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Response to U.S. Treasury and President’s Working Group: Terrorism (Re)insurance

September 2013

AONQUARTERLYINSURANCEMARKETUPDATE2009 ii

Response to U.S. Treasury and President’s Working Group: Terrorism (Re)insurance © Copyright 2013 Aon plc 1

AONQUARTERLYINSURANCEMARKETUPDATE2009 ii

Table of ContentsAbout Aon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

General Solicitation for Comments: Aon Response . . . . . 4

Solicitation for Specific Comments . . . . . . . . . . . . . . . . . 4TRIA Termination Considerations . . . . . . . . . . . . . . . . . . . . . . . . . 4

TRIA Summary – Still the Main Choice of U.S. Insureds . . . . . . . . . 4

Terrorism Pricing Continues Path to Affordability . . . . . . . . . . . . . 5

Market for Embedded TRIA Property Insurance . . . . . . . . . . . . . . . 8

Standalone Terrorism Marketplace . . . . . . . . . . . . . . . . . . . . . . . . . 9

Rating Tier Exposures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Willingness of Insurance Market to Offer Terrorism Not Tied to Existing Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

TRIA has Created the Private Market for Terrorism . . . . . . . . . . . 12

Current TRIA Retentions for the Industry . . . . . . . . . . . . . . . . . . . 13

Insurance Market Considerations . . . . . . . . . . . . . . . . . . . . . . . . 16

Terrorism Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Terrorism Pricing by Industry Subsector . . . . . . . . . . . . . . . . . . . 19

Terrorism Limits by Subsector . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Terrorism Limits by Terrorism Type . . . . . . . . . . . . . . . . . . . . . . . 23

Terrorism Pricing Trends – Twelve Months Ending 6/30/13 (Q22013) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Standalone Terrorism Pricing – Twelve Months Ending 6/30/13 (Q22013) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

TRIA Only Pricing – Twelve Months Ending 6/30/13 (Q22013) . 25

TRIA and Non Certified Pricing – Twelve Months Ending 6/30/13 (Q22013) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Implications for Coverage of Nuclear, Biological, Chemical & Radiological Terrorism (NBCR) events . . . . . . . . . . . . . . . . . . . . . 26

Workers’ Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Cyber Acts of Terrorism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Reinsurance Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Additional Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Key Contacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33


About AonAon plc (NYSE:AON) is the leading global provider of risk management, insurance and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 65,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative and effective risk and people solutions and through industry-leading global resources and technical expertise. Aon has been named repeatedly as the world’s best broker, best insurance intermediary, reinsurance intermediary, captives manager and best employee benefits consulting firm by multiple industry sources. Visit www.aon.com for more information on Aon and www.aon.com/manchesterunited to learn about Aon’s global partnership and shirt sponsorship with Manchester United.

Executive SummaryAon plc, as the leading global (re)insurance broker, is in a unique position in assessing the demand, pricing and associated risks linked to terrorism both in terms of global scope and premium volume placed into the market. Although a revised version of the original Terrorism Risk Insurance Act (TRIA) federal legislation was signed into law reauthorizing the program for seven years via the Terrorism Risk Insurance Program Reauthorization Act in 2007 (TRIPRA, herein after “TRIA”), the Act’s imminent expiration at the end of 2014 has already generated dislocation within the commercial Property & Casualty (P&C) (re)insurance marketplace. Aon remains committed to assisting its clients – both on the insurance and reinsurance side – with establishing long-term, viable terrorism risk transfer and mitigation solutions. TRIA remains the only viable solution for handling the full quantum of terrorism insurance exposures in the U.S.

TRIA, which created a federal reinsurance backstop for losses stemming from acts of terrorism, has been an unqualified success in stabilizing the insurance markets by allowing insurers to provide much-needed terrorism coverage to consumers at prices they are able to afford. TRIA became law on November 26, 2002 and has since been extended and modified twice: in December 2005 and again in December 2007.

The federal backstop TRIA enables the primary insurance industry to provide terrorism insurance coverage to our nation’s businesses. The nature of terrorism risk differs from other insurable risks because the frequency of loss from terrorism is neither predictable nor random. Terrorists continually attempt to defeat loss prevention and mitigation strategies. In addition, the insurance industry does not have access to all existing information about terrorism, targets and potential attacks for obvious national security reasons.


If TRIA were to expire in 2014 the vast majority of the existing insurance market for terrorism risk would disappear. Aon tracked property insurance market behavior prior to the previous expiration of the various reauthorizations of TRIA and, in each instance, more than 80% of the existing capacity for terrorism risk would have been withdrawn from the market in the absence of TRIA. Moreover, TRIA’s potential expiration is also causing capacity issues within other lines of P&C insurance, most notably in casualty and workers’ compensation insurance.

TRIA’s reauthorization beyond 2014 is essential to keep the terrorism risk insurance marketplace stable. Since 2001, terrorism has become one of the key catastrophic perils facing the (re)insurance industry and has generated a sizable additional risk load for insurance buyers. A functional market for terrorism reinsurance will not emerge in the absence of TRIA. Without TRIA, the cost and risk of terrorism will fall to policyholders who will have to shoulder increased premiums and, at worst, face the inability to secure terrorism coverage in any form. Simply put, this will create a tax on the key drivers of the U.S. economy at a time when the nation is still struggling to overcome the challenges of the financial crisis.


General Solicitation for Comments: Aon ResponseTreasury solicits comments on behalf of the President’s Working Group,1 including information in support of such comments where appropriate and available, regarding the long-term availability and affordability of insurance for terrorism risk since 2010, when the President’s Working Group issued its last report. Identify and explain any and all factors relating to the availability and affordability of terrorism insurance, and particularly how these factors have affected the availability and affordability of terrorism insurance since 2010.

Solicitation for Specific Comments

TRIA Termination Considerations

(1) Describe and explain in detail any and all possible ramifications from the termination of the Program on December 31, 2014, including any available evidence to support the predicted result, regarding:

(a) The availability and affordability of insurance for terrorism risk in the United States generally;

(b) The availability and affordability of insurance for terrorism risk in the United States specifically by line of business; geographic location, including the rating tiers defined by the Insurance Services Office, Inc.; and other relevant characteristics; and

(c) Additional specific effects on commerce in the United States.

(1)(a) Response: The availability and affordability of insurance for terrorism risk in the United States generally

TRIA Summary – Still the Main Choice of U.S. Insureds

The Terrorism Risk Insurance Act (TRIA) of 2002 was extended by amendment on December 22, 2005 and, again, on December 26, 2007. TRIA requires insurers to “make available” terrorism insurance for commercial Property & Casualty (P&C) policies, in return for providing the P&C industry with USD 100 billion of annual aggregate reinsurance protection for catastrophic terrorism losses occurring in the U.S. and some limited overseas locations.

TRIA is triggered when the Treasury Secretary, in concurrence with the Secretary of State and the Attorney General, certifies that an incident meets the TRIA definition of an act of terrorism. To be certified, an event must cause at least USD 5 million in aggregate property and casualty insurance losses. No reinsurance is offered by TRIA unless losses exceed USD 100 million per occurrence.

Each insurer is responsible for paying out a certain amount in claims – a deductible equal to 20% of the preceding year’s direct earned premium – before federal assistance becomes available. For losses above a company’s deductible, the federal government will cover 85%, while the insurance carrier contributes 15% in “coinsurance.” Losses covered by the program are capped at USD 100 billion and insurers’ exposures are specifically capped at their individual deductible and

1 The President’s Working Group is composed of the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the Securities and Exchange Commission, and the Chairman of the Commodity Futures Trading Commission (or their respective designees). The Secretary of the Treasury, or his designee, is the Chairman of the President’s Working Group. Exec. Order 12,631, 53 FR 9421 (Mar. 18, 1988).


co-insurance retentions within that USD 100 billion. TRIA does not cover auto, life, health, reinsurance or personal lines of insurance. TRIA also calls for recoupment of payment by the federal government under the program in certain cases. The Act specifies an aggregate insurance industry retention, currently USD 27.5 billion. In the event the insurance industry’s retained losses (after TRIA recoveries) are less than this amount, 133% of the difference between USD 27.5 billion and that retained amount will be recouped by the federal government via a policy surcharge.

$100B

$100m Program Trigger

85% TRIA coverage

TRIA Coinsurance exposure

TRIA Terrorism Coverage

TRIA Deductible

Original policy deductible15%TRIA

Co-ins

20% of gross earned premium(prior year)

Policy Deductible

Terrorism Pricing Continues Path to Affordability

By any measure, TRIA has been the key driver of ensuring the availability and affordability of terrorism insurance in the U.S. The public/private partnership providing USD 100 billion of reinsurance capacity to the P&C insurance industry has provided not only needed terrorism insurance capacity, but also a unique and mandatory offer of terrorism coverage to all commercial P&C buyers that need terrorism coverage. The importance of TRIA’s mandatory offer of coverage, requiring insurers to offer terrorism coverage per the TRIA remit that does not materially differ from the underlying terms, conditions and deductibles of the P&C insurance to which it attaches, is the basis for the market that exists for this risk in the U.S. TRIA’s positive impact on terrorism insurance pricing is clearly demonstrated in the chart below, with property terrorism pricing declining, on average, by close to 50 percent in the period running from 2002 to 2012 (YE).2

2 Pricing in the referenced chart is expressed as a percentage of median terrorism premium divided by median property premium, which is a preferred measure of terrorism costs for insureds as terrorism, following the events of 9/11, has become an added cost that is weighed and measured by all P&C insurance buyers.


