going
forward?
Mr. Sinnott. Yes. Because particularly where you are
looking at a situation that maintains competition, and there
still is competition out there amongst the insurance companies,
and they are looking at their rates, yes, I think we can.
Senator Reed. Now again, these plans are rather
complicated, but the industry plan as I understand it would set
up initially a pool which would take the risk, and if the pool
is exhausted, the Government would step in. So in a sense, the
first industry proposal has the industry absorbing risk to a
certain limit and not the Government. The White House plan, and
again, I stand to be corrected if necessary, would have the
first dollar of risk paid for by the Government. Is that a
fair----
Mr. Ferguson. In a word, yes. It is an 80/20 quota share,
yes.
Mr. Reed. Again, this goes to the notion which is common of
someone paying a deductible first before the Government steps
in or the insurance company steps in. Could you elaborate the
industry's rationale for your proposal and why it might be
better, different, or more effective than the White House
proposal?
Mr. Vagley. There are a number of proposals, Senator. The
industry proposal was really advanced, it was really based on
the British model and the British experience and the experience
of other nations after they became unfortunate members of the
terrorism-at-home club. Our model is predicated on their
concept, which is called Pool Re. It simply is a way of taking
risks that would be unfathomable for any particular company, a
tall office building in a major metropolitan area, and in the
absence of reinsurance, available commercial reinsurance
coverage, in effect spreading that risk through a pooling
mechanism, in effect creating a mutual insurance company into
which all primary insurers would pool their risks, and that
would be reinsured by the Government, acting itself as a
reinsurer.
That proposal has been effective in the United Kingdom. To
my knowledge, the British government has not paid out a pound
in liabilities. The Administration's proposal, which Ron
described as a quota share, would provide at least in the
initial year an 80/20 sharing of risk, Government and industry.
In that proposal, although in our view perhaps not as efficient
as the pool proposal, would also be effective because it would
allow underwriters in a real sense to get their arms around the
defined liability.
Then there is a third proposal which has been discussed but
not reduced to legislative form, which is in effect the
deductible approach. That may be a little more difficult. And
the industry may have to determine and create some mechanisms
to deal with the retention level underneath it, because it does
in a way present the same kinds of difficult underwriting risks
that the status quo presents in terms of a real reluctance to
write those big risks upfront because you could be eating 100
percent of it instead of just 20 percent of it, say, in the
Administration's proposal. But it can be made to work.
And I guess our view, and this picks up on Senator Dodd's
and Senator Gramm's statements is, there are the business
imperatives which we understand very well, and then there are
the political imperatives, which you understand far better than
we do, and the challenge for us and I think the challenge for
all of us is to find the common ground there. It may be that
the proposals we think are the most efficient are simply
indigestible in terms of the remaining time and the body
politic.
Senator Reed. Let me ask one final question or two if the
time allows, certainly one. In essence, I know this is not
designed to be a bailout of the industry. I know the purpose
here is to allow ranges of business from small drycleaners to
large office complexes to buy insurance at reasonable rates.
But essentially, from a business perspective, you all will be
laying off risk to other people. Typically, you pay for that in
your industry. You pay a fee, you take your risk. In any of
these proposals, would the industry be essentially paying a fee
or paying anything to the Government to absorb risk?
Mr. Vagley. The pool proposal does provide for payments by
the industry to the Government for reinsurance.
Mr. Reed. Mr. Ferguson.
Mr. Ferguson. Just as a footnote on that, interestingly
enough, the Pool Re in the United Kingdom, they had a different
twist on it. Once the Pool Re accumulated assets of $1 billion
I believe, then they were going to start to pay the reinsurance
they were getting from the U.K. government. It was a slight
twist on it.
Mr. Reed. Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you.
Senator Carper.
COMMENTS OF SENATOR THOMAS R. CARPER
Senator Carper. They gave us two microphones so we can talk
out of either side of our mouths.
[Laughter.]
Senator Carper. Maybe you do not do that in Connecticut, I
do not know. But I think they do.
[Laughter.]
Senator Carper. To our panelists, welcome. I have just come
from another hearing. We all serve on a bunch of different
committees, and as former Congressman Bartlett knows, you
cannot be present at all of them, and I am going to ask you if
I can just cover some ground that you have already covered
that, but to the extent if you could do and do it quickly, I
would be most grateful.
Secretary O'Neill was here yesterday and laid out the
Administration's proposal, which I thought had a fair amount of
merit. They had obviously given it a good deal of
consideration. If each of you could just take 30 seconds to add
briefly to it please, what you like about it and what you do
not.
Mr. Baker. Senator, I am here representing the banking
industry. From the standpoint that the economy is dangerously
weakening, and this is a time when we probably need to work
together to resolve that, we really have no view on the
particular programs themselves or the merits of them, other
than we probably need to do something sooner rather than later.
And our own recommendation would be it should have a time limit
and certain constraints put on it, as all these programs
should.
Senator Carper. In your testimony, did you lay out a number
of principles? Someone did.
Okay. Please.
Chairman Sarbanes. We moved Mr. Baker up from the next
panel. In fact, Mr. Baker, if you need to excuse yourself, you
ought to go ahead.
Mr. Sinnott. Our reaction to the Treasury proposal is
favorable for these reasons. It can be enacted quickly. It is
the least intrusive from a Government standpoint, the easiest
to unwind. You do not need to staff up on the Government side
to do this, and it is the least complex.
The others are complex. Anytime you have an industry
aggregate, there is questions as to who gets what and how the
aggregate is accumulated. Having said that looking at it from
the consumer standpoint, it should be seamless. As long as the
industry and the Government are in partnership on this and it
provides the ability for the insurance policy to not be
restricted, then it becomes an internal seamless issue.
I would say, though, that the one thing we would want to
look at it again, because we also act as a reinsurance broker
to the insurance companies, is how this mechanism would work.
To make sure that it maximizes the amount of private industry
you can get back into the market.
Senator Carper. Thank you. Thirty seconds.
Mr. Ferguson. First, I thought Secretary O'Neill just did a
fantastic job of laying out the issues. I really applaud him.
Second, any of the three proposals that are in play and being
discussed could in theory work. Third, the devil is in the
details. You might want to arm wrestle about whether the 80/20
and the way it goes in the second year and the third year is
the right parameters, but in theory, can it work? Yes, it can
work.
Senator Carper. Thank you. Twenty-nine seconds. That was
good.
Mr. Vagley. Senator, I thought what was perhaps most
important about the Administration's proposal was clearly the
recognition of the need that this was not a trivial or
frivolous subject and another in a succession of industries
seeking relief from the events of September 11. That was an
important recognition. I think in terms of its basic structure,
it is workable, it is relatively straightforward. In our view,
the retention levels in the outyears are high. It would not
necessarily promote the objectives of the legislation.
Having said all that, however, I would like to indicate
again, lest we seem to be preferring one plan over another,
though perhaps we do, that we are for any plan that will help
stabilize this market and that is politically feasible and are
not wedded to the details of any particular proposal.
Senator Carper. Thank you. I have been wrestling with a
couple of different terms looking at a statement of Mr.
Ferguson where you talk about adjusted commercial U.S.
insurance property and casualty, possibility of a surplus of
$126 billion. We have a staff briefing that was given to us
where they talk about that surplus number is close to $300
billion. I have a hard time reconciling that.
Chairman Sarbanes. He has a table. He has worked that down.
Mr. Ferguson. I can reconcile it very quickly. The $300
billion is a correct number. Fire and life plus property and
casualty, it is $300 billion. If you take the surplus that goes
along with the companies that predominately write personal
lines of business, your personal automobile, your homeowners
and so on, and make a couple of other adjustments--I will not
go through them, but you come down to the $125 billion. I can
reconcile them.
Senator Carper. Thanks. I would just observe in closing
that we do not have a whole lot of time before the end of the
year in terms of oversight and things. We need to move forward
with some dispatch. And I will not quibble with what the
Administration has proposed. It probably will change it to some
extent. But it does have simplicity. And if I can understand
it, it is a pretty good sign that others could as well. And to
the extent that we can agree on something that is fairly simple
and straightforward, we might actually be able to pass it to
the House through the Senate and work it out with the White
House and get it done in a timely matter.
Thank you very much.
Chairman Sarbanes. Well, gentlemen, thank you very much.
Mr. Baker, you had better go. I am worried about you.
[Laughter.]
Chairman Sarbanes. I want to put a couple of questions to
the others, so if you want to slip away. I want to ask a couple
of very simplistic questions. If you have a major property or
casualty loss in some geographic area of some sort which is in
the ambit of the industry handling it on its own, do you then
raise rates across the country to all your clients in order to
make up for that hit, or do you localize the rate increase?
Mr. Sinnott. A combination really. The individual policy
that has sustained the loss at renewal, that is going to be
recognized, just as good loss experience is recognized. But if
the overall loss experience, as it has been, as we mentioned in
the property area, is across the board, then everyone will have
some degree of increase.
Chairman Sarbanes. All right. I want to get a handle on the
magnitude of this problem. What is the premium flow into the
property and casualty business?
Mr. Ferguson. For the commercial lines business, which
would be the relevant base here, sir, that would be about $145
billion. That is for everything.
Chairman Sarbanes. One hundred forty-five billion dollars.
Well, now the Treasury's proposal in Year Three would have the
industry exposed for $36 billion.
Mr. Ferguson. Correct.
Chairman Sarbanes. Leaving aside for the moment the problem
of in excess of $100 billion, which we discussed before,
putting that to one side, and that was left in this black hole
called the discretion of Congress.
[Laughter.]
Chairman Sarbanes. But putting that to one side, now, an
increase as I calculate here of about 23 percent uniformly in
your premium flow would cover that exposure. Is that correct?
Do you cover it 100 percent or do you cover it a factor of 100
percent?
Mr. Ferguson. Your mathematics are impeccable. That is
correct. The problem----
Chairman Sarbanes. I know you have the problem that that is
not exactly how you do it, but I am just trying to get a sense
of----
Mr. Ferguson. Your math is correct, but in practice, it
would not work out that way because, of course, in some States
and in some classes of business, it would be thought that they
are not particularly targeted for terrorism and so they would
have much less increases and others would have more. But I do
not mean to quibble with your arithmetic.
Chairman Sarbanes. The 150 is not homeowners.
Mr. Ferguson. Correct. The 145 to 150 is commercial lines
only. My best guess, Senator Gramm. Commercial lines only,
workers' comp, property, general liability, roll it all up,
about $145 billion.
Chairman Sarbanes. All right. Now one other question. I did
not understand Mr. Vagley. On the one hand, you say we should
preserve rate review by appropriate State regulators. On the
other hand, you seem to want to alter their process. Is that
correct?
Mr. Vagley. I think we would like to alter the process with
respect to terrorism and rate review. However, there are State
regulators who disagree with that.
Chairman Sarbanes. Let me just say this just as
observation. I have not discussed this with my colleagues. I am
frank to tell you the simpler you keep this and the less you
seek to change current arrangements, whatever they may be, I
mean, the NAIC yesterday talked about consumer protection
provisions. If this is envisioned as a vehicle for getting
other type changes, it is going to significantly complicate it.
You have a problem on the tort issue in my opinion. First of
all, we do not have jurisdiction over that. We may run into a
serious problem in that regard.
Senator Dodd. That has never stopped the Committee up here
before.
[Laughter.]
Senator Dodd. We claim the whole world as jurisdiction.
Chairman Sarbanes. I understand, but it is highly relevant
as we consider this, since we may have to assert jurisdictional
lines in order to keep moving forward so we do not undercut our
own case, if I may say so. But in any event, I just wanted to
make that observation. People who have things up on the shelf
they have been wanting to get and then they want to take them
off the shelf and put them into this pot, that greatly
complicates the stew.
Senator Dodd. Let me just say that I agree with Senator
Sarbanes on that point, too. That is something all of us feel.
If we are going to get something done here, it has to be done
very tightly. But I would put on the rate issue, we talked
about this already, with the exception of some 12 States, and I
may be wrong on that number, writing commercial insurance, that
you set the rates and then the States-by-State law determine
whether or not that rate is justifiable. And I do not know why
you would want to change that.
Mr. Vagley. We do not. As a matter of fact, it really was
in recognition of precisely what you described; that this
should be narrowly focused on terrorism risks and not seek to
advance any other legislative agenda. That the proposal that we
advanced was in compliance with that.
And with respect to the two areas of potential State
regulatory interference, even the State regulators are in
agreement that it is necessary in the one instance to have a
common definition of terrorism, for instance, where States
cannot require greater coverage, so that in the worst of all
worlds, there is incongruent coverage. And my understanding is
even the States agree that a pricing mechanism such as we have
advanced which does kind of cut the baby in half, it is a final
use system consistent with what Senator Dodd said is
understandable and agreeable, and we are not seeking any
additional leverage or advantage even though we might prefer to
do so. Our understanding, Senator, Mr. Chairman, is that this
bill, if it is to advance, with all the difficulties of the
remaining time available and all the circumstances surrounding
the issue, must really be laser-like and focused on this
principal issue.
Chairman Sarbanes. Let me ask one other question just for
my own enlightenment. What is your reaction if someone says why
doesn't the Government just assume the responsibility for
terrorism on the premise that one of the things the Government
ought to be able to do is protect the society against
terrorism, so we are not going to put this in the private
sector. And if we have a terrorism attack and a loss, the
Government will pay for it and the industry will go on about
its business of ensuring the other kinds of risks that do not
relate so directly to, in a sense, our national security.
Mr. Ferguson. Senator, that argument can be advanced. I
think it comes down to the philosophical issues. My own answer
would be let us construct a plan where the private sector has
the opportunity to return to normal and not put the Government
permanently in the insurance business. But I recognize others
will have different viewpoints.
Mr. Sinnott. If I can add to that, there are other perils
called riots, civil commotion, that governmental bodies,
whether it is the local police force, are responsible for
securing. I think that they are all manageable. They can all be
dealt with in the private sector. Terrorism is another part of
that. It can be dealt with so long as we are not in the
situation that we are currently in.
Senator Gramm. Mr. Chairman, first let me say that in terms
of a Government program, We could do that, and there is some
programs that could be adopted that would be, in my opinion,
worse than a Government program. The problem is transitioning,
the problem is how do you get out of it, and I know you are not
proposing a Government program.
Chairman Sarbanes. I am just trying to feel for the
parameters of this.
