1. TERRORISM INSURANCE: IN SEARCH OF A FEDERAL BACKSTOP TERRORISM INSURANCE: IN SEARCH OF A FEDERAL BACKSTOP Frank J. Kehrwald Vice President and Associate General Counsel Employers Reinsurance Company P & C Re Americas April 15 - 16, 2002 Casualty Actuarial Society 2002 Special Interest Seminar The Changing Insurance Market

2. 2 Infinite Risk … And Finite Capital Attacks of September 11 Largest Insured Loss Ever: Estimated $35-$75 Billion ‘92 Hurricane Andrew: $20 Billion ‘94 Northridge Earthquake: $16 Billion Approximately 70% of Loss Will Lie With Reinsurers 25% of Worldwide Reinsurance Industry’s Surplus Insurance Industry Answered the Call Despite Unforeseeability of Event, and Absence of Premium Late September: Awareness that Industry Could Not Alone Absorb Another Devastating Attack Mounting Concern About January ‘02 Renewals

3. 3 Following the unprecedented events of September 11, 2001, it was apparent early on that the insurance and reinsurance industries would be unable to provide absolute coverage for all risks relating to terrorism. Insurers and Reinsurers alike have worked to achieve a solution to the question of whether war and terrorism coverage could continue to be provided in the same manner as provided prior to the tragic events of September 11, 2001. Provide Customers a Solution Agreement on Need for a “Federal Backstop”

4. 4 Insurable Risks The industry has been actively involved in considering and facilitating solutions for protection. Classes of risks and limits were identified that could be comfortably insured for terrorism and can manage for a price. One item that impacted the decision is the hope of federal intervention in the form of a federal backstop for war and terrorism that would be enacted creating support for the industry with future claims. Absent an industry solution to assist in spreading the sizeable retention, many found the uncontained exposure too catastrophic. Identify Insurable Risks and Limits

5. 5 Reinsurance Market: Terrorism Property: Large (over $100 mm) per risk terrorism limits are very expensive or unavailable (many multiples of prior costs, if at all - typical approach is a sublimit). Casualty: High hazard classes are very expensive or unavailable (i.e. explosives, munitions, large stadiums/sporting events, port/transit authorities, major airports, buildings/structures > 500 ft. from ground up). Workers’ Compensation: Monitoring accumulations by location (counting/limiting large numbers of employees at any one location). Some Coverage Available for Certain Risks -- But at a High Cost

6. 6 ISO Endorsement Primary motive: to protect insurer solvency. Threshold: –Commercial Property & Commercial General Liability is $25 mm loss. –Threshold is met if an event causes death or serious injury to 50+ people. Items that occur within 72 hours and appear to be working together are considered one incident. Biological or chemical agents: –Intent is to release biological/chemical agents, insurance will not cover any loss. –Combined with another incident, the threshold applies. Sunset Clause: Withdrawn within 15 days of the President signing a federal backstop into law.

7. 7 Market Impact The ISO terrorism exclusion approach of a universal property and casualty exclusion limit for all risks is inadequate because it fails to distinguish between the severity of risks or the appropriateness of the retention amount. (But it is better than no exclusion.)

8. 8 Broad Consensus on Need For Action Many “Federal Backstop” Proposals Emerge Proposals Advanced By: Insurance Industry Bush Administration Congressional Leaders NAIC Consumer Groups Business Community

9. 9 Existing Programs: Early Focus on Existing Models National Flood Insurance Program National Crop Insurance Program UK’s Pool Re Israel’s Terrorism Insurance Program Others When a Risk Becomes Too Large For Private Sector to Go It Alone

10. 10 Insurance Industry Proposal Homeland Security Mutual Reinsurance Company Modeled After UK’s “Pool Re” Primary Companies Retain 5%, Cede 95% to Homeland Homeland Reinsured By Federal Government Other Features: –6 year Program Covering All Lines –No Cap on Federal Liability –Claims Managed by Industry –Limited Preemption of State Regulation (Definition of Terrorism, Rates/Forms, Credit for Reinsurance)