Median Terrorism Premium as % of Med. Property Premium

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 H1

% of Property Premium

Source: Aon Data

Absent the mandatory offer of coverage and the USD 100 billion backstop, the insurance market has repeatedly signaled that it will not offer the same level of terrorism coverage. This is not speculation. It is backed by firm insurance carrier behavior in the run-up to the prior Act’s expirations and this process has begun again for insureds that have begun to negotiate insurance contracts that extend beyond 2014. The chart above demonstrates a noticeable increase in terrorism pricing starting in the Q1 of 2013, which is a function of both prevailing rate cycles, but also tied to insurance markets beginning to adjust their portfolios of risk to manage the potential expiration of TRIA.

As insurers are forced by regulators, management and rating agencies to manage terrorism risk based upon TRIA’s expiration, many carriers have begun to scale back capacity for terrorism risk in 2013. For example, Fitch Ratings warns, in a July 2013 special report, “Although private market standalone terrorism coverage has increased over time, it is unlikely that substantial private market capacity would arise as a substitute to TRIPRA coverage if the program is allowed to expire.”3 This has led to a classic “supply” versus “demand” equation, with reduced capacity leading to pricing increases for terrorism in 2013. Per the chart below, terrorism pricing increases for property insurance have been most notable in the specialty “Standalone Terrorism” market and for clients with high terrorism risk profiles that need to use both “Standalone” and “TRIA” coverage to build adequate terrorism limits.4

3 Fitch Ratings, “U.S. Terrorism Reinsurance: Looming Uncertainty of Program Renewal,” July 31, 20134 Terrorism Categories measured by Aon’s GRIPTM benchmarking database are:

1) Standalone Terrorism - all standalone terrorism for clients with US and/or non US values. Generally purchased by the highest risk Aon clients who cannot secure terrorism coverage via TRIA as property markets price themselves out of the mandatory offer or decline to quote

2) TRIA Only - embedded terrorism (part of property placement) for US risks only. Typically, lowest risk Aon clients. 3) TRIA and Non Certified - embedded terrorism (part of property placement) for US risks (TRIA) and non US risks (foreign) – i.e., clients with foreign values, but

generally not considered target portfolios. Non Certified can also be a reference to US only risks, wherein the markets are providing embedded terrorism to cover the USD 5 million Certification Trigger under TRIA (i.e., coverage for acts of terrorism that don’t meet the USD 5 million combined Insured Loss P&C trigger under TRIA)

4) Standalone and TRIA - mix of both by layer or clients using an onshore “TRIA Captive” structure to access TRIA directly and then reinsuring retained US TRIA exposures via standalone terrorism markets (as well as non US via standalone). Also typically the highest risk Aon clients or clients requiring high terrorism limits.

5) “Take-Up Rate” refers to those Aon clients electing to purchase some form of terrorism coverage.


Property Terrorism Insurance Expiring vs Renewal Pricing by Coverage Type - Twelve Months Ending 6/30/13

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Renewal - Annualized Average Premium as % of Total Program Premium

Expiring - Annualized Average Premium as % of Total Program Premium

TRIA onlyTRIA & StandaloneTRIA & Non CertifiedStandaloneAll Types

Perc

enta

ge o

f Pro

pert

y Pr

emiu

m

Source: Aon Data

It is expected that pricing volatility will increase throughout the balance of 2013 and will become particularly acute in Q42013, as major insurance contracts come up for renewal in 2014 with a portion of the contract extending beyond the end of 2014 and TRIA’s scheduled expiration on 12/31/2014. If the prior two extensions of TRIA are any indication, it is expected that a decision on whether to extend TRIA, substantially modify TRIA or allow it to expire will not be clear until well into 2014. This will have a further detrimental impact on terrorism pricing as both insureds and their major insurance P&C trading partners will not have any degree of certainty regarding the state of the terrorism market – potentially up until the last month of 2014 (e.g., the prior two extensions in 2005 and 2007 did not take place until December of both years).

(1)(b) Response: The availability and affordability of insurance for terrorism risk in the United States specifically by line of business; geographic location, including the rating tiers defined by the Insurance Services Office, Inc.; and other relevant characteristics

The debate over the availability and affordability of terrorism insurance has focused primarily on the commercial property line of business, which has remained the commercial Property & Casualty (P&C) industry’s focus since 9/11. Much of the focus on property has been a function of the insured property losses flowing from 9/11 of USD 24.2 billion (out of a total estimated Insured Loss of USD 40 billion plus) 5, which created the initial insurance capacity crisis that TRIA was designed to address. Aon addresses the property insurance marketplace accordingly, below. To summarize:

5 Source: Insurance Information Institute, “Terrorism Risk: A Constant Threat”, June 2013. Insured losses in USD and adjusted for 2012 inflationary impact. http://www.iii.org/assets/docs/pdf/paper_Terrorism_2013_final.pdf


1. Availability and affordability: Because of TRIA’s long-term benefits, and disregarding continued capacity constraints in certain geographic postal code areas, property terrorism capacity remains relatively affordable.

2. Capacity for property terrorism insurance comes from two sources: One is embedded “TRIA” capacity that attributable to the “mandatory offer” of terrorism coverage that underpins TRIA, with roughly USD 14 billion of “per insured” or “per risk” of theoretical terrorism capacity available for any one insured.

3. The other source of property terrorism insurance is the specialty standalone terrorism market, which, while part of the overall P&C marketplace, is terrorism capacity that is available outside of the TRIA “mandatory offer” of coverage, but sourced from many of the same markets providing the technical per risk property capacity of USD 14 billion. However, the specialty standalone terrorism market only has USD 2 billion plus of maximum “per risk” capacity, with capacity falling to USD 750 million “per risk” in problem aggregation zones.

4. Rating Tier Exposures: Please see Aon’s response on Page 11.

Market for Embedded TRIA Property Insurance

Property terrorism capacity sourced from TRIA’s “mandatory offer” of coverage is intrinsically tied to overall property capacity. In theory, available property all risk capacity matches available TRIA capacity. The reality is very different in that TRIA has no pricing controls over the premium an insurance carrier can charge under the “mandatory offer” requirement. As such, many insurance companies actively price themselves out of the offer of TRIA coverage to either discourage the take-up of the mandatory offer of coverage or encourage the use of alternative markets to handle the terrorism risk (i.e., the specialty standalone terrorism markets).

So, while theoretical TRIA capacity on a “per insured” or “per risk” basis is well in excess of USD 14 billion, the reality is that other, non-terrorism related exposure items can vastly decrease the available capacity for terrorism risk – specifically, natural catastrophe perils like windstorm, flood and earthquake. When these perils are included, capacity drastically shrinks to the levels indicated below. With the overlay of terrorism perils, insureds with exposures in both natural catastrophe exposed and terrorism “high hazard” locations face dramatically reduced theoretical and actually available terrorism limits. Finally, other factors, such as an individual insured’s loss history, occupancy and other perils can operate to dramatically decrease the difference between technical and actually available capacity.

Per Risk Technical All Property Capacity, including Critical Windstorm, Earthquake and Flood vs. Standalone Terrorism

$0

$5000

$10000

$15000

High Hazard FloodCritical EarthquakeCritical WindStandalone TerrorismAll Risk Property

$ in

Mill

ions

$14,420

$2,200

$4,016

$2,850$2,265

Source: Aon Data


Most importantly, this market for embedded TRIA terrorism coverage is functioning solely on the basis of TRIA being in place. Absent TRIA, Aon has tracked property market carrier behavior in the run-up to TRIA’s expiration at the end of 2005 and TRIEA 2005’s expiration at the end of 2007. In both instances, nearly 85% of the available “per risk” property capacity looked to exclude terrorism risk upon TRIPRA 2007’s predecessor legislation expiring without extension. In other words, if TRIPRA 2007 were to expire, “per risk” embedded TRIA property capacity would drop from its theoretical level of USD 14 billion to less than USD 2.14 billion “per risk,” or an 85% reduction in available insurance supply for property risks.

Aon comments in greater detail regarding take-up rates for terrorism coverage in Section 5 but, based upon Aon’s benchmarking data, nearly 80% of Aon’s clients who purchase terrorism insurance are reliant on embedded TRIA coverage out of a total take-up rate of 65% on average. So, in effect, the disappearance of TRIA, removal of the mandatory offer of coverage and the limited market for alternatives to embedded TRIA coverage discussed below (i.e., standalone terrorism) will remove a key source of continued availability and, more importantly, affordability for major U.S. multinational employers and organizations. Without the embedded TRIA coverage option, there will no longer be a functional market for commercial property terrorism coverage.

