A.M. Best Comments on Likely Extension of Terrorism Risk Insurance Program

On Jan. 8, 2015, the Senate overwhelmingly passed the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA) to reinstate the federal Terrorism Risk Insurance Program, which expired Jan. 1, 2015. The House had already passed the bill on Jan. 6, 2015, with a vote of 416 to 7. The vote now sends the measure to President Obama, who is expected to sign it into law. The reauthorization extends the federal backstop for an additional six years but the law does not address a permanent risk-sharing solution between the private sector and the federal government for insuring terrorism risks. The new bill is essentially identical to the one passed by the House in December by a 417-7 vote, but died in the Senate due to disagreements about a provision related to the Dodd-Frank financial reform act.

In addition to extending the federal backstop, the bill gradually increases the $100 million trigger to $200 million by $20 million annual increments over the next five years, starting in 2016 (see Exhibit 1). The new bill also increases the industry's co-participation by 5% to 20% over the next five years, with a 1% increase annually starting next year. The aggregate insurer retention will increase by $10 billion to $37.5 billion over the next five years beginning in 2015; in the sixth year, the deductible will be revised to equal the annual sum of insurer deductibles for all insurers participating in the program for the prior three years. The limit, or cap, on the federal backstop remains at $100 billion and the individual insurer deductible remained unchanged at 20% of the preceding year's net earned premium. However, the trigger for the backstop will be increased to $200 million from $100 million, with annual increases of $20 million per year over the next five years. Finally, the mandatory recoupment, or the amount that must repaid to the federal government if payment is required following an event, was increased from 133% to 140%.
As stated in the Best's Briefing issued on Oct. 9, 2013 (Future of TRIPRA Remains Uncertain, Rating Pressure Intensifies), "the temporary nature of TRIPRA exemplifies why it is crucial for the financial strength of any insurer with a material exposure to terrorism risk to have a comprehensive risk management process." The increase in the industry deductible, trigger and co-participation could potentially alter the net liability of risks previously insured by a company, causing the insuring of these risks to exceed a company's risk tolerance. Increases to the net liability will also affect a company's risk-adjusted capitalization, with the magnitude dependent upon how large the risks are in relation to a company's surplus. Since a permanent solution has not been put in place, A.M. Best will continue to conduct stress tests on insurers to evaluate the affect terrorism exposures will have on balance sheets without the benefit of TRIPRA. Companies that are deemed to be over-reliant upon TRIPRA will need to have mitigation strategies in place prior to the planned expiration of the program, or they will likely face negative rating pressure.
The methodology used in determining ratings is Best's Credit Rating Methodology, which provides a comprehensive explanation of A.M. Best's rating process and contains the different rating criteria employed in the rating process. Best's Credit Rating Methodology can be found at www.ambest.com/ratings/methodology. For more information on how terrorism risk is viewed by A.M. Best, please see the criteria report, "The Treatment of Terrorism Risk in the Rating Evaluation."
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