Breaking and associated brands will be offline for scheduled maintenance Friday Feb. 26 9 PM US EST to Saturday Feb. 27 6 AM EST. We apologize for the inconvenience.


Thank you for sharing!

Your article was successfully shared with the contacts you provided.
On Sept. 11, 2001, terrorists inflicted an unprecedented $36 billion loss on the insurance industry. Yet the insurance system absorbed the loss without systemic failure. Its performance in a time of great national crisis was magnificent. But the supply of terrorism insurance temporarily dried up as insurers reassessed risk. The temporary market disruption had downstream adverse effects on parts of the American economy, particularly the real estate and construction sectors. Under these circumstances and in the face of intense corporate lobbying, the government enacted the Terrorism Risk Insurance Act of 2002. This program provided free federal insurance coverage to the insurance companies in the event of an extreme loss. The statutory purpose was to “allow for a transitional period for the private markets to stabilize, resume pricing of such insurance, and build capacity to absorb any future losses.” An exogenous shock typically creates temporary price dislocation, which is followed by a new market equilibrium. Since the insurance program was envisioned as a temporary price stabilization measure, it had a sunset date of Dec. 31, 2005. There is always an entitlement effect associated with government benefits. This is particularly so when well-funded, organized corporate interest groups have a stake. The corporate lobby’s strategy is clear; the “temporary” should be made permanent through continued long-term extension of the program. This is certainly rational behavior � what corporation wouldn’t want free insurance coverage on a permanent basis? In the summer of 2005, I (among others) expressed the sentiment that “betting against a powerful insurance lobby is always a perilous venture.” As predicted, before the eve of the program’s sunset, the government acceded to the lobbying pressure and extended the federal insurance program for another two years. Now, the federal insurance program is set to expire again on Dec. 31, 2007. On Nov. 16, the Senate passed a bill extending it by seven years. The House previously passed a bill extending it by 15 years. Once again, the corporate lobby has argued that terrorism risk is unpredictable and potentially extreme, and thus uninsurable or economically infeasible without federal support. This argument is not credible. Most acts of terrorism, just like most hurricanes, earthquakes and tornados, will not result in extreme insurance loss. Since 9/11, there have been several multibillion-dollar loss events, including hurricanes Katrina and Rita, and perhaps the recent Southern California wildfires. Yet the most visible terrorist acts since 9/11, the Madrid and London bombings, have resulted in modest insurance losses. The insurance industry is far more likely to experience severe loss from a natural catastrophe than a conventional act of terrorism (most policies exclude nuclear, chemical and biological attacks). Let’s be clear about the economics of the insurance business. In the market, risk has a price. When the government subsidizes the cost of risk, it is covered for free. In the years 2002, 2003 and 2004, the insurance industry collected terrorism premiums of, respectively, $700 million, $2.3 billion and $2.7 billion without claims. Once extreme risk is eliminated from the equation, the sale of terrorism insurance becomes highly profitable and virtually guaranteed over time. Also, the insurance industry has strengthened significantly since 2001. At the end of 2002, the net worth of property and casualty insurers was approximately $285 billion. By the end of 2006, their net worth increased to $487 billion, including a $31 billion underwriting gain for the year. There is no need to subsidize a well- financed, profitable industry whose core business is to assume fortuitous risk for profit. More to the point, it is the function of the insurance industry to take risk for profit rather than riskless profit. Distorted incentives When risk is mispriced, there is a great potential for mischief. When government interferes with the market-pricing function, it distorts proper risk-taking behavior and incentives. Government-subsidized flood insurance is widely regarded as a catastrophe in itself because it motivates people to take bad risks, such as continued habitation of high-risk areas. Subsidized terrorism insurance is no different. In arguing against an extension of the federal terrorism insurance program, I observed in a 2005 law review article that “subsidized [terrorism] insurance will tend to distort market incentives and may increase the costs to the economy over a long period.” This was not the abstract musing of an academic. The nonpartisan Congressional Budget Office (CBO) recently found that “commercial policyholders as a group are not taking significant steps to avoid or mitigate terrorism risks associated with their existing properties.” The provision of free terrorism insurance has already created bad risks, and bad results are simply a matter of time and probability. Two points are worth emphasizing. First, according to the CBO, free federal insurance “does not lower the total costs of terrorism risk but rather shifts more of the burden from commercial property owners and their tenants to taxpayers.” A fair actuarial premium for the government insurance backstop is approximately $850 million per year. Second, and more important, federal insurance actually increases cost to the economy. The CBO found that the federal insurance subsidy provides a disincentive to insurers “to make their premiums sensitive to their policyholders’ risk of incurring losses from an act of terrorism.” In other words, “efforts to mitigate risk could increase in the absence of subsidized insurance.” If the federal subsidy to the insurance industry is extended again or made permanent, Congress and President Bush should explain why American taxpayers should fund a corporate subsidy that ultimately causes greater loss of property and life, undermines national security and advances the agenda of terrorists. Robert J. Rhee is an associate professor at the University of Maryland School of Law.

This content has been archived. It is available through our partners, LexisNexis® and Bloomberg Law.

To view this content, please continue to their sites.

Not a Lexis Advance® Subscriber?
Subscribe Now

Not a Bloomberg Law Subscriber?
Subscribe Now

Why am I seeing this?

LexisNexis® and Bloomberg Law are third party online distributors of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® and Bloomberg Law customers are able to access and use ALM's content, including content from the National Law Journal, The American Lawyer, Legaltech News, The New York Law Journal, and Corporate Counsel, as well as other sources of legal information.

For questions call 1-877-256-2472 or contact us at [email protected]


ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2021 ALM Media Properties, LLC. All Rights Reserved.