Standalone Terrorism Marketplace

Standalone terrorism exists as a specialty sub-set market within the property marketplace. This market is comprised of global P&C carriers and reliant on TRIA’s backstop for some of the capacity it deploys to insureds in the U.S. This standalone marketplace is an active trading partner with Aon’s large account and middle market insureds that have sizable exposures in problem terrorism zones; belong to industry subsectors that are viewed as more vulnerable than others to terrorism risk; or, simply, need to purchase terrorism coverage to build higher terrorism limits in conjunction with embedded TRIA coverage.

The standalone terrorism market was in place to cover global terrorism exposures before 9/11 and has emerged as a growth area for terrorism risk in a post-9/11 insurance world. Per the chart below, capacity has increased by over 130% since 2006, to a technical level of USD 2.200 billion and a normal “per risk” level of USD 1.595 billion (which is reduced to USD 750 million or less in certain problem postal code/ZIP code zones. Also, note that these figures do not include Berkshire Hathaway reinsurance capacity of USD 500 million “Normal Line” and USD 1.0 billion “Maximum Line”).

Standalone Terrorism Capacity by Region (excludes Berkshire Capacity) - Based Upon Normal Maximum Per Risk Capacity

$ in

Mill

ions

$02006 2007 2008 2009 2010 2011 2012

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

UK/EuropeBermudaUS

$100$165

$420

$100 $100 $225$200 $175

$150 $250

$225

$250

$225

$250

$250

$870 $880

$910

$1,025 $1,000$1,095

Source: Source: Aon Risk Solutions Annual Capacity Charts


The growth of the standalone market since 2006 has been driven by several factors: (1) record global catastrophes since 2006 that have caused new markets to enter the property and terrorism marketplace; (2) the high profitability of the standalone terrorism marketplace since 9/11; and, (3) the overall growth of individual property market lines overall capacity. Finally, the Lloyd’s of London marketplace, with its ease of capital entry, center of expertise for standalone terrorism and related perils and shared reinsurance structure, has proven to be the overwhelming choice in terms of a business platform for most markets entering the standalone terrorism arena. As capital flow and start-up activity has slowed in the Bermuda market, the London market has also seen a shift in some Bermuda capacity traditionally written in Bermuda to London. There have been no sizable start-ups in the U.S. P&C marketplace entering the standalone terrorism marketplace, but two Lloyd’s carriers have entered the U.S. market since 2006 with separate platforms for their terrorism underwriting, with a new entrant in 2013 also setting up dedicated underwriting in the U.S. (XL Group).

Normal Maximum Line Capacities - Standalone Terrorism

Lloyd's

AIG

Arch Europe

ACE Europe

Axis SpecialtyHannover

Hiscox USA

Lancashire

Montpelier

Validus/Talbot

58%

6%

0.3%

3%

9%

1%

6%

6%

3%6%

The charts below track capacity by key capacity participants in the standalone marketplace. As noted, from a “Normal Maximum Line” standpoint, close to 60% of the “per risk” standalone capacity comes from the Lloyd’s markets, with AIG/Lexington leading capacity offerings in the U.S. and Axis, Hiscox USA, Validus and other markets offering substantial “per risk” capacity offerings via either Bermuda, the U.S. or London underwriting platforms.


Underwriter Normal ($) maximum Line Absolute ($) maximum Line

Various Syndicates at Lloyd’s 925,000,000 1,195,000,000

AIG / Lexington 100,000,000 250,000,000

Arch Insurance Company (Europe) Ltd 5,000,000 5,000,000

Ace European 50,000,000 50,000,000

Axis Specialty 150,000,000 200,000,000

Hannover Rückversicherungs-Aktiengesellschaft 15,000,000 50,000,000

Hiscox USA 100,000,000 100,000,000

Lancashire Insurance Company UK Ltd 100,000,000 200,000,000

Montpelier Re 50,000,000 50,000,000

Validus/Talbot US 100,000,000 100,000,000

Total 1,595,000,000 2,200,000,000

National Indemnity Company 500,000,000 1,000,000,000

Total incl Berkshire 2,095,000,000 3,200,000,000

Source: Aon Risk Solutions Annual Capacity Charts

Rating Tier Exposures

Carriers insuring businesses across the U.S. place all clients’ portfolios into different tiers of risk, depending upon their physical location, being Tier 1, 2 or 3. Tier 1 can be classified as one of the following: it is within a major central business district (CBD); it contributes to the aggregation of other similar risks that, for example, are a specific industry type (e.g., defense subsector, wherein multiple defense contractors have manufacturing plants concentrated in a given geographic location) that may require sharing resources; or, their distance from a prized asset increases their likelihood of being affected by an attack. These risks attract the highest risk rating a carrier can apply, as aggregate or capacity to write insurance in this area is limited by the nature of the exposure. Carriers often also refer to these as the “Restricted Zips.” Once you move away from the above and are still in smaller cities and towns, these are Tier 2 exposures. Rural or suburban located risks are Tier 3.

In order to ensure that risks fall into the correct tier, carriers use sophisticated modeling tools. These can be either a version of RMS (one of the prevailing catastrophe models used by property and terrorism insurers) or the carriers’ own similarly designed product, which enables close monitoring of the buildup of any exposure in any given zip code. This is closely controlled by carriers’ actuaries and modelers in order to ensure that once they have reached the threshold of their appetite for that class of business, in that zone, they cease to provide any further coverage. To exceed this threshold would expose the carrier to a net loss, i.e., something not insured by their reinsurer and which would directly affect their profit and loss.

It is important to note that rating tiers are structured based on past, active and future perceived threats. However, a large-scale terrorism attack in a non Tier 1 area would have the potential to expand the definition of restricted areas (e.g., an attack in Tier 2 city or town).


(2) If the Program were to continue beyond December 31, 2014, describe and explain in detail any revisions or modifications to the Program that would promote the availability and affordability of terrorism insurance, including any accompanying challenges that might arise from any proposed revisions or modifications to the Program. All views regarding the appropriate role of the federal government in supporting the availability and affordability of insurance for terrorism risk are welcome.

Aon does not recommend any changes to the current TRIPRA coverage or retention structure for the reasons noted below, with Aon’s general opinion being that retentions are currently set at a high enough level to ensure that all but the most catastrophic of terrorism events are retained primarily by commercial P&C insurers. Any debate regarding current insurer and industry retentions under TRIA must recognize that the current market for terrorism risk in the U.S. exists due to the “mandatory offer” of coverage requirement of TRIA, which forces insurers to offer terrorism coverage for commercial P&C insurance lines backed by TRIA. So, Aon believes the question is not whether the industry can absorb more in terms of retentions under any extension of TRIPRA 2007, but whether the industry will offer terrorism coverage in the absence of the TRIA reinsurance backstop. The answer to the latter has and will generally be “no” without TRIA in place.

Willingness of Insurance Market to Offer Terrorism Not Tied to Existing Capital

Opponents of TRIA’s reauthorization frequently point to the insurance and reinsurance industry’s record policy holder surplus or, effectively, its available capital to pay losses for all lines of insurance business. There is no doubt that the industry currently enjoys levels of capital well in excess of historic levels since 9/11. The industry has also demonstrated the ability to absorb record natural catastrophe insured losses in both 2011 and 2012 on a global basis. It has also paid and absorbed individual insured loss events for major catastrophe losses that exceeded insured loss estimates for 9/11. However, focusing on the industry’s available capital without acknowledging its general unwillingness to offer terrorism coverage absent TRIA misses the key feature that has made TRIA successful: in return for the annual aggregate USD 100 billion TRIA backstop, insurance carriers are obligated to offer the coverage. Without TRIA, the insurers, where they are allowed by law, will look to exclude terrorism coverage as they have when prior versions of TRIA were set to expire.

TRIA has Created the Private Market for Terrorism

Another key argument against extending TRIA focuses on perceived U.S. taxpayer exposure under TRIA for federal funds that would be disbursed under TRIA. This argument ignores the fact that insurers are required to retain all but the largest of terrorism losses with built in “recoupment” provisions in TRIA that mandate the payback of federal reinsurance funds within certain complex calculations for insurance marketplace aggregate retentions. (this figure has increased from USD 10 billion in 2003 to USD 27.5 billion in 2007, until the end of 2014). Moreover, TRIA allows the federal government to mandate the payback of any federal reinsurance funds remitted for certified TRIA losses at its discretion. In short, using total 2012 commercial P&C direct earned premiums, Aon estimates that the insurance industry, under the current TRIA backstop, would be retaining approximately USD 27.5 billion of losses in the event of a certified terrorism attack or series of attacks that meet or exceed that insurance marketplace aggregate retention level.