Senator Gramm. I think having tried to think through that
in terms of my own preferences, the problem is not that the
world would come to an end if the Federal Government said, in
these narrowly defined areas, we are just going to cover it
directly. The problem is how do we get out of it and how do we
get the private sector into it. And then over time how do we
keep it from growing where people want to broaden the
definition of terrorism. So, at least, in my own mind, that is
why I have rejected that.
I would like to say that I think your point you made is the
key to us getting this bill written, and that is if somebody
wants to put something in here, the heavy burden of proof on
them is you have to prove that it will not work or work well
without it. I think if we begin with that premise, writing this
bill will be doable, and there is not any other way to do it. I
think Senator Dodd and I have felt for several years now that
we had a real problem, if we had a major hurricane and we had
an earthquake in the same year, and at some point, we have to
come to grips with that. And I would prefer to do it by
changing tax policy and letting you build up reserves rather
than the Federal Government getting permanently into protecting
against cataclysms. But on the other hand, if we bring any
extraneous issue into this, we are lost.
Mr. Sinnott. Mr. Chairman, can I bring up one issue on that
that was mentioned earlier that I do not think is extraneous.
At the hearing I was at yesterday, I was not aware of the fact
that the Treasury or the Administration, which is of course the
Treasury proposal, covered property insurance but somehow did
not include business interruption. That is a very serious
impediment.
Senator Gramm. They are very concerned about the potential
cost of it, the open-ended nature of it, and that is why I am
not saying I agree with them, but that is why they did it.
Mr. Sinnott. Business interruption is important and I can
give you a list of corporations that do not purchase it. There
are some very large corporations that do not purchase this
coverage.
Senator Dodd. Here is the problem you get into with that.
We talked about it. There is an easier one. Where the car
service, because it serves a particular industry that was hit,
it goes out of business because it does not have the capital to
sustain it. The other business interruption is where some of us
on the plane have some place to go and sign a contract. Then
you get into that business interruption. You have a broad
definition of that and boy, it becomes a nightmare.
Mr. Sinnott. I agree but I think that the definitions are
fair under the policy. There is an insurance policy with terms
and conditions and that coverage has been there for as long as
I have been around, and it is adjustable. So I do not know why,
if the insurance industry has been able to deal with that, via
it's accounting, the Government could not deal with it too. It
would create a serious defect to excuse business interruption.
Senator Dodd. It is a challenge, just by the way----
Chairman Sarbanes. Actually, you are making a very
important point.
Senator Gramm. If you can narrow it, you can make the
point, but you are going to have to do that.
Chairman Sarbanes. If you leave it out, then you have left
out an important aspect of the coverage, or leave it out
altogether.
Senator Dodd. Let me ask you two other quick questions. We
are talking property and casualty here but you know the
questions come up about life and health. It seems to me I do
not know how you are going to avoid particularly the health
area, the life. There may be some other argument you can make,
but the health insurance issues are going to be hard to exclude
from this calculation. That is one question.
The second, how do you define an act of war as it is
usually defined and terrorism. When does an act of terrorism
become an act of war or not an act of war? Do you think we can
draw that distinction well enough?
Mr. Sinnott. It is most of the definition. When you have an
agent acting in concert with a government, a foreign
government, in other words, acting at the direction of that
government, that can be construed as a war risk rather than a
terrorist risk. On the other hand, in most cases, it is up to
the government. The government is the one who really declares
whether a state of war exists.
Chairman Sarbanes. We have another panel. Unless there is
anyone who has a question, this has been an extremely helpful
panel. And we really appreciate your coming. Thank you.
If the other panel will come forward.
[Pause.]
Chairman Sarbanes. We are very pleased to have this panel.
I know we held you a bit but you can tell we were having a
pretty interesting and helpful session. We will just go
straight across the panel. Mr. Donohue, it is nice to see you
again. We are pleased to have you back with us and we will be
very happy to hear from you.
STATEMENT OF THOMAS J. DONOHUE
PRESIDENT AND CEO, U.S. CHAMBER OF COMMERCE
Mr. Donohue. Thank you, Senator. I am here because the
American consumers and businesses require the financial
security provided by terrorism insurance to get the economy
moving again. I am not an expert in insurance the way many of
you are, but I do understand the challenges facing American
businesses.
The problem is the recent events are making adequate
terrorism insurance hard to come by, and the Government
temporarily needs to be part of the solution in whichever way
you think is appropriate. September 11 will result in the
largest one day insured loss in U.S. history. My understanding
is the industry will lose $30 to $60 billion in claims, easily
surpassing the previous record of $30 billion from Hurricane
Andrew.
And, without adding any of my other views about the role of
the class action and trial lawyers, let me say that depending
on the activities of the Government, some of which have been
very positive in locating where these matters will be resolved
and who gets involved in it, that number could be significantly
higher, and it is a matter to be concerned about, but I am sure
not resolved in this legislation.
The insurance industry is committed to meeting its
obligations and I think they were very forthcoming. The
Administration was talking about war. These people walked in
and said we are going to pay our bills. No one was asking the
Government to bail out the industry, or to take care of its
established obligations.
The problem, however, is in the wake of our events of
September 11, insurers and reinsurers feel compelled, as you
have heard, to reduce terrorism coverage or not to offer it at
all, and that is where you get the complication. If you do not
have it, whose crawling all over your circumstances? And they
are bankers and they are investors and they are partners and
everyone else that wants to know what happened if I put my
money on the line and we either have an activity or we create
one, how are we going to be sure that if there is an overt act
of terrorism that we are going to be paid?
This market disruption caused by a lack of terrorism
insurance coverage, if it is not provided, could have deep and
potentially devastating effects. Let me list them quickly.
First, businesses that cannot get the coverage may have to cut
back their operations or stop what they are doing in a
particular business area; trucking firms, railroads, airlines,
ships, may all be compelled to say, I am not going to carry
this, I am not going to go there, I am going to limit my
business activities to protect my interests or to meet the
requirements of my bank or my other financial partners.
Second, the lack of such coverage could prevent many
businesses from obtaining financing. Or it could accelerate in
what happens with existing financing, in that people are going
to come to them and say, okay, you don't have the insurance,
you have to pay me in a certain amount of time, or I have to
increase your costs, or I am going to close down your line, and
this is a real serious problem. A lot of loans require evidence
of terrorism insurance. If you do not have it, the loan is not
a performing loan.
Finally, businesses that are left with no choice but to
self-insure against this risk are going to have to really think
very hard. They are going to find it very difficult. But I want
to pass a thought on to the Committee. Let us assume we do not
do this. Let us assume people go bear or people deal with all
these issues. If we have another major terrorist incident, I
mean something of the magnitude we have had, you are going to
pay for it anyway.
It is very clear that if we are sitting here a year from
now and some terrible, horrific thing happens, and the people
sitting up and down this table say, every single one of the
major casualty insurance companies in this country are going to
go bankrupt, you are going to take care of it. So what you are
really doing is like the guy with the oil filter. You are going
to cover me now or you are going to cover me later.
Senator Gramm. You are buying insurance.
[Laughter.]
Mr. Donohue. You are buying insurance and what you are
doing is you are keeping the private sector in this right up to
their necks about as far as they can go, so the water does not
get where they are drowning. And what this is, and by the way,
I am a private sector guy, and I am opposed to creating some
massive, new Federal deal that covers this thing for now and
forever. What we are talking about is a bridge and we would
better make it a bridge that damn well finds a way to get to
the other end of it, or as Senator Dodd said, and you said as
well, Senator Gramm, we are going to be adding more and more
ornaments to this Christmas tree in a big hurry.
Anyway, I came up here with a very simple message. I am not
an expert on the insurance issue and not an advocate for one
solution or the other, other than it ought to be as much
private as we can so that the private sector does all of the
background work, carries all of the administrative work; we do
not need another Government agency. We need the Government to
insure itself from what it is eventually going to do if it has
to.
And I want to congratulate the Committee. It has been
extraordinary for me in the last couple of weeks to see how
people have said, wait a minute, we have a political agenda,
but let us sit down and figure out how we are going to handle
these things. I just came back, for just a half a second, I
just came back from the APEC meetings in China, and I was with
business leaders and government leaders all around the country
and around the world. It is a very simple thing over there.
Everybody figured out they made a big mistake. Those guys just
got their act together, they are all playing the same music,
they are walking the same step, and I give you great credit for
what you are doing.
But I will tell you this is something else you have to do
and you need to find a way to do it so that it is done in the
private sector. You take the least amount of risk, but you
understand if you do not do it, you are going to do it anyway.
Thank you very much.
Chairman Sarbanes. Mr. O'Brien.
Senator Dodd. We have Donohue, O'Brien, and Knorr. Are you
Irish?
Chairman Sarbanes. He is from the City of Chicago.
Senator Dodd. It sounds like a Dublin law firm up there.
[Laughter.]
STATEMENT OF THOMAS J. O'BRIEN
SENIOR VICE PRESIDENT OF FINANCE AND
CHIEF FINANCIAL OFFICER, LCOR, INC.
REPRESENTING
THE REAL ESTATE ROUNDTABLE
Mr. O'Brien. Thank you, Mr. Chairman. My name is Tom
O'Brien. I am Chief Financial Officer of LCOR Inc. As such I am
responsible for companywide oversight of LCOR's finances, risk
management and insurance activities which includes the $700
million U.S. Patent and Trademark Office's new headquarters in
Alexandria, Virginia; the JFK Airport terminal port facility in
New York, a $1.2 billion airport terminal developed and
operated by a private consortium, and various other offices and
multifamily homes located throughout the country but primarily
from New York to Washington.
I am what Mr. Sinnott earlier referred to as an insurance
consumer. LCOR is a national real estate development,
management company. We specialize in structuring and
implementing public, private development. We have completed
projects in 15 States and the District of Columbia including
one for 16 million square feet of space and 18,000 residential
units.
The company has completed developments or has under
construction projects totaling $4.4 billion and over $1.6
trillion in pre-
development. LCOR is and has been involved in some of the
Nation's largest most complex and most creative developments.
We are currently active throughout the United States as well as
Pennsylvania, where we are headquartered. I feel well-
represented by the Senators on this Committee based on that.
But I am here today as a longstanding member of the Real
Estate Roundtable and on behalf of a number of real estate
agencies and trade groups that are submitting to this Committee
written testimony. As many of you are aware, the tragic events
of September 11 triggered the withdrawal of virtually all new
insurance on property and casualty. This is caused by the
insurance industry's inability to predict future man-made
catastrophic insurance losses. This will be increasingly
apparent throughout the industry on January 1 when
approximately 70 percent of the policies are up for renewal.
I am personally involved in transactions of more than $2
billion that have been impacted by the eliminating of terrorism
coverage. By way of example, since September 11, our JFK
Terminal Four Project has already had its liability coverage
for terrorism revoked. We are told that we will lose our
properties' terrorism coverage and that our current policy
limit will be pushed upward 50 percent. Our premiums will be
doubling and our revenues have been drastically affected due to
reduced capacity in volume.
As CFO of a commercial and residential real estate
development and a property owner, I know from my 20 years of
experience that it is not possible to buy, sell, or finance a
property unless it is adequately covered by insurance. A
significant percentage of privately owned properties are open
to the public including shopping centers, offices, hotels, and
they will need to renew their insurance coverage on or before
January 1. Many of these owners have been advised that the
policies may not be renewed or that the new policies will
exclude exposures currently insured, including terrorism. These
owners have also been advised that they will all likely have to
absorb significant increases in premiums. They have also been
advised that there are greatly expanded uninsured exposures due
to policy exclusions. Without adequate insurance, it would be
difficult, if not impossible, to develop, operate, or acquire
properties, refinance loans, and sell commercial mortgaged-
backed securities.
Since real estate transactions are primarily based on
prudent risk-taking, the disappearance of coverage for
terrorism acts will affect the underwriting of real estate and
other businesses which could severely disrupt the economy. It
will not only effect real estate owners and lenders, but also
their tenants, who lease facilities, their employees and
customers, and lenders and also anyone who rents an apartment
or buys a new car. I am very concerned about the short- and
long-term future of the real estate industry, unless the
Federal Government creates some type of mechanism to help
provide this coverage.
The scale of the industry is immense. Estimates are $4.6
billion of real estate and as the current policies expire,
there is tremendous uncertainty about the status of debt in
this sector. Mr. Baker spoke to some of those concerns on the
banking side. But obviously it goes well beyond that. Before
September 11, property and general liability policies typically
covered losses including business interruption costs from
terrorism and similar acts. However, as other testimony has
shown, future policies will likely exclude coverage for
terrorism and sabotage in addition to the current exclusion
practices of war.
As Secretary O'Neill and others have stated already, the
Federal Government needs to help insure the commercial property
owners and other businesses that cannot continue to obtain
insurance coverage for losses related to terrorism in the
future. I must also add that action needs to be taken as soon
as possible, because there are policies expiring every day and
new transactions pending which are being heavily impacted by
the lack of resolution.
I am not really familiar with the traffic signals, but I
know red means stop. May I go on?
Chairman Sarbanes. For a little bit.
[Laughter.]
Mr. O'Brien. We have already said that 70 percent of the
policies terminate on January 1.
Chairman Sarbanes. The light gets less waivable the more we
move through.
Mr. O'Brien. That is fine. I am almost through. I think it
is key that we talk about some of the necessary characteristics
of a workable plan. From a real estate perspective, we believe
they include the following duration. Real estate is a long-
lived asset and is generally financed over a long period of
time, generally 10 to 30 years. Thus, if a program is created
of insufficient length that may not be able to provide the
stability in the long term, so any program created must be of
sufficient duration to provide reasonable certainty of the
future availability of this coverage.
The second point is the definition of terrorism. The line
between terrorism and acts of war has certainly been blurred
since September 11. The President, as well as the media, have
focused on our current war against terrorism. We believe any
program created must cover an expansive notion of terrorism so
that future events along the lines of September 11 and similar
acts are covered, are not excluded from coverage in the future.
The third point is development of deductibles and limits of
coverage. The real estate industry is concerned about what
could be dramatic increases in deductibles to property owners,
which could be tantamount to no insurance coverage at all. And
accordingly, any program must carefully apportion loss exposure
between property owners, lenders, insurers, and the Federal
Government.