11. 11 Federal Reinsurance on Quota Share Basis A Complex Federal Structure, But a Positive Proposal Bush Administration Proposal 3-Year Program - Property & Casualty Only Annual $100 Billion Cap If Cap Exceeded, Go Back to Congress Claims Filed with Insurance Company, Verified, Company Portion Paid, Submitted to Department of Treasury for Payment of Balance Federal Definition of Terrorism Year Layer (Billions) Industry Share Government Share $0-20 $20-100 1 20% 10% 80% 90% $0-10 $10-20 $20-100 20% 10% 80% 90% 2 $0-20 $20-40 $40-100 100% 50% 10% 0% 50% 90% 3

12. 12 Federal Reinsurance With Large “Industry-Wide” Deductible Senate Concerned About Industry “Skin in the Game” Senate Proposal: Gramm/Dodd 3-Year Program - Property & Casualty Only Total $100 Billion Cap Claims Payment Mechanism? Preemption of State Regulation? Tort Reform: Ban on Punitive Damages Year Layer (Billions) Industry Share Government Share $0-10 $10-100 1 100% 10% 0% 90% $0-10 $10-100 100% 10% 80% 90% 2 $0-20 $20-100 100% 10% 0% 90% 3

13. 13 Insurance Companies Pay 100% up to “Trigger” Above Trigger, Government Pays 90% and Industry Pays 10% Trigger: –Industry Wide Retention: $1 Billion Industry Wide Loss –Company Specific Retention: $100 Million Industry Wide Loss and Company Specific Loss in Excess of 10% of Company’s Capital and Surplus or Net Written Premium Repayment to Federal Government: –Under $20 Billion: Industry Wide Assessment –Over $20 Billion: Policyholder Surcharge Other Features: –1-Year Program (Possible 2-Year Extension) for P&C Lines –Limited Preemption of State Regulation (Definition of Terrorism, Rates/Forms) –Tort Reform: Ban on Punitive Damages, Limits on Attorneys Fees A Federal Loan Program for Terrorism Losses Passed U.S. House of Representatives November 29, 2001 House Proposal: Oxley/Baker Year Layer (Billions) Industry Share Government Share $0-10 $10-100 1 100% 10% 0% 90% $0-10 $10-100 100% 10% 80% 90% 2 $0-20 $20-100 100% 10% 0% 90% 3

14. 14 Senate Committee (Hollings): Other Proposals Pre-Funded Government Run Pool Senator McCain: $50 Billion Industry Retention Consumer Federation of America NAIC Administered Fund A Multitude of Proposals... No Consensus

15. 15 “Notional” $10 Billion Industry Wide Retention Company Specific Retention Equal to 7.5% of its Direct Written Premium Government Share of Loss: Elusive Administration / Senate Compromise Agreement Was Near, But Failed to Materialize If Industry Wide Loss is Less than $10 Billion, Government Pays 80% of Loss Above Company Retention If Industry Wide Loss is Greater Than $10 Billion, Government Pays 90% of Loss Above Company Retention

16. 16 Integrating the Proposal into Reinsurance With the proposed Senate solution of a federal backstop, the issue arose concerning how to integrate the proposal or eventual backstop into existing reinsurance. Recoveries by the Reinsured from other reinsurance including federal reinsurance backstop, if any, shall be applied by the Reinsured to reduce the last dollar loss (from the top down) before calculation of indemnity hereunder. Allocation of loss by Reinsured for aggregate stop loss or federal backstop indemnity applying to loss under all lines of business, shall be applied to loss incurred by the Reinsured to the Annual Statement line of business for which the loss was incurred.

17. 17 What Went Wrong? Too Many Distractions Prevented a Clear Consensus Sharp Disagreement Over “Bill Killers” –Tort Reform –Loan v. Shared Responsibility Partisan Division Over Economic Stimulus Technical Complexity/Compressed Time Frame Concern Regarding “Insurance Industry Bailout”

18. 18 Future of “Federal Backstop” Proposals Who will make the impact to have the legistation passed? –Property Owners –Developers –Investors –Lenders –To a lessor degree, the industry. Despite the challenging road ahead with this legislation, the industry must continue to speak out on the need for federal support.