Should TRIA disappear, the requirement that insurers offer the coverage disappears and the availability for terrorism insurance will decline dramatically. Most companies and organizations that are now purchasing terrorism coverage will look to alternatives, such as decreased limits or declining to purchase the coverage. This will shift the risk of terrorism losses to the U.S. economy and, ultimately, taxpayers. Those companies and organizations that continue to purchase terrorism coverage will have to do so at cost levels that are multiples of today’s pricing, in effect, having an additional tax placed on their operations to ensure that they have terrorism coverage. Basically, the TRIA incentive to encourage private market insurance participation disappears with TRIA.

Current TRIA Retentions for the Industry

TRIA, fortunately, has not been triggered by any U.S. based terrorism event, even with the most recent Boston bombings in 2013. As such, it remains an untested product. Conceptually, however, it has progressively shifted more risk onto the private P&C insurance market via several key mechanisms. The key issue is how much more retained loss can the industry take without testing its commercial viability and triggering rating agency downgrades based upon capital adequacy levels being impaired.

Two key percentage retentions are built into TRIA. One is the 15.0% “Coinsurance” or industry retention excess of the 20.0% TRIA Deductible. The 20.0% TRIA Deductible is applied against an individual insurer’s consolidated, prior year Direct Earned Premium for lines of business covered by TRIA. On a combined basis, it is estimated that the 15.0% Coinsurance and 20.0% TRIA Deductible generate combined industry TRIA retentions equal to the USD 27.5 billion figure noted above.

TRIA Coinsurance & TRIA Deductible Increases

2007-201420062005200420032002

5.0%

10.0%

15.0%

20.0%

25.0%

TRIA Deductible (Industry Retention)Coinsurance (Industry Retention)

0.0%

Program Year

Source: TRIPRA 2007 Act and successor Acts


Another retention is the TRIA Loss Trigger, which functions as a per occurrence retention for low level terrorism events on the basis that no reinsurance funds will flow from TRIA to the insurance market (including qualifying captive insurers) until a certified TRIA loss reaches a certain loss threshold. This per occurrence mechanism is currently set at USD 100 million under TRIPRA 2007, having increased from USD 5 million in 2003. For many smaller and medium size P&C insurance carriers, this USD 100 million per occurrence retention represents a significant capital event. Setting the Loss Trigger any higher would have a negative impact on the ability of many smaller and medium size P&C insurers to offer terrorism coverage to the extent they are able to today.

The combined impact of these two retentions on the commercial insurance industry is significant. To measure the impact, we consider two loss scenarios. The World Trade Center attack of September 11th resulted in a non-life insurance loss of USD 32.5 billion (source: Insurance Information Institute, “Terrorism Risk: A Continuing Threat Impacts for Property/Casualty Insurers,” September 2012). In 2013 dollars that loss, conventional in nature, is indexed to USD 40.7 billion (using U.S. Department of Labor, CPI statistics). In April 2006, the American Academy of Actuaries, in a letter to the President’s Working Group on Financial Markets, advised a NBCR loss of USD 656 billion, an amount in excess of the insurance industry’s capital and surplus, was possible.

The table below is an estimate prepared by Aon Benfield reflecting the impact of the indexed WTC loss above, as well as a more moderate USD 100 billion NBCR event, on the capital and the capital adequacy of commercial insurance in the U.S. In a USD 41 billion conventional loss, assuming a USD 27.5 billion industry retention under TRIA6, the industry would retain that figure plus 15% of the loss excess of that amount for a total retention of USD 29.5 billion. Assuming tax deductibility and the ability to book the recovery, the after-tax earnings and capital charge would be USD 19.1 billion. The corresponding figures for a USD 100 billion NBCR event are total retention of USD 38.4 billion and after-tax capital charge of USD 24.9 billion.

The table reflects the impact of those losses on the USD 278.5 billion capital base of the commercial insurance industry7. The minimum A.M. Best rating necessary for commercial viability is “A-“ and that rating is based on capital adequacy. Currently the estimated commercial insurance industry’s capital adequacy is roughly on par with the bottom 25th percentile of the “A-“ rating range. The capital charges from the loss examples above would drop the adequacy of capital to levels that would threaten industry viability from a financial ratings perspective.

6 Fitch Ratings, “U.S. Terrorism Reinsurance: Looming Uncertainty of Program Renewal,” July 31, 20137 A.M. Best


Aon Benfield Estimated A.M. Best - Baseline Capital Adequacy Ratio (BCAR)

2012 Estimate

Industry EstimateAfter 41Bn

Conventional AttackAfter $100Bn CBNR Attack

B1 Fixed Income Securities 15,365,132 15,365,132 15,365,132

B2 Equity Securities 45,103,545 45,103,545 45,103,545

B3 Interest Rate 3,077,741 3,077,741 3,077,741

B4 Credit 18,407,672 18,407,672 18,407,672

B5 Loss and LAE Reserves 130,847,736 130,847,736 130,847,736

B6 Net Premiums Written 64,498,273 64,498,273 64,498,273

B7 Business Risk – – –

Unadjusted Required Capital 277,300,098 277,300,098 277,300,098

Covariance Adjustment 115,624,280 115,624,280 115,624,280

Net Required Capital 161,675,818 161,675,818 161,675,818

Reported Surplus 278,562,614 278,562,614 278,562,614

UPR Equity 15,950,301 15,950,301 15,950,301

Loss Reserve Equity 15,125,156 15,125,156 15,125,156

Fixed Income Equity 23,086,636 23,086,636 23,086,636

Miscellaneous Adjustment – – –

Surplus Notes (722,376) (722,376) (722,376)

Catastrophe Stress Event – (19,191,250) (24,943,750)

Adjusted Policyholder Surplus 332,002,331 312,811,081 307,058,581

Capital Adequacy Ratio 205.4% 193.5% 189.9%

Source: A.M. Best Statement File

A.M. Best’s Capital Adequacy Scale

Rating Minimum25th

Percentile2012

Median

A++ 175 256 298

A+ 160 223 326

A 145 225 292

A- 130 203 272

B++ 115 181 219

B+ 100 134 175

• TRIPRA deductible and related 15% co-participation

– USD 29.5 billion net pretax (assumes USD 41billion loss)

– USD 38.3 billion net pretax (assumes USD 100 billion loss)

• Assuming tax deductibility and the ability to book the recovery, the after tax earnings and capital charge would be USD 19.1 billion and USD 24.9 billion

• The loss would reduce the capital adequacy around 11 to 16 points depending on the net retention

• The risk of natural catastrophe, adverse development on loss reserves, investment default or devaluation or other risks inherent in insurance companies could compound the losses


Insurance Market Considerations

(3) Describe and explain the ability of the insurance industry to model, quantify, and underwrite terrorism risk, and the resulting impact of such analysis on the availability and affordability of terrorism insurance, including an examination of the price (by line of business, location of risk, and other relevant characteristics) and coverage options for terrorism insurance.

The insurance and (re)insurance underwriting industry has made great strides in terms of the industry’s ability to model, assess and underwrite terrorism risk. However, there remain several unique aspects of terrorism as a risk that have, to date, prevented the industry from being able to adopt the same tools used to classify and underwrite other natural and man-made catastrophic perils. Restrictions impeding the modeling and underwriting of terrorism include:

1. Modeling constraints: Terrorism models have increased in terms of sophistication, but they still lack the historical information required to accurately model the frequency of terrorism events. Simply put, “Frequency” (how often a loss event repeats itself) multiplied by “Severity” (how large that loss might be) yields “Losses” via the models. The “Frequency” measure, along with the “Severity” measure, is the general basis for predictive or “probabilistic” modeling. Without the ability to measure “Frequency” for terrorism, model output is suspect. The inability to source historical information on terrorism, which is an emerging global peril, makes accurately predicting terrorism events more “art than science.”

The range of potential weapons scenarios, targets and the quality of exposure data used to measure attack scenarios have all improved, but for the most part, terrorism modeling remains a means for underwriters to measure how much limit they have at risk in a given geographic area – nothing more, nothing less. In this way, most of the models being used are “deterministic” and focus on individual or multi-location exposures based upon given weapons scenarios overlaid on narrowly defined geographic zones.

2. Unique nature of terrorism risk: Terrorism, by its very man-made nature, does not lend itself to generating the important historical data needed and used by natural catastrophe models. While terrorism attack data has improved since 9/11, the relative lack of large-scale events on U.S. soil makes underwriting the risk difficult. So, the default assumption, per the modeling constraints noted above, is to underwrite terrorism risk to the limit provided on an individual risk or portfolio of risks with the assumption that the full limit will be lost. What this does in practice is to severely limit the amount of aggregate insurance any one insurance carrier can offer in a given geographic location.

