An Overview of The Terrorism Risk Insurance Act

Limitations on Coverage

For lessors and lessees, the Act makes the U.S. government a reinsurer of insurance company risks of terrorism, while requiring insurers to provide terrorism coverage for a period ending December 31, 2005. The legislation, however, limits its coverage to acts of terrorism by foreign terrorists (not domestic ones). It does not provide coverage for nuclear, biological or chemical attacks, and does not provide coverage for leased property physically outside of the United States. The Act offers no federal support for events of less than $5 million, nor coverage of losses of over $100 billion in aggregate by either federal government or insurer. Further, the Act does not provide coverage where the Secretary of Treasury does not certify an 'act of terrorism' as noted above.

The legislation impacts current insurance coverage by rendering any exclusion of terrorism void (if an exclusion existed). It also causes deductibles and terms to match substantially the same terms in the basic line of insurance. Insurance companies set market-driven premiums.

Following the passage of the bill, insurers gave their insureds at least a 30-day notice ending February 24, 2003 of changes in the terrorism coverage of their insureds. By that date, the insured had to accept terrorism coverage and pay for it. If the lessee, as the insured, did not pay for coverage, the terrorism insurance exclusion may have been reinstated (that is, a lessee may not have coverage now). If reinstated, a lessee may have to buy stand-alone terrorism coverage.

Lessors should understand that terrorism insurance has not returned to pre-9/11 levels or costs and that a vast majority of companies have not purchased this coverage (outside of aviation), according to some reports. In addition, the federal legislation has left some large gaps and limits in coverage. Moreover, terrorism insurance is expensive and rates are market driven. Finally, the terms of policies may be complex. Given these changes, lessors should involve risk managers early in a transaction to assess their insurance coverage for terrorism risks.

The Terrorism Risk Insurance Act of 2002 (the Act) was signed by President Bush on November 26, 2002 and is available at: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=107_cong_bills&docid=f:h3210eas.txt.pdf.

Lessors should be familiar with the Act as it provides protection against certain terrorist threats and affects multiple lines of insurance coverage they may want from lessees. The Act also requires awareness of new changes in lessors' insurance documentation and coverage.

Congress passed this legislation after insurers either canceled or excluded coverage following the events of September 11, 2001 and forced insurers back into the business of providing terrorism insurance. The Act is a short-term plan, which expires December 31, 2005, and responds to occurrences in excess of $5 million. It requires that the Secretary of Treasury certify that an event is an 'act of terrorism.' Once this certification occurs, insurance companies and the federal government share the risk of loss of an act of terrorism. The federal government will pay up to $100 billion in losses per year after insurers pay their deductible and ten percent of the losses in excess of the deductible. The deductibles for insurance companies are reflected in a percentage of premiums as follows:

• 
  
• 2003 ' 7 percent of direct premiums earned by insurers
  
• 2004 ' 10 percent of direct premiums earned by insurers
  
• 2005 ' 15 percent of direct premiums earned by insurers
  
  

The lines of insurance affected under the Act include property insurance, liability insurance, aviation and marine insurance.

Limitations on Coverage

For lessors and lessees, the Act makes the U.S. government a reinsurer of insurance company risks of terrorism, while requiring insurers to provide terrorism coverage for a period ending December 31, 2005. The legislation, however, limits its coverage to acts of terrorism by foreign terrorists (not domestic ones). It does not provide coverage for nuclear, biological or chemical attacks, and does not provide coverage for leased property physically outside of the United States. The Act offers no federal support for events of less than $5 million, nor coverage of losses of over $100 billion in aggregate by either federal government or insurer. Further, the Act does not provide coverage where the Secretary of Treasury does not certify an 'act of terrorism' as noted above.

The legislation impacts current insurance coverage by rendering any exclusion of terrorism void (if an exclusion existed). It also causes deductibles and terms to match substantially the same terms in the basic line of insurance. Insurance companies set market-driven premiums.

Following the passage of the bill, insurers gave their insureds at least a 30-day notice ending February 24, 2003 of changes in the terrorism coverage of their insureds. By that date, the insured had to accept terrorism coverage and pay for it. If the lessee, as the insured, did not pay for coverage, the terrorism insurance exclusion may have been reinstated (that is, a lessee may not have coverage now). If reinstated, a lessee may have to buy stand-alone terrorism coverage.

Lessors should understand that terrorism insurance has not returned to pre-9/11 levels or costs and that a vast majority of companies have not purchased this coverage (outside of aviation), according to some reports. In addition, the federal legislation has left some large gaps and limits in coverage. Moreover, terrorism insurance is expensive and rates are market driven. Finally, the terms of policies may be complex. Given these changes, lessors should involve risk managers early in a transaction to assess their insurance coverage for terrorism risks.