19. 19 House of Representatives Presentation Richard Hillman, Director, Financial Markets and Community Investment testified before the Subcommittee on Oversight and Investigations, Committee and Financial Services, House of Representatives on Wednesday, February 27, 2002 that: –Insurers are shifting terrorism risk to property owners and businesses. –Reinsurers are reducing exposure. –Primary companies are seeking to exclude coverage. –As business exposure to uninsured risks rises, so do the potential economic consequences. –Another attack could have more severe economic consequences, and specific impact on borrowers, new lending and investment activity.

20. 20 Impact of Congress Action “Deciding whether Congress should act to help businesses obtain insurance against losses caused by terrorism is properly a matter of public policy. The consequences of continued inaction, however, may be real and are potentially large.” –Richard Hillman, February 27, 2002

21. 21 A New Approach Senator Charles Schumer (D-NY) spoke at the joint Commercial Insurance Legislative Summit with a new proposed terrorism risk insurance program. Working with Senate majority leader Thomas Daschle and Treasury Secretary Paul O’Neill to develop legislation which: –Provides compensation to U.S., up to an aggregate cap of $100 million –Narrowly defines the term “act of terrorism” –Provides congressional payment authority for the program –Authorizes the Treasury Secretary to implement the Act Proposed Terrorism Risk Insurance Act of 2002

22. 22 A New Approach Other thoughts… –Republicans want lawsuit limitations –Democrats blocked a plan to allow the Senate to choose between the Republican and Democratic Plans –Parties intend to work out a voting plan Last year, the House passed a bill that would lend money to insurers to pay claims. The Senate has not acted on a competing proposal.

23. 23 Presidential Support On April 8, President Bush spoke to 75 insurance, hospitality, real estate and construction executives. –Congress should create a federal back-up plan to help insurance companies pay terrorism claims. –Drag on the economy caused by September 11, 2001 A $2 bb construction project in Nevada is on hold because of terrorism coverage concerns affecting 16,000 jobs Gwinnett County, GA was only able to obtain $50mm of terrorism coverage for $300mm property value (sewage treatment plant and county jail) Pritzker Realty unable to obtain financing for a Chicago office building without terrorism coverage New York Metropolitan Transit Authority has only $150mm terrorism coverage for bridges and tunnels worth $1.5bb Presidential and Economic Concerns

24. 24 APPENDIX

25. 25 2002 Activity The Call for Action Continues “USA: No Government Terror Insurance Plan Likely - Analysts” -- 1/14/02 Reuters “Terrorism Insurance Elusive / for Big or High- profile Buildings, Market Has Nearly Vanished” -- 1/20/02 Houston Chronicle “An Appeal on Terrorism Insurance” -- 1/30/02 The Washington Post “US Congress Needs More Proof for Terror Insurance Backstop” -- 1/31/02 Dow Jones Capital Markets Report “Scarcity of Terrorism Insurance Said to Be Taking Quiet Toll” -- 2/1/02 Hartford Courant “Lobbyists Try New Strategy for Terror - Insurance Bill” -- 2/13/02 Real Estate Journal.com “Insurers Call for Greater Government Aid to Meet Terrorism Bill” -- 2/12/02 The Independent “The Financial Services Roundtable and the AFL- CIO Have Teamed up to Urge President Bush and Congress to Revisit Federal Terrorism Reinsurance Legislation” -- 2/21/02 Congress Daily “Oxley Kelly Release Excepts From GAO Report Bolstering the Case for Terrorism Insurance Protection” -- 2/25/02 Congress Daily “Insuring Against Terror Costly” -- 2/26/02 Washington Post “Terrorism Insurance: Rising Uninsured Exposure to Attacks Heightens Potential Economic Vulnerabilities” -- 2/27/02 U.S. General Accounting Office release of Richard J. Hillman’s (Director, Financial Markets and Community Investment) testimony before the Subcommittee on Oversight and Investigations, Committee on Financial Services, House of Representatives