Testimony of Ben S. Bernanke
Chairman of the Council of Economic Advisers
Before the Committee on Banking, Housing, and Urban Affairs
United States Senate
On the Terrorism Risk Insurance Act of 2002
July 14, 2005
Thank you, Chairman Shelby, Ranking Member Sarbanes, and members of the committee, for
this opportunity to discuss the Treasury Departments report on the Terrorism Risk Insurance
Act of 2002 (TRIA).
The Economic Climate in 2001 and 2002 was Uncertain
The terrorist attacks of September 11th, 2001, which devastated thousands of lives and wreaked
billions of dollars in losses, also came at a time of considerable macroeconomic uncertainty. By
that time, our economy had already slid into recession. Payroll employment peaked in March
2001 and declined through the remainder of 2001 and 2002. Industrial production stalled in the
second half of 2000 and had already fallen by more than 5 percent by September 2001. At the
time of the attacks, stock prices had been falling for a year and a half. The terrorist attacks
heightened concerns about the near-term strength of a number of sectors of the economy,
including aviation, travel and tourism, the financial industry, and nonresidential construction.
Nearly one million jobs were lost in the first 90 days after September 11th.
As of late 2001, the prospect that terrorism risk insurance might be unavailable raised particular
concerns. Prior to September 11th, insurers underwriting property and casualty policies
generally treated terrorism as a negligible risk. The industry had not developed models of the
likelihood or severity of potential terrorist events and consequently did not have the capacity to
price those risks. Moreover, the large payouts associated with September 11th and low returns to
insurers portfolios reduced the financial capacity of the insurance industry. Some observers
pointed out that, if terrorism risk insurance were unavailable or prohibitively expensive, the
capitalized value of existing commercial structures might decline, possibly creating significant
financial problems for lenders and building owners. The willingness of builders to undertake
new commercial construction, or their ability to obtain financing for that construction, might also
be reduced, putting construction jobs and economic growth in jeopardy. These concerns
contributed to the prevailing climate of uncertainty about the economy in 2002.
In retrospect, survey results in the Treasurys report suggest that the market for terrorism risk
insurance did not dry up in 2002, to the extent feared. The insurer survey indicates that more
than 70 percent of insurers writing in commercial property and casualty (P&C) lines wrote
terrorism risk insurance in 2002, and that 60 percent of commercial P&C policies written in 2002
carried terrorism cover. The policyholder survey offers a somewhat different picture, but
likewise indicates that terrorism risk insurance was available in 2002. Nevertheless, given the
considerable uncertainties of the time, it was prudent for Congress to enact TRIA and for the
President to sign it into law in November 2002. TRIA provided a temporary Federal backstop in
terrorism risk insurance and allowed the insurance industry a transition period to adjust to post-
Insurers Have Increased Their Capacity to Deal with Terrorism Risk
The tragic events in London last week underscore the ongoing risks posed by terrorism. In the
period immediately after September 11th, the ability of the insurance industry to handle terrorism
risks was in considerable doubt. However, the evidence presented in the Treasury report
suggests that, in the nearly four years since the attacks, private insurers have developed increased
capacity to deal with such risks.
Insurer capital, known as policyholder surplus, has rebounded and now exceeds pre-September
11th levels. This surplus approached $341 billion in the third quarter of 2004, a 33 percent
increase over the third quarter of 2001. The industry booked this increase of $85 billion over
three years despite absorbing heavy hurricane losses last fall.
The industry has developed new analytical tools, including sophisticated models of loss exposure
that allow insurers to limit and manage their accumulation risk from a terrorist attack. Better
measurement of accumulation risk facilitates the spreading of the risk of loss from a terrorist
attack across a broader set of insurers. The industry has also made progress in modeling the
likelihood of terrorist attacks, although this is an area where considerable challenges remain.
The insurance industrys capacity to bear terrorism risk is not unlimited, of course. Some have
raised concerns about the industrys ability to handle what might be termed a mega-event,
resulting in insured losses of more than $100 billion. However, it is important to keep in mind
that TRIA, as currently structured, provides reinsurance only up to $100 billion and does not
specify how losses above $100 billion would be handled. TRIA states only that Congress would
determine the source and procedure by which any payments in excess of $100 billion would be
made. Likewise, should TRIA be allowed to expire and a mega-event were to occur, presumably
Congress and the Administration would evaluate the overall situation and determine how to
respond to such losses.