3. Limited potential geographic loss footprint: Terrorism exposures tend to be underwritten based upon the proximity of assets to “target” risks, within a confined geographic radius that can be as little as 250 yards from a given target risk point. This methodology of controlling risk exposure allows for a conservative measure of how much exposure one insurance carrier is willing to put at risk within overlapping zones (e.g., one conventional and prevailing measure is the blast radius of a ten ton truck bomb). The reality is that this approach quickly exhausts available aggregate limit for both embedded TRIA terrorism and standalone terrorism underwriters. The limited supply translates into high demand in “target” locations. The overlapping concentric circles of risk aggregate are amplified in major metropolitan areas where there are high value assets, many of those assets and a limited market supply for those assets. Moreover, each insurance carrier’s appetite for aggregate risk varies as do their actual risk portfolios, making certain postal codes particularly sensitive to shifts in capacity and pricing.

4. Shifting risk profile and attack methods: Globally since January 1, 2007, there have been 24,700 terrorism related incidents, perpetrated by terrorist organizations ranging from Al-Qaeda in the Arabian Peninsula (AQAP) to the Earth Liberation Front (ELF), as well as the so-called “lone wolf.” Of these incidents there have been 19 in the U.S., including bombings, armed attack, kidnapping or hostage taking, sabotage and assassination. These attacks alone accounted for 173 injured and 25 fatally wounded persons.


5. Balance sheet exposure to insurers: Rating agencies like S&P, A.M. Best and Fitch play a key role in assigning financial strength or “claims paying” ratings to commercial P&C insurers and (re)insurers. For first-party risks, like property terrorism, catastrophe modeling results are a key component to (re)insurer capital adequacy measures. High volatility, low probability lines of business – like terrorism – are difficult for (re)insurers to maintain on their balance sheets in terms of the basic impact on their capital adequacy scores and associated ratings. Therefore, they have three options: (1) exclude the risk where they can (which will be the default for the industry absent TRIA); (2) carefully control their aggregate exposure to worst case scenario events (which all carriers are now forced to do); or, (3) reinsure a portion of the those exposures to the reinsurance markets (limited option currently and in the near future per Aon’s response to Question 6 below).

6. Lack of a viable private (re)insurance market to replace TRIA’s aggregate USD 100 billion of capacity: (see Aon’s response to Questions 6 and 8, below).

Terrorism Pricing

Terrorism insurance property pricing, as noted in Aon’s response to Question (1)(a), has declined by over 50% from the period TRIA initially incepted in 2002 until the end of 2012. Pricing for terrorism risk is very much tied to geography, proximity to perceived targets, terrorism mitigation measures taken by individual insureds and the specific industry subsectors they operate in, as some industries are perceived to carry higher risk loads than others.

Aon Property Broking’s GRIP8 database assigns two measures to pricing for terrorism risk: as a “percentage of Total Insured Values” (rate-based) or as a “percentage of Property Premium” (typical measure used by insureds). The former is a simple calculation of terrorism premium divided by Total Insured Values (or “TIV,” which represents combined Property Asset values and Business Interruption values). The latter is a function of total terrorism premiums divided by total property premiums, expressed as a percentage.

Terrorism categories measured by Aon’s GRIP benchmarking database are broken out into four specific categories:

1. Standalone Terrorism - all standalone terrorism for clients with U.S. and/or non U.S. values. Generally purchased by the highest risk Aon clients who cannot secure terrorism coverage via TRIA, as property markets price themselves out of the mandatory offer or decline to quote.

2. TRIA Only - embedded terrorism (part of property placement) for U.S. risks only. Typically, lowest risk Aon clients.

3. TRIA and Non Certified - embedded terrorism (part of property placement) for US risks (TRIA) and non U.S. risks (foreign) – i.e., clients with foreign values, but generally not considered target portfolios. Non Certified can also be a reference to U.S.-only risks, wherein the markets are providing embedded terrorism to cover the USD 5 million Certification Trigger under TRIA (i.e., coverage for acts of terrorism that don’t meet the USD 5 million combined Insured Loss P&C trigger under TRIA).

4. Standalone and TRIA - mix of both by layer or clients using an onshore “TRIA Captive” structure to access TRIA directly and then reinsuring retained U.S. TRIA exposures via standalone terrorism markets (as well as non-U.S. via standalone). Also, typically the highest risk Aon clients or clients requiring high terrorism limits.

Across these four measures of terrorism categories, twelve-month year-over-year pricing indicates different pricing trends for Property Terrorism based upon category, with “Standalone” and “TRIA & Standalone” seeing pricing increases as a “Percentage of Property Premium,” and “Standalone,” “TRIA & Standalone” and “TRIA Only” seeing pricing increases as a “Percentage of TIV.”

8 Aon Global Risk Insight Platform® (Aon GRIP) is the world’s leading global repository of risk and insurance placement information, with insight into Aon’s USD 94 billion in bound premium flow.



0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Renewal - Annualized Average Premium as % of Total Program Premium

Expiring - Annualized Average Premium as % of Total Program Premium

TRIA onlyTRIA & Stand Alone

TRIA & Non Certified

Stand AloneAll Types

Source: Aon Data


0.0000%

0.0010%

0.0020%

0.0030%

0.0040%

0.0050%

0.0060%

Renewal - Annualized Average Premium as % of TIV

Expiring - Annualized Average Premium as % of TIV

TRIA onlyTRIA & Stand Alone


Stand AloneAll Types

Source: Aon Data


Terrorism Pricing by Industry Subsector

Aon Property tracks a total of twelve subsectors, with pricing as a percentage of property premium being the highest (historically as well) for the Entertainment, Financial Institutions, Real Estate, Technology and Transportation industry sectors. Pricing for terrorism as a percentage of premium has remained historically lower for Consumer Goods, Natural Resources and Industrial & Materials industry subsectors.

By either the measure of terrorism pricing as a “Percentage of Total Insured Values” or pricing as a “Percentage of Property Premium,” terrorism pricing varies dramatically by industry subsector as demonstrated in the chart below. Using the “Percentage of Property Premium” measure, certain high take-up rate subsectors, such as Entertainment and Real Estate, for example, generate very different average terrorism premiums as a percentage of property premiums, with Entertainment insureds seeing over a 7.0% additive terrorism cost to their property premiums and Real Estate insureds seeing approximately 4.0% of additive cost, with other subsectors, like Transportation, Financial Institutions and Technology, falling in between these pricing bands.

Property Terrorism Insurance Take-Up and Pricing by Industry - Twelve Months Ending 6/30/13

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

Take-Up

TransportationTechnologyReal Estate

Public Sector

Pharm-ChemNatural Resources

Industrials & Materials

Health CareFinancial Institutions

EntertainmentConsumer Goods

Agribusiness and Food Systems

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

Annualized Premium as % Total Program Premium

Take

-Up

Rate%

of Annualized Premium

Source: Aon Data

When benchmarking using total terrorism premiums divided by Total Insured Values (total physical assets and business interruption values) is used as a measure, the twelve months ending expiring terrorism pricing versus renewal pricing shows a general trend towards most industry subsectors seeing pricing increases.


Property Terrorism Insurance Expiring vs Renewal Pricing by Industry - Twelve Months Ending 6/30/13

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

Renewal - Annualized Premium as % of Total Program Premium

Expiring - Annualized Premium as % of Total Program Premium

TransportationTechnologyReal EstatePublic SectorPharm-ChemNatural Resources


Health Care

Financial Institutions



Source: Aon Data

Property Terrorism Insurance Expiring vs Renewal Pricing by Industry - Twelve Months Ending 6/30/13

0.0000%

0.0010%

0.0020%

0.0030%

0.0040%

0.0050%

0.0060%

0.0070%

0.0080%

Renewal - Annualized Premium as % of TIV

Expiring - Annualized Premium as % of TIV



Health Care

Financial Institutions



Source: Aon Data


There is a notable difference in terrorism pricing changes over the last 12 months when using the two different measures employed by Aon to track terrorism pricing: “Expiring vs. Renewal Pricing by Industry as a Percentage of Total Property Premium” and “Expiring vs. Renewal Pricing by Industry as a Percentage of Total TIV.” Basically, the increase when using the “TIV” measure can be traced to lower overall TIV growth and the decrease when using the “Percentage of Total Program Premium” measure can be attributed to declining overall property premiums in the last twelve months, through Q22013. Terrorism price movement has been driven by several factors, which include:

• AverageGrowthofTotalInsuredValuesoverEconomicCycle: For Aon’s property benchmarking portfolio, TIV exposures grew an average of 7.73% over the policy years covering 2005 through 2008. With the financial crisis, lower earnings and divestitures had the effect of lowering overall average TIV growth to 3.13% for the policy years running from 2009 through 2012. As pricing (i.e., total premiums) increased over the 2011 to 2012 hardening market property cycle, it has resulted in lower TIVs, but relatively static terrorism pricing, resulting in increases in terrorism premiums for many industry subsectors. So, while TIVs have generally increased for property clients, TIV growth has slowed following the financial crisis.