One last thing in terms of premium cost disclosure. You may
have heard earlier that property and casualty rates have
already been predicted to skyrocket prior to the attack on
America. We believe insurers should be required to separately
disclose the cost of comparison coverage and impact on the
overall insurance rates; otherwise it will be impossible for
insurance consumers to discern the actual increase in the
policy as a result of the difficulty in writing the terrorism
coverage versus the increase as a result of normal market
conditions.
Finally, our Congress must not fail to act. The real estate
industry welcomes the opportunity to work with the
Administration and Congress to achieve a workable solution to
this immediate problem and help our company get back to its
core mission of creating better places to live, learn, work,
and play.
Thank you for the opportunity.
Chairman Sarbanes. Thank you very much, Mr. O'Brien. That
was a helpful statement. I think you actually made a couple of
important points toward the end. Afterwards, you might consult
with Mr. Donohue. He is a pro. You notice he came in right on
the mark.
[Laughter.]
Chairman Sarbanes. When the light turned he was right
there, but he has had a lot of experience in doing this.
Mr. O'Brien. Yes, Mr. Chairman. This is my first Committee
meeting, much less appearance, so I apologize.
Chairman Sarbanes. You did a good job. We appreciate your
comments. Mr. Knorr, the Chief Financial Officer of the City of
Chicago. We are very pleased to hear that you want to get this
perspective. I also have a statement for the record sent to us
by Marc Morial, the Mayor of New Orleans, who is President of
the U.S. Conference of Mayors.
Without objection, we will include that in the record, and
the Mayor is urging us to take immediate legislative action.
Chairman Sarbanes. Mr. Knorr.
STATEMENT OF WALTER K. KNORR
CHIEF FINANCIAL OFFICER, CITY OF CHICAGO, ILLINOIS
Mr. Knorr. Thank you, Mr. Chairman, for inviting me to
testify today. My name is Walter Knorr. I am the Chief
Financial Officer of the City of Chicago. I appreciate the
opportunity to present to the Committee a matter of great
concern to the City of Chicago, and I am sure to other cities
throughout America. The price of war and terrorism liability
insurance, as a result of the tragic acts of September 11, has
escalated to incredible levels, if available at all. The
insurance industry is uncertain about the risk of terrorism and
therefore appears unable to assess and price that risk.
In Chicago, our insurance carrier recently cancelled our
war and terrorism liability insurance coverage for Chicago
O'Hare International Airport and Chicago Midway Airport. Prior
to September 11, we paid an annual premium of $125,000 for $750
million of war and terrorism liability coverage. If we want to
renew our coverage, it will cost us $6,950,000 for $150 million
of war and terrorism liability coverage. I will repeat those
figures to you. Our premium has risen from $125,000 to
$6,950,000. Our coverage has dropped by $600 million. That is a
premium increase of over 5,000 percent for substantially less
coverage.
Putting it another way, the cost of $1,000 of coverage has
risen from 16 cents to $46.33 per $1,000. This is an
astronomical increase, almost 29,000 percent. This
extraordinary cost increase would be passed along primary to
our tenants at O'Hare and Midway airports, namely the airlines
operating out of those airports.
The financial problems of most airlines have been well
publicized. A cost increase of this magnitude would negate the
city's efforts to cut costs of airport operations to benefit
the airlines and keep them viable. It would also undue the
efforts of this Congress to assist the airlines financially
during these uncertain times.
Chicago is not alone in this. We are aware of a number of
other major airports across the country that have received
equally exorbitant quotes for war and terrorism liability
coverage. In addition, the Chicago airports have been warned
that their premiums for property and liability insurance may
double, triple, or even quadruple and deductibles will increase
significantly.
The problem extends beyond the airports. It includes
infrastructure. The City of Chicago insures a toll bridge that
connects Interstate 94 to the Indiana Tollway. Our most recent
annual premium was $406,000 for $386 million of coverage. In
mid-September, the city received a nonrenewal notice for this
bridge with the ominous indication that the insurance carrier
could not quote a new rate but that the rate will increase by
more than 30 percent and potentially much higher. One would
expect insurance costs associated with terrorism to increase
substantially for many other public and private structures,
existing buildings, buildings under construction, public
meeting areas like sports stadiums and convention centers and
other prominent infrastructure.
The increased insurance costs will undoubtedly be passed
along to the tenants and users of these assets. If those costs
were significant, and I think they could be, they could have an
extremely negative economic impact. Tenants would have to
decide whether to pay those higher costs or leave the city and
take jobs with them.
The insurance crisis hits major cities the hardest because
cities would appear to be the most likely targets for terrorist
attacks. While terrorists may pick out individual targets, the
attacks are directed at the Nation as a whole, and the risk
should be spread to the Nation as a whole. In these uncertain
times, the Federal Government should act as an insurer for
future terrorist attacks and catastrophic losses. There are two
proposals before this Committee and the City of Chicago is not
taking a formal position on the two proposals. The City does
believe it is imperative that the Federal Government act on the
insurance problem to provide certainty of insurance at
reasonable rates, and hopefully mitigate the cost to Government
and business.
Thank you again for this opportunity. I will be available
for questions that you may wish.
Chairman Sarbanes. Thank you very much for these
statements. When do these policies whose figures you quoted
come up for
renewal?
Mr. Knorr. We received a 7 day cancellation after September
11 on war and terrorism. So as I mentioned, I know of nine
other major airports across the country that are in the process
of examining these quotes for these levels of coverage to
substantially reduce levels of coverage. We are all in the same
position.
Chairman Sarbanes. Do you have coverage at the moment under
the old terms?
Mr. Knorr. Under the old terms.
Chairman Sarbanes. When do you lose that coverage?
Mr. Knorr. We lost it with a cancellation so right now we
are in a position where we will have to rely on sovereign
immunity or we basically would be in a position to have to
piggyback onto the war risk insurance that is attached to
airlines as vendors.
Chairman Sarbanes. In other words, you are not covered?
Mr. Knorr. With this terrorism insurance, yes.
Chairman Sarbanes. They also said you could keep it at
these figures?
Mr. Knorr. These are the quotes we have given back in
exchange for $750 million for $150 million.
Chairman Sarbanes. So you are examining the implications of
that?
Mr. Knorr. I would say so.
Chairman Sarbanes. Senator Dodd.
Senator Dodd. I thank you as well. It has been very helpful
testimony. It makes the case that maybe we should have had you
on first in a way because this really is an economic issue.
As someone pointed out earlier, here they come again, this
crowd, always showing up at the trough taking advantage of
tragedy on September 11 to raid the Treasury. I do not believe
that is occurring. I do not believe it occurred in the airline
industry, but you have heard that from certain quarters.
What we are talking about here is not providing any
assistance at all to the insurance industry. What we are trying
to do is to encourage the industry to stay in the business, to
see to it they are going to provide the insurance to public and
private entities around the country so that they can borrow
money, they can do the things that are necessary for the
economy to continue to operate. So the testimony here is very
important so the case can be made.
I can see already the words they are using, the word
bailout. I know what a bailout is. I have seen them around
here. This does not even come close to falling into that
category. But the mantra has developed somehow, it becomes
almost a cliche, and I think your testimony about the
implications here, and I will make the point, I probably did
not make as well as I would like to, but I get very worried. I
am very worried about the condition of our economy anyway. When
you add the events of September 11 and the events of the last
several weeks, I worry that we are going to be able to
hopefully sustain the level of public support for what needs to
be done in order for us to successfully deal with the issue of
terrorism. That will require a population that is willing to
support the kind of expenditures and efforts that are going to
be necessary over a long period of time.
I believe the President is absolutely correct. This is not
a conflict that is going to be resolved quickly. You can only
resolve it if its representatives have the support of their
people for continuing to invest in that effort. And if you have
a weakened economy, if you have high unemployment rates, if you
have people worried about those conditions, it will be harder
to sustain the kind of effort that will be necessary.
I suspect that those who are responsible for the attacks on
September 11 in some small way will count on an eroding public
support, and the quickest way that happens is a weakening
economy. So I am not convinced that everything we are going to
do in this area is right.
Grover Norquist, who I do not necessarily associate with on
too many occasions----
[Laughter.]
Senator Dodd. ----but he had the best piece of advice I
have heard given by anybody. He was asked 2 or 3 weeks ago what
advice he would give a Member of the Senate these days. I
thought, oh, boy, here it comes. I can just imagine what this
advice is going to be. And he said, if I were a U.S. Senator, I
would read every bill. And that is pretty good advice. It is
good advice at any time anyway, but we are legislating quickly
here and maybe we ought to be careful about what gets included.
But I think that this is a very critical element for us to have
on the table and done. It may not be everything everyone would
want, but it is a very needed piece in this puzzle or this
pattern we are putting together here, to try and prosecute
successfully the war on terrorism but also see to it that our
own country is going to remain strong.
I thank you. And, Mr. Chairman, I do not really have any
specific questions. I just want to thank you for your
testimony.
Chairman Sarbanes. Senator Corzine.
Senator Corzine. I very much appreciate the real world look
at what the cost of this is and what implications it would have
for business or the public sector. I would like to ask Mr.
O'Brien again, because I am troubled by our focus on a limited
duration program, do you believe that you will have access, do
you think your industry will have access to credit if we come
up with a 1 or 2 year program with cancellation clauses and
other kinds of options that
insurance carriers undoubtedly will write here. How do you feel
that is going to impact your ability to finance some of the
kinds of projects you have talked about?
Then let me compliment you. I think the concept of making
sure that the terrorism premium is disclosed so that we are not
mixing apples and oranges in here is a very insightful and
responsible point. And then I would love to hear your comments
on the business interruption issue as well.
Mr. O'Brien. Thank you, Senator.
I have had some first-hand discussions this week with
longer-term lenders and bond underwriters and bond insurers
because many of our larger public-oriented projects end up
being in bond financing. And on Monday of this week, I was
asked that specific question. Okay, talk to me about the next
12 months, or talk to me then about the next 28 years, because
that is what I am underwriting. I am agreeing to accept the
exposure to today's bondholders. This is the underwriter saying
to me, how do I know that there is going to be availability of
some product that is going to protect me from this unknown,
unquantifable risk, and it clearly focuses much more on the
fact we have a 3 year development cycle. In cases at patent and
trademark headquarters, we actually fixed the rental rate for
the Government 2 years ago.
So 2 years ago, the Government asked for bids, we gave our
final best offer, we fixed the rental rate. This month or
probably next month we will hopefully go forward on starting
construction. Some 3\1/2\ years later, the Government will pay
the first dollar of rent to us and they will pay rent during
the next 20 years. Throughout that 5 year period, 2 years back
and 3 years forward, we are bearing tremendous uncertainty in
terms of construction costs, interest rates, but now suddenly,
in the last month-and-a-half, the cost of insurance
availability and terms has become predominant. And what you
could say, some might look at it as a mundane area of the
business in terms of insurance, at least from a real estate
developer's perspective. Suddenly, it has become front and
center.
So I certainly am concerned about a reasonable certainty as
to future availability. I am not proposing by any means that
the program would last 20 plus years, but there is certainly a
need to look beyond the 12 month time horizon. Many of the
insurers have the luxury of deciding every 12 months whether
they are going to renew the coverage. But investment decisions
are made on a much longer period of time, and I cannot look
back 12 months, 24 months from now, it is too late. So it is
definitely a concern of ours.
As far as the premium side, I said we clearly were already
aware that premiums were rising quite dramatically and Mr.
Knorr's comments I can share. The percentages may vary but all
premiums are really skyrocketing, and to the extent there is a
way to quantify the portion of the increased cost that
ultimately is passed on to us and the buyers, the insurer does
not bear the ultimate cost. He is the balance sheet in between
the loss and the ultimate recipient or beneficiary being us,
the insurance buyer. So ultimately they are going to pass the
cost along to us in one form or another, and we would at least
like to know that it is a fair, calculable sum, so I appreciate
the question because it did come up in the first panel, and I
really think it is an important one.
Senator Dodd. Jon, let me just interrupt. You made this
point. In your previous life you know how quickly these
questions do come up. Putting this aside, just going back in
your earlier incarnation, how quickly these issues arose.
Senator Corzine. Nobody is going to write a prospectus now
without the question of terrorism being one of the risk
characteristics that you have to address. And it is going to,
it is either addressed because we have insurance and that is
going to impact the bottom line of the company, so it is going
to end up impacting stock valuations, or if you do not have
insurance, then you are going to pay a spread that is
dramatically broader for getting access and credit, if you can
get it at all. And by the way, it is just as true for Mr. Knorr
and the City of Chicago with regard to bridge financing or
any--I do not mean bridge in the financial context, but between
Indiana and Illinois. I do not think people get how big a
problem this is with regard to the financial interlacing, and I
could not agree with you more. We are going to need to have a
sustainable economic environment to fight this broader
terrorism, and if we do not address these kinds of issues, I do
not want the perfect to be the enemy of the good, but I think
somehow or another we are not thinking about the duration
issue.
Chairman Sarbanes. I think it is an important point. The
Pool Re approach, which the insurers put together, he knows
what that problem is. I understand it because you have this
pool and it can go on. You know, the one in England has gone on
now for a number of years. The Government's never actually had
to pay anything.
Senator Dodd. It is a million dollars. It is a rather very
small program.
Senator Corzine. But the Government is the backstop for the
insurance.
Senator Dodd. And the actuarial efforts are much easier
under that scenario.
Chairman Sarbanes. That approach takes care of Mr.
O'Brien's problem as I understand it.
Mr. O'Brien. To the extent I understand it, Mr. Chairman I
think it really comes back to no one has all the answers but we
cannot look at this as a 12 month issue or even a 2 month
issue. I disagree with the statement this morning that if this
had happened in March it would not be a problem. That is just
not the real world. It is a problem. That is because the
industry is really not able to quantify and charge for what is
an unquantifiable risk.
Senator you had asked a second question about business
interruption and it was something that I had given some thought
to over the last few days. Because, as we have all seen, in New
York in particular, the recovery and the acts of private and
Governmental parties have been phenomenal, but on the private
side, none of that would have been possible without business
interruption and some of the property coverages that are
currently in effect.
If it would happen without any type of terrorism coverage,
things would just stop because there would be no funds from the
private sector to do any of the kinds of things like reopen
some of the neighboring buildings and restore the economy in
that part of New York City.
