TERRORISM REINSURANCE YESTERDAY AND TODAY

1. TERRORISM REINSURANCE YESTERDAY AND TODAY Ed Hochberg

2. TERRORISM REINSURANCE AGENDA: • History of Terrorism Reinsurance • USA • Europe – UK, France, Germany, Spain • Terrorism Reinsurance Today • Major Categories of Coverage • Major Elements Influencing Pricing and Terms • Emerging Issues

3. History of Terrorism Reinsurance - USA Pre-September 11, 2001 • (Re)insurance functions well when individual losses are random, uncorrelated and not enormous since risks can be spread over a large population • Terrorism losses pre-9/11were generally small, random and uncorrelated, so private (re)insurance markets were able to cover terrorism risk effectively and without fanfare • Insurance against terrorism risk was included in most commercial lines without extra premium • Stand-alone terrorism market was mainly limited to providing solutions for property owners and trade/investment exposures in countries with elevated terrorism risk (UK, Colombia, Sri Lanka, etc.)

4. History of Terrorism Reinsurance - USA Post-September 11, 2001 • The perceived and real potential for enormous and/or a sustained run of smaller correlated terrorism losses meant risk spreading would no longer work as smoothly • The correlation of terrorism risk exists on two levels, (1) multiple lines affected instantaneously and (2) several catastrophic attacks can occur simultaneously • High risk of private (re)insurer insolvency • Policyholders suffering losses might not be paid coverage due under policies • The inability of (re)insurance industry to predict number, scale, frequency or correlation of future terror attacks resulted in widespread imposition of exclusion clauses

5. History of Terrorism Reinsurance - USA Post-September 11, 2001 (continued) • Demand: Commercial insurance customers wanted and needed terror coverage • Supply: Insurers were reluctant to provide terror coverage • Outcome: Urgent need for a solution • After much private and public research and debate, the only immediate way to ensure compensation of terrorism victims was through governmental guarantees • Enter Terrorism Risk Insurance Act (TRIA)

6. History of Terrorism Reinsurance - USA Terrorism Risk Insurance Act (TRIA) • Passed by Congress November 19, 2002, signed into law November 26, 2002, to expire December 31, 2005 • Acknowledgement by Government that terror risk is too unpredictable, with too severe a loss potential, for (re)insurance industry to safely handle • Provides federal backstop for certain acts of terrorism via temporary federal program for sharing risk of loss from foreign terrorist attacks with insurance industry • Temporary measure to allow time for private markets to stabilize, resume pricing of such insurance and build capacity to absorb future losses while preserving State insurance regulation and consumer protection

7. History of Terrorism Reinsurance - USA Terrorism Risk Insurance Extension Act (TRIEA) • Approved by Congress on December 17, 2005 to expire December 31, 2007 – may not renew • Under the Act(s) carriers are required to: • Offer terrorism coverage • Retain a (staggering) increasing portion of their prior year’s DEP for covered lines (20% in 2007) • Carry increasing co-participations (15% in 2007) • Growing number of private industry products • However, private (re)insurance industry continues to work with the federal government and policyholders to establish an on-going, viable private-public solution

8. History of Terrorism Reinsurance - USA Alternatives to TRIA or further extensions thereof: • The federal government as a retrocessionaire or a finite reinsurer? • Federal securitization of terrorism loss options? • No role for federal government? • Capital markets – bonds/securitizations? • On-going public/private partnership? • Mutual insurance organization similar to UK?

9. History of Terrorism Reinsurance – UK Pre-September 11, 2001 • 1993: Government-backed terrorism reinsurance pool, “Pool Re”, established in response to property losses from bombings by IRA • Mutual insurance organization • HM Treasury acts as reinsurer of last resort • Participating (re)insurers must be properly authorized • (Re)insurer coverage by/participation in pool optional • Coverage generally limited to property policies

10. History of Terrorism Reinsurance - UK Post-September 11, 2001 • Coverage expanded to include more risks (e.g., NBC) • Premiums, generally based on location and amount of coverage purchased, doubled due to more participation • Annual and per event losses of (re)insurers capped • Retentions based on degree of pool participation • Industry-wide retentions escalate over time • No surcharge after losses to Pool Re • Facets of Pool Re encouraging competition: • Max deductible raised to encourage private reinsurer re-entry into market • Insurers free to set premiums for underlying policies

11. History of Terrorism Reinsurance - France Pre-September 11, 2001 • France suffered several waves of deadly terrorist attacks during the 1980s and 1990s • French law does not allow commercial property insurers to dissociate terrorism coverage from commercial property • September 9, 1986: French law obligates insurers to provide terrorism coverage up to the overall limits of a property policy • Post September 11, 2001, in light of the perceived increased in terrorism risk, many insurers stopped covering terrorism, which meant they had to stop covering commercial property • The French government urgently need to find a solution

