These issues will be examined in a report to be completed later this summer coauthored by Kunreuther and Wharton colleagues Dr. Neil Doherty (Frederick H. Ecker Professor of Insurance and Risk Management and chair of the department), Dr. Scott Harrington (professor of health care systems), Dr. Paul Kleindorfer (Anheuser-Busch Professor of Management Science and professor of decision sciences, economics, and business and public policy), Dr. Erwann Michel-Kerjan (research fellow), Dr. Mark Pauly (Bendheim Professor and professor of health care systems, business and public policy, insurance and risk management, and economics), Dr. Isadore (Irv) Rosenthal (senior fellow), and Peter Schmeidler (senior consultant).

The purpose of the report is to inform congressional deliberations on whether to renew the Terrorism Risk Insurance Act (TRIA), a temporary law enacted in the wake of 9/11 that established the federal government as a backup reinsurer against catastrophic losses from foreign acts of terrorism on U.S. soil. Commercial reinsurers, hit by billions of dollars in claims from 9/11, effectively withdrew from the market shortly after, leaving primary insurers with no way of spreading the extremely high risk of covering their clients against another such event.

With the government protecting the insurers—who are now required to offer terrorism coverage to their clients—more businesses have since purchased coverage against terrorist attack, but face the prospect of much higher premiums or even no coverage if the government withdraws from the market by allowing TRIA to expire at the end of this year.

Many insurance industry professionals argue that TRIA has achieved its goals since being enacted in November 2002, and so should be extended for at least a couple of years while a more permanent solution is found.

The act’s supporters also contend that government is just as responsible for aiding recovery from such an attack as it is for attempting to prevent one because it is a matter of national security that is arguably related to the conduct of U.S. foreign policy.

“Some say this problem is directly related to U.S. foreign policy and so should be dumped right in the lap of the government,” says Dennis Kuzak, senior vice president at EQECAT Inc., one of the three leading U.S. firms that model catastrophic risk.

But others say the government’s presence in the market discourages private-sector mitigation of the terrorist threat such as strengthening buildings or increasing airline security, impedes the development of a private market, and shifts the costs of a future attack to taxpayers rather than to the owners of targeted businesses or buildings.

The Wharton report is expected to coincide with an assessment of TRIA from the U.S. Treasury. But the non-partisan Congressional Budget Office (CBO) is already on record as opposing the extension of the act, arguing that the private sector will ultimately do a better job without government playing a role.

At the February roundtable, the CBO’s David Torregrosa argued that expiration of the act would increase businesses’ incentive to mitigate their own risk by shoring up buildings or by moving their operations to locations that are seen as less-likely targets for terrorists. TRIA may result in higher overall costs because it is a disincentive to taking such actions, Torregrosa argued. “In general, private investors are better off bearing the risk.”

The CBO’s report, published in January 2005, argued that insurance rates should be increased to reflect higher anticipated costs, and it rejected the view that TRIA should be extended because terrorism is assumed to be a long-term problem.

Those higher premiums following its termination, critics of the act add, would encourage businesses to build or reinforce structures to withstand terrorist attacks and would spur the development of risk-spreading mechanisms such as catastrophe bonds, which pay high rates of interest to the holder who runs the risk of losing both interest and principal in the event of a terrorist attack.

The conclusions of the Wharton roundtables have fed into the Wharton Risk Center report, which Kunreuther hopes will play an important role in congressional deliberations later this year on whether to renew the act and, if so, how it might be modified. But in his role as moderator of the discussions, Kunreuther has been careful to remain neutral in the debate. Taking sides, he believes, would immediately reduce the Risk Center’s effectiveness in presenting and analyzing the problem. “Once you get into the politics, you’ve lost your credibility in evaluating the pros and cons,” he says. Accordingly, the report will not be making recommendations but rather will evaluate policy alternatives and provide arguments on both sides so that government and industry can make an informed decision.

In his role as facilitator, Kunreuther often succeeds in identifying common ground among an audience whose members have diverse agendas and competing points of view to represent, says Frank Nutter, president of the Reinsurance Association of America and a participant in the roundtables. “He brings an intellectual capacity to the discussion.”

The independent stance of Kunreuther and the Risk Center in articulating the debate over terrorism insurance also adds credibility in the eyes of the Bush administration, which is likely to be sympathetic toward Wharton’s work because of the school’s traditionally pro-market stance, Nutter adds. “The value of the Wharton Risk Center is to step back from the fray and help us recognize what would seem to be in the best interests of both the government and the private sector. It’s an independent voice.”

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©2005 The Pennsylvania Gazette
Last modified 07/02/05

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FEATURE: Insuring Against Terror