Senator Corzine. Senator Clinton, at a Budget Committee
hearing this morning, and I wish I had the sheet, I wrote it
down, but said that the businesses that were interrupted in the
immediate area were like 300 but if you take south of Canal
Street, which has been completely interrupted by the process,
it is over 1,200 and most of that is small business and it is a
devastating concept to think we leave business interruption out
of these kind of packages.
Chairman Sarbanes. Anything else, Jon.
[No response.]
Senator Dodd. I think while Jon was asking that question,
Mr. O'Brien, you had a very clear good example of how this can
get way out of hand very quickly.
Mr. O'Brien. Thank you, Senator.
Chairman Sarbanes. Gentlemen, than you very much. Mr.
O'Brien, for your first time you made a very substantial
contribution. We appreciate it very much.
Mr. Knorr, do not tell the mayor about this Irish problem.
[Laughter.]
Chairman Sarbanes. This hearing stands adjourned.
[Whereupon, at 12:30 p.m., the hearing was adjourned.]
[Prepared statements and additional material supplied for
the record follow:]
PREPARED STATEMENT OF LESLIE M. (BUD) BAKER, JR.
Chairman, Wachovia Corporation
Representing
The Financial Services Roundtable
October 25, 2001
Mr. Chairman and Members of the Committee, thank you for the
opportunity to testify on this critical matter. My name is Leslie M.
Baker, Jr., Chairman of the Wachovia Corporation, here on behalf of the
Financial Services Roundtable, of which I am the Immediate Past
Chairman. The Financial Services Roundtable is a trade association for
the Nation's largest integrated financial services companies. Our 100
members are drawn from the ranks of the banking, insurance, and
securities companies.
I am here today to tell you that without full cooperation between
our Government and America's private industries in support of insurance
activities there could be major disruption in the marketplace and harm
to the economy.
On October 10, 2001, 30 chief executives from Roundtable member
companies signed a letter to the Congress expressing concern over the
impending lack of terrorism coverage and urging Congress to act this
year. It is important to note that 22 of those 30 signatories are
bankers, including Wachovia. This makes the point further that this is
not an issue solely about the insurance industry. Mr. Chairman, I ask
your consent to have the letter entered into the record.
The President of the United States, Chairman of the Federal
Reserve, Secretary of the Treasury and many Members of Congress have
recognized that our economy needs an economic stimulus package. Without
Congressional action to provide a Federal backstop for terrorism
insurance, efforts to provide an economic stimulus could be
ineffective. This is an issue about the ability of the United States to
recover from the terrorist attacks of September 11 and the ongoing
issues of uncertainty, which now weigh upon the economy.
The possibility of further terrorist acts in the United States
places uncertainty into many sectors of our economy. Without adequate
insurance coverage, our Nation could face economic, market, and
employment disruption. To assist in revitalization and to avoid an
economic downturn in the United States, the Financial Services
Roundtable urges this Committee to create some form of Federal
assistance for insurance losses due to acts of terrorism.
The Nature of the Problem
Property and casualty insurance coverage is one of those subjects
that normally attracts little public attention. However, it is a vital
part of our economy and affects large and small companies in industries
from banking to real estate, and beyond. Insurers assume risks that
other parties cannot. For example, insurers shield developers from the
risks associated with major construction; they protect shippers
transporting goods and commodities; they cover losses associated with
homes and cars; they protect employees through workers' compensation
programs and disability coverage; and they protect businesses from
legitimate claims arising from business interruption.
The property and casualty insurance industry has announced that it
is paying all private sector claims associated with the September 11
attacks. These costs apparently could reach $50 billion or more.
Additional acts of terrorism are unpredictable and, as the attack on
the World Trade Center illustrates, the losses from such attacks can be
massive. Acts of terrorism are ``human acts'' rather than acts of
nature. As such, there is no existing actuarial analysis available to
evaluate such risk. Risk that cannot be priced or managed translates
into the inability of primary insurers to offer policies or get
reinsurance. Thus, if primary carriers cannot transfer risk for acts of
terrorism through the reinsurance market then they cannot sell polices
that include coverage for such acts. If they are unable to sell polices
that include terrorism coverage; a lender may be precluded from making
loans due to increased exposure to uninsured risk.
A Banker's Perspective
As I stated earlier, without insurance coverage for terrorist acts,
it will be much more difficult, for bankers to extend or renew
commercial loans or lines of credit for business purposes,
construction, or development. To assess the viability of a particular
loan, a bank must carefully assess the risk of the loan and price it
commensurate with that risk. Obviously if the risk is too great, the
bank cannot grant the loan at all. One way borrowers reduce risk to
themselves and the bank is to acquire insurance protection against a
number of risks. Purchasing appropriate insurance is standard business
practice for anyone attempting to obtain financing in the United
States.
If the insurance industry cannot offer adequate insurance to a
borrower or a bank because it cannot properly price or reinsure the
risk, the bank is faced with a serious risk assessment problem. Is it
prudent to make a loan to construct a pipeline, or a power plant, or an
airplane, or a ship, or a large shopping center or office building when
the potential for the borrower to repay the loan is diminished by
inadequate insurance coverage? For most banks, the answer will be no.
Indeed in many cases such a loan, most assuredly, would be considered
unsound.
As part of the underwriting process a bank must gain understanding
of likely sources of repayment in the normal course of events and under
catastrophic circumstances. A normal part of the underwriting process
is to make certain that appropriate insurance coverage is available.
This risk protection is good for the customer as well. In the absence
of insurance there must be adequate cash reserves in place to provide
for the retirement of debt. Without insurance, however, such cash
reserves would lock up capital that our customers need to grow their
business and create jobs. Either way, a loan may not be approved
without one of these provisions in place and this is not an acceptable
outcome for an economy already dangerously slowed.
Wachovia is one of the five largest commercial real estate lenders
in the United States. Our company has total commercial exposure of
approximately $252 billion including real estate and small business
loans. Specifically, Wachovia's exposure to commercial loans secured by
real estate is $49 billion and our exposure to small business is $12
billion. It is important that we continue to serve our customers. In
particular, I am concerned about the impact on small business customers
who are already experiencing wide disparity in quoted premiums due to
insurers' inability to price products consistent with standard
actuarial analysis. In the case of large or small business, only the
Federal Government can provide the insurance industry with the
breathing room it needs to return to a stable, rational market. Without
a Federal backstop, businesses will have to self-insure putting their
capital--and ours--at risk. Magnify that potential loss of capital
across the domestic banking sector to gain an appreciation for the
dramatic impact a loss of insurance could have on our economy.
Mr. Chairman, it is impossible to determine if, when or where a
terrorist might strike, but it is quite clear what the business
ramifications can be. I am certain, however, that the lack of insurance
coverage for terrorism will mean fewer loans and that will mean
constriction of economic activity throughout the country. When a loan
is not made, the jobs that would have been created to build a plant or
run an office will not occur.
The Solution
Mr. Chairman, these economic problems need not arise. With
appropriate support and assistance from the Federal Government, the
insurance industry can be in a position to accept the risk associated
with terrorist attack, and our economy can continue its march to
recovery. However, something must be done immediately before
reinsurance contracts expire at the end of the year.
The Financial Services Roundtable is familiar with the various
proposals that have been developed. As an organization, we have
deliberately not stated a preference for any particular one. There are
insurance experts in the private and public sector working to develop
details of a plan that can best address the problem. From my
perspective, any proposal must pass a simple test: it must return
certainty to the market. As such, the program must be in place for an
adequate amount of time, and must give primary insurers a chance to
understand changes in the marketplace and explore adequate alternatives
for reinsurance. I am certain, given the close collaboration between
the Congress, the Administration, and the industries affected we can
develop a workable solution.
Thank you Mr. Chairman. I would be pleased to answer any questions.
----------
PREPARED STATEMENT OF ROBERT E. VAGLEY
President, American Insurance Association
October 25, 2001
Chairman Sarbanes, Senator Gramm, and other Members of the
Committee, my name is Robert E. Vagley, and I am President of the
American Insurance Association, the leading property and casualty
insurance trade organization in the United States, representing more
than 410 insurers that write over $87 billion in premiums each year.
AIA member companies offer all types of property and casualty
insurance, including those most impacted by the horrific events of
September 11: commercial liability, commercial property, and workers'
compensation. Before I begin my formal remarks, I would like to thank
you for the outstanding leadership you have shown on this issue, and
for this opportunity to testify before the Banking Committee at this
crucial time.
The tragic events of September 11, 2001, forever changed our
collective understanding of, and concern about, terrorism on our own
shores. The scope and nature of those attacks were unprecedented in
world history. None of us--neither private nor public sector
interests--had made accommodations for this type of occurrence, because
such things were simply beyond our conception. Unfortunately, we are
now presented with a new view of the very real risks and potentially
infinite costs associated with terrorist acts. The new, post-September
11 world in which we find ourselves is fundamentally different than
that which existed before, for Americans in general, and very
specifically for property/casualty insurers and our customers.
Today, I would like to address two topics. First, I would like to
briefly describe how our industry has responded to the tragic events of
September 11. Then, I would like to share our thoughts on how we can
make certain that insurers are able to continue meeting the
expectations and future needs of our policyholders with respect to
terrorism and the wide range of other risks which we insure.
Current estimates of total insured losses resulting from the
September 11 attacks stand at between $30 and $60 billion, although the
final number will not be known for some time, and could end up being
much higher. This makes the September 11 attacks, by far, the most
costly insured event in history. Although no natural disaster or man-
made catastrophe even comes close, for the sake of some reference, I
would note that Hurricane Andrew, which devastated south Florida in
1992, caused approximately $19 billion in insured losses, perhaps half
to one-third of the September 11 losses. Put another way, the September
11 losses will exceed the entire property/casualty industry's net
income for the past 3 years (1999, 2000, and 2001). On that single day,
3 years of industry profits, including investment income, were wiped
out.
I want to be very clear about our response to the horrific attack
on the World Trade Center. Notwithstanding the enormity of this loss,
the insurance industry has been publicly and steadfastly committed to
meeting our promises to policyholders affected by the events of
September 11. We have not attempted to invoke war exclusions, despite
the militaristic nature of, and rhetoric surrounding, the attacks. We
are paying our claims quickly and fully. We have received claims in
excess of $20 billion to date. And, unlike other industries who were
directly affected by the attacks, we are not asking for any financial
assistance from legislators or regulators to meet our obligations.
Recognizing that the American people and our economy will recover
and move onward, we also are looking ahead. Although the property/
casualty insurance industry can deal with the incredible losses from
September 11, we are very concerned about what will happen if there are
additional, large-scale terrorist attacks in the future. It is critical
that you, as public policymakers, share our recognition that terrorism
currently presents core challenges to the insurance market that we
cannot meet.
The financial capacity of our industry, while sizeable, is limited.
Unfortunately, the potential harm that terrorists can inflict is both
totally unpredictable in frequency and unlimited in severity. As Warren
Buffet, CEO of Berkshire Hathaway, recently stated, ``Terrorism today
is not at all like terrorism 25 years ago. And now you have something
where the nature of the risk, the power to inflict damage, has gone up
a factor of--who knows what--10, 50 . . . you cannot price for that.''
Put simply, that which is not quantifiable is not insurable in the
traditional sense.
As you probably are aware, more than two-thirds of annual
reinsurance contracts agreements by which primary insurance companies
purchase their own insurance to adequately spread the risk of large-
scale losses--are renewed each January 1. Reinsurers already have
notified primary carriers that they intend to exclude or dramatically
scale back terrorism coverage in the reinsurance contracts coming up
for renewal. Although the primary insurance sector of the industry is
adversely affected by such decisions, we recognize that this may well
be the reinsurers' only way to protect their own solvency.
Primary carriers, however, do not have the same flexibility as
reinsurers with respect to our own products because we are subject to
tighter regulatory controls. Any terrorism exclusions we might choose
to introduce must be approved by individual State insurance
departments. If approved, our customers could find themselves bearing
100 percent of the risks associated with terrorism. Certainly, the
repercussions of this are clear. However, if exclusions were not
approved, primary insurers would be left to shoulder 100 percent of
future terrorist losses, which we simply cannot afford to do. Our only
remaining option--one we would prefer not to consider--would be to
simply withdraw from certain markets, and/or lines of coverage.
So we face a very difficult challenge: how can we remain solvent,
and still serve the real needs of our customers for financial
protection against terrorism? I am proud to say that insurers are
working hard with you, your colleagues in the House, with the Bush
Administration, to come up with a public policy solution that will
allow us to continue providing this much-needed coverage to our
policyholders.
We believe that the only course of action is immediate enactment of
legislation to create a Federal financial backstop for losses that
result from future terrorist attacks. This backstop could be temporary,
existing only for as long as it is needed. The legislation must be
enacted before Congress recesses for the year, since so many
reinsurance contracts which cover this risk will expire on January 1.
The legislation we are seeking is not, repeat not, a ``bailout''
for the insurance industry. In fact, the primary beneficiaries of such
legislation would be our customers, and the U.S. economy. Ultimately,
the costs of risk must be borne by the policyholders who seek
protection through insurance. Given the unprecedented nature of the
terrorism threat, the best way for this to be done is through a public/
private partnership that allows us to service the coverage needs of our
policyholders while remaining financially strong enough to pay all
potential claims, whether from terrorism acts or the other ordinary and
extraordinary events that affect our business.
The goal of needed legislation is to ensure that adequate insurance
coverage remains available to American businesses. Federal Reserve
Chairman Alan Greenspan recognized this when he testified before
Congress last week, coming to what he termed the ``very unusual
conclusion that the viability of free markets may, on occasion, when
you are dealing with a degree of violence, require that the costs of
insurance are basically reinsured by the taxpayer, as indeed they are,
for example, in Great Britain and in Israel and in other countries
which have run into problems quite similar to ours.''
There are a number of ways in which this could be done. One is the
British-style reinsurance pool concept, and another is the quota share
approach recently suggested by the Administration. A third would
involve some industry-wide deductible or retention. We are not wedded
to the details of any particular proposal; not even our own. However,
in order for any legislative plan to be successful in averting the
looming economic crisis, it must be drafted in a way that improves
predictability, stabilizes the market, and preserves insurer solvency.
No proposal can make the risk of terrorism go away, nor can it make
the cost of insurance against terrorism risk go away. However, the
right legislation can provide a way for the public and private sectors,
on a short-term basis, to comanage this risk--a risk whose dimensions
changed fundamentally and exponentially on September 11.