TRIAs Effect on Pricing and Availability: Evidence from the Treasury Study
We cannot observe the counterfactual of what would have happened to the pricing and
availability of terrorism risk insurance had TRIA not been enacted. But the Treasury studys
survey results allow a comparison of pricing and availability immediately before and after
TRIAs enactment, as well as changes to pricing and availability in the second year of TRIAs
operation, as higher deductibles were phased in and the Federal provision of reinsurance was
The survey results indicate that, after the passage of TRIA, the proportion of P&C policies
carrying terrorism cover at a non-zero premium increased. This pattern tended to raise average
premiums for terrorism risk insurance after the introduction of TRIA. On the other hand,
policies that had non-zero premiums in 2002 exhibited a pattern of declining cost share for
terrorism risk insurance (as a proportion of total P&C premiums) between 2002 and 2003. The
net effect was a slight increase in the cost share of terrorism risk insurance across all policies
after the introduction of TRIA, contrary to some expectations.
Between 2003 and 2004, TRIAs insurer deductible for Federal reinsurance increased from 7 to
10 percent of direct earned P&C premiums, shifting some exposure to terrorism losses from the
Federal government back to insurers. Yet, despite this increased exposure, the cost share of
terrorism risk insurance across all policies rose only slightly, from 1.6 percent of P&C premiums
in 2003 to 1.7 percent in 2004. It would be inappropriate to read too much into these results
about the likely effects of allowing TRIA to expire. However, at least for the period during
which TRIA has been in force, the surveys do not support the view that the cost share of
terrorism risk insurance is highly sensitive to changes in the industrys risk exposure.
Regarding the availability of insurance, the insurer survey indicates that the proportion of
commercial P&C policies carrying terrorism risk insurance grew by 7 percentage points between
2002 and 2003, and the policyholder survey found that takeup rates for P&C policyholders rose
during that period as well. These results suggest that TRIA improved the availability of
insurance during 2003. However, the proportion of commercial P&C policies carrying terrorism
risk insurance remained stable through 2004, while takeup rates increased, despite the fact that
TRIAs increasing deductible raised insurers exposure to terrorism risks. Again, it is important
not to extrapolate these results too far. However, at least after 2003, availability of insurance
does not appear to have been closely linked to the industrys overall exposure to terrorism risk.
These insurer and policyholder survey results are consistent with the view that TRIA succeeded
in providing a transition period for insurers. The data also appear consistent with the view that
insurers have been able to cope with increased exposure to terrorism risks as the Federal
provision of reinsurance has diminished.
The Economy Has Strengthened
The economy is more robust now than when TRIA was enacted. GDP growth has increased
from 2.3 percent in 2002 to 3.9 percent in 2004 (fourth quarter over fourth quarter). The
unemployment rate, which was 6.0 percent in December 2002, has fallen to 5.0 percent as of
June 2005. Overall construction jobs (residential and nonresidential) are at a record high 7.2
million. Financial markets are also functioning well now, with more credit available at lower
long-term rates. The economic uncertainties that partly motivated TRIAs adoption have
receded and the economy is fundamentally stronger and more robust.
TRIA has succeeded in its limited role of providing a transition period for the insurance industry
to adjust to the new realities after September 11th, through a temporary Federal backstop.
Continuation of the program in its current form is likely to hinder the further development of the
insurance market by crowding out innovation and capacity building.
Consistent with its original purpose as a temporary program scheduled to end on December 31,
2005, and the need to encourage further development of the private market, the Administration
opposes extension of TRIA in its current form.
Any extension of the program should recognize several key principles: the temporary nature of
the program, the need to rapidly expand the development of private markets and capacity, as well
as the need to substantially reduce taxpayer exposure. The last point bears emphasizing: TRIA
does not eliminate terrorism risk but merely shifts the burden to taxpayers. It should be noted
that, should a large terrorism event occur, the Treasury would face many competing priorities,
and the responsibility to provide large insurance payments under TRIA could put a heavy strain
on the governments finances.
If TRIA is to be retained, it should be reformed in such a way as to increase the role of private
insurers and significantly diminish the public responsibility for terrorism risks. The
Administration would accept an extension only if it includes a significant increase to $500
million of the event size that triggers coverage, increases the dollar deductibles and percentage
copayments, and eliminates certain lines of insurance from the program, such as commercial
auto, general liability, and other lines that are much less subject to accumulation risks. The
Administration also supports reasonable reforms to ensure that injured plaintiffs can recover
against negligent defendants, but that also guarantee that no person is able to exploit the
litigation system, exposing the American taxpayer to excessive and inappropriate costs. We look
forward to discussing this very important issue further with Congress.