• Risk Perception: Certain industry subsectors attract higher pricing due to perceived or actual risk exposure to terrorism, such as Financial Institutions (major metropolitan concentrations of value); Real Estate (commercial, hospitality and habitational concentrations of risk in metro areas) and Entertainment (stadiums, theme parks and other assets with high concentrations of people on an event basis). Others are not viewed as at risk from either a targeting or geographic standpoint, such as Consumer Goods manufacturers and Industrial & Materials plants. Others, while viewed as at risk on a target basis, such as Natural Resources and Pharm-Chemical industry sectors, often have a spread of risk or lower aggregations of values in non-metropolitan areas that allow markets to charge lower terrorism premiums as a percentage of property premiums.

• Overall Property Premium Rate Environment: High natural catastrophe exposures for certain industry subsectors also tend to drive terrorism pricing upward due to several factors. For Embedded TRIA Coverage, as property premiums increase, there is a tendency for markets to increase terrorism pricing overall to maintain the same percentage loading for terrorism premium to property premium. Recent overall property rate increases spanning seven consecutive quarters due to record 2011 and 2012 catastrophe losses have had a tendency to push up terrorism pricing for clients overall as well. The same mindset is employed when insureds are accessing the specialty standalone terrorism markets, as capacity for these risks is sourced from the same markets that have driven property pricing upward in most instances. In short, the property premium rating environment has the ability to negatively and positively impact terrorism pricing irrespective of the actual terrorism threat environment. The chart below demonstrates the overall property rate environment as one being characterized by rate increases since Q12011, with rate movement upward slowing since Q12012, but still remaining in positive territory in terms of rate increases until Q22013. As property rate increases have decelerated in the last twelve months, terrorism premiums as a percentage of property premiums have also dropped. However, as previously noted, terrorism pricing has begun to move upwards in 2013 as markets have begun to respond to the prospect of TRIA expiring at the end of 2014.


Terrorism Insurance Year Over Year Rate Change - 2007-2013

-20.0

-18.0

-16.0

-14.0

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

TerrorismProperty - National AccountsProperty - All

Q2

'13

Q1

'13

Q4

'12

Q3

'12

Q2

'12

Q1

'12

Q4

'11

Q3

'11

Q2

'11

Q1

'11

Q4

'10

Q3

'10

Q2

'10

Q1

'10

Q4

'09

Q3

'09

Q2

'09

Q1

'09

Q4

'08

Q3

'08

Q2

'08

Q1

'08

Q4

'07

Q3

'07

Q2

'07

Q1

'07

Source: Aon Data

Terrorism Limits by Subsector

Terrorism limits by subsector are a reflection of both average “all risk” property limits secured by subsectors and associated average terrorism limits overall. Through Q22013, the average Property All Risk limit for Aon’s portfolio was USD 471 million with the average Terrorism limit across all industry subsectors equating to USD 334 million, consistent with the overall trend of insureds purchasing higher All Risk Property limits than Terrorism limits.

Across industry subsectors, the highest average limits purchased were in Transportation, Healthcare and Pharm-Chemical. Lower limits were seen for Financial Institutions, Real Estate and Entertainment. However, these limits track only third-party insurance sourced for overall limits with many of Aon’s Financial Institutions, Real Estate, Entertainment and other clients employing the use of their onshore U.S. captives to supplement their private market insurance limits with direct access to the TRIA backstop via their captives.


Average Terrorism Limit by Industry - Twelve Months Ending 6/30/13

$0

$100,000,000

$200,000,000

$300,000,000

$400,000,000

$500,000,000

$600,000,000

$700,000,000

$800,000,000

$900,000,000



Health CareFinancial Institutions



Source: Aon Data

Terrorism Limits by Terrorism Type

Terrorism limits by Terrorism Coverage Type for Q22013 continue to vary, with the average limit for “TRIA Only” being the lowest at USD 349 million and the highest for “TRIA & Standalone” at USD 654 million. Again, this is consistent with historical buying patterns as clients that rely on a combination of “TRIA & Standalone” terrorism tend to be those with the greatest need for higher limits due to their risk profile and potential for catastrophic terrorism loss. Conversely, “TRIA Only” clients that have not had to seek the recourse of the more expensive “Standalone” terrorism market have tended to have lower risk profiles and a corresponding lower need for overall terrorism loss limit.

Average Terrorism Limit by Coverage Type - Twelve Months Ending 6/30/13

$0

$100,000,000

$200,000,000

$300,000,000

$400,000,000

$500,000,000

$600,000,000

$700,000,000

TRIA onlyTRIA & Stand AloneTRIA & Non CertifiedStand AloneSource: Aon Data


Terrorism Pricing Trends – Twelve Months Ending 6/30/13 (Q22013)

By Terrorism Coverage Type, average and median terrorism pricing has varied in terms of trending based upon category, with “Standalone” terrorism pricing trending upwards and other categories trending on a flat basis or upwards depending upon the category. Again, pricing trends should be tracked in tandem with overall property pricing trends for the same quarters per Aon Benchmarking.

Standalone Terrorism Pricing – Twelve Months Ending 6/30/13 (Q22013)

Standalone Terrorism Pricing - As % of Total Property Premium

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

Median Annualized Premium as % of Total Property Premium

Average Annualized Premium as % of Total Property Premium

Q3 - 2012 Q4 - 2012 Q1 - 2013 Q2 - 2013Twelve Months Ending 6/30/13

Source: Aon Data

In the chart above, “Standalone” terrorism pricing has seen the greatest increase on a 12-month basis, with a large spike in pricing for the Q22013. Increased pricing here is a function of two main measures: (1) more insureds looking to standalone terrorism as an option to hedge against TRIA’s potential expiration in 2014 and (2) standalone terrorism markets responding to this increased demand and the uncertainty in the marketplace over TRIA’s lifespan beyond 12/31/2014. Basically, demand for standalone has increased against a limited supply.

Finally, while Aon has historically tracked “TRIA & Standalone Pricing” as an insurance purchasing subset, the data set for this type of terrorism purchasing is too small to warrant analysis.


TRIA Only Pricing – Twelve Months Ending 6/30/13 (Q22013)

For the “TRIA Only” twelve-month pricing cycle, pricing has shown a general trend towards increasing for this category, which is generally viewed as having the lowest terrorism risk profile as noted before. Here “TRIA Only” pricing shows an average increase that is not as substantial as “Standalone” and “TRIA & Standalone” pricing. Price trending for this category demonstrates movement in TRIA pricing at a time when Property All Risk pricing is seeing continued declines. The increase in overall pricing is due to the same factors of uncertainty surrounding TRIA’s expiration in 2014 that are being seen for other categories.

TRIA Only Pricing - As % of Total Property Premium

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%




Source: Aon Data

TRIA and Non Certified Pricing – Twelve Months Ending 6/30/13 (Q22013)

“TRIA and Non Certified Pricing” shows a general trend towards terrorism pricing for this category to maintain a flat line trend, with some general decrease on a twelve-month basis. Insureds falling into this category are generally viewed as low risk, but with non U.S. exposures requiring the need to source terrorism coverage on an embedded basis that covers both TRIA and foreign locations (i.e., Non Certified locations). This category of insured, as with lower risk “TRIA Only” purchasers, is unlikely to see serious pricing movement upward until their insurance contracts either come up for renewal in the Q42013 or into 2014 as they are faced with the withdrawal of TRIA capacity via conditional endorsements either imposing sublimits or absolute exclusions on terrorism for their portfolios.


TRIA and Non Certified Pricing - As % of Total Property Prermium

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%




Source: Aon Data

(4) Describe and explain, with supporting information where available, any additional insurance market considerations that could impact the long-term availability and affordability of terrorism insurance (e.g. implications for coverage of insurance for nuclear, biological, chemical, and radiological acts of terrorism; cyber acts of terrorism; and terrorism in workers’ compensation policies).

Implications for Coverage of Nuclear, Biological, Chemical & Radiological Terrorism (NBCR) events

Despite TRIA backstopping NBCR events, NBCR coverage, simply put, is not readily available in P&C marketplace, with the exception of certain lines, like Workers’ Compensation, where it is mandated at a statutory state level. For property placements, typical exclusions present in most policies mean that any associated TRIA coverage excludes NBCR.

There is a limited standalone terrorism market for NBCR, with realistic limits of USD 100 million to USD 200 million maximum. However, typical prevailing pricing of a 5.0% plus Rate on Line (premium divided by limit) has prevented most insureds from purchasing the coverage. The potential for NBCR events, particularly nuclear and radiological attacks, to damage large areas for prolonged periods forces underwriters to carefully limit the geographic area that they provide NBCR for and, given the low limits available, most insureds elect not to purchase the coverage. Clean-up and remediation are viewed as somewhat easier for chemical or biological attacks and there has been movement by standalone terrorism underwriters to offer these covers as an adjunct to their terrorism offerings.


The only other avenue for securing NBCR coverage is via a qualifying onshore captive with the original policy to which TRIA attaches having any NBCR exclusionary wording removed for TRIA qualifying events. Many global large corporate insureds have elected this coverage route in the search for capacity for NBCR risks on the property side.

