Stephen Mixter & Michael Owendoff. Journal of Corporate Real Estate. Volume 6, Issue 1. December 2003.
Introduction
This paper is intended to supplement the authors’ earlier paper entitled ‘Selected Insurance and Lease Issues to Consider After the Terrorist Attacks of 11th September, 2001.’ As of the date of that paper there still was much debate between the US House of Representatives and the US Senate over their respective terrorism insurance bills. Much of the debate revolved around the inclusion of certain tort-reform concepts. Congress finally agreed on a modified version of the House bill, which President Bush signed into law on 26th November, 2002.
This paper will provide a general overview of the material provisions under the Act, which have been characterised as being ‘subtle and complex.’ It still is unclear whether the Act will accomplish its intended purposes. Since the effective date of the Act, only about 20 per cent of the policy holders have elected to pay the additional premium for this governmentbacked terrorism insurance coverage. As a result it is unlikely that the Act will have a significant impact 011 the majority of insureds, and therefore the pre-Act terrorism exclusions and other matters which were discussed in detail in the prior paper continue to be germane.
Overview of the Act
Although the Act accomplished a number of things, three of its provisions are by far the most significant. First, the Act prohibits certain policy exclusions pertaining to certified acts of terrorism and effectively voids or nullifies any such exclusions which were in effect as of the date the Act was signed into law. secondly, the Act mandates that most insurance companies ‘make available’ coverage for certified acts of terrorism at least until the end of 2004. Finally, the Act creates a temporary federal reinsurance programme for property and casualty losses arising from certified acts of terrorism until the end of 2005, unless extended by Congress.
Prohibited exclusions
One of the most significant provisions of the Act involves its potential effect on policy exclusions concerning losses from acts of terrorism. The Act effectively voids any exclusions for ‘acts of terrorism’ (as defined by the Act) under property and casualty insurance policies that were in force on 26th November, 2002. Although this provision may appear on its face to void all previously promulgated terrorism exclusions in insurance policies, the actual effect is much more limited in that it voids such exclusions only to the extent that they would exclude losses which are explicitly covered as ‘acts of terrorism’ under the Act. The Act does not affect the other policy exclusions, such as the broad exclusions for the so-called ‘NBC’ (nuclear, biological or chemical) events described in the prior paper.
As was the case in interpreting terrorism exclusions in insurance policies prior to the Act, the critical question under the Act remains: ‘What are “acts of terrorism”?’ ‘Acts of terrorism’ are defined in the Act as terrorist acts committed on behalf of any foreign person or foreign interest where the damage from the event, in the aggregate, is in excess of 88m. In addition, in order to fall within the definition the acts at issue must be certified as ‘acts of terrorism’ by the secretary of the Treasury, in concurrence with the secretary of State and the Attorney General of the United States. The Department of the Treasury has refused to establish a definitive time frame within which the secretary of the Treasury would be required to make a determination or certification that a particular ‘act of terrorism’ has occurred.
Since the Act limits ‘acts of terrorism’ to those acts that are committed on behalf of any foreign person or foreign interest, acts of domestic terrorism or domestic civil disturbances, such as Timothy McVeigh’s bombing of the Alfred K Murrah Federal Building in Oklahoma City on 19th April, 1995, are not considered ‘acts of terrorism’ under the Act.” In addition, the Act does not (with limited exceptions for losses involving certain aircraft, ships and US foreign missions) cover acts of terrorism occurring outside the USA.
Since the Act voids terrorism exclusions in insurance policies only to the extent that they would have the effect of excluding losses which are explicitly covered as ‘acts of terrorism’ under the Act, it is instructive to review the terrorism exclusions which were established in the wake of the September 11th attacks. As a result of the events of September 11th and the staggering claims subsequently experienced by the insurance industry, most property insurance policies which were issued or renewed post-9/11 began specifically to exclude certain losses caused by terrorism or terrorist acts. In fact, by 22th February, 2002, insurance regulatory agencies in 45 states, plus the District of Columbia and Puerto Rico, had approved an endorsement prepared by the Insurance Services Office, Inc. (ISO) that insurers could use in both their commercial property policies and their liability policies to exclude coverage for terrorism. The ISO, a company that collects actuarial statistics and prepares standard policy language and forms of insurance for the insurance industry, defines terrorism as:
Activities against persons, organisations, or property of any nature that involve the following:
1. Use or threat of force or violence; or commission or threat of a dangerous act; or commission or threat of an act that interferes with or disrupts an electronic, communication, information or mechanical system; and
2. When one or both of the following applies:
a. The effect is to intimidate or coerce a government or the civilian population or any segment thereof; or to disrupt any segment of the economy; or
b. It appears that the intent is to intimidate or coerce a government or to further political, ideological, religious, social or economic objectives or to express (or express opposition to) a philosophy or ideology.