What must be in the legislation from our perspective to make it
workable? First, rather than 51 possible separate definitions of
``terrorist act,'' there must be a uniform national definition that
will constitute the terrorism coverage provided by insurance policies
all across America. A broad national definition of terrorism is
essential to avoid nonconcurrence of coverages among primary insurers,
reinsurers, and the Federal backstop. Such uniformity cannot be
achieved if States retain the authority to approve or disapprove policy
forms in this narrow area.
Second, insurers must be able to quickly include the price for
terrorism coverage in their insurance policies, rather than be required
to go to every State insurance regulator and seek that regulator's
approval for the terrorism rate in every property/casualty line. Even
with a Federal terrorism reinsurance program that provides a partial
backstop, individual insurers' retention for terrorism risk will be
expensive, given the huge uncertainties and potentially large losses we
collectively face as a Nation. States cannot take the attitude that
``terrorism cannot happen in our particular backyard,'' and therefore
suppress rates. Mindful of the general prerogatives of State insurance
regulators in the rate-setting arena, there must be language in place
that preserves rate review by the appropriate State regulator, but does
not subject the rates to any review or approval prior to or in
connection with the timely introduction of those rates into the
marketplace.
Third, we recognize that any Federal terrorism reinsurance program
will include a number of important details with respect to the
mechanics of reimbursement and other issues. These details must be
drafted and implemented in a way that is workable for insurance
companies and our regulators.
We understand that, in all likelihood, any new risk-sharing
mechanism for terrorism coverage will include some significant
retention of future losses by private insurers. On that point, I would
like to note that the more risk insurers are forced to retain, the less
stability there will be in the marketplace. Also, the higher the
retention, the higher prices will have to be.
Terrorism has become uninsurable in the private marketplace as
currently structured. Period. Appreciating that an immediate, stopgap
solution may be somewhat imperfect, we expect that dislocations will
still occur as insurers cautiously re-enter the marketplace. It is our
hope that, with time and experience, we will be able to craft longer-
term, more complete solutions that avoid such disruptions.
In the absence of Federal legislation to prevent the complete
collapse of the commercial insurance market, entire sectors of the U.S.
economy could be left wholly exposed and unable to continue the normal
course of business. I urge you to act quickly and decisively to ensure
that all businesses are able to obtain much-needed protection against
future losses.
I thank you for your attention and look forward to responding to
your questions.
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PREPARED STATEMENT OF RONALD E. FERGUSON
Chairman, General Re Corporation
Representing
The Reissurance Association of America
October 25, 2001
I am one of the 2,400,000 people that work in the American
insurance industry--life and health, property, and casualty--day in and
day out. I am proud of our industry. I am proud of the role we play in
our society and in our economy. I am proud of our team, the 2,400,000
people who are working hard, along with every other American, to get
this great country back on its feet. And I am proud of the way we have
stepped up to the losses of September 11 without complaint.
Our sympathy and condolences go to the families and friends of all
who have suffered tragic losses in the September 11 terrorist attacks
on our country. We also express our deep gratitude and respect for the
courageous emergency services, military personnel, and volunteers for
their heroic efforts in this time of national pain.
I might add that for a lot of us in the insurance industry this is
not just about business, it is personal. We lost a lot of friends.
People who worked in the insurance industry accounted for at least 490
of those killed in the World Trade Center. My family was fortunate--our
son-in-law was among those who escaped unharmed.
General Re, a wholly owned subsidiary of Berkshire Hathaway Inc.,
is among the four largest reinsurers in the world, and a market leader
in the United States. While General Re is also in the life reinsurance
business, I am here today to talk mainly about the property and
casualty insurance and reinsurance business.
Let me first say that I believe that the U.S. insurance and
reinsurance industry will be able to meet its policy and contract
obligations, and to pay the losses arising out of the September 11
terrorist attacks. Insurers and reinsurers do not need a bailout for
those losses from the Federal Government, and are not asking for one.
We all know that the terrorist attacks of September 11, 2001
resulted in unprecedented losses of life, personal injury, and property
damage. It is difficult to estimate the total insured losses that the
U.S. property and casualty insurance and reinsurance industry will
ultimately pay as a result of those terrorist attacks. In addition to
the normal problems involved in estimating large or catastrophic
losses, in this case there may be liability issues that may take years
to fully resolve.
Some recent analysts' reports have suggested that $25 billion to
$40 billion is a reasonable range of estimated total insured losses
(property, casualty, life, and health) from the September 11 terrorist
attacks. Some analysts have even suggested that the total insured
losses could exceed the range of numbers I just mentioned. My own view
is that total insured losses (property, casualty, life, and health)
will be at the high end of the $25 billion to $40 billion range.
Before September 11 the threat of terrorism within our borders
seemed remote. Because of that, no insurance or reinsurance premiums
were collected for terrorism coverages, and no assets or reserves were
allocated to terrorism exposures. That means that the September 11
terrorism losses must be paid from the industry's capital account. The
total capital and surplus of the U.S. property and casualty insurance
and reinsurance industry at June 30, 2001--including both personal
lines and commercial lines writers was $298 billion. That figure
includes $26.6 billion of capital in separately capitalized U.S.
domestic professional reinsurers. That total industry capital consists
of required regulatory risk-based capital, as well as the additional
capital needed to support operating and investment risks and to meet
the reasonable expectations of policyholders and claimants, rating
agencies, stockholders, and others.
The exposure to loss from the September 11 terrorist attacks is not
spread evenly across the total insurance industry capital base. The
great bulk of those losses will fall on the capital base of the
commercial lines insurers and reinsurers.
One way of looking at the commercial lines capital base is set out
in Exhibit A. It shows that--after subtracting personal lines capital,
the Berkshire Hathaway capital that is not allocated to the affected
lines, and the pre-September 11 third quarter declines in common stock
values--the affected property and casualty commercial lines insurers
and reinsurers (U.S. and non-U.S.) had a September 10 estimated
combined total capital base of $126 billion. That $126 billion capital
base has now been reduced by $25 billion to $40 billion of losses--pre-
tax and gross of nondomestic reinsurance.
Tillinghast, in a just-released study for the American Insurance
Association, noted that the September 11 losses might rest on an even
smaller capital base--perhaps $80 billion to $100 billion.
Three things stand out as being very clear to me:
First, the commercial lines capital base can obviously fund a total
September 11 insured loss of $25 billion to $40 billion--or an even
larger loss from that event.
Second, many actuarial and underwriting principles and practices
will have to change. While not a complete list, here are five things
that will change:
We will have new and different notions about the size, shape,
and trends of insured losses and the required risk loads
Most lines of business will require a greater capital
allocation
Risk-based capital standards will be revised by regulators and
rating agencies to incorporate terrorism risk
The cost of capital for the insurance business will, other
things being equal,
go up
We need to rethink risk diversification or its opposite, the
correlation of risk
And there will be other actuarial and underwriting changes.
Third, the commercial lines capital base cannot take the hit from
another sizeable terrorist event without seriously compromising the
ability of the property and casualty commercial lines industry to meet
its commitments for losses arising from other underwriting and balance
sheet risks.
The simple fact is that, on its own, the U.S. insurance and
reinsurance industry cannot afford to take on the potentially unlimited
exposure to loss arising from insuring against terrorist acts. The
commercial lines capital base I have described, while able to absorb
the losses from the September 11 attacks, simply will not be able to
sustain multiple events like those attacks. No one at present can
reasonably predict either the number or scale of future terrorist
attacks we might face before our war on terrorism is won.
We support and applaud the steps that the Federal Government is
taking to combat terrorism. But until those efforts have borne the
fruit of significant reduction in the potential for terrorist attacks,
it is close to impossible for many insurers and reinsurers to
responsibly underwrite or assume terrorism risk. We simply cannot
evaluate the frequency and severity of terrorism losses using
traditional underwriting and actuarial techniques. There are no models
that would let us price the risk with confidence, and the consequence
of error is ruin. That is why as an industry we need to explore
alternative ways to cover losses arising from terrorism.
The September 24, 2001 edition of The Wall Street Journal featured
this quote from Warren Buffett, Berkshire's Chairman:
I think in the future, the Government is going to have to be
the ultimate insurer for acts of terrorism . . . An industry
with very large, but finite, resources is not equipped to
handle infinite losses.
In some very important ways, insurance is the grease that
lubricates the American economic machine. Insurance and reinsurance
coverage for terrorism risks is necessary for our economic recovery--so
that lenders will lend, and builders will build, and employers will
hire. It is that simple.
Going forward, we need to find a way to provide insurance against
terrorist acts that assures both the continued financial viability of
the U.S. insurance and reinsurance industry, and the continued
availability and affordability of the wide range of products and
services provided by that industry.
In a rare--if not unique--show of unity, the property and casualty
insurance and reinsurance industries universally agree that the best
way to do that is to have the Federal Government act as the ``reinsurer
of last resort'' for terrorism insurance and reinsurance coverage,
similar to the plan used in the United Kingdom.
Federal Reserve Chairman Alan Greenspan appears to agree. On
October 17, 2001, he said:
What hostile environments do is induce people to withdraw, to
disengage, to pull back. It is quite conceivable you could get
a level of general hostility that would make viable market
functioning very difficult, . . . I can conceive of situations
[where] the premiums that would be necessary to enable a
private insurance company to insure against all those risks and
still get a rate of return on their capital would be so large
as to inhibit people from actually taking out that insurance, .
. .
Therefore you are led to what is an unusual conclusion that
the viability of free markets on unusual occasions, when you
are dealing with violence, . . . [that it is necessary that]
the costs of insurance are reinsured by the taxpayers, . . .
Free markets and Government reinsurance, in this very unusual
circumstance they are indeed compatible . . .
(Source: Bloomberg)
It is increasingly clear that State regulators, the Administration,
Members of Congress, and a broad swath of Americans and American
businesses also agree that we need a solution.
All of these interests may not currently agree on the right way to
structure that Federal reinsurer role--we have all heard the several
proposals that have been advanced. But there is nearly universal
agreement on the fact that this is a significant and urgent problem
that needs to be solved before Congress recesses.
While the size and scale of the September 11 terrorist attacks are
unprecedented, there are precedents for Government involvement--here
and abroad--in the solution of temporary insurance market disruptions.
The Federal Government ran an insurance program during World War II.
FAIR plans were developed to deal with insurance scarcity in the wake
of the 1960's urban riots. More recently, the United Kingdom and other
countries have developed government-backed solutions to terrorism
insurance.
When the need for these kinds of programs abates, they tend to fade
away. When we are successful in our war against terrorism, we fully
expect that any Federal terrorism insurance solution also fade away as
normal market solutions return.
We are eager to work with this Committee, other Members of
Congress, the Administration, State insurance regulators, and others to
find a solution that makes sense for the country and for the faltering
economy, which badly needs an injection of confidence. The solution
must also make sense for frustrated and injured policyholders and
claimants, for the insurance industry and its regulators, and for you.
Insurance is, after all, a critical part of the central nervous system
of this economy and this society.
We are not looking for a bailout for the insured losses flowing
from the tragic events of September 11. We are looking for a way
forward to serve our clients and fulfill our role in the economy.
I am reminded of a quote from Winston Spencer Churchill, one of my
personal heroes. Slightly more than 60 years ago, as Britain was
engaged in the early stages of World War II, Churchill said, ``Give us
the tools. We will do the job.''
As we face a different kind of war, and as we find the way forward
for the insurance industry, I could not possibly say it any better to
you and to the Congress: give us the tools.
I am grateful for the opportunity to speak to you today, and would
be pleased to answer any questions you may have.
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PREPARED STATEMENT OF JOHN T. SINNOTT
Chairman and CEO, Marsh, Inc.
Representing
The Council of Insurance Agents and Brokers
October 25, 2001
Mr. Chairman and Members of the Committee, I am John T. Sinnott,
Chairman and CEO of Marsh, Inc, headquartered in New York City. Marsh
is the world's largest risk management and insurance brokerage firm. We
have 35,000 employees and serve clients in over 100 countries around
the world. We also serve virtually all of the major insurance firms
with reinsurance broking and related services through our Guy Carpenter
unit. My testimony is on behalf of my firm as well as the member firms
of the Council of Insurance Agents and Brokers.
I would like to thank you, Mr. Chairman, for giving me this
opportunity to testify today on the topic of burgeoning terror
insurance availability crisis in the wake of the September 11 attacks.
While it has been said many times before, I think it bears repeating
that the events of that day have changed the United States, and that
life and business as we once knew it will never be the same. The events
of that day were singularly devastating on one industry--the financial
services industry--not only in business terms, but also in human terms.
The World Trade Center housed several companies from the banking,
securities, and insurance industries that must now deal not only with
the new business challenges facing them as a result of the attacks but
also with the loss of colleagues and employees. Within the insurance
industry, the brokerage community was hit particularly hard. Marsh
maintained offices in both of the World Trade Center towers and the
space that we occupied in the North Tower comprised the floors directly
struck by the first aircraft. No one in those offices at the time
escaped. In fact, of the 1,900 members of the Marsh & McLennan
Companies working in both towers, and who were visiting that day, 294
were lost. Another colleague was a passenger aboard one of the
aircraft. The world's second largest brokerage firm, Aon, also had a
large presence in Tower 2. They lost 200 of their colleagues. While our
first response was to focus on our people and the families of those
lost, we also realized that we had to begin the job of our affected
clients in resuming their usual business operations.
The events of September 11 have changed the landscape of commercial
insurance in a way that I have not seen in my 36 years in the business.
To be sure, there have been trying times in the past--the liability
crisis in the mid-1980's, the property catastrophe coverage problems in
the early 1990's following Hurricane Andrew, to name a couple. Marsh
rose to the occasion during both those crises to help our clients
secure the coverage that they needed to adequately protect their
businesses. This is a function that is quite common in the brokerage
community--not merely selling insurance products, but identifying
client needs and developing new and innovative products or programs to
address coverage shortfalls and to make our clients more successful.
In response to the mid-1980's liability crisis, Marsh played a
leading role in the creation of the insurance and reinsurance companies
ACE Limited in 1985 and XL Capital in 1986. These companies were formed
to provide excess liability and directors' and officers' liability
coverages at a time when the market could not provide the necessary
capacity. These companies were very successful in providing much-needed
market capacity. They exist as major insurers today. Similarly, Marsh
played a role in the creation of Mid Ocean Limited during the property
catastrophe reinsurance crisis following Hurricane Andrew in 1992. This
company has also done very well in meeting the needs voiced by our
clients.