Workers’ Compensation

For workers’ compensation, NBCR coverage has major implications for insurance carriers offering this coverage along with other lines, like property, that create a potential multi-line clash of losses in the event of a large scale, urban terrorism event. Workers’ compensation insurers are exposed to significant loss of capital emanating from NBCR and other terrorism events. This is due to the fact that workers compensation policies cannot exclude these risks and injuries or death sustained by employees are compensated according to amounts prescribed by each state’s law. As such, the most important underwriting tool to manage the risk of terrorism and NBCR is to actively manage exposure to companies in geographies and cities prone to these risks and to decline to underwrite business that violates set thresholds. The second tool insurers use to manage these exposures is access to reinsurance capital including TRIA. The cost and availability of such reinsurance capital continues to influence insurers’ willingness to accept workers’ compensation risks and the price at which they offer such protection to their customers.

Following the aftermath of 9/11, insurers began to collect employee concentration data as a critical component of the underwriting submission. They created underwriting models which track their exposure to human concentration in geographies perceived to be prone to loss such as major metropolitan centers or the headquarters of major Western companies and other institutions of significance.

We are confident that without TRIA (or similar reinsurance capital) the cost of workers’ compensation insurance will be significantly higher, if available at all. We have seen recent market action where a single yet important insurer curtailed their willingness to provide workers’ compensation coverage to “high risk” enterprises. These enterprises experienced a doubling (or more) of their costs. We are confident that the loss of TRIA would have a much greater impact to the market than a single insurer. Further, we think the cost impact would penetrate much deeper into the market and affect all companies – not just companies that present higher risks to the market.

Cyber Acts of Terrorism

As is the case with NCBR exposures, there is limited coverage available for this risk in the property standalone terrorism market. Cover is available for the forensic side of the risk, such as the recovery of data, but not for physical damage following a cyber attack. The most common way of securing protection against this exposure is via an insured’s captive vehicle.

Cyber acts of terrorism have the potential to affect the entire spectrum of risks – from physical property that is vulnerable to attacks from “Stuxnet”-like computer viruses, to products that contain chips with embedded software, to degradation or complete failure of critical infrastructure stakeholders. The Department of Commerce has described cyber security insurance as a potentially “effective, market-driven way of increasing cyber security” because it may help reduce the number of successful cyber-attacks by promoting widespread adoption of preventative measures; encouraging the implementation of best practices by basing premiums on an insured’s level of self-protection; and limiting the level of losses that companies face following a cyber-attack (http://www.dhs.gov/publication/cybersecurity-insurance). As a result, cyber events have the ability to impact numerous lines of insurance coverage. However, most property and general liability policies exclude “intangible perils,” such as computer viruses, electronic worms, Trojan horses and Distributed Denial of Service attacks. Cyber insurance has developed to fill this gap, which is becoming increasingly more important with the evolution to massive dependence on technology and information assets.

Base cyber insurance policies typically include an exclusion for war and terrorism. However, it is possible to obtain a carve-back for “Cyber Terrorism” from most insurers. After all, it is often difficult to determine whether a Cyber-attack is an “Act of Terrorism” or a 13-year-old hacker in his basement. Furthermore, the U.S. government has incentivized entities to fight

http://www.dhs.gov/publication/cybersecurity-insurance

http://www.dhs.gov/publication/cybersecurity-insurance


terrorism through the use of innovative technologies via “The Support Anti-Terrorism by Fostering Effective Technologies Act of 2002,” (the “SAFETY Act”), which provides limitations on liability and damages for claims against sellers of anti-terrorism technologies arising out of the use of anti-terrorism technologies, contingent on having liability insurance.

The bigger problem is the lack of cyber insurance capacity in certain industries, such as large energy, utility, gas, water, etc. entities, to cover an accident, disaster, cyber event or the cataclysmic meltdown of national critical infrastructures. The current USD 250 million in capacity is not sufficient and exclusions for damage to infrastructure is unacceptable. The majority of developments to date on the cyber risk transfer front relate to privacy or data breach risk, and specifically, breaches of Personally Identifiable Information (“PII”). Many breached entities and other responsible parties have been aided tremendously by their insurance policies. Privacy, however, is only a fraction of the entire cyber spectrum, and companies that are not consumer-facing or do not participate in the PII chain are struggling with the insurability of their cyber risk. Consider that while annual cyber premiums are approaching USD 1 billion on an annual basis, annual commercial property and general liability premiums are in excess of USD 151 billion. Defined cyber premiums account for a mere 1/151th of risk transfer in an economy where more businesses put a higher value on intangible assets than on traditional assets like plant, property, equipment and inventory.

The insurance industry has been slow to embrace this evolving reality to provide true end-to-end solutions that provide confidence to policyholders that the majority of cyber risk is covered. The insurance industry can serve as a catalyst and facilitator to significantly improve cyber security solutions. Precedent for this action may be found in TRIA, which for a limited period provides compensation for insurers who suffer sufficiently large losses resulting from designated acts of terrorism, subject to recoupment through risk-spreading premiums on other insurance products. Essentially, the limited market for cyber terrorism that does exist is reliant on TRIA’s continuation beyond 2014.

(5) Explain and describe in general the demand (or “take-up”) of terrorism insurance and provide specific data and information, where available, regarding the take-up rate by line of business, location of the risk, and other relevant characteristics.

Property Terrorism Take-Up Rate by Year

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

Terrorism Take-Up Rate Log. (Terrorism Take-Up Rate)

2013 YTD20122011201020092008200720062005200420032002

Source: Aon Data


After initially only being in the low 30% range in 2002 with TRIA’s initial passage, the take-up rate for property terrorism grew substantially to 60% plus as of 2006, and has remained at a 60% to 65% average rate since 2006.

Property Terrorism Insurance Take-Up - Twelve Months Ending 6/30/13

Purchased

Not Purchased

66%

34%

Source: Aon Data

By coverage subclass, terrorism take-up rates vary greatly, with TRIA on its own or as a component part comprising the vast majority of terrorism purchasing (80%) via “TRIA Only,” “TRIA & Non Certified” or “TRIA & Standalone” purchasing. “Standalone” terrorism, on its own, only comprises 19.9% of terrorism purchasing, but accounts for a sizable portion of Aon’s property clients’ overall premium spend on terrorism.

Aon Property Take-up Split by Subclass of Terrorism

Standalone


TRIA & Stand Alone

TRIA only20%

42%5%

33%

Source: Aon Data

Aon does not capture property terrorism data on a geographic basis for a number of reasons. One, within the global large corporate space, concentrations of values in only one geographic region are extremely rare. Two, often, when geographic regions are coded by other groups, the “geography” reference is actually to the region producing and servicing the insurance business, but is not representative of the actual exposure within any given geographic region.


For casualty, the risks of terrorism affect general and products liability and workers’ compensation insurance. Workers’ compensation law does not permit insurers to exclude terrorism from their policies. As such, the “take up” of terrorism insurance is 100%. As discussed above, these insurers manage their risk of loss through reinsurance (including TRIA) or by declining to participate in the market.

Insurers writing general liability insurance offer terrorism protection in their policies. Premiums tend to be in the 1% to 3% of the total policy premium. As such, the take up is quite high – approximately 90%.

Reinsurance Considerations

(6) Describe and explain in detail the long-term availability and affordability of private reinsurance for terrorism risk. Analyze, with supporting information, the impact of the Program, and any changes to the Program, on the private reinsurance market for terrorism risk, including any accompanying challenges that might arise from revisions or modifications to the Program.

Since the implementation of TRIA in 2002, Property Treaty Reinsurance generally has provided coverage for acts of terrorism on personal lines insurance portfolios as well as Commercial Lines losses perpetrated by “domestic” agents; loss from acts of terrorism committed by foreign agents is excluded. All loss caused by Nuclear, Biological, Chemical & Radiological (NBCR) means is excluded. The distinction between foreign and domestic terrorism in Property Treaty Reinsurance has continued despite the 2007 enactment of the Terrorism Risk Insurance Program Reauthorization Act, which removed that distinction in the Act. Thus, protection for foreign terrorism or for any NBCR loss, in addition to the coverage afforded by TRIA, requires purchase of standalone reinsurance cover if insurers require it.

Reinsurance for workers’ compensation treats terrorism differently. Capacity for all terrorism is generally available, excluding NBCR coverage, within workers’ compensation catastrophe covers. NBCR coverage is available at modest prices relative to property, on the order of an additional 2% - 3% Rate-on-Line (ROL), which is premium costs divided by loss limit. While not a significant quantum of premium, the incremental price does equate to a 25% - 50% increase in the cost of workers’ compensation catastrophe cover.

