The United States Congress is not going to extend the Terrorism Risk Insurance Act (TRIA), the financial backstop for U.S. property insurers against terrorist attacks, this year but with reinsurance capacity high this may result in a shortage of terrorism reinsurance cover.
Ratings agency Standard & Poor’s believes that the longer TRIA remains absent from the market, the greater the chance that traditional reinsurance capital, and to an increasing degree alternative capital, could be deployed into the space to make up for lost capacity.
With politicians seemingly unable to agree on the future of TRIA, which again seems partly to do with the U.S. legislatures habit of stuffing unrelated policies into laws facing Congress, there is considerable uncertainty right now as to whether any agreement to extend or replace TRIA could be reached in the near future.
TRIA never benefitted reinsurance firms anyway, S&P notes, and the protection it offered actually competed with traditional reinsurance that offered similar coverage. Without TRIA in place S&P believes that there could be an increase in demand for terrorism reinsurance cover and that the market could, in its currently over-capitalised state, meet this demand easily.
Aggregate private-market reinsurance capacity can be anywhere from $3 billion to $4 billion per risk, S&P notes, while capacity in high-risk areas where insurers could have aggregation issues is still only around $1 billion per risk, which the rating agency views as underinsured.
While TRIA is absent S&P believes that there could be a jump in demand for terrorism reinsurance protection and that this could actually ease some of the imbalance between the reinsurance market’s supply and demand issues, offering reinsurers a chance to put to work some of the excess capital in the space.
The longer TRIA remains absent from the market the more likely greater demand will be seen and this could result in higher rates for terrorism reinsurance, S&P explains. More reinsurance capacity could then become available from traditional reinsurers, while S&P also expects that alternative capital could become more active in underwriting terror risks as well.
Alternative and third-party capital is already being deployed into some terrorism related risks and in the past some catastrophe bonds have been exposed to terror events, by providing mortality linked protection. There is a chance that with TRIA absent we could see a growing interest in replicating these efforts and securitization of terror related mortality risk could become a viable option again, particularly now the risk modelling is so improved.
However, S&P says that it does not view additional private-market capacity to be sufficient alone to replace the $100 billion layer of protection previously provided by TRIA. So for once in the reinsurance market, if TRIA does remain absent, demand may outstrip supply of capacity.
Interestingly, the absence of TRIA has ramifications for the broadening of reinsurance terms and conditions that we have been hearing about all this year. With some reinsurers reported to have bundled covers like terrorism or cyber risk into renewal contracts, as a sweetener to seal the deal, there could be some who regret that while TRIA remains absent.
The absence of TRIA may also mean that the January renewals do not see as much in the way of broadening of terms or extension of coverage to include terrorism risk, S&P notes. Reinsurers may use the changed market dynamics, as a result of TRIA’s absence, as a way to resist rate declines and any further pressure to expand coverage.
Quite what the absence of TRIA will mean for any reinsurers that have taken on significantly more terrorism risk, as a result of offering broader coverage to their clients, remains to be seen. Only an event would likely show that issue up.
Despite the potential for increased terrorism reinsurance demand, S&P says that it expects reinsurance market conditions will remain difficult, despite the potential for additional demand for capacity.
Congress is expected to begin working on TRIA and whether to save or change it as soon as it returns from its Christmas and New Year break, on the 6th of January, S&P expects. Any continued absence will result in changing dynamics in the insurance and reinsurance market though.
They (insurers) will seek to limit their exposures in peak risk areas like downtown Manhattan by purchasing additional reinsurance and targeting underwriting actions. In addition to exclusions and sublimits, commercial property and workers’ compensation policies may see rate increases, if not nonrenewals, where exposure is concentrated. We do not expect NBCR coverage to be available on any lines except those like workers’ compensation where regulation expressly requires it. Currently available private-market capacity could leave buildings in peak zones underinsured.
If TRIA legislation remains dormant for long enough, however, well-capitalized insurance companies, compelled by market demand and a desire to deploy excess capital, may begin providing terrorism coverage for higher premiums. Also, stand-alone terrorism coverage providers are likely to provide additional capacity for the right price. Individual companies’ strategies could diverge significantly and result in a confused and uncertain market.
In an interview with rating agency A.M. Best Frank Nutter, president of the Reinsurance Association of America, said that TRIA’s absence could present an opportunity for some reinsurers. “Some reinsurers definitely have said that they are willing to write more terrorism exposure. It is a market that lends itself to negotiation over increased terms for coverage of terrorism in the property cat treaties. I know that that has been happening. I’m told that that’s been happening.”
Nutter also said that it was likely to result in additional work for reinsurers at the January renewals, saying; “It probably means for the reinsurers a much more active negotiation here at year-end with their client companies over what this means for them, given that the program will not be in place as of Jan. 1. It’s not clear what will be done in the next Congress. For our members it’s a matter of engaging in the Jan. 1 renewals more actively in a context that’s different than everyone presumed.”
Risk modelling firm AIR Worldwide also provided some details on the implications of TRIA absence:
If TRIA expires, commercial insurers will no longer be required to offer terrorism coverage beginning January 1. Without a federal backstop, insurers may seek to limit underwriting for high concentrations of risks in major cities—causing terrorism insurance coverage to become unavailable or unaffordable. Insurers that do continue to offer commercial terrorism insurance would likely be required to maintain higher capital standards in order to avoid negative rating implications. Where coverage for terrorism-related events is still available, prices for this coverage will increase.
In the absence of TRIA, the workers’ compensation insurance market would be particularly vulnerable to terror attack losses. State workers compensation statutes offer insurers less flexibility to control terrorism risk through modifications such as policy limits or coverage exclusions. With or without TRIA, it is mandatory for U.S. employers to provide workers’ compensation coverage. If coverage is not available, employers may be forced to purchase insurance in the residual markets or self-insure. This could result in large amounts of risk being transferred to the residual market in a few states.
Allowing TRIA to expire would have widespread implications, not only for the insurance industry, but also for the broader economy. Construction and real estate business sectors may be unable to obtain financing without adequate terrorism coverage in place. If insurers limit underwriting following an expiration of TRIA, businesses with high concentrations of employees could have difficulty obtaining coverage for workers’ compensation, including higher education institutions, hotels, airports, hospitals, and financial services, among many others.
So while TRIA remains absent there will be additional work to do for reinsurers, and some insurance-linked securities (ILS) fund managers that allocate capital to terror risks, to derive exactly what the expiration of TRIA means for them and what opportunities it may present.
The longer it remains absent the greater the opportunity is likely to become. With reinsurance firms facing pressure across broad swathes of the industry, a new opportunity to deploy capital may be extremely attractive to them right now so we could see capacity diverted to meet insurers terrorism reinsurance coverage needs.
How this impacts terms and conditions at the January renewal remains to be seen, but it is hard to imagine any provider of reinsurance capital would agree to bundling terror cover within a catastrophe treaty under the current circumstances.
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