It was in this same spirit of responding to customer needs that MMC
Capital, our sister company, recently announced the formation of AXIS
Specialty Limited, a new insurance and reinsurance company formed to
provide capacity needed in the wake of the September 11 attacks. AXIS
has an initial capitalization in excess of $1 billion, and will begin
underwriting later on this quarter.
Our firm is proud to be able to continue our tradition of
responding to supply and demand imbalances in the insurance and
reinsurance markets. But I must tell you in all candor that what your
Committee heard has been hearing over the past 3 weeks is true--there
is an immediate crisis that demands your attention. In the current
unique, and hopefully short-term, environment of uncertainty, the
private sector alone will not be able to provide the insurance capacity
America's businesses need to conduct their operations. Government
involvement is needed until the environment becomes secure and returns
to a state of more normalcy.
The problem with what happened on September 11 is that it presented
a risk that no one had could conceive would happen. When the buildings
were built, loss scenarios did contemplate the impact of one Boeing
707, the largest commercial aircraft at the time, however the idea of
two, fully fueled 767's hitting both towers was unimaginable. Thus, we
arrive at the problem presented by terrorism: the magnitude and
severity of potential future events.
There has been considerable discussion about the scale of the World
Trade Center and associated losses of September 11. While it will be
some time before the total costs of the tragedies are computed, we all
know that they represent the largest-ever losses in the insurance
industry, by far. The previous largest insured loss was Hurricane
Andrew at nearly $20 billion--or less than half of the losses of
September 11. Some further context--the most recent catastrophic losses
for the insurance industry--including Hurricane's Andrew and Hugo, the
Northridge and Kobe earthquakes and the Lothar and Martin windstorms in
Europe--totaled $53 billion in losses. Chances are that the losses
stemming from the attacks at the World Trade Center will exceed that
number--perhaps significantly.
The true cost of these events will not be known for years, because
some types of insurance, such as business interruption and workers'
compensation, do not constitute one-time payments but are rather
ongoing for longer periods of time. While the industry has stated it
can cover the severity of losses from this event, it is very unclear
that the industry will be able to meet any frequency of future losses
that may occur. We are told by Federal authorities to expect
retaliatory strikes against America and that it is virtually impossible
to completely shield ourselves from the assaults of those who disregard
their own lives.
We have already seen massive and virtually unanimous signs of the
unwillingness to take on such risks that are unquantifiable. As our
commercial clients' policies have come up for renewals, we have seen a
majority of insurers add terrorism exclusions to their policies. Of the
top 25 property insurers with whom we trade, 17 have stated that
terrorism exclusions will apply effective immediately and most of the
others can also be expected to apply exclusions.
While most insurers will be unwilling to underwrite terrorism risks
going forward, there may be a few companies who will be willing to take
on those risks. However, even if they are willing to provide the
coverage, it is not clear that they will do so at prices which are
affordable by most businesses. And clearly, such efforts will
involve adverse selection, in that many businesses that are considered
most vulnerable probably will not be able to secure coverage at any
price from any insurer, absent Federal intervention.
Similarly, there is now a new definition of what a maximum insured
loss may be. There are not many people who would have ever believed
that the Twin Towers of the World Trade Center could or would be
completely destroyed, turned into a pile of dust and rubble, with
nothing of value left, and with thousands of deaths and injuries. We
know now that it is possible, and that the concept of a maximum insured
loss post-September 11 does not in any way resemble the concept we had
before that date. Threats can come from anywhere in the world, not just
from one's business partners or from Mother Nature. The scope of risks
we must plan for has changed as well.
This change in the perception of risk will have great repercussions
in the pricing of policies going forward. Before September 11, the
insurance industry was already experiencing what is known as a ``hard
market,'' meaning that premium rates were rising. That trend has now
accelerated significantly. We are now seeing average rate increases in
the area of 65 percent to 75 percent coupled with dramatically
increased deductibles, and a contraction of available limits and
coverages. Some price increases exceed 100 percent.
It is for this reason that I would urge the Congress to address the
market contraction that we are facing before it adjourns for this year.
We are facing a deadline at the end of the year for reinsurance
contract renewals that will begin to exclude terrorism coverage. If
insurers cannot cede this risk to a reinsurer, they will be unwilling
to take it on themselves and will refuse to offer the coverage. That is
why I am delighted that proposals to address the insurance problems we
face are being advanced.
We all are familiar with the two major proposals--the 80/20 plan
and the pooling arrangement. There are others as well. Until there is a
cure for the current environment of uncertainty created by the prospect
of terrorism, the insurance coverage our clients need cannot be
obtained from the private sector solely. In this somewhat unique--and
hopefully short-term environment, it is critical that the public and
private sectors collaborate. Then, once the environment has stabilized,
and we achieve a state of greater normalcy in the environment, it
should be practical for Government involvement to decline and
ultimately be withdrawn.
As mentioned above, my firm has been severely affected by the
events of September 11. The first aircraft directly struck our offices
in the World Trade Center and we lost 295 members of our corporate
family. That was the real tragedy and is still with us in our offices
and hallways.
We also incurred huge losses of property and equipment. So I speak
here today from painful personal experience--and perhaps with a deeper
understanding of what our clients face as they look to an uncertain
future.
Mr. Chairman, let me restate that we are on the brink of an
availability/affordability crisis insurance caused by the terrorist
events. I commend you for holding this hearing, for your efforts to
create a solution that restores and strengthens the private
marketplace, and I urge you to work with your colleagues in Congress
and the Administration and within our industry to find workable
answers.
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PREPARED STATEMENT OF THOMAS J. DONOHUE
President and CEO, U.S. Chamber of Commerce
October 25, 2001
Good morning, Mr. Chairman and Members of the Committee. I am
Thomas J. Donohue, President and Chief Executive Officer of the U.S.
Chamber of Commerce and Chief Executive Officer of the U.S. Chamber
Institute for Legal Reform. The U.S. Chamber is the world's largest
business federation, representing more than three million businesses
and professional organizations of every size, in every business sector,
and in every region of the country. The central mission of the Chamber
is to zealously represent the interests of the entire business
community before Congress, the Administration, the independent agencies
of the Federal Government, and the courts. The mission of the Institute
for Legal Reform is to reform the Nation's State and Federal civil
justice systems to make them simpler, fairer, and faster while
maintaining access to our courts for legitimate lawsuits.
I welcome this opportunity to testify before you on the urgent need
for prompt Congressional action to help make sure that insurance
coverage for terrorism is available. I also ask that my full statement
be inserted into the record.
The terrorists who attacked our Nation September 11 deliberately
struck at the center of U.S. finance and commerce. Congress has acted
promptly to help address a number of the immediate needs raised by the
September 11 attacks by passing the Air Transportation Safety and
System Stabilization Act as well as providing much needed emergency
funding to help with the immediate recovery. Unfortunately, more work
is needed to help shore up our economy, and passage of Trade Promotion
Authority and an adequate economic stimulus package would represent
significant steps. But even those efforts will be inadequate if
American business is unable to move forward secure in the knowledge
that the potential risks associated with future terrorist attacks will
not cripple them beyond the point of recovery.
The attacks have had a significant impact on the insurance
industry. September 11 will result in the largest insured loss in U.S.
history. It has been estimated that the insurance industry will pay
between $30 and $58 billion in claims, and some estimates are even
higher. To put the magnitude of this event in perspective, it easily
surpasses the $30 billion, without adjusting for inflation, paid for
claims because of Hurricane Andrew. The insurance industry has
indicated that it remains committed to meeting its obligations to
policyholders for the events of September 11. These claims for
terrorist losses will be paid directly by the primary insurers
operating in the United States, with a major portion of the costs
ultimately shared throughout the global insurance and reinsurance
community.
The problem, however, is that in the wake of these events, insurers
and reinsurers are examining how to manage the heightened level of
terrorism risk they are facing and are reevaluating what coverage, if
any, they may provide for it. The September 11 attacks fundamentally
changed assumptions about the scope of risks and losses associated with
terrorism. It now seems that any commercial enterprise, from Main
Street-type small businesses to multinational American ``icon''
corporations, could become targets of or affected by the next terrorist
attack on American soil. As a result of the potentially astronomical
increase in liability, the insurance industry has begun to indicate
that it cannot cover losses associated with future terrorist attacks.
A single-day event of the magnitude experienced on September 11 is
a substantial hit to the capital base of many companies as well as the
worldwide insurance industry as a whole. While the attack may strain
many insurance companies, current indications are that the majority of
companies will be able to meet their obligations. However, in the short
run, the United States and global reinsurance industry does not have
the capacity to provide protection against another major incident, or a
continuing series of incidents. Companies with significant losses
stemming from the terrorist attack will need to raise fresh capital in
order to maintain their capacity to insure against all other risks
covered by their contracts. Uncertainties regarding losses from future
terrorist attacks will likely make raising fresh capital problematic.
As a result, because of the unprecedented scope and nature of the
losses sustained last month and the unpredictability of future
liabilities, insurance coverage against future acts of terrorism will
become virtually unobtainable for the vast
majority of policyholders.
Major reinsurers have already alerted their clients that they
intend to sharply reduce or eliminate their coverage for terrorist
attacks, particularly policies on large commercial risks such as office
towers, transportation hubs, sports arenas, and the aviation industry.
The lack of reinsurance would leave primary insurance companies on the
hook for all of the risk of a terrorist attack, a position they cannot
assume. This, in turn, will force primary insurers to eliminate the
availability of such coverage. Therefore, because the majority of
American businesses traditionally renew their insurance contracts each
January 1, businesses of all sizes and kinds could be left without
insurance against terrorist acts.
What does that mean? If not corrected, this market disruption in
insurance coverage will have deep, widespread, and potentially
devastating ripple effects throughout the entire U.S. economy.
Businesses that cannot secure full insurance coverage, including
coverage for terrorist acts, may decide that risks from a lack of
complete coverage leave them too vulnerable thus forcing them to reduce
operations that would be considered too likely to be terrorist targets.
This would result in layoffs and the elimination or decreased
availability of a variety of products and services. For example,
without adequate coverage, trucking firms, railroads, airlines, and
ships may be unable to transport many types of cargo or limit their
destinations.
In addition, a lack of terrorism insurance coverage could
significantly harm the ability of many businesses to obtain financing
or otherwise buy or sell properties, businesses, or projects.
Furthermore, it is important to note that this is not only a
prospective problem. For example, the terms of most loans require
evidence of adequate insurance. If adequate insurance is no longer
available, borrowers may find themselves in technical default of their
loan terms. As a result, lenders would be in the position of
potentially having to try to find adequate insurance coverage for their
borrower that may not exist or either accelerating payments under the
terms of the loan or calling-in the loan in its entirety. They may also
be forced to cut down on the amount of available credit as they build
their reserves in the event of additional terrorist attacks. Finally,
if businesses decide to self-insure the risk of future terrorist
attacks, they may find it difficult, if not impossible, to attract
their own reinsurance or even new capital.
The principle upon which insurance rests is the ability to spread
risk so that no single person or entity is forced to bear the full
impact of an economic loss. Without this ability to spread risk,
individual American businesses cannot afford to take on the potentially
unlimited exposure to loss arising from uninsured terrorist attacks.
Without some appropriate partnership between the insurance industry and
the Federal Government, the looming constriction in the insurance and
reinsurance markets threatens to inflict serious injury to the U.S.
economy. This would potentially result in American businesses and
citizens incurring substantial losses even if we do not suffer a future
terrorist attack.
It is critical that the business community, the Administration, and
Congress come together before the end of this year's Congressional
session to develop and implement an appropriate Federal financial
backstop for terrorism exposure. If such a backstop is not created, our
Nation's economic recovery will be seriously jeopardized. Whatever
approach is developed, it should support ongoing efforts of the private
insurance and reinsurance markets to return to their proper role of
underwriting risks while recognizing a Government backstop may be
necessary for a period of time.
The Chamber recognizes that there are a number of ways in which
this issue could be addressed and we stand ready to work with all of
the stakeholders to ensure that a workable mechanism is developed so
that we can avoid a widespread economic crisis and keep American
businesses in business. I would be happy to answer any questions you
may have. Thank you.
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PREPARED STATEMENT OF THOMAS J. O'BRIEN
Senior Vice President of Finance and Chief Financial Officer, LCOR,
Inc.
Representing
The Real Estate Roundtable
October 25, 2001
My name is Thomas J. O'Brien, and I am the Senior Vice President of
Finance and Chief Financial Officer of LCOR. As a member of LCOR's
Management Committee, I am responsible for the company-wide oversight
of LCOR's finances, risk management, and insurance activities--
including those of the JFK International Air Terminal LLC--a $1.2
billion air terminal redevelopment project and its related
operations.
LCOR is a national real estate development, asset management,
investment, and operations management company, specializes in
structuring and implementing public/private developments. We have
completed projects in 15 States and the District of Columbia, including
more than 1.6 million square feet of commercial space and 18,000
residential units. The company has $4.4 billion in developments
completed or under construction, and over $1.6 billion in
predevelopment. As the leader in public/private development, LCOR is,
or has been, involved in some of the Nation's largest, most complex,
and creative developments. LCOR's operating offices are in New York
City, Washington, DC, New Jersey, Dallas, Denver, and Berwyn,
Pennsylvania, where the company also has its corporate office.
I am here today as a long-standing member of The Real Estate
Roundtable and on behalf of a number of real estate organizations and
trade groups that are separately submitting written testimony.
The tragic events of September 11 have triggered a withdrawal of
virtually all commercial property and casualty insurance coverage for
terrorist damage. While this will become readily apparent throughout
the economy on January 1, when approximately 70 percent of the policies
on commercial properties are scheduled for renewal, it is already a
problem in our market.
As the CFO of a commercial property owner, I know that it is not
possible to buy, sell, or finance a commercial building unless it is
covered by adequate insurance. A significant percentage of owners of
commercial properties open to the public, including shopping centers,
offices, and hotels renew their insurance coverage on January 1 each
year. Many of these owners have been advised that their policies may
not be renewed or that their new policies will exclude terror/war
risks.