Currently, in the standalone terrorism reinsurance market, the supply of reinsurance capacity exceeds demand. The terrorism reinsurance market has not changed appreciably since 2006, remaining fairly inactive. Reinsurers have grown slightly more comfortable with the exposure, and capacity has increased. The increased supply and technological advances in modeling have driven prices down. Nevertheless, the inability to assign frequencies to the occurrence of terrorism events makes the value proposition for buyers difficult to assess, leading to a lack of firm orders for this coverage by most of Aon’s treaty reinsurance clients.

Standalone terrorism treaty reinsurance, in the few instances it is purchased, is typically done on an aggregate, all lines basis — particularly on larger programs. Pricing for this product has decreased since a post-9/11 high by 50%, from high-teen rates on line (ROL) to high-single digit ROL’s for coverage, including NBCR terrorism. At current market pricing, in excess of USD 1 billion of capacity is available for a single treaty on a conventional basis; USD 300 million – 400 million if NBCR is included.


In addition to the treaty reinsurance market, the facultative reinsurance market also provides terrorism capacity (facultative reinsurance provides reinsurance for single risks or “policies” and not portfolios of business). For non-metropolitan risks, up to USD 1 billion (excluding NBCR) of per risk capacity is available. For risks in metropolitan areas, up to USD 400 million in capacity is available, excluding NBCR. This market has also recently started to offer coverage for NBCR. If NBCR coverage is included, however, available capacity drops to USD 100 million. In the past several years, roughly USD 150 million of capacity has been added to the market to get to these current figures. The entry of new reinsurers into the market has increased the capacity on the order of 15%. It is important to note that most of these “facultative” reinsurance markets are also the same standalone terrorism markets that provide direct insurance – so this is not additive capacity to overall standalone property terrorism coverage.

Contrary to the treaty market, the facultative market generally sees demand outstrip supply. There is a finite amount of facultative capacity available and, during the course of the year, the supply tends to be fully or close to fully utilized. The facultative approach to terrorism tends to be more cost effective given the ability to surgically deal with exposures rather than protect an entire portfolio, as on treaty reinsurance. Pricing can be more competitive and purchases more directed at peak exposures.

Long term, with the federal backstop in place and without a major event in the U.S., we do not foresee significant change in either pricing or capacity.

6(b) Analyze, with supporting information, the impact of the Program, and any changes to the Program, on the private reinsurance market for terrorism risk

Some observers have posited that the federal backstop has hindered growth of the private terrorism reinsurance market. This commentary generally cites the supply/demand disconnect in treaty reinsurance noted above as proof. However, this observation overlooks other metrics that suggest it is not TRIA that has slowed development of private market reinsurance but rather it is a lack of demand by insurers that has led to the stagnant standalone terrorism reinsurance market.

It is difficult to calculate insurers’ TRIA deductibles precisely from available public information due to the lack of segregated reporting of Directors’ & Officers’ Liability premium and U.S.-only premium. Nevertheless, Aon Benfield’s recent analysis of insurers’ TRIA deductibles showed that more than 250 separate insurance groups had a 2012 TRIA deductible equal to or greater than 10% of their Policyholders Surplus (capital to pay claims). Due to the reporting issue noted above, the deductibles are somewhat overstated but it is clear that with a small minority of insurers purchasing standalone terrorism reinsurance, the industry retains a sizeable exposure net, protected only by the federal backstop.

The inability to model the peril of terrorism, given the lack of credible frequency parameters, makes the buy-decision a difficult one. In all other forms of reinsurance, frequency and severity are analyzed to present a quantifiable risk transferred to reinsurers. That risk is then compared to the cost of protection and the buy/no-buy decision made. Even at the reduced pricing that exists now for standalone terrorism reinsurance compared to post-9/11, the outlay of premium without measurable benefit is a decision most insurers are not prepared to make.

6(c) …including any accompanying challenges that might arise from revisions or modifications to the Program.

Should TRIPRA be allowed to lapse, Aon expects a significant withdrawal of insurance capacity for terrorism and a reversion to a post-9/11 environment. The intervening decade plus since 9/11 and the lack of loss will lead some insurers to allocate capital to terrorism, but without the federal backstop, overall capacity will reduce dramatically. For those insureds required


to purchase terrorism insurance, premiums will increase substantially due to reduced supply. A more limited, more expensive market will be the result.

Private market reinsurance will step in to provide the backstop that TRIA currently provides but, even with the reduced supply of terrorism insurance capacity, there will be an increase in demand for reinsurance. There is significant capital and surplus in the traditional reinsurance market, in excess of USD 500 billion, but that capital supports all lines of business. It is not possible that the reinsurance industry could fully replace the USD 100 billion of capacity provided by the federal backstop.

The termination of the TRIA program would also eliminate the federal “make available” provision; this does not mean, however, that insurers will not be required to make terrorism insurance available. Aon anticipates that in the absence of a federal “make available” provision, insurance regulators in many states will step into the vacuum created and compel insurers in their various states to provide terrorism coverage.

Another drain on available reinsurance capacity should TRIA lapse will come from insurers seeking reinsurance for terrorism losses from statutory coverages, namely Workers’ Compensation and Standard Fire Policy (SFP) requirements. The statutory nature of workers’ compensation insurance means insurers cannot exclude terrorism from original policies. Reinsurers have generally provided conventional terrorism coverage in workers’ compensation reinsurance but the bulk of terrorism reinsurance secured by insurers, however, comes from the federal backstop. Should TRIA lapse, Aon anticipates a surge in demand for reinsurance generated by increased terrorism exposure retained. Similarly, an elimination of TRIA will mean insurers and reinsurers will have to address the massive potential accumulation of terrorism losses from fire occasioned by a terrorism event.

Private market reinsurance has shown itself flexible in meeting the needs of client insurers. This flexibility has its limitations, dictated by financial constraints and prudent business practice. The industry capital is limited and the peril of terrorism is not random or fortuitous. Private market reinsurance will assist but is not the answer.

Additional Considerations

(8) Describe and explain any other developments, considerations, or market issues that might affect the long-term availability and affordability of terrorism risk insurance

Recently, non-traditional sources of capital have had a profound impact on property catastrophe reinsurance, increasing the supply and reducing the cost of private market reinsurance. Despite losses from Hurricane Sandy in late 2012, pricing for property catastrophe reinsurance from January 1, 2013 through July 1, 2013 has declined up to 20% according to Aon Benfield market analysis.

This non-traditional capital comes from two groups: hedge funds and insurance-linked securities (ILS) investors. Recent discussion with this new capital indicates that there is little appetite at current pricing for terrorism risk. The two issues precluding involvement are: 1) the inability to model the peril with confidence (ILS investors) and 2) the relatively low returns currently available on standalone terrorism (hedge funds).

From this latter group currently, pricing for terrorism coverage is on the order of twice that of the traditional private market source. Even at those higher prices, capacity is limited with likely USD 100 million available per insurer. Should TRIPRA lapse and standalone reinsurance pricing increase, we would expect some interest by hedge funds but not in an amount sufficient to impact pricing.


Conclusion

Ultimately, in Aon’s opinion, the key drivers of capacity and pricing for terrorism insurance and reinsurance outlined in our various responses above are all intertwined to varying degrees with no one factor outweighing another. All of these factors lead to the conclusion that a marketplace for terrorism risk that would exist in TRIA’s absence would be constrained by capacity shortfalls, higher pricing and would ultimately provide a disincentive for insureds to purchase terrorism insurance.

Since its inception in 2002, TRIA in its various forms has increasingly shifted the risk of terrorism loss to the private market. But it has also had the benefit of forcing insurers to offer terrorism coverage. If the mandatory offer of coverage disappears with TRIPRA 2007 expiring without replacement, then the market will contract. This is not supposition – it has been backed up by carrier behavior with prior TRIA expirations – with nearly 85% of property insurance carriers looking to exclude terrorism in the absence of TRIA. Should TRIA expire, it would be expected that more capital would enter the market in the form of specialty standalone terrorism insurers, but this capital would not come close to approximating the USD 100 billion of contingent reinsurance capital provided by TRIA. Finally, it is highly unlikely that the risk models will improve to a level that satisfies the primary concerns of (re)insurers: the ability to accurately forecast terrorism accumulation exposures, the range of potential loss scenarios and, most importantly, the size and frequency of potential losses.

Finally, and most importantly, the risk of terrorism loss remains very present in the U.S. and globally. Without TRIA’s economic safety net, a successful terrorism attack will have long-ranging impact on the U.S. economy, without the TRIA framework to encourage private market participation for this emerging risk.

Key Contacts

Aaron DavisManaging Director of OperationsAon Broking - U.S. PropertyAon Risk [email protected]

Ed RyanAon BenfieldSenior Managing DirectorAon [email protected]

Aon, plc 2013. All rights reserved.

This Report is for general informational purposes only and is not intended to provide individualized business or legal advice. The information contained herein was compiled from sources that Aon considers to be reliable; however, Aon does not warrant the accuracy or completeness of any information herein and accordingly the data, statements and conclusions contained in this repost should not be relied upon for any particular purpose.

#12991— 09/13

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