12. History of Terrorism Reinsurance - France Post-September 11, 2001 • December 10, 2001: France established temporary terrorism reinsurance pool, “GAREAT” • All property owners must purchase coverage • All insurers must join pool • Premiums set on basis of amount of coverage purchased – rates don’t vary by industry or location • Insurers bear initial losses, private reinsurance bears middle layers of loss, government bears catastrophic losses (without cap) • Government shares in premiums • Extended - in effect until December 31, 2007

13. History of Terrorism Reinsurance - Germany Pre-September 11, 2001 • Insurance against terrorism risk included in most commercial lines without extra premium

14. History of Terrorism Reinsurance - Germany Post-September 11, 2001 • September 3, 2002: Germany established temporary terrorism reinsurance pool, “Extremus AG” • Coverage optional • Premiums set on basis of amount of coverage purchased – rates don’t vary by industry or location • Insurers bear initial losses, private reinsurance bears middle layers of loss, government bears catastrophic losses (with cap) • Government shares in premiums • Extended - in effect until December 31, 2007

15. History of Terrorism Reinsurance - Spain Pre-September 11, 2001 • 1941-1954 (During Spanish Civil War): State established permanent insurance pool, “Consorcio de Compensacion de Seguros” • Covers natural disaster and terrorism losses • Property damage only • Integrated into policies issued by private insurers that collect premiums on Consorcio’s behalf • Mandatory insurer participation • Premiums set on basis of amount of coverage purchased – rates don’t vary by industry or location

16. History of Terrorism Reinsurance - Spain Post-September 11, 2001 • Coverage against complete range of risks expanded to include business interruption • Spain’s pool paid losses from the March 11, 2004 bombings of several train stations in Madrid

17. Terrorism Reinsurance Today • The market has come a long way since 2001 • Many reinsurers in London, Bermuda, and Continental Europe provide terrorism cover on some basis • However, the market for terrorism reinsurance is estimated to have only approximately $6 to $8 billion in global capacity and only $1 to $2 billion for NBCR1 • This compares to estimated potential losses in excess of $100 billion • Also by way of comparison, the global property catastrophe market, which excludes terrorism, is in excess of $120 billion of capacity 1 Based upon the testimony of Christopher Nassetta, CEO of Host Hotels and Resorts, on behalf of the Coalition to Insure Against Terrorism, to the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises and the Subcommittee on Oversights and Investigations of the House Committee on Financial Services on September 27, 2006.

18. Major Categories of Coverage • Property – TRIEA (Certified) and Non-Certified • Property – Stand-alone • Workers’ Compensation/Personal Accident • Other and Miscellaneous Exposures • Personal lines

19. Major Categories of Coverage Property – TRIEA (Certified) and Non-Certified • Capacity: Substantial, in the hundreds of millions • Markets: Primarily London and Bermuda for stand-alone cover • Sometimes “thrown in” on mainframe treaties, depending upon the nature of the exposure (e.g. “main street” businesses outside of major metro areas), although in this case NBCR is not typically included • Sometimes terrorism is excluded in mainframe treaties, but coverage for the “fire following” exposure is provided

20. Major Categories of Coverage Property – Stand-Alone • There have been treaties placed for specific terrorism insurance (outside of TRIEA) • Such treaties tend to be E&S situations – trophy properties, etc. • Capacity: More restricted since these tend to be higher risk situations involving somewhat broader cover - tend to be more “clashy” • Many entities who reinsure this exposure write it directly • Markets: Dominated by London, Bermuda, and Berkshire

21. Major Categories of Coverage Workers’ Compensation/Personal Accident • Issues similar to TRIEA Property • Issues revolve around PML measurement (e.g. how many employees/people are actually in a location at a single time?) • Capacity: Relatively plentiful for non-CBI and non-NBCR exposures • Markets: London market tends to lead in this space

22. Major Categories of Coverage Other and Miscellaneous Exposures • Aviation – For US carriers, terrorism is presently covered by the Department of Transportation • Hull – Aviation War, which is typically reinsured in the marine market • Passenger and Third Parties – Excluded with war risk via AVN 48, with a “write back” via AVN 52 • Marine – typically handled in the marine war market • Contingency, etc. – coverage is available, and is handled various ways…

23. Major Categories of Coverage Personal Lines • Frequently “thrown in” on mainframe treaties • Particularly true outside of CBI’s • Not perceived as a major exposure

24. Major Elements Impacting Price and Terms • New York, New York • Other CBI’s • Outside of NY and other CBI’s, capacity is relatively plentiful and inexpensive • Analogous to peak zone exposures in property, but without reliable modeling • NBCR • Makes PML/RDS evaluation relatively difficult • Potential range of exposure much bigger • Contingent Business Interruption • Viruses/Cyber Terror

25. Emerging Issues • Sunset of TRIEA – • What will the market look like after 12/31/07? • More exposure? • Even if TRIEA sunsets, what about the run-off? What about “fire following”? What about workers’ comp? • Rating Agencies – • Views are evolving • Typically used if larger than property PML’s • If rating agencies step up “concern”, it will spur demand