Without adequate insurance, it will be difficult, if not
impossible, to operate or acquire properties, refinance loans, and to
sell commercial-backed securities. Disappearance of coverage for
terrorist acts for real estate and other businesses could severely
disrupt the economy. I am very concerned about the short-term future of
the real estate industry unless the Federal Government creates some
type of mechanism that would provide this coverage.
The scale of the real estate industry is immense--with income-
producing real estate representing an estimated $4.6 trillion--with
$2.05 trillion in institutional-grade real estate. In the institutional
real estate market--which includes office,
retail, hospitality, multifamily, and industrial--there is total equity
of $372.7 billion--largely supplied by REIT's (39.3 percent) and
pension fund investors (38.6 percent)--and total debt of $1.67
billion--with 42 percent held by commercial banks, 14.8 percent held by
CMBS investors, and life insurance companies holding 13 percent. This
does not include approximately $6.7 trillion in owned homes (single
family, condominiums, and co-ops).
As these policies expire, there is tremendous uncertainty about the
status of debt to the sector, with some $700 billion in commercial bank
debt, $350 billion of loans in CMBS, $220 billion of loans held by life
insurance companies that ran the risk of being in nonmonetary default
without the availability of terrorist coverage. This lack of coverage
raises profound liquidity concerns not only on existing loans and the
institutions that hold them but on the ability of borrowers to secure
financing going forward.
Before September 11, property and general liability policies
covered losses stemming from terrorist acts. But as confirmed by
insurance industry CEOs' testimony before the House Financial Services
Committee on September 26, future policies will exclude coverage for
both terrorist acts and acts of war. Additionally, they stated that
reinsurance for terrorism is currently unavailable in the marketplace,
Without reinsurance, there will likely be no primary insurance covering
terrorist damage. As a result, the real estate and construction
industries, which account for over a quarter of the Nation's gross
domestic product, could face severe economic dislocation in the coming
months if the Federal Government does not immediately address
insurance-related issues tied to terrorism.
The Federal Government should play a role to ensure that commercial
property owners and other businesses can obtain insurance coverage for
damage from acts of terrorism. It is important to act before these
policies terminate on January 1 to ensure that insurance coverage for
terrorist acts is available in the future. Necessary characteristics of
a workable plan include the following:
Duration: Because real property is a long-lived fixed asset, it
is generally financed over a long term--typically 10-30 year
term. Thus, if the program created is of insufficient length,
it may not provide sufficient stability in the short term. Any
program created must be of sufficient duration to provide
financial certainty for these long-term lenders.
Definition: The line between ``terrorism'' and ``acts of war''
has been blurred significantly since the September 11 attacks
on the World Trade Center and the Pentagon. President Bush and
news media have been focused on our current ``war against
terrorism.'' The real estate industry is concerned that the
next
incident in this ongoing conflict may be considered an ``act of
war'' by the insurance industry and therefore be excluded from
coverage. Accordingly, any program created must cover an
expansive notion of terrorism so that future events along the
lines of September 11 are covered--and are not excluded from
coverage in the future as an act of war.
Deductible: The real estate industry is concerned that a
dramatic and unsupportable increase in deductibles to property
owners could be tantamount to no insurance coverage at all. For
example, if a real estate owner plans to acquire a $10 million
property with $3 million of equity and $7 million of debt, an
insurance policy with a deductible of $3 million or more,
effectively would wipe out the real estate owner's equity and
would militate against investment in the property. Accordingly,
any program created must carefully consider apportionment of
loss exposure among property owner, lender, insurer and the
Federal Government.
Disclosure: With property and casualty insurance rates already
skyrocketing prior to the attack on America, insurers should be
required to separately disclose the cost of terrorist coverage
to avoid any misunderstanding as to the program's impact on
overall insurance rates. Otherwise, it would not be possible to
discern the actual increase in the policy as a result of the
difficulty in writing terrorism and act of war coverage and the
result of other issues.
The Congress must not fail to act. Our industry welcomes the
opportunity to work with the Administration and Congress to achieve a
workable solution to this immediate problem this year.
Thank you for the opportunity to be here today.
PREPARED STATEMENT OF WALTER K. KNORR
Chief Financial Officer, City of Chicago, Illinois
October 25, 2001
Thank you, Mr. Chairman for inviting me to testify today. My name
is Walter Knorr and I am the Chief Financial Officer of the City of
Chicago. I appreciate the opportunity to present to the Committee a
matter of great concern to the City of Chicago and, I am sure, to other
cities throughout America.
The cost of war-and-terrorism liability insurance as a result of
the tragic acts of September 11 has escalated to incredible levels. The
insurance industry is uncertain about the risk of terrorism, and
therefore unable to assess and price that risk.
In Chicago, our insurance carrier recently canceled our war-and-
terrorism liability insurance coverage for Chicago O'Hare International
Airport and Chicago Midway Airport. Prior to September 11, we paid an
annual premium of $125,000 for $750 million of war-and-terrorism
liability coverage. If we want to renew our insurance, it will cost us
$6.95 million for $150 million of war-and-terrorism liability coverage.
I will repeat those figures for you. Our premium has risen from
$125,000 to $6,950,000. Our coverage has dropped by $600 million. That
is a premium increase of over 5,000 percent for substantially less
coverage. Expressed another way, the cost of $1,000 of coverage has
risen from 16 cents to $46.33--an increase of 28,956 percent. This
extraordinary cost increase would be passed along primarily to our
tenants at O'Hare and Midway, namely the airlines operating out of
those two airports. The financial problems of most airlines have been
well publicized. A cost increase of this magnitude would negate the
city's efforts to cut the costs of airport operations to benefit the
airlines and keep them viable. It also would undo the efforts of this
Congress to assist the airlines financially during these uncertain
times.
Chicago is not alone in this. We are aware of a number of other
major airports across the country that have received equally exorbitant
quotes for war-and-terrorism liability coverage. In addition, the
Chicago airports have been warned that their premiums for property and
liability insurance may double, triple, or even quadruple--and
deductibles will increase significantly.
The problem extends beyond airports. The City of Chicago insures a
toll bridge that connects Interstate 94 to the Indiana Tollway. Our
most recent annual premium was $406,000 for $386 million of coverage.
In mid-September the city received a nonrenewal notice for this bridge,
with the ominous indication that the insurance carrier could not quote
a new rate, but that the rate will increase by more than 30 percent and
potentially much higher. One would expect insurance costs associated
with terrorism to increase substantially for many other public and
private structures: existing buildings, buildings under construction,
public meeting areas like sports stadiums and convention centers, and
other prominent infrastructure. The increased insurance costs would
undoubtedly be passed along to the tenants and users of the these
assets. If those costs were significant--and I think they could be--
they could have an extremely negative economic impact. Tenants would
have to decide whether to pay those higher costs or leave the city and
take jobs with them.
The insurance crisis hits major cities the hardest because cities
would appear to be the most likely targets for terrorist attacks. While
terrorists may pick out individual targets, the attacks are directed at
the Nation as a whole and the risk should be spread to the Nation as a
whole. In these uncertain times, the Federal Government should act as
an insurer for future terrorist attacks and catastrophic losses.
There are two proposals before this Committee, and the City of
Chicago is not taking a position on the two proposals. The city does
believe it is imperative that the Federal Government act on the
insurance problem to provide certainty of insurance at reasonable
rates, and hopefully mitigate the cost to Government and business.
Thank you again for this opportunity. I will be available for any
questions you might have.
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STATEMENT OF STEVE LEHMANN, FCAS, MAAA
Vice President for Property/Casualty
American Academy of Actuaries
October 25, 2001
Introduction
The American Academy of Actuaries appreciates the opportunity to
provide comments on issues related to insurance and the threat of
future terrorist acts. The Academy hopes that these comments will be
helpful as the Committee considers related proposals.
The Academy is the nonpartisan public policy organization for the
actuarial profession and assists policymakers through presentation of
clear actuarial analysis. For more than 30 years, membership in the
Academy has been a hallmark of professional quality for U.S. actuaries.
Academy members are bound by rigorous professional standards for
conduct, practice and qualification, and discipline.
The actuarial profession is uniquely qualified to examine issues
relating to insurance and reinsurance of catastrophes. Academy members
who practice in the insurance field typically have a broad
understanding of insurance risk and company
financial management, and they are well equipped to evaluate
reinsurance arrangements. Many Academy members also have extensive
practical experience in evaluating the financial risk associated with
natural disasters and other catastrophic events and in pricing related
coverages for the private marketplace.
Given this expertise, the actuarial perspective is valuable in
examining the fundamental aspects of insurance and in describing policy
considerations associated with proposals to address the impact of
terrorism on the insurance industry.
Defining the Problem
In the aftermath of September 11, insurers and insureds face a
significant problem with respect to future coverage of terrorism risk,
due to both the nature of insurance and the nature of the threat
involved.
Insurance is at the foundation of a free market system, because it
gives entrepreneurs and businesses the freedom to focus their resources
on the conduct of their business without concern over the magnitude and
volatility of potential fortuitous losses. Insurers accept that risk as
long as it is quantifiable and appropriately priced. Where that is not
possible, insurers become reluctant to accept the risk.
A dramatic change occurred on September 11, when a new risk of
terrorism emerged from an event that had never even been imagined by
insurers or insureds. The risk of terrorism involves prospective losses
of unknown but potentially very high severity and unknown frequency.
This makes risk quantification very difficult. Furthermore, it reaches
beyond first-party property coverage to involve other coverages (such
as workers' compensation, liability, and business interruption) that
are also difficult to quantify. Even building a new risk model to
define the scope of
potential losses from acts of terrorism will be extremely difficult.
This difficulty is aggravated by the inapplicability of existing models
and the total absence of any historical data.
As a result of the September 11 events, there is enormous strain on
the entire insurance system. Insurance mechanisms have to bear
previously existing risks as well as the unknown and unpriced risk
associated with terrorism. Additionally, though the industry may have
retained significant surplus following the September 11 attacks, such
surplus is needed to support all of the risk assumed by insurers for
all of the lines of business they have written. Given these
difficulties, in the short term at least, insurers are being driven to
avoid losses that could occur from acts of terrorism in order to
preserve their own financial security. From a public policy
perspective, lack of coverage for such losses is not an acceptable
outcome.
Private-Sector Solutions
Because insurance coverage plays such a vital role in our economic
system, various proposals have emerged to provide some limitation on
the aggregate risk from terrorism to be borne by the private sector.
The immediate actuarial problem of pricing this new risk can be
diminished by limiting the losses that would have to be paid by the
private insurance market. In considering solutions to the problem,
considerable discussion has focused on the concept of a terrorism
reinsurance mechanism, that in turn raises a number of important
concerns. For example:
How would such a mechanism be funded? Would it be funded
prospectively by premiums charged to the participant insurers,
retrospectively by assessments to the participant insurers, or
through some combination of these approaches?
How would liquidity be assured so that funds would be
immediately available to pay claims when they occur?
How would the terrorism trigger be defined so as to preclude
coverage disputes between participating insurers?
Would this mechanism be voluntary or mandatory? Would it be
available to noninsurer, risk-assuming entities such as self-
insured municipality pools?
Will Governmental protection be available as a backstop above
a finite limit of loss?
Answers to each of these questions and perhaps others will be
necessary before a pricing model can be developed. Broad-based
participation by insurers is critical to spreading terrorism risk if a
private-sector mechanism is adopted. If the mechanism is voluntary,
there must be adequate incentives to entice insurers to participate.
Voluntary participation in any mechanism also brings up issues of
potential adverse selection (that is, only high-risk insurers and
businesses participate).
It has been suggested that it would be appropriate for Government
to provide coverage for terrorism losses above a certain limit. In view
of the magnitude of potential losses, it is difficult to conceive of
any effective mechanism that would not have to involve the Federal
Government, at least in the short term. However, any short-term
solution will undoubtedly require future modification to reflect an
increased understanding of the risk involved as well as subsequent
experience gained in addressing it. All of the proposals currently
being considered sunset in less than 10 years. A sunset period is
necessary to provide time for the insurance industry to develop
adequate risk assessment techniques while providing protection for
insurers and insureds in the interim. A new mechanism may also be
needed to address terrorism risk over the long term.
Conclusion
Some mechanism is needed now to ensure stability of insurance
coverage. Some level of Government intervention appears to be necessary
and appropriate in the short term. Over time, the insurance industry
should be able to develop tools and techniques to help quantify and
assess the risk of terrorist attacks more effectively.
Public policymakers evaluating any proposal designed to assist
insurers in achieving that objective and to protect insureds from the
threat of terrorism should carefully weigh the following
considerations:
Incentives for participation in voluntary mechanisms;
Potential for adverse selection;
Funding source and liquidity of mechanism; and
Level of government involvement in the short term and long
term.
The American Academy of Actuaries is available as a resource to the
Committee as it seeks to address this important concern.
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STATEMENT OF THE AMERICAN COUNCIL OF LIFE INSURERS
October 25, 2001
The ACLI is the principal trade association for the life insurance
industry, representing 426 companies, which account for 80 percent of
the life insurance premiums and 81 percent of annuity considerations in
the United States among legal reserve life insurance companies. ACLI
member company assets account for 80 percent the total assets of legal
reserve life insurance companies. We appreciate the opportunity to
present this statement to the Committee on Banking, Housing, and Urban
Affairs on the topic of insurance coverage for terrorist acts.
As the collateral effects of the attacks of September 11 continue
to unfold, much attention has been focused on the financial condition
of the insurance industry. In this regard, the property/casualty
insurance business will ultimately incur losses estimated at between
$30 to 50 billion, while the life insurance industry losses will be in
the $4 to 6 billion range.
Both segments of the insurance industry have repeatedly sought to
assure the public and Members of Congress that they have adequate
resources to cover these losses. However, the threat of additional and
perhaps more widespread terrorist attacks, with even more devastating
losses, dictate that Congress examine the capacity of the insurance
system to respond to such previously unthinkable scenarios. We commend
the Committee for its timely examination of this critical issue.
Thus far, the property/casualty industry has been the focus of
efforts to develop a private sector/Government partnership to
underwrite the risks associated with expanded terrorist losses. This is
appropriate as the property/casualty industry has obviously had to
absorb a much greater impact on its available capital reserves as well
as a more immediate response from its reinsurers that terrorist
coverage would be severely limited or unavailable in the future.