Under the ISO definition, however, any act that causes less than $25m in insured damage (including business interruption losses) is excluded from the terrorism exclusion (ie, it is still covered by the policy), except that, regardless of the level of the loss, in no case are so-called ‘NBC’ events covered. It is important to note that this $25m threshold does not operate like a coverage limit, under which the insurer would cover the portion of the loss up to, but not exceeding, $25m; rather, if the aggregate losses exceed $25 million there is no coverage at all for the event in question. This means that, for example, a $24m terrorism loss which is not the result of an NBC event would be fully covered, subject to the other policy provisions, whereas (in the absence of an affirmative endorsement providing such coverage) no coverage at all would be available with respect to a $26m terrorism loss, regardless of its nature.
Therefore, the ISO form of terrorism exclusion would apply to all acts that both (1) fell within the definition of ‘terrorism’ and (2) caused damage in excess of $25m. Nevertheless, losses that arose from causes such as anthrax contamination would not be covered at all, since they are biological in nature.
Mandated coverage
In addition to voiding certain exclusions, the Act requires that, from 26th November, 2002 until 21st December, 2004, all ‘insurers’ must ‘make available’ coverage for ‘insured losses’ on terms that may ‘not differ materially from terms, amounts and other coverage limitations applicable to losses arising from events other than acts of terrorism.’ ‘Insured losses’ include any loss resulting from an act of terrorism that is covered by primary or excess property and casualty insurance issued by an insurer if such loss occurs within the USA (with certain limited exceptions). Thus, the Act does not require an insurer to insure a loss caused by a so-called NBC event (even if such event was caused by a foreign person within the USA and resulted in damage exceeding $5m in the aggregate), because an NBC policy exclusion is typically included in most property and casualty insurance programmes and also applies to losses arising from events other than acts of terrorism. By 1st September, 2004, the secretary of the Treasury will determine whether this mandated coverage is to be extended beyond 31st December, 2005.
With respect to policies that had been issued prior to 26th November, 2002, the Act required insurers to notify their policy holders by 24th February, 2003 of the coverage available under the Act, the additional premium due for such coverage and the date (which could not be less than 30 days following the notice) on which the terrorism exclusion in its policy would be reinstated if such premium was not paid (the ‘Disclosure’). The Act specifically requires that the insurer provide ‘clear and conspicuous disclosure … of the premium charged for the insured losses covered by the Act.’ For policies issued after 26th November, 2002, the Disclosure must be provided ‘at the time of offer, purchase, and renewal of the policy.’
Obviously, the Act does not in any way require that such coverage be purchased by the insured. Although The Department of the Treasury is required under the Act to monitor the price and availability of terrorism insurance, the Act does not limit the premium that an insurer may charge for terrorism insurance. Premiums will vary drastically based on the perceived level of risk of terrorism at the insured location; however, the Act does expressly recognise the authority of the individual states to regulate excess premiums. The Act requires insurers to give their msureds 30 days to consider the Disclosure. If the insured does not elect to accept the coverage by paying the premium “within that time frame, then the pre-Act terrorism exclusions can be reinstated in their entirety.”
Federal backstop
Lastly, the Act establishes a temporary reinsurance programme that provides federal funds of up to $100bn to cover losses from certain certified terrorist acts. Under this reinsurance programme, the federal government will reimburse each insurer that participates in the federal programme for 90 per cent of its annual aggregate loss from the certified terrorist acts after the insurer has met its annual aggregate ‘deductible.’ The deductible for each insurance company increases over the three-year term and is expressed as a percentage of its ‘direct earned premium’ during the prior year for its commercial insurance products. In 2003, the deductible is set at 7 per cent of the prior year’s direct earned premium; in 2004, at 10 per cent; and in 2005, at 15 per cent.
Many insurers were not happy with the deductible requirements under the Act. One executive from Keniper Insurance Company indicated that, if a terrorist act were to occur within one year of the Act’s passage, Kemper’s deductible could reach $300m. Another paper estimated that the largest insurance carrier, AIG, would have a deductible of approximately $898m in 2003.
Conclusion
Although the Act may appear on the face of it totally to change the landscape with respect to terrorism insurance coverage, on a practical level its impact has been much more limited. The fact that the Act does not void any of the other broad exclusions which exist in insurance policies, such as those for NBC events, means that exclusions covering events which many might view as being acts of terrorism continue to be applicable. In addition, in part because the premium for terrorism coverage is not regulated by the Act and premium levels remain high, only about one-fifth of the insureds that have been offered such coverage have chosen to purchase it. As a result, the terrorism exclusions which had evolved prior to the Act continue to apply to the vast majority of insureds, and therefore it is necessary to have a good working knowledge of those concepts as well as of the Act itself.