On September 11th, 2001, 19 terrorists in four hijacked airplanes pierced the heart of the American economy, and the resulting shockwave forced governments and insurers around the world to assess their ability to deal with such unprecedented terrorist violence. Less than two hours after the first plane struck the World Trade Center in New York City, the insurance industry was facing losses higher than those from any other natural or human-created disaster in history. The repercussions continue to reverberate through the global economy, and the increases in offshore insurance premiums and deductibles are bringing businesses into captives in record-breaking numbers.

Due in part to a soft market that had lasted 15 years, insurance companies were ill-prepared to handle the liability resulting from the massive losses of September 11th, and because no one had anticipated terrorism of such magnitude, underwriters had failed to limit or exclude terrorist acts from most insurance policies. Policyholders, regulators, and investors panicked, fearful that the insurance industry would collapse under the drain on resources necessary to cover the tens of thousands of affected lives. Insurance involvement would, by necessity, include property insurance; life, health, and disability insurances; workers' compensation; business interruption and lost revenues insurance; automobile insurance; and liability insurance. Insurance and investment experts have since branded the pre-September 11th industry's lack of premiums and reserves for terrorist coverage foolish. Had the attacks on New York City been nuclear, as Berkshire Hathaway CEO Warren Buffet stated in the aftermath, the loss could have destroyed most of the insurance industry with losses that exceeded the net worth of property-casualty insurers worldwide.

Even while dealing with personal losses-the World Trade Center housed offices for Aon, Fireman's Fund, Frenkel, Keefe Bruyette, Kemper, MMC, RPI, and Scor-the insurance industry put its energy into reassuring the world that it could pay claims associated with the attacks. At the same time, however, it began to reassess its willingness to cover future losses resulting from terrorism.

Federal assistance provides some relief for insurers

Concerns that an attack similar to or even worse than the one on September 11th would destabilize the industry led insurers either to exclude coverage for terrorist attacks or to drastically limit coverage. Insurers' immediate cancellation of all third-party war-risk coverage for the airline industry forced the American and European governments to provide federal assistance. The U.S. government's willingness to provide federal support was enough encouragement for insurers to request similar aid, and the resultant 2002 Terrorism Risk Insurance Act provides a three-year backstop in which the federal government acts as a reinsurer.

Government-backed "reinsurance of last resort" is new only in the U.S. In the U.K., for example, limited coverage has been available for years for property damage and business interruption due to terrorism via a contract developed between the Pool Reinsurance Company Limited (Pool Re) and the U.K. government. September 11th prompted the British government to extend coverage to all terrorism risks, not just those resulting from fire and explosions. Other European countries have also initiated or expanded government-backed terrorism reinsurance plans in the wake of the tragedy, binding the insurance industry with government far more closely than ever before.

Lower risks, higher costs

The exclusions insurers are placing on coverage shift the financial burden of terrorism onto commercial businesses, which are, as a result, at far greater risk for collapse in the event of another attack, potentially creating more danger to the global economy than the events of September 11th. Exclusions provide stabilization for the insurance industry, but arguably do nothing to protect business owners or the global economy from future acts of terrorism.

The introduction of terrorism exclusions has been the most notable change in property-casualty insurance, but the rise in deductibles and premiums has been the one most angrily received. The losses resulting from a terrorist attack like September 11th are so catastrophic-the bill facing the global insurance industry had already reached $50 billion (ﾣ33 billion) only a year later-that insurers say they are still struggling to put a price on future terrorism coverage. However, the across-the-board increase in premiums has been called exploitative, with some critics accusing the industry of inflating prices to make up for the losses of the past several years. In high-risk locations like Washington D.C., building insurance has as much as tripled, and premiums for prominent events like the 2002 FIFA World Cup in Asia have become prohibitive. Globally, insurance rates are at an overall four-decade high, even higher than they were following Hurricane Andrew, formerly the United States' most expensive disaster. What angers many critics is that the changes insurers have made and the new governmental coverage have lowered their risks, yet they continue to charge high prices for less comprehensive coverage-or for coverage that, on the surface, has little to do with terrorism.

More captive solutions

Higher costs, tighter underwriting, extensive restrictions on terrorism coverage, and governmental interventions have left some businesses willing to gamble that they will never be the victims of terrorism. Estimates for last year showed over half the commercial businesses in the U.S. without terrorism insurance, leaving those who opted for coverage with increased operating costs and those who have not with uninsured risk. As a result, businesses are increasingly seeking to offset their potential risk by self-insuring through the development of captives. Captives first appeared in the 1980s, when businesses were having trouble securing certain types of insurance, as they are now with terrorism coverage. Captives are set up by parent companies, trade associations, or groups of companies to protect against risks. Onshore captives enjoy tax advantages and freedom from the regulations common in offshore insurance. However, because successful captives are typically dependent both on a company's ability to manage its own risk and loss and on finding offshore fronting and insurers, only those companies with sound ability to manage their finances and claims will be successful.

Despite the potential pitfalls of trying to form a captive for those companies that have never done so before, the captive marketplace exploded in 2002 with a record 462 new formations. Having licensed over 20% of the new captives, the Cayman Islands reported the most explosive captive growth. Despite this record number, the industry also saw a record number of liquidations, and 2002 ended with only five more total active captives than the previous year. The trend toward captive growth is expected to continue, although some experts have noted that the importance of fronting services and reinsurers will also grow.  

The impact of the events of September 11th has been widespread, and in the years ahead, the insurance industry will continue to shift and settle, and then slowly rebuild-just as the rest of the world has done in the wake of September 11th.