Because the life insurance industry has more than $3.2 trillion in
assets and processes, on the average, about 10,000 death claims each
day, the losses of life resulting from the September 11 attacks, while
tragic, do not pose a threat to the solvency of the life insurance
industry. However, the potential for continued acts of terrorism to
result in substantially more significant adverse effects on mortality,
and by that we mean the potential for mass death and disability on a
much larger scale than we have previously experienced or imagined,
gives rise to questions that we believe must be considered by Congress
as well as the life insurance business. Will there continue to be a
viable private sector market for life insurance products that cover
risks of terrorism? Put differently, will life reinsurers continue to
enter into reinsurance treaties covering catastrophic risks that
include acts of terrorism? Additionally, if there are realistic
prospects of an act of terrorism of sufficient magnitude to adversely
affect the overall solvency of the life insurance business, is there a
justifiable need for some mechanism to address that situation, and, if
so, what form might such a mechanism take? The uncertainty surrounding
these questions suggests a need for the Committee to evaluate the
potential needs of the life insurance industry, including its
customers, as part of its current inquiry.
At this time, we are not seeking the establishment of a mechanism
similar to those under consideration for property/casualty insurers.
Indeed, it is not clear at this point that such a mechanism would be
necessary or useful for life insurers. Nor is there any agreement
within our industry as to what such a mechanism should look like were
it deemed to be necessary. We think it is prudent, however, to start
the process of asking ``what if ?'' and to begin doing it now, before
events necessitate a last-minute, crisis-driven reaction that might not
be entirely in the best interests of the life insurance industry or its
customers.
In that regard, the ACLI has developed a proposal to create a study
commission comprised of Government and private sector representatives
to assess the potential effects on the life insurance industry of
further terrorist activities. The proposal is designed to be included
in whatever legislation the Congress develops to address property/
casualty insurance issues. This is not a request for Government
assistance. It is instead our industry laying down a marker to reflect
the need to examine this issue thoughtfully, hopefully without the risk
of being overtaken by events.
Briefly, the proposal would work as follows. A nine member study
commission would be appointed to assess: (1) possible steps that could
be taken to encourage and sustain the private market for life insurance
products covering death or disability resulting from acts of terrorism
and the threat of such acts; and (2) possible steps or mechanisms to
sustain or supplement the ability of life insurers to cover losses due
to death or disability resulting from acts of terrorism that
significantly affect mortality experience or jeopardize the solvency of
the industry as a whole.
This study commission would be comprised of five representatives
from Government (two from Treasury, one from Commerce, one from the
Office of Homeland Security, and one from the ranks of State insurance
regulators) and four from the private sector (two representing life
insurers, and two representing life reinsurers). Any affirmative
recommendations by the study commission would have to have the
concurrence of at least two-thirds of the commission members to assure
that such recommendations have at least some support from the life
insurance business.
The study commission would have 30 days to organize itself and
another 90 days to complete its work. The report of the commission
would be submitted to the President pro tempore of the Senate and the
Speaker of the House, with a copy to the White House. The legislation
would direct Congress to give ``prompt and deliberate consideration''
to any recommendations for Federal legislative action contained in the
report. The study commission would be disbanded within 60 days after
submission of the report.
To reiterate, by advancing this study commission, the ACLI is
simply suggesting that the question of how acts of terrorism, or even
the threat of such acts, will affect the life insurance business is a
critical matter warranting prompt and thoughtful consideration by both
the private sector and Government. The events of September 11 have
unquestionably introduced great uncertainty into the life insurance
business. This uncertainty involves concerns over the way in which the
risk of terrorism will be covered in insurance policies, how that risk
will be quantified, how attendant pricing decisions will be made, and
whether future events that even a few months ago were unimaginable
carry with them the potential to overwhelm the solvency of our
business. Given this uncertainty and the gravity of the issues at
stake, we believe a study as outlined in the attached draft language is
an appropriate response at this juncture.
STATEMENT OF THE INDEPENDENT INSURANCE AGENTS OF AMERICA
October 25, 2001
This testimony is submitted on behalf of the Independent Insurance
Agents of America (IIAA). IIAA is a nonprofit trade association that
represents over 300,000 independent insurance agents and brokers and
their employees nationwide. IIAA's membership is composed of large and
small businesses that offer consumers a wide array of products in every
State, city, and town in the country. The independent insurance agent
and broker industry sells 75 percent of all commercial lines policies
in the country. In essence, independent agents and brokers write
coverage for America's businesses, and through this unique prism of
expertise and for the reasons outlined below, we strongly urge the
passage of legislation to ensure the availability and affordability of
essential business insurance products in the aftermath of the horrific
acts of September 11.
The terrorist acts of September 11 have had a profound impact upon
all of us, with the insurance industry being hit particularly hard,
both physically and financially. IIAA has over 20 agency members in
Lower Manhattan, including one that was previously located in the South
Tower of the World Trade Center, and many more had valued customers who
were located in the complex. In the days and weeks that have followed
the attacks, countless victims and survivors have begun putting their
lives back in order, and the insurance industry has played a pivotal
role in this recovery-and-rebuilding process. We are proud and pleased
by the manner in which our industry responded to the events of
September 11, and the best news was that things worked as they were
intended. The insurance industry has honored its commitment to
thousands of Americans in their greatest time of need--and the industry
is proving that it has the resources needed to quickly and fully pay
claims.
Although the insurance industry has responded efficiently and
effectively to these attacks, we must now work to ensure that the
industry is in a position to respond in similar ways to future
terrorist attacks. In order to address these new challenges, we will
need the leadership and assistance of the U.S. Congress and the Bush
Administration to ensure that appropriate insurance coverage remains
available. The issue of terrorism reinsurance is so vital to the future
of American businesses--large and small alike--and to the health of the
Nation's economy that it needs Washington's immediate attention. The
time for action is now. Congress and the
Administration need to address this important national policy issue as
soon as
possible.
The possibility of further terrorist attacks elucidates the need
for mechanisms to assure the continuing availability of coverage for
these risks. Although the insurance industry is prudently managed and
well capitalized, it cannot and should not be expected to provide
coverage for an uncertain number of attacks in the future (that cannot
be scientifically modeled) without the establishment of a Government
mechanism that can provide a backstop for losses caused by terrorism.
While most insurance policies today exclude damage from war, they
typically do not include terrorism exclusions.
The problem now is that many understandably skittish domestic and
foreign reinsurers stated that they would not cover terrorist acts when
contracts come up for renewal on January 1. Primary insurers warn they
cannot support repeated terror claims, especially if reinsurers exclude
such losses from coverage. Without reinsurance, insurers will leave
markets, exclude terrorism coverage or charge premiums that, in
essence, will make insurance coverage unaffordable and largely
unavailable. The specter of any of these options has dire ramifications
for commercial consumers of insurance products that need the financial
protection offered by insurance to stay in business and on commercial
life insurers, agents, and brokers that serve them. Failure to address
this potential coverage gap will thus not be felt only within the
insurance industry but on the national economy as a whole.
Development of a terrorism reinsurance pool to cover commercial
policies is critically important not just to insurance companies,
agents and brokers, but also to the future viability of literally
hundreds of thousands of small and large U.S. businesses. Without some
kind of mechanism to cover terrorism losses, insurance protection would
be difficult--if not impossible--to find, financiers would be reluctant
to lend, and businesses would be hesitant to invest. The end result is
an economic shockwave to the U.S. economy. No one wants to return to an
insurance market like the mid-to-late 1980's when the lack of available
or affordable insurance altered the business and personal activities of
Americans. Therefore, the issue of terrorism reinsurance is critical.
For this reason, IIAA supports the creation of a Federal backstop
to ensure that the industry will be able to continue offering coverage
for damages caused by terrorism. In establishing such a backstop, we
will be able to restore coverage for the millions of businesses that
will otherwise be unable to renew their current insurance policies and
we will be able to restore the confidence customers rely upon in
securing their needs through all insurance policies.
When insurance industry representatives testified before the U.S.
House of Representatives Financial Services Committee on September 26,
the panelists' concerns focused more on the future than the present,
and all seemed to agree that the U.S. Government must play a role in
addressing the need for terrorism reinsurance. IIAA believes that
Congressional action is necessary, and we believe the creation of a
Federal backstop is a necessary element of any proposal that attempts
to address these issues. The establishment of a Federal backstop would
help ensure the continued solvency of the insurance industry, stabilize
premiums, allow reinsurance companies to have renewed confidence to
underwrite primary insurers, and make terrorism coverage available to
the buyers who urgently need it. Regardless of whether it is the
stability expected from the proposed establishment of a U.S. Treasury
Federal backstop that the insurance industry agrees upon, a division of
future terrorist claims between the insurance industry and the Federal
Government suggested by the Administration, or a hybrid proposal, the
core objective must be to insure that mechanism are instituted to
enable small and large businesses to purchase insurance policies that
might otherwise be unavailable or unaffordable in the wake of the
September 11 attacks. IIAA pledges to continue working with the
Administration, Members of this Committee, consumers, our industry
colleagues, and any others to ensure that an appropriate solution is
attained. The issue of terrorism reinsurance is so vital to the future
of American businesses and to the health of the Nation's economy that
it needs the immediate attention of Congress. Without a backstop for
acts of terrorism, most insurance companies have two options stop
writing many types of commercial insurance or charge significantly
higher premiums. The specter of either option has dire ramifications
for many business owners and agents and brokers. The impact on
independent agents and brokers and their business clients is such a
major concern that IIAA believes prompt Congressional action is
absolutely necessary. We are very pragmatic when it comes to drafting
and moving legislation to address this national issue. While interested
parties may have differing opinions on how such a mechanism should
work, we believe it is far more important to expeditiously work through
differences to achieve the timely enactment of a proposal that can meet
the immediate and long-term needs of the customers of independent
agents and brokers, We stand ready to work with you on this important
national issue.
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STATEMENT OF MARC H. MORIAL
Mayor of New Orleans, Louisiana and
President, U.S. Conference of Mayors
My name is Marc H. Morial, and I serve as the Mayor of New Orleans,
as well as the President of the U.S. Conference of Mayors. I appreciate
the opportunity to submit this statement in support of Federal
legislation to create a reinsurance mechanism to help manage future
terrorism risk.
The U.S. Conference of Mayors has been in Washington this week
meeting with Governor Ridge regarding the efforts of the Office of
Homeland Security to protect our Nation from heinous terrorist acts
such as the World Trade Center and Pentagon attacks of September 11,
and the more recent distribution of anthrax through the U.S. mails.
We are hopeful that the Office of Homeland Security, as well as the
other fine efforts of Congress and the Administration, will prevent
future terrorist attacks on U.S. soil. However, in the event that such
attacks may occur, insurance is critical to the ability of cities like
New Orleans to protect themselves, their residents, and the businesses
located within them from ruinous financial harm.
Unfortunately, the possibility of further terrorist attacks has
made property/casualty insurance against the terrorism risk virtually
unobtainable. This market crisis will be greatly exacerbated very soon,
since many reinsurance and commercial
insurance contracts come up for renewal each January 1. Reinsurers
already are saying they will exclude ``acts of terrorism'' from
coverage on a going-forward basis. Primary insurers may soon seek to
follow suit. Such exclusions would leave municipalities and airports,
as well as their residents and business citizens, greatly exposed to
future losses. The immediate enactment of Federal terrorism reinsurance
legislation is needed to avert this market crisis. Cities like New
Orleans need to focus their efforts on preventing future terrorist
attacks, not on struggling to find insurance in a market that does not
have the financial capacity to address our needs.
The need for a Federal terrorism reinsurance program affects us at
several levels. First, our Nation's economy is in turmoil and was in
trouble before the September 11 tragedy. Now in the aftermath, we
recognize that certain economic sectors are further imperiled. It is
important for Congress to enact an economic stimulus program. America
needs to create new jobs for its workers and help keep the people who
have jobs employed. But this effort may be all for naught if there is
no insurance. Insurance is a critical element supporting our Nation's
economic infrastructure. We can talk stimulus all we want but without
insurance no one is going to build new buildings, no one is going to
invest capital in new ventures, no one is going to employ the people
who live in our cities and towns. Our economic well being is dependent
on the availability of insurance.
Second, many cities carry private sector insurance for our
municipal properties, municipal workforce, and liability exposures. In
the absence of insurance, we simply do not have programs in place to
manage terrorism risk. Moreover, even assuming we can obtain coverage,
if the price of insurance skyrockets because insurers have no way to
even begin to quantify this exposure, these cost increases must be
passed through to our taxpayers, at a time when many of them have seen
their income drop as a result of the indirect effects of the September
11 tragedy. While we recognize that Federal legislation is not going to
remove this risk entirely from our portfolio, a Federal backstop to
private insurance will help us to better manage this risk.
Third, our residents and corporate citizens need to obtain their
own insurance coverage. While this need exists nationwide, based on the
attack on the World Trade Center some people perceive that the cities
in our Nation have a greater terrorist threat. If businesses which
choose to locate in urban areas cannot obtain insurance, they may
relocate to suburban or rural areas, robbing us of critical economic
development and the resulting tax base. For cities like New Orleans
that rely heavily on tourism, it is also critical that hotels and other
tourist destinations in urban areas can get insurance, or they may be
forced to shut their doors, robbing us of the revenue that tourists
bring to establishments throughout our city.
Fourth, cities throughout the United States rely on insurers to
invest in municipal bonds. In 2000, the par value of municipal bonds
held by the insurance industry in the United States totaled
$212,443,600,509 (102,368 issues), and for the State of Louisiana,
$2,590,746,580 (1,835 issues). Moreover, nearly two-thirds of the
property/casualty insurance industry's assets, or over $500 billion,
are invested in governmental bonds, with the vast majority of these at
the municipal level. These bonds are essential in allowing State and
local governments to finance everything from schools, parks, highways,
sewer, and water facilities to airports and senior citizen housing. If
another major terrorist attack occurs, and insurers do not have
adequate capacity, insurers would be faced with selling billions in
bonds. This, in turn, could depress the value of bonds as huge volumes
are liquidated, particularly in an economic downturn environment,
making it more difficult for State and local governments to finance new
projects or to rebuild.
For cities like New Orleans, the consequences of the impending
terrorism insurance market failure are real and serious, from the
perspective of our own risk management programs, the preservation of
our tax base, and the viability of our municipal bond offerings. I urge
Congress to take immediate legislative action to address this issue as
part of our Nation's efforts to enhance homeland security.