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John P. Dearie is a partner in the insurance and reinsurance practice group in the New York office of Edwards & Angell. He may be reached at [email protected]. Laurie A. Kamaiko is counsel in that practice group. She may be reached at [email protected]. On nov. 26, 2002, the Terrorism Risk Insurance Act of 2002 was signed into law, and became effective immediately. Public Law 107-297, 116 Stat. 2322. See www.treasury.gov/trip. As the act has been in effect for less than a year, there is still extensive debate as to whether it will achieve its objectives of making insurance coverage of the risk of terrorism available and affordable. Generally, all commercial property and casualty lines, including workers’ compensation, are included under the act. Gray areas still remain, however, as to the definition of “commercial line.” One area of confusion concerned policies issued to individuals operating as professional corporations, and policies that cover both personal and commercial risks. Accordingly, the Treasury Department provided a formula for ascertaining if such a policy is subject to the act. A policy in which less than 25% of the total premium is attributable to commercial coverage is considered to have only “incidental” commercial coverage, and is not subject to the act. However, if more than 25% of the policy premium is for commercial exposure, then the policy is subject to the act but its premium can be allocated between its commercial and noncommercial components in determining which portion falls under the act. 31 C.F.R. Part 50, at 9809-10. The act also has some peculiar carve-outs and inclusions. For example, medical malpractice insurance is explicitly excluded from the act, which appears to leave other professional liability insurance, such as policies insuring lawyers and accountants, subject to the act. While it is unclear what terrorism risks would be associated with professional liability, one would generally consider individuals and institutions providing medical services to be at greater risk for a terrorism loss than those providing legal services. Some of these apparent discrepancies may be ironed out in upcoming rules and regulations. Which terrorist acts are covered and which are not? Not all terrorist acts are subject to the act. This has led many to question the effectiveness of the legislation in ensuring there is available insurance for the types of terrorism risk that most businesses face. Under § 102(1), only terrorist acts that are “certified” by the secretary of the treasury, in concurrence with the secretary of state and the U.S. attorney general, are covered by the program. This certification is not subject to judicial review. 67 Fed. Reg. 76206. Thus, political pressures may be brought to bear on the decision whether to certify an act as one of terrorism under the statute. For a terrorist act to be “certified,” it must involve a violent act, or an act dangerous to life, property or infrastructure. The act must be committed on behalf of a foreign person or interest, as part of an effort to coerce the civilian population of the United States or to influence the policy or conduct of the U.S. government by coercion. To be covered, the loss must occur within the United States, to the premises of a U.S. mission or to a U.S. air carrier or vessel. § 102(5). Thus, acts of purely domestic terrorism, such as the Oklahoma City bombing, would not be covered. This has encouraged some insurers to offer stand-alone coverage for acts of domestic terrorism that are not covered by the act. No act may be certified as an act of terrorism if it is committed as part of the course of a war declared by Congress (except for workers’ compensation coverage), or if it results in losses which, in the aggregate, do not exceed $5 million. § 102(1)(B). This exclusion from the act is actually a very narrow one, as the armed conflicts in which the United States has been involved in the last 50 years have not been wars declared by Congress. State approvals of terrorism exclusions that are broader than those allowed by the act are pre-empted. The risk that terrorists may use “dirty bombs” or other methods that result in nuclear, biological or chemical contamination has been a frequent media topic. One of the issues generating concern by both policyholders and insurers is the effect of existing exclusions in policies for losses arising from nuclear events, and for losses arising from contamination from biological or chemical agents (often part of pollution exclusions). While these are not terrorism exclusions per se, they include “embedded terrorism exclusions” in that the scope of such exclusions could include losses arising from terrorist events. The act contains arguably contradictory provisions as to whether such policy exclusions will be effective insofar as they encompass losses arising from terrorism. On one hand, the act expressly provides that it voids any terrorism exclusion to the extent it excludes coverage of losses that would otherwise be insured under the