Insurance and reinsurance: the insurance market post September 11th

The immediate shock of the terrorist attack on the World Trade Centre (WTC) has subsided but the Bali bombing reminds us that the vicious targeting of Western interests for terrorist attacks is likely to continue.

The insurance claims arising out of the terrorist attack on the WTC are unprecedented and of immense significance to the world insurance market. It has recently been estimated by Federal Reserve experts that the attack that destroyed the WTC has cost New York USD33 - 36bn with some estimates rising much higher as the cost of the losses is re-assessed. The losses, estimated from October 2001 to June 2002, include USD7.8bn that the 2,795 people killed in the attack would have earned had they lived and USD21.6bn to clean up and replace the twin towers. New York lost an additional USD3.6bn to USD6.4bn in wages from job cuts and reduced hours in businesses such as the restaurant industry. Much of the loss will fall on the insurance and reinsurance industry under a variety of insurance coverages, such as property, aviation, business interruption, personal accident and third party liability policies.

There have already been a number of disputes arising out of the insurance coverages following the WTC loss. One of the largest disputes concerns the direct property insurance covering the WTC twin towers. The dispute has arisen largely because, at the time of the attack, the property insurers of the twin towers had not issued an agreed policy wording. The WTC had recently been leased by its owner, the New York Port Authority, to a group of real estate investors led by Larry Silverstein. On 11th September, the Silverstein Group was still finalising its insurance programme. Each of the 22 insurance companies had signed binding authorities ("binders") that obligated them to provide property insurance but wordings had not been agreed. This may seem surprising, but in the insurance market there is quite often a delay in finalising the formal policy wording, even though the insurers are on risk from the time that the insurance slip or binder is signed.

A central issue in the dispute turns on what is the applicable policy wording. The policy wording Mr Silverstein claims is applicable contains a narrow definition of loss so that each tower is a separate loss occurrence, thus entitling him to recover the policy limit (approximately USD3.5bn) in respect of the loss of each tower, making a total of USD7bn.

On the other hand, the insurers' position is that the applicable wording contains a broad loss occurrence definition, adding together losses arising out of one cause or a series of similar causes, i.e. the cause of the loss being the attack on the twin towers. The insurers argue that under this wording, the destruction of the twin towers was one loss so that Silverstein can recover only in the region of USD3.5bn. If the insurers' argument is successful, the practical effect will be that Silverstein is only insured for one of the twin towers.

There has recently been a United States Court decision in relation to three of the twenty-two property insurers. The Court ruled that the wording with the wide definition of "occurrence" applies to those insurers and that the destruction of the twin towers was one loss under that wording. Although this decision is significant, Silverstein has been allowed to pursue an expedited appeal. A trial will take place in 2003 on which wording is applicable to the other nineteen insurers, and whether the destruction of the twin towers was one or more loss under those wordings.

In terms of risk management, the disputes that have arisen clearly illustrate the importance of understanding the extent of coverage purchased and of ensuring that it is reflected in the policy wording.

Steps taken by the British Government in light of WTC

The London insurance market has been familiar with terrorism losses for many years and although insurers' preference might be to exclude from cover all terrorist acts, the London market is able, with government backing, to cover the perils of terrorism. The government-backed pooling scheme is being developed in other countries and it is by no means the case that terrorist acts are uninsurable.

During 2002 the pooling arrangements in the UK were extended specifically to meet the increased and wider terrorist threat posed in light of the WTC attack.

The Reinsurance (Acts of Terrorism) Act 1993 established a government-backed unlimited liability reinsurance company, The Pool Reinsurance Company (Pool Re), specifically to ensure that insurers were able to fund losses from terrorist acts without questions over their own or their reinsurers' solvency. The Act followed the IRA's St Mary Axe bomb on 10th April 1992 that caused £800m of damage to the heart of London's commercial district. In November 1992 the Association of British Insurers announced that its members had been provided with model terrorism exclusion clauses, with the implication that, as a matter of policy, from 1st January 1993 insurers would exclude cover for terrorist acts. The government reacted by setting up Pool Re.

In 2002 the government reviewed the cover offered by Pool Re and extended it to offer commercial customers cover for insurance attacks causing property damage and consequent business interruption by all risks, rather than the previous restriction to damage caused by fire and explosion. This means that a terrorist attack involving nuclear, chemical or biological contamination, impact by aircraft, or flood damage will all be covered by the Pool Re scheme. The exclusion of damage caused by nuclear devices was due to be deleted by 1st January 2003. An exclusion in respect of computer hacking and virus damage will remain. Premium increases have been applied and the deductibles borne by each insurer in the scheme were adjusted to reflect the greater potential cost to insurers of a WTC-style incident.

These extensions to cover are crucial to ensure that the government's role as reinsurer of last resort remains effective to underpin the commercial insurance market in a climate where previously unthinkable insurance liabilities are considered a real prospect.

There is however still an area where Pool Re offers no comfort for commercial interests and their insurers. The legislation that underpins Pool Re restricts its scope to damage to property caused by terrorist activity, and consequential business interruption costs. This means that liability insurers do not benefit from Pool Re backing. Personal injury and employers' liability losses were a significant part of the losses resulting from WTC and Bali. These outstanding concerns on liability are being pursued in separate discussions between insurers' representatives and Government.

For further details please contact Richard Tosh at [email protected] or tel +44 (0)20 7367 2884 or Susan Hopcraft at [email protected]