act. On the other hand, the act provides that insurers subject to the act must “make available” coverage for losses arising from a certified act of terrorism, coverage that “does not differ materially from the terms, amounts, and other coverage limitations applicable to losses arising from events other than acts of terrorism.” In many policies, losses arising from nonterrorist events are subject to exclusions for nuclear, biological or chemical contamination. The Treasury Department has stated that the “make available” requirement does not mean that insurers must make available coverage for all types of risks. Insurers can exclude coverage of risks that they are otherwise permitted to exclude by the applicable state authorities. The Treasury Department gave as an example that of an insurer that does not cover all types of risks because the state to whose oversight the insurer is subject permits exclusions for certain types of losses, “e.g., nuclear, biological or chemical events,” in which case the insurer would not be required to make such coverage available. 68 Fed. Reg. 19302, 31 CFR Part 50 §§ 10-14 and 17-19. Thus, it appears that exclusions which are not terrorism exclusions per se, but which operate to exclude certain types of losses arising from terrorist events, such as nuclear, chemical or biological contamination, are still effective. This has resulted in many insurance consumers deciding not to pay for the terrorism coverage which insurers must offer under the act because of concern that the coverage will not apply to the exposures they consider likely to occur. The federal reinsurance provided under the act applies only to catastrophic terrorist events resulting in very large losses. Losses must reach both company and industry minimum amounts before an insurer’s eligibility for federal reinsurance reimbursement is triggered. The industry deductible is $10 billion for 2003, $12.5 billion for 2004 and $15 billion for 2005. The annual deductible for each insurer is based on a percentage of its commercial lines’ direct earned premium for the prior year, including the portion of the premium that relates to coverages other than terrorism. The deductible for each insurer started at 1% of its direct earned premium in 2002; is 7% in 2003; will rise to 10% in 2004; and will be 15% in 2005. This deductible applies regardless of whether all the policyholders generating that premium accept the terrorism coverage that must be offered to them under the act. Moreover, premiums of affiliated insurers are aggregated together for purposes of calculating their deductibles. § 102(7). This can result in very substantial deductibles that an insurer must satisfy before it is eligible to receive federal reimbursement. These large deductibles mean that insurers have a large exposure not reinsured under the act in the event of a certified terrorist act. Yet under the act, those insurers must still offer terrorism insurance to their policyholders. This has led many insurers to charge substantial premiums for the terrorism coverage they must offer under the act. It has also left plenty of room for a private reinsurance market to fill in the gaps left by the federal reinsurance provided under the act. The future of the program is uncertain While the goal of the act is to make terrorism coverage affordable as well as available, the premiums charged by companies for this additional coverage have been substantial. Initial premium charges for this mandated terrorism coverage have been reported to range from 5% to 150% or more of the policy premium, with most charges in the 20% range. Most policyholders to whom the terrorism coverage has been made available have decided not to take advantage of the offer. Reportedly, fewer than 20% of eligible entities have opted to pay for the terrorism coverage. Many large companies and properties are choosing instead to buy stand-alone terrorism coverage that offers coverage for domestic acts and those involving biochemical agents. Reasons cited by policyholders for opting out of terrorism coverage include the high cost of the coverage, as well as the limitation to losses arising from foreign terrorism and the uncertainty of the extent of the coverage it will afford in the event of a terrorist attack involving nuclear, biological or chemical agents. Some policyholders simply do not believe a terrorist attack will ever threaten them, or believe that if it does, the government will step in to pay losses. Treasury officials have warned members of the insurance industry not to assume that the Terrorism Risk Insurance Act of 2002 will be renewed. The industry will be scrutinized as to whether it has used the backstop of federal reinsurance provided by the act to develop private market alternatives, or whether the insurance industry has simply relied upon the federal government ultimately bailing it out. Thus, it remains to be seen whether, when the time comes to consider renewing the act, Treasury and Congress will perceive it as having